Quarterly Report (10-q)

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


☑			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2022


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 0-18649

The National Security Group, Inc.

(Exact name of registrant as specified in its charter)


Delaware		63-1020300
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

661 East Davis Street
Elba,	Alabama	36323
(Address of principal executive offices)		(Zip-Code)

Registrant’s Telephone Number including Area Code (334) 897-2273

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


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $1.00 per share	NSEC	The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No

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

Large accelerated filer o Accelerated filer ☐

Non-accelerated filer þ Smaller reporting company ☑

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 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 ☐ No þ


Class						Outstanding May 16, 2022

Common Stock $1.00 par value						2,532,632 shares

Table of Contents

THE NATIONAL SECURITY GROUP, INC.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
			Page No.
	Item 1. Financial Statements

		Condensed Consolidated Balance Sheets (UNAUDITED EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)	5
		Condensed Consolidated Statements of Operations (UNAUDITED)	6
		Condensed Consolidated Statements of Comprehensive Loss (UNAUDITED)	7
		Condensed Consolidated Statements of Changes in Shareholders’ Equity (UNAUDITED)	8
		Condensed Consolidated Statements of Cash Flows (UNAUDITED)	9
		Notes to Condensed Consolidated Financial Statements (UNAUDITED EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)	10
		Report of Independent Registered Public Accounting Firm	32

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		33

	Item 3. Quantitative and Qualitative Disclosures about Market Risk		44

	Item 4. Controls and Procedures		45


PART II. OTHER INFORMATION

	Item 1. Legal Proceedings		45
	Item 1A. Risk Factors		45
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities		45
	Item 3. Defaults Upon Senior Securities		46
	Item 4. Mine Safety Disclosures		46
	Item 5. Other Information		46
	Item 6. Exhibits		46

SIGNATURE			46

Table of Contents

Cautionary Statement Regarding Forward-Looking Statements

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

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

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

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

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

▪The Company's financial results can be adversely affected by increases in frequency and severity of policy claims. While a generally manageable risk, frequency and severity can cause significant earnings volatility. Increased claims frequency is typically driven by increases in severe weather outbreaks while severity can be driven by inflation, increased claims settlement cost and litigation related expenses.

▪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 from catastrophe events. 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, along with liquidity at the holding company level. 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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PART I

Item 1. Financial Statements

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


($ in thousands)	March 31, 2022		December 31, 2021

ASSETS	(UNAUDITED)
Investments
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2022 - $590; 2021 - $650)	$	581	$	608
Fixed maturities available-for-sale, at estimated fair value (cost: 2022 - $92,236; 2021 - $92,186)	89,383		94,743
Equity securities, at estimated fair value (cost: 2022 - $1,609; 2021 - $1,609)	4,083		3,977
Trading securities	179		191
Receivable for securities sold	—		1,032
Mortgage loans on real estate, at cost	141		142
Investment real estate, at book value	2,671		2,671
Policy loans	1,769		1,767
Company owned life insurance	4,700		5,069
Other invested assets	1,472		1,619
Total Investments	104,979		111,819
Cash and cash equivalents	12,941		10,034
Accrued investment income	775		698
Policy receivables and agents' balances, net	14,903		14,379
Reinsurance recoverable	2,613		2,489
Deferred policy acquisition costs	7,227		7,332
Property and equipment, net	1,525		1,536
Income tax recoverable	218		280
Deferred income tax asset, net	3,250		2,403
Other assets	908		713
Total Assets	$	149,339	$	151,683
LIABILITIES AND SHAREHOLDERS' EQUITY
Property and casualty benefit and loss reserves	$	9,217	$	8,930
Accident and health benefit and loss reserves	4,309		4,349
Life and annuity benefit and loss reserves	35,055		34,966
Unearned premiums	35,102		34,107
Policy and contract claims	1,189		1,210
Other policyholder funds	1,313		1,302
Short-term notes payable and current portion of long-term debt	500		500

Long-term debt	12,693		12,690


Other liabilities	9,622		9,827
Total Liabilities	109,000		107,881
Contingencies
Shareholders' equity
Common stock	2,535		2,535
Additional paid-in capital	5,650		5,650
Accumulated other comprehensive income (loss)	(2,253)		2,021
Retained earnings	34,450		33,639
Treasury stock, at cost	(43)		(43)
Total Shareholders' Equity	40,339		43,802
Total Liabilities and Shareholders' Equity	$	149,339	$	151,683

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)


($ in thousands, except per share)	Three months ended March 31,
		2022		2021
REVENUES
Net premiums earned		$	15,515	$	15,062
Net investment income		868		804
Investment gains (losses)		(272)		310

Other income		122		136
Total Revenues		16,233		16,312
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits and settlement expenses		8,792		9,303
Amortization of deferred policy acquisition costs		990		971
Commissions		2,100		2,136
General and administrative expenses		2,119		2,304

Taxes, licenses and fees		770		536
Interest expense		147		138
Total Benefits, Losses and Expenses		14,918		15,388

Income Before Income Taxes		1,315		924

INCOME TAX EXPENSE (BENEFIT)
Current		63		(32)
Deferred		289		234
		352		202

Net Income		$	963	$	722

INCOME PER COMMON SHARE BASIC AND DILUTED		$	0.38	$	0.29

DIVIDENDS DECLARED PER SHARE		$	0.06	$	0.06

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)


($ in thousands)	Three months ended March 31,
		2022		2021

Net income		$	963	$	722

Other comprehensive income (loss), net of tax
Changes in:
Unrealized losses on securities, net of reclassification adjustment of $2 and $— for 2022 and 2021, respectively		(4,274)		(1,635)
Unrealized gain on interest rate swap		—		489

Other comprehensive loss, net of tax		(4,274)		(1,146)

Comprehensive loss		$	(3,311)	$	(424)

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)


($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Common Stock		Additional Paid-in Capital		Treasury Stock
Balance at December 31, 2021	$	43,802	$	33,639	$	2,021	$	2,535	$	5,650	$	(43)





Comprehensive loss:

Net income for March 31, 2022	963		963		—		—		—		—





Other comprehensive loss (net of tax)	(4,274)		—		(4,274)		—		—		—








Cash dividends	(152)		(152)		—		—		—		—

Balance at March 31, 2022	$	40,339	$	34,450	$	(2,253)	$	2,535	$	5,650	$	(43)


($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Common Stock		Additional Paid-in Capital		Treasury Stock



















Balance at December 31, 2020	$	45,366	$	33,665	$	3,585	$	2,533	$	5,626	$	(43)





Comprehensive loss:

Net income for March 31, 2021	722		722		—		—		—		—





Other comprehensive loss (net of tax)	(1,146)		—		(1,146)		—		—		—








Cash dividends	(152)		(152)		—		—		—		—

Balance at March 31, 2021	$	44,790	$	34,235	$	2,439	$	2,533	$	5,626	$	(43)

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


($ in thousands)	Three months ended March 31,
	2022		2021
Cash Flows from Operating Activities
Net income	$	963	$	722
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation expense and amortization/accretion, net	100		51

Investment losses (gains)	272		(310)

Deferred income taxes	289		234
Amortization of deferred policy acquisition costs	990		971
Changes in assets and liabilities:
Change in receivable for securities sold	1,032		(42)
Change in accrued investment income	(77)		(105)
Change in reinsurance recoverable	(124)		3,857
Policy acquisition costs deferred	(885)		(947)
Change in accrued income taxes	63		(32)
Change in net policy liabilities and claims	777		(168)
Change in other assets/liabilities, net	(277)		742

Other, net	8		3
Net cash provided by operating activities	3,131		4,976
Cash Flows from Investing Activities
Purchase of:

Available-for-sale securities	(3,439)		(12,645)


Property and equipment	(16)		(3)
Proceeds from sale or maturities of:
Held-to-maturity securities	28		101
Available-for-sale securities	3,345		5,031




Other invested assets, net	(1)		36
Net cash used in investing activities	(83)		(7,480)
Cash Flows from Financing Activities
Change in other policyholder funds	11		11



Dividends paid	(152)		(152)
Net cash used in financing activities	(141)		(141)
Net change in cash and cash equivalents	2,907		(2,645)
Cash and cash equivalents, beginning of period	10,034		19,887
Cash and cash equivalents, end of period	$	12,941	$	17,242

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

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries: National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO). NSFC includes a wholly-owned subsidiary, Omega One Insurance Company (Omega). The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the condensed consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated in the condensed consolidated financial statements. The financial information presented herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which includes information and disclosures not presented herein.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these consolidated financial statements are reserves for future life insurance policy benefits, liabilities for losses and loss adjustment expenses, reinsurance recoverable associated with loss and loss adjustment expense liabilities, deferred policy acquisition costs, deferred income tax assets and liabilities, assessments of other-than-temporary impairments on investments and accruals for contingencies. Actual results could differ from the estimates used in preparing these consolidated financial statements.

Earnings Per Share

Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding were 2,532,632 at March 31, 2022 and 2,530,370 at March 31, 2021. The Company did not have any dilutive securities as of March 31, 2022 and 2021.

Concentration of Credit Risk

The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts subject to FDIC insured limits of $250,000 per entity. At March 31, 2022, the net amount exceeding FDIC insured limits was $7,102,000 at three financial institutions. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of financial institutions on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.

Policy receivables are reported at unpaid balances. Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk. Receivables from agents, less provision for credit losses, are composed of balances due from independent agents. At March 31, 2022, the single largest balance due from one agent totaled $2,000.

Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet its obligation could result in losses to the insurance subsidiaries. Allowances for losses on reinsurance recoverables are established if amounts are believed to be uncollectible. At March 31, 2022 and December 31, 2021, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At March 31, 2022, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.

Accounting Changes Not Yet Adopted

Reference Rate Reform

In March 2020, the Financial Accounting Standards Board (FASB) issued guidance that provides temporary optional expedients and exceptions to the current guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

(LIBOR) and other interbank offered rates to alternative reference rates. The Company has exposure to LIBOR based financial instruments through its subordinated debentures. The contracts with respect to these borrowings contain alternative reference rates that would automatically take effect upon the phasing out of LIBOR and would not materially change the liability exposure. The guidance was effective upon issuance and may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2022. The Company is evaluating the optional expedients and exceptions in the guidance but does not expect the adoption of this guidance to have a material impact on its financial position or results of operations.

Targeted Improvements to the Accounting for Long-Duration Contracts

In August 2018, the FASB issued guidance to improve the existing recognition, measurement, presentation and disclosure requirements for long-duration contracts issued by an insurance entity. The guidance improves timeliness of recognizing changes in the liability for future policy benefits and modifies the rate used to discount future cash flows. The guidance will simplify and improve accounting for certain market-based options or guarantees associated with deposit type contracts and simplify the amortization of deferred policy acquisition costs. The guidance also introduces certain financial statement presentation requirements, as well as significant additional quantitative and qualitative disclosures. The guidance is effective for fiscal years beginning after December 15, 2024 and interim periods within those fiscal years beginning after December 15, 2025. Early adoption is permitted. The Company is currently evaluating the impact of this new guidance. Due to the nature and extent of the changes required to the Company’s life insurance operations, the adoption of this standard is expected to have a material impact on the consolidated financial statements.

Financial Instruments - Credit Losses

In June 2016, the FASB issued guidance that replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The FASB released additional guidance in November 2018 that provides scope clarification. This guidance is effective for fiscal years beginning after December 15, 2022, including interim periods within those years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Recently Adopted Accounting Standards

None

NOTE 2 – VARIABLE INTEREST ENTITIES

The Company holds passive interests in limited partnerships that are considered to be Variable Interest Entities (VIE) under the provisions of ASC 810 Consolidation. The Company is not the primary beneficiary of the entities and is not required to consolidate under ASC 810. The entities are private placement investment funds formed for the purpose of investing in private equity investments. The Company owns less than 1% of the limited partnerships. The carrying value of the investments totals $544,000 at March 31, 2022 ($555,000 at December 31, 2021) and is included as a component of Other Invested Assets in the accompanying condensed consolidated balance sheets.

In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,279,000 of variable rate subordinated debentures issued by the Company. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 7, are reported in the accompanying condensed consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $279,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 of trust preferred securities and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $3,093,000 of unsecured junior subordinated deferrable interest debentures. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $2,995,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the Trust. The Subordinated Debentures, disclosed in Note 7, are reported in the accompanying condensed consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $93,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

NOTE 3 – INVESTMENTS

Our investment in available-for-sale securities, which are reported at fair value, includes fixed maturity securities and equity securities. Net unrealized gains or losses on fixed maturities are reported after-tax as a component of other comprehensive income (loss). Changes in fair value of equity securities are reported in investment gains/losses as a component of net income.

The amortized cost and aggregate fair values of investments in available-for-sale securities as of March 31, 2022 are as follows:


($ in thousands) Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. Government corporations and agencies	$	5,172	$	46	$	196	$	5,022


Agency mortgage backed securities	19,469		63		990		18,542
Asset backed securities	4,567		6		142		4,431
Private label mortgage backed securities	3,743		4		199		3,548
Corporate bonds	49,655		814		1,479		48,990

States, municipalities and political subdivisions	9,630		15		795		8,850

Total Fixed Maturities	92,236		948		3,801		89,383
Equity securities	1,609		2,474		—		4,083
Total	$	93,845	$	3,422	$	3,801	$	93,466

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of March 31, 2022 are as follows:


($ in thousands) Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value

Agency mortgage backed securities	$	581	$	12	$	3	$	590



Total	$	581	$	12	$	3	$	590

The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2021 are as follows:


($ in thousands) Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. Government corporations and agencies	$	5,171	$	173	$	19	$	5,325
Agency mortgage backed securities	18,407		333		217		18,523
Asset backed securities	4,710		63		17		4,756
Private label mortgage backed securities	2,878		17		38		2,857
Corporate bonds	51,391		2,635		418		53,608
States, municipalities and political subdivisions	9,629		131		86		9,674

Total Fixed Maturities	92,186		3,352		795		94,743
Equity securities	1,609		2,368		—		3,977
Total	$	93,795	$	5,720	$	795	$	98,720

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2021 are as follows:


($ in thousands) Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Agency mortgage backed securities	$	608	$	42	$	—	$	650



Total	$	608	$	42	$	—	$	650

The amortized cost and aggregate fair value of debt securities at March 31, 2022, by contractual maturity, are presented in the following table. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)



($ in thousands)	Amortized Cost		Fair Value
Available-for-sale securities:
Due in one year or less	$	3,103	$	3,122
Due after one year through five years	20,896		21,060
Due after five years through ten years	21,688		21,402
Due after ten years	46,549		43,799
Total	$	92,236	$	89,383

Held-to-maturity securities:

Due after one year through five years	$	6	$	6
Due after five years through ten years	3		3
Due after ten years	572		581
Total	$	581	$	590

A summary of securities available-for-sale with unrealized losses as of March 31, 2022, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows:


($ in thousands)	Less than 12 months				12 months or longer				Total
March 31, 2022	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Total Securities in a Loss Position
U.S. Government corporations and agencies	$	3,263	$	196	$	—	$	—	$	3,263	$	196	3
Agency mortgage backed securities	15,030		856		1,076		134		16,106		990		45
Asset backed securities	4,073		142		—		—		4,073		142		8
Private label mortgage backed securities	3,505		199		—		—		3,505		199		5
Corporate bonds	20,900		1,227		1,403		252		22,303		1,479		35



States, municipalities and political subdivisions	5,517		705		716		90		6,233		795		11



	$	52,288	$	3,325	$	3,195	$	476	$	55,483	$	3,801	107

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

A summary of held-to-maturity securities with unrealized losses as of March 31, 2022, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows:


($ in thousands)	Less than 12 months				12 months or longer				Total
March 31, 2022	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Total Securities in a Loss Position
Agency mortgage backed securities	$	209	$	3	$	—	$	—	$	209	$	3	1






	$	209	$	3	$	—	$	—	$	209	$	3	1

A summary of securities available-for-sale with unrealized losses as of December 31, 2021, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows:


($ in thousands)	Less than 12 months				12 months or longer				Total
December 31, 2021	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Total Securities in a Loss Position
U.S. Government corporations and agencies	$	1,814	$	19	$	—	$	—	$	1,814	$	19	2
Agency mortgage backed securities	10,129		217		—		—		10,129		217		19
Asset backed securities	1,501		17		—		—		1,501		17		3
Private label mortgage backed securities	1,963		38		—		—		1,963		38		2
Corporate bonds	11,121		418		—		—		11,121		418		18



States, municipalities and political subdivisions	3,629		77		798		9		4,427		86		7



	$	30,157	$	786	$	798	$	9	$	30,955	$	795	51

There were no securities held-to-maturity with unrealized losses as of December 31, 2021.

The Company conducts periodic reviews to identify and evaluate securities in an unrealized loss position in order to identify other-than-temporary impairments. For securities in an unrealized loss position, the Company assesses whether the Company has the intent to sell the security or more-likely-than-not will be required to sell the security before the anticipated recovery. If either of these conditions is met, the Company is required to recognize an other-than-temporary impairment with the entire unrealized loss reported in earnings. For securities in an unrealized loss position that do not meet these conditions, the Company assesses whether the impairment of a security is other-than-temporary. If the impairment is determined to be other-than-temporary, the Company is required to separate the other-than-temporary impairments into two components: the amount representing the credit loss and the amount related to all other factors. The credit loss is the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of other-than-temporary impairments is reported in earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income (loss), net of taxes.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

Management has evaluated each security in a significant unrealized loss position in the fixed maturity investment portfolio. The Company has no material exposure to sub-prime mortgage loans and approximately 4% of the fixed income investment portfolio is rated below investment grade. Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments.

For the three months ended March 31, 2022, the Company realized no other-than-temporary impairments. For the year ended December 31, 2021, the Company realized no other-than-temporary impairments. At March 31, 2022, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $158,000, $147,000 and $138,000. After evaluation by management, it was determined that each of these losses were driven by changes in market interest rates. Management currently has the intent and ability to hold these investments until recovery so no other-than-temporary impairments were recognized. At December 31, 2021, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $105,000, $44,000 and $39,000.

Major categories of investment income are summarized as follows:


($ in thousands)	Three months ended March 31,
		2022		2021
Fixed maturities		$	814	$	757
Equity securities		42		49
Mortgage loans on real estate		2		2

Policy loans		33		34

Other		16		2
		907		844
Less: Investment expenses		39		40
Net investment income		$	868	$	804

Major categories of investment gains (losses) are summarized as follows:


($ in thousands)	Three months ended March 31,
		2022		2021
Realized gains on fixed maturities		$	3	$	—
Realized gains on equity securities		—		357
Gains (losses) on trading securities		(12)		7
Change in fair value of equity securities		106		3
Change in surrender value of company owned life insurance		(369)		(57)



Net investment gains (losses)		$	(272)	$	310

Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

An analysis of the net change in unrealized gains (losses) on available-for-sale securities follows:


($ in thousands)	March 31, 2022		March 31, 2021
Fixed maturities	$	(5,410)	$	(2,069)
Deferred income tax	1,136		434
Change in net unrealized gains (losses) on available-for-sale securities	$	(4,274)	$	(1,635)

NOTE 4 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

Our available-for-sale securities consists of fixed maturity and equity securities which are recorded at fair value in the accompanying consolidated balance sheets.

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

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

Level 1 - Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 1 assets and liabilities consist of money market fund deposits and certain of our marketable debt and equity instruments, including equity instruments offsetting deferred compensation, that are traded in an active market with sufficient volume and frequency of transactions.

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets include certain of our marketable debt and equity instruments with quoted market prices that are traded in less active markets or priced using a quoted market price for similar instruments. Level 2 assets also include marketable equity instruments with security-specific restrictions that would transfer to the buyer, marketable debt instruments priced using indicator prices which represent non-binding market consensus prices that can be corroborated by observable market quotes, as well as derivative contracts and debt instruments priced using inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Marketable debt instruments in this category generally include commercial paper, bank time deposits, repurchase agreements for fixed-income instruments, and a majority of floating-rate notes, corporate bonds, and municipal bonds.

Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. Level 3 assets and liabilities include marketable debt instruments, non-marketable equity investments, derivative contracts, and company issued debt with values determined using inputs that are both unobservable and significant to the values of the instruments being measured. Level 3 assets also include marketable debt instruments that are priced using indicator prices that we were unable to corroborate with observable market quotes. Marketable debt instruments in this category generally include asset-backed securities and certain floating-rate notes, corporate bonds, and municipal bonds.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

Assets/Liabilities Measured at Fair Value on a Recurring Basis

Financial assets measured at fair value on a recurring basis as of March 31, 2022 are summarized in the following table by the type of inputs applicable to the fair value measurements:


($ in thousands)	Fair Value Measurements at Reporting Date Using
Description	Total		Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
U.S. Government corporations and agencies	$	5,022	$	5,022	$	—	$	—


Agency mortgage backed securities	18,542		12,934		5,608		—
Asset backed securities	4,431		2,443		1,988		—

Corporate bonds	48,990		—		48,990		—


Private label asset backed securities	3,548		—		3,548		—
States, municipalities and political subdivisions	8,850		—		8,850		—


Trading securities	179		179		—		—
Equity securities	4,083		2,702		—		1,381
Total Financial Assets	$	93,645	$	23,280	$	68,984	$	1,381

The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below.

Fixed maturities available-for-sale — The fair values of the Company’s public fixed maturity securities are generally based on prices obtained from independent pricing services. Consistent with the fair value hierarchy described above, securities with quoted market prices in active markets for identical assets are reflected within Level 1 while securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.

Trading securities — Trading securities consist primarily of mutual funds whose fair values are determined consistent with similar instruments described above under “Fixed Maturities” and below under “Equity Securities.”

Equity securities — Equity securities consist principally of investments in common and preferred stock of publicly traded companies and privately traded securities. The fair values of our publicly traded equity securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy.

Estimated fair values for our privately traded equity securities require a substantial level of judgment. Privately traded equity securities are classified within Level 3.

As of March 31, 2022, Level 3 fair value measurements of assets include $1,381,000 of equity securities in a local community bank whose value is based on an evaluation of the financial statements of the entity. The Company does not develop the unobservable inputs used in measuring fair value.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

The table below presents a reconciliation for all assets and for all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2022:


($ in thousands) For the three months ended March 31, 2022	Equity Securities		Interest Rate Swap
Beginning balance	$	1,614	$	—
Total gains or losses (realized and unrealized):
Included in earnings	(233)		—
Included in other comprehensive income	—		—
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,381	$	—
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of March 31, 2022:	$	(233)	$	—

For the three months ended March 31, 2022, there were no assets or liabilities measured at fair values on a nonrecurring basis.

Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 are summarized in the following table by the type of inputs applicable to the fair value measurements:


($ in thousands)	Fair Value Measurements at Reporting Date Using
Description	Total		Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
U.S. Government corporations and agencies	$	5,325	$	5,325	$	—	$	—


Agency mortgage backed securities	18,523		11,916		6,607		—
Asset backed securities	4,756		2,730		2,026		—

Corporate bonds	53,608		—		53,608		—


Private label asset backed securities	2,857		—		2,857		—
States, municipalities and political subdivisions	9,674		—		9,674		—

Trading securities	191		191		—		—
Equity securities available-for-sale	3,977		2,363		—		1,614
Total Financial Assets	$	98,911	$	22,525	$	74,772	$	1,614

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)


($ in thousands) For the year ended December 31, 2021	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	1,502	$	(619)
Total gains or losses (realized and unrealized):
Included in earnings	112		—
Included in other comprehensive income	—		619
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,614	$	—
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of December 31, 2021:	$	112	$	—

For the year ended December 31, 2021, there were no assets or liabilities measured at fair value on a nonrecurring basis.

The following methods and assumptions were used to estimate fair value of each class of financial instrument for which it is practical to estimate that value:

Cash and cash equivalents — the carrying amount is a reasonable estimate of fair value.

Fixed maturities held-to-maturity — the carrying amount is amortized cost; the fair values of the Company’s public fixed maturity securities that are classified as held-to-maturity are generally based on prices obtained from independent pricing services.

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

Policy loans — the carrying amount is a reasonable estimate of fair value.

Company owned life insurance — the carrying amount is a reasonable estimate of fair value.

Other invested assets — the carrying amount is a reasonable estimate of fair value.

Other policyholder funds — the carrying amount is a reasonable estimate of fair value.

Debt — the carrying amount is a reasonable estimate of fair value.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

The carrying amount and estimated fair value of the Company’s financial instruments as of March 31, 2022 and December 31, 2021 are as follows:


($ in thousands)	March 31, 2022				December 31, 2021
Assets and related instruments	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Held-to-maturity securities	$	581	$	590	$	608	$	650
Mortgage loans	141		141		142		142
Policy loans	1,769		1,769		1,767		1,767
Company owned life insurance	4,700		4,700		5,069		5,069
Other invested assets	1,472		1,472		1,619		1,619
Liabilities and related instruments
Other policyholder funds	1,313		1,313		1,302		1,302
Short-term notes payable and current portion of long-term debt	500		500		500		500
Long-term debt	12,693		12,693		12,690		12,690

NOTE 5 – PROPERTY AND EQUIPMENT

Major categories of property and equipment are summarized as follows:


($ in thousands)	March 31, 2022		December 31, 2021
Building and improvements	$	3,504	$	3,504
Electronic data processing equipment	1,527		1,511
Furniture and fixtures	475		475
	5,506		5,490
Less accumulated depreciation	3,981		3,954
Property and equipment, net	$	1,525	$	1,536

Depreciation expense for the three months ended March 31, 2022 was $27,000 ($96,000 for the year ended December 31, 2021).

NOTE 6 – INCOME TAXES

The Company recognizes tax-related interest and penalties as a component of tax expense. The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is not subject to examinations by authorities related to its U.S. federal or state income tax filings for years prior to 2015. Tax returns have been filed through the year 2020.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The Company recognized net deferred tax asset positions of $3,250,000 at March 31, 2022 and $2,403,000 at December 31, 2021.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

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



($ in thousands)	As of March 31, 2022		As of December 31, 2021
General expenses	$	1,513	$	1,548
Unearned premiums	1,476		1,436
Claims liabilities	755		751


NOL carryforward	1,138		1,459
Impairment on real estate owned	147		147
Unrealized losses on trading securities	3		—
Unrealized losses on securities available-for-sale	599		—

Deferred tax assets	5,631		5,341


Depreciation	(96)		(99)
Deferred policy acquisition costs	(1,518)		(1,540)
Pre-1984 policyholder surplus account	(248)		(265)
Unrealized gains on securities available-for-sale	—		(537)
Unrealized gains on equity securities	(519)		(497)
Deferred tax liabilities	(2,381)		(2,938)

Net deferred tax asset	$	3,250	$	2,403

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


($ in thousands)	Three months ended March 31,
	2022		2021
Deferred policy acquisition costs	$	(22)	$	(4)


Trading securities	(3)		(2)
Unearned premiums	(40)		(82)
General expenses	35		(8)
Depreciation	(3)		(2)
Claims liabilities	(4)		13


Impact of repeal of special provision on pre-1984 policyholder surplus	(17)		(17)
NOL carryforward	321		336
Unrealized gains (losses) on equity securities	22		—

Deferred income tax expense	$	289	$	234

Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

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


	Three months ended March 31,
	2022		2021
Federal income tax rate applied to pre-tax income (loss)	21.0	%	21.0	%
Dividends received deduction and tax-exempt interest	(0.2)	%	(0.3)	%
Company owned life insurance	5.9	%	1.3	%





Other, net	0.1	%	(0.1)	%
Effective federal income tax rate	26.8	%	21.9	%

At March 31, 2022, the Company has approximately $5,419,000 of net operating loss carryforwards available ($1,138,000 tax benefit) to be applied to future periods. These carryforwards expire in 2040.

NOTE 7 – NOTES PAYABLE AND LONG-TERM DEBT

Short-term debt and current portion of long-term debt consisted of the following as of March 31, 2022 and December 31, 2021:


($ in thousands)	March 31,		December 31,
	2022		2021


Current portion of installment note payable due in November with variable interest rate equal to the WSJ prime rate plus 0.5%, with a 4.75% floor. Unsecured.	$	500	$	500


	$	500	$	500

Long-term debt consisted of the following as of March 31, 2022 and December 31, 2021:


($ in thousands)	March 31,		December 31,
	2022		2021






Promissory note with variable interest rate equal to the WSJ prime rate plus 0.5%, with a 4.75% floor; maturity November 2023. Annual installment payments beginning November 2020. Unsecured.	$	500	$	500

Subordinated debentures issued on December 15, 2005 with floating rate interest equal to 3-Month LIBOR plus 375 basis points; net of $129,000 in debt issuance cost ($131,000 in 2021); maturity December 15, 2035. Interest payable quarterly. Redeemable prior to maturity. Unsecured.	9,150		9,148

Subordinated debentures issued on June 21, 2007 with floating rate interest equal to 3-Month LIBOR plus 340 basis points; net of $50,000 in debt issuance cost ($51,000 in 2021); maturity June 15, 2037. Interest payable quarterly. Redeemable prior to maturity. Unsecured.	3,043		3,042
	$	12,693	$	12,690

NOTE 8 – POLICY AND CLAIM RESERVES

The Company regularly updates its reserve estimates as new information becomes available and events occur that may impact the resolution of unsettled claims. Reserve estimation can be an inherently uncertain process and reserve estimates can be revised up or down depending on changes in circumstances. Changes in prior years' reserve estimates are reflected in the results of operations in the year such changes are determined.

Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

The following table is a reconciliation of beginning and ending property and casualty reserve balances for claims and claim adjustment expense:


($ in thousands)	Three months ended March 31,
		2022		2021
Summary of claims and claim adjustment expense reserves
Balance, beginning of year		$	8,930	$	10,177
Less reinsurance recoverable on unpaid losses		2,139		3,321
Net balances at beginning of year		6,791		6,856
Net losses:
Provision for claims and claim adjustment expenses for claims arising in current year		8,737		9,034
Estimated claims and claim adjustment expenses for claims arising in prior years		(995)		(1,078)
Total increases		7,742		7,956
Claims and claim adjustment expense payments for claims arising in:
Current year		4,922		5,280
Prior years		2,427		2,416
Total payments		7,349		7,696
Net balance at end of period		7,184		7,116
Plus reinsurance recoverable on unpaid losses		2,033		2,393
Claims and claim adjustment expense reserves at end of period		$	9,217	$	9,509

Claims and claim adjustment expense reserves before reinsurance recoverables at March 31, 2022 were down moderately compared to prior year primarily due to a reduction in spring storm activity. The estimate for claims arising in prior years was reduced $995,000 in 2022 (reduced $1,078,000 in 2021) due to favorable loss development during the year on claims arising in prior years.

Accident and Health Claim Reserves

The Company, through its life insurance subsidiary, underwrites a limited number of short duration accident and health contracts. These claims are typically settled in three years or less and the reserve for unpaid claims totaled $398,000 at March 31, 2022 ($390,000 at December 31, 2021). These claims are a component of policy and contract claims which totaled $1,189,000 at March 31, 2022 ($1,210,000 at December 31, 2021).

NOTE 9 – REINSURANCE

The Company's insurance operations utilize reinsurance in the risk management process in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is placed through yearly renewable term coverage. Property and casualty reinsurance is placed on an excess of loss basis to cover losses from catastrophe events. Reinsurance contracts do not relieve the insurance subsidiaries of the obligation indemnify policyholders with respect to the underlying insurance contracts. Failure of re-insurers to honor their obligations could result in credit related losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurance companies and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the companies to minimize their exposure to significant losses from reinsurance insolvencies.

In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other individually significant large loss events that cause unfavorable underwriting results or have adverse impacts on regulatory capital levels by re-insuring certain levels of risk in various areas of exposure with reinsurance companies. NSFC maintains a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes and tropical storms.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

Under the catastrophe reinsurance program, the Company retains the first $4,000,000 in losses from the first catastrophe event and $2,000,000 from a second catastrophe event.

Catastrophe reinsurance coverage is 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
Catastrophe Aggregate			100% of $2,000,000 in excess of $2,000,000 after $2,000,000 aggregate deductible

Each reinsurance layer covers events occurring from January 1 through December 31 of the contract year. All significant reinsurance companies under the program carry AM Best ratings of A- (Excellent) or higher, or equivalent ratings.

The Company's catastrophe reinsurance contract allows for one reinstatement. The Company maintains reinstatement premium protection (RPP) to cover reinstatement premiums incurred. The RPP further reduces risk from a major catastrophe and serves to protect the Company's capital position by reducing the modeled 100 year event net cost.

Amounts recoverable from re-insurers are estimated in a manner consistent with the claim liability associated with the underlying insurance policies. Amounts paid for prospective reinsurance contracts are reported as prepaid reinsurance premiums and amortized over the remaining contract period.

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

At March 31, 2022, the largest reinsurance recoverable of a single reinsurer was $217,000 ($219,000 at December 31, 2021). Amounts reported as ceded incurred losses were related to development of losses from prior year catastrophes.

NOTE 10 – EMPLOYEE BENEFIT PLANS

The Company and its subsidiaries have an established retirement savings plan (401K Plan). All full-time employees are eligible to participate, and all employer contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Company matching contributions for the three months ended March 31, 2022 amounted to $45,000 ($46,000 in 2021). The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limits.

The Company established a non-qualified deferred compensation plan under which Company directors are allowed to defer all or a portion of directors' fees into various investment options. A supplemental executive retirement plan (SERP) covers named executive officers, with the Company contributing 15% of executive compensation to the plan. Contributions to the plan are fully vested upon the earlier of death, disability, change in control, or ten years of participation in the plan. Costs for amounts related to the non-qualified deferred compensation plans for the three months ended March 31, 2022 and 2021 amounted to an approximate decrease of $161,000 and an increase of $24,000 in employee benefit related expenses, respectively.

The Company and its subsidiaries established an Employee Stock Ownership Plan (ESOP) in January 2010, to enable eligible employees to acquire a proprietary interest in the Company's common stock and to provide retirement and other benefits to such employees. There were no contributions during the three months ended March 31, 2022 and 2021. All contributions were made in cash for purchase of Company shares in the open market. The Company has not allocated newly issued shares directly to the plan and the plan has no debt.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

NOTE 11 – SHAREHOLDERS' EQUITY

During the three months ended March 31, 2022 and year ended December 31, 2021, changes in shareholders' equity consisted of net income of $963,000 and $582,000, respectively; dividends paid of $152,000 in 2022 and $608,000 in 2021; an other comprehensive loss of $4,274,000 in 2022 and other comprehensive loss of $1,564,000 in 2021; and common stock issued of $26,000 in 2021. Other comprehensive income (loss) consisted of changes in accumulated unrealized gains/losses on securities available-for-sale.

Preferred Stock

Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference. There is currently no Preferred Stock issued or outstanding.

Common Stock

The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share. There is currently no Class A Common Stock issued or outstanding.

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

The table below provides information regarding the Company's preferred and common stock as of March 31, 2022 and December 31, 2021:



	Authorized	Issued	Treasury	Outstanding
Preferred Stock, $1 par value	500,000	—	—	—
Class A Common Stock, $1 par value	2,000,000	—	—	—
Common Stock, $1 par value	3,000,000	2,535,577	2,945	2,532,632

On May 21, 2021, 2,262 shares of common stock were issued to directors as compensation under the 2019 Equity

Incentive Plan previously approved by shareholders.

Treasury Stock

Treasury stock may be purchased pursuant to the share repurchase plan authorized by the Board of Directors in May 2020. Effective June 1, 2020, the Board authorized the repurchase of up to $500,000 of the Company's outstanding common stock. The plan expired May 31, 2021.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

NOTE 12 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Accumulated other comprehensive income (loss) ("AOCI") includes certain items that are reported directly within a separate component of shareholders' equity. The following table presents changes in AOCI balances:


($ in thousands)	Three months ended March 31,
	2022		2021
Unrealized Gains (Losses) on Cash Flow Hedges
Balance at beginning of period	$	—	$	(489)
Other comprehensive income for period:
Other comprehensive gain before reclassifications	—		489


Net current period other comprehensive income	—		489
Balance at end of period	$	—	$	—

Unrealized Gains (Losses) on Available-for-Sale Securities
Balance at beginning of period	$	2,021	$	4,074
Other comprehensive loss for period:
Other comprehensive loss before reclassifications	(4,272)		(1,635)


Amounts reclassified from accumulated other comprehensive loss	(2)		—
Net current period other comprehensive loss	(4,274)		(1,635)
Balance at end of period	$	(2,253)	$	2,439

Total Accumulated Other Comprehensive Income (Loss) at end of period	$	(2,253)	$	2,439

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2022:


($ in thousands) Details about Accumulated Other Comprehensive Loss Components	Amounts Reclassified from Accumulated Other Comprehensive Loss		Affected Line Item in the Statement Where Net Income is Presented








Unrealized Gains on Available-for-Sale Securities	$	3	Net investment gains
	3		Total before tax
	(1)		Tax expense
	$	2	Net of Tax

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2021:

($ in thousands)

Details about Accumulated Other Comprehensive Income Components

Amounts Reclassified from Accumulated Other Comprehensive Income

Affected Line Item in the Statement Where Net Income is Presented

Unrealized Gains on
Available-for-Sale Securities

—

Net investment gains

—

Total before tax

—

Tax expense

—

Net of Tax

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

NOTE 13 – SEGMENTS

The Company’s property and casualty insurance operations comprise one business segment. The property and casualty insurance segment primarily underwrites home insurance coverage with primary lines of business consisting of dwelling fire and extended coverage, homeowners (including mobile homeowners) and other liability.

Management organizes the business utilizing a niche strategy focusing on lower valued dwellings and older homes that can be difficult to insure in the standard insurance market. Our chief decision makers (Chief Executive Officer, Chief Financial Officer and subsidiary President) review results and operating plans making decisions on resource allocations on a company-wide basis. The Company’s products are primarily produced through independent agents within the states in which we operate.

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

Total assets by industry segment at March 31, 2022 and December 31, 2021 are summarized below:


($ in thousands) Assets by industry segment	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations

March 31, 2022	$	149,339	$	87,515	$	57,437	$	4,387

December 31, 2021	$	151,683	$	87,657	$	59,278	$	4,748

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

Net income (loss) by business segment for the three months ended March 31, 2022 and 2021 is summarized below:


($ in thousands) Three months ended March 31, 2022	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter- company Eliminations		Total
REVENUES
Net premiums earned	$	14,161	$	1,354	$	—	$	—	$	15,515
Net investment income	346		653		4		(135)		868
Investment gains (losses)	(368)		109		(13)		—		(272)

Other income	122		198		249		(447)		122
	14,261		2,314		240		(582)		16,233
BENEFITS AND EXPENSES
Policyholder benefits paid	7,742		1,147		—		(97)		8,792
Amortization of deferred policy acquisition costs	702		288		—		—		990
Commissions	2,034		66		—		—		2,100
General and administrative expenses	2,005		398		201		(485)		2,119

Taxes, licenses and fees	680		90		—		—		770
Interest expense	—		9		138		—		147
	13,163		1,998		339		(582)		14,918
Income (Loss) Before Income Taxes	1,098		316		(99)		—		1,315
INCOME TAX EXPENSE (BENEFIT)	309		64		(21)		—		352
Net Income (Loss)	$	789	$	252	$	(78)	$	—	$	963


($ in thousands) Three months ended March 31, 2021	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter-company Eliminations		Total
REVENUES
Net premiums earned	$	13,672	$	1,390	$	—	$	—	$	15,062
Net investment income	305		622		12		(135)		804
Investment gains	101		203		6		—		310

Other income	136		204		240		(444)		136
	14,214		2,419		258		(579)		16,312
BENEFITS AND EXPENSES
Policyholder benefits paid	7,956		1,447		—		(100)		9,303
Amortization of deferred policy acquisition costs	687		284		—		—		971
Commissions	2,059		77		—		—		2,136
General and administrative expenses	2,071		402		310		(479)		2,304

Taxes, licenses and fees	449		87		—		—		536
Interest expense	—		10		128		—		138
	13,222		2,307		438		(579)		15,388
Income (Loss) Before Income Taxes	992		112		(180)		—		924
INCOME TAX EXPENSE (BENEFIT)	220		23		(41)		—		202
Net Income (Loss)	$	772	$	89	$	(139)	$	—	$	722

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

The following table presents the Company’s gross and net premiums written for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2022 and 2021, respectively:


($ in thousands)	Three months ended March 31,
		2022		2021
Life, accident and health operations premiums written:
Traditional life insurance		$	1,010	$	1,018
Accident and health insurance		380		392
Gross life, accident and health		1,390		1,410
Reinsurance premium ceded		(53)		(43)
Net life, accident and health premiums written		$	1,337	$	1,367
Property and Casualty operations premiums written:
Dwelling fire & extended coverage		$	12,376	$	11,863
Homeowners (Including mobile homeowners)		4,392		5,027

Other liability		481		534



Gross property and casualty		17,249		17,424
Reinsurance premium ceded		(2,551)		(2,405)
Net property and casualty written		$	14,698	$	15,019
Consolidated gross premiums written		$	18,639	$	18,834
Reinsurance premium ceded		(2,604)		(2,448)
Consolidated net premiums written		$	16,035	$	16,386

The following table presents the Company’s gross and net premiums earned for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2022 and 2021, respectively:


($ in thousands)	Three months ended March 31,
		2022		2021
Life, accident and health operations premiums earned:
Traditional life insurance		$	1,030	$	1,042
Accident and health insurance		377		391
Gross life, accident and health		1,407		1,433
Reinsurance premium ceded		(53)		(43)
Net life, accident and health premiums earned		$	1,354	$	1,390
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage		$	11,512	$	10,178
Homeowners (Including mobile homeowners)		4,724		5,362

Other liability		476		537



Gross property and casualty		16,712		16,077
Reinsurance premium ceded		(2,551)		(2,405)
Net property and casualty earned		$	14,161	$	13,672
Consolidated gross premiums earned		$	18,119	$	17,510
Reinsurance premium ceded		(2,604)		(2,448)
Consolidated net premiums earned		$	15,515	$	15,062

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2021 AMOUNTS)

NOTE 14 – CONTINGENCIES

In the ordinary course of business, the Company and its subsidiaries are routinely a defendant in or party to pending or threatened legal actions and proceedings related to the conduct of their insurance operations. These suits can involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of the Company's subsidiaries, and other miscellaneous causes of action. It is inherently difficult to predict the outcome of such matters, particularly when the claimant seeks very large or indeterminate damages or when the matters present novel legal theories or involve multiple parties. An accrued liability is established when loss contingencies are both probable and estimable. However, there is potential loss exposure in excess of any accrued amounts. The Company monitors pending matters for further development that could affect the amount of the accrued liability.

The Company maintains loss and loss adjustment expense reserves on litigated claims that occur in the routine course of business in the insurance operations of the subsidiaries. These reserves are included in the liability for benefit and loss reserves on the balance sheet and include estimates for associated legal costs for individual claims. In addition the Company has a current accrual of $750,000 for legal expenses and third party claimant settlement cost. There are no individual actions not accrued that are deemed material by management based upon an evaluation of information presently available.

NOTE 15 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest during the three months ended March 31, 2022 was $129,000 ($169,000 in 2021). There was no cash received from or paid for income taxes during the three months ended March 31, 2022. There was no cash received from or paid for income taxes during the three months ended March 31, 2021.

NOTE 16 – SUBSEQUENT EVENTS

Management has evaluated subsequent events and their potential effects on these condensed consolidated

financial statements through the filing date of this Form 10-Q.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

of The National Security Group, Inc.

Results of Review of Interim Financial Information

We have reviewed the condensed consolidated balance sheet of The National Security Group, Inc. (the Company) as of March 31, 2022, and the related condensed consolidated statements of operations, comprehensive loss, changes in shareholders’ equity and cash flows for the three-month periods ended March 31, 2022 and 2021, and the related notes (collectively referred to as the interim financial statements). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2021, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 23, 2022, we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2021, is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived.

Basis for Review Results

These interim financial statements are the responsibility of the Company’s management. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.


/s/ Warren Averett, LLC
PCAOB ID # 2226
We have served as the Company’s auditor since 2009.
Birmingham, Alabama
May 16, 2022

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Item 2. 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", "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 three month period ended March 31, 2022 and 2021 and should be read in conjunction with the Condensed Consolidated Financial Statements and Notes which accompany this report. The financial information presented herein should also be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which includes information and disclosures not presented herein. Please refer to our note regarding forward-looking statements on page 4 of this report.

The National Security Group, Inc. operates in ten states with 68.2% of total premium revenue generated in the states of Alabama, Georgia and Mississippi. We operate in two business segments summarized as follows:

•The Property and Casualty (P&C) segment is the most significant segment, accounting for 92.2% of gross earned premium in 2022. The P&C segment operates in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.

•The Life segment accounted for 7.8% of gross premium revenue in 2022. The Life segment is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.

The P&C segment operations are 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 NSFC organized in 1992. Omega produces no direct written premium and is authorized to underwrite lines of business similar to NSFC; therefore, all references to NSFC or P&C segment in the remainder of this discussion will include the insurance operations of both NSFC and Omega.

The Life segment operations are 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 subject to review and approval by the insurance department for the respective state in which the rates will apply.

All of our insurance companies have been assigned ratings by AM Best Co (Best). On April 29, 2021, AM Best affirmed the Financial Strength Rating (FSR) of B++ (Good) and the Long-Term Issuer Credit Rating (Long-Term ICR) of "bbb" of NSFC. In addition, AM Best affirmed the FSR of B+ (Good) and Long-Term ICR of "bbb-" of Omega. The AM Best outlook for the ratings was revised from "stable" to "negative" for NSFC and Omega. AM Best affirmed the FSR of B++ (Good) and the Long-Term ICR to "bbb" for NSIC. The outlook for the ratings of NSIC was revised from "stable" to "negative". AM Best also affirmed the Long-Term ICR of "bb" of the parent holding company, NSEC, with a revised outlook from "stable" to "negative". Effective January 31, 2022, AM Best placed the companies under review with developing implications upon the announcement that NSG has entered into a merger agreement under which the group will be acquired by VR Insurance Holdings, Inc. The under review with developing implications status reflects the need for AM Best to assess fully the business strategy, financial and operational impacts on the group as a result of the acquisition. The ratings will remain under review pending the

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completion of the acquisition and AM Bests’ assessment of post-acquisition rating fundamentals. Currently, the acquisition is expected to close by the end of the second quarter of 2022.

The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On November 30, 2021, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.

The earnings in the property and casualty segment have seasonal volatility due to severe storm activity resulting in incurred losses and loss adjustment expenses from hurricane, tornado, wind and hail related insurance claims These storm systems or other natural disasters are generally classified as catastrophes (referred to as "catastrophe" or "cat" events/losses throughout the remainder of this document) by Property Claim Service (PCS) when an individual event causes $25 million or more in industry wide direct insured losses and affect a significant number of policyholders and insurers.

Information in this discussion is presented in whole dollars rounded to the nearest thousand, except for per share information. Tabular amounts are presented in thousands.

Summary:

For the three months ended March 31, 2022, the Company had net income of $963,000, $0.38 income per share, compared to net income of $722,000, $0.29 income per share, for the three months ended March 31, 2021; an increase of $241,000. Pretax income from operations for the first quarter of 2022 totaled $1,587,000 compared to a pretax income from operations of $614,000 in the first quarter of 2021. Results for the first quarter of 2022 were positively impacted by a $453,000 increase in net premiums earned, coupled with a $511,000 decrease in claims and were the primary reasons for the $973,000 increase in pretax income from operations in the first quarter of 2022, compared to the same period in 2021.

For the three months ended March 31, 2022, the Company had investment losses of $272,000 compared to investment gains of $310,000 for the three months ended March 31 2021; a decrease of $582,000. The primary reason for the first quarter 2022 investment losses, compared to the first quarter 2021 investment gains, was our investment in company owned life insurance (COLI) decreased $312,000. In addition, we had no realized gains on the sale of equity securities during the first quarter of 2022 compared to $357,000 in realized gains on the sale of equity securities for the same period in 2021.

In the first quarter of 2022, the Company incurred claims totaling $8,792,000 compared to $9,303,000 for the same period last year. Life segment claims were down $300,000 and P&C segment claims were down $214,000 in the first quarter of 2022, compared to the first quarter of 2021. Life segment claims incurred from whole life insurance policies decreased $260,000 in the first quarter of 2022 compared to the same period last year. The primary component of the decline in the P&C segment was claims from a reduction in claims other than weather and fire perils which declined $325,000, in the first quarter of 2022, compared to the same period last year. In addition, reported losses from weather related events were down $65,000. Partially offsetting the declines mentioned previously was an increase in reported fire losses of $262,000 in the first quarter of 2022 compared to the first quarter of 2021.

The Company ended the first three months of 2022 with a decrease in general and administrative expenses of $185,000 compared to the same period last year. The primary reasons for this decrease were a $458,000 reduction in costs associated with director's expenses, employee benefits and litigation expenses in the first quarter of 2022 compared to the same period last year. Partially offsetting these decreases was a $155,000 increase in consulting fees in the first quarter of 2022 compared to the first quarter of 2021. The primary reason for the increase in consulting fees was expenses associated with the pending merger with VR Insurance Holdings.

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Financial results for the three months ended March 31, 2022 and 2021, based on U.S generally accepted accounting principles, were as follows:


Unaudited Consolidated Financial Summary	Three months ended March 31,
($ in thousands, except per share)		2022		2021

Gross premiums written		$	18,639	$	18,834
Net premiums written		$	16,035	$	16,386

Net premiums earned		$	15,515	$	15,062
Net investment income		868		804
Net investment gains (losses)		(272)		310

Other income		122		136
Total Revenues		16,233		16,312

Policyholder benefits and settlement expenses		8,792		9,303
Amortization of deferred policy acquisition costs		990		971
Commissions		2,100		2,136
General and administrative expenses		2,119		2,304

Taxes, licenses and fees		770		536
Interest expense		147		138
Total Benefits, Losses and Expenses		14,918		15,388


Income Before Income Taxes		1,315		924




Income tax expense		352		202

Net Income		$	963	$	722


Income Per Common Share		$	0.38	$	0.29




Reconciliation of Net Income to non-GAAP Measurement

Net income		$	963	$	722
Income tax expense		352		202
Investment (gains) losses, net		272		(310)

Pretax Income From Operations		$	1,587	$	614

We provide a reconciliation of net income to the non-GAAP measurement "pretax income from operations". The purpose of this reconciliation is to provide investors with information routinely utilized by management in analyzing and comparing the performance of our insurance operations between periods. This information reflects the financial performance of our insurance operations without the impact of investment gains/losses. We typically invest in equity securities with a long-term view. Short-term volatility due to changes in market value of equity securities held for sale, along with realized investment gains/losses on both fixed maturity and equity investments, can mask both the positive or negative performance of our insurance operations from period to period.

Premium Revenue:

For the three months ended March 31, 2022, net premiums earned were up $453,000 at $15,515,000 compared to $15,062,000 during the same period last year. The increase in premium revenue was primarily driven by an increase in net earned premium in the P&C segment of $489,000 or 3.6%. The increase in P&C segment net earned premium was primarily attributable to a 13.1% increase in gross earned premium in our dwelling fire program. This increase was due to rate increases in the program over the past twelve months and additional premium generated by our re-underwriting project in the dwelling fire program in which we reviewed valuations of properties insured due to increasing repair costs and claims inflation. The increase in P&C net earned premium was partially offset by a 6.1% increase in reinsurance premium ceded due to an increase in reinsurance costs related to our 2022 catastrophe reinsurance contract renewal. As mentioned previously, the increased frequency of weather related losses over the past several years has driven the need to increase rates in states and programs that have been most impacted by this persistent pattern of severe weather.

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Investment Gains (Losses):

Investment losses, for the three months ended March 31, 2022, were $272,000 compared to investment gains of $310,000 for the same period last year. The primary reason for the first quarter 2022 investment losses, compared to the first quarter 2021 investment gains, was our investment in company owned life insurance (COLI) decreased $312,000. In addition, we had no realized gains on the sale of equity securities during the first quarter of 2022 compared to $357,000 in realized gains on the sale of equity securities for the same period in 2021.

Net Income:

For the three months ended March 31, 2022, the Company had net income of $963,000, $0.38 income per share, compared to net income of $722,000, $0.29 income per share, for the same period last year. As mentioned previously, results for the first quarter of 2022 were positively impacted by a $453,000 increase in net premiums earned coupled with a $511,000 decrease in claims and were the primary reasons for the increase in net income in the first quarter of 2022 compared to the first quarter of 2021.

Pretax Income from Operations:

For the three months ended March 31, 2022, our pretax income from operations was $1,587,000 compared to pretax income from operations of $614,000 for the three months ended March 31, 2021; an increase in pretax income of $973,000. As discussed above, an increase in earned premium and a decrease in claim activity were the primary reasons for the improvement in our income from operations, in the first quarter of 2022, compared to the same period last year.

P&C Segment Combined Ratio:

The P&C segment ended the first quarter of 2022 with a GAAP basis combined ratio of 92.2%. Reported catastrophe losses totaled $1,687,000 and added 11.8 percentage points to the combined ratio. In comparison, the P&C segment ended the first quarter of 2021 with a GAAP basis combined ratio of 95.8% with $1,736,000 in reported catastrophe losses increasing the combined ratio by 12.6 percentage points. Non-catastrophe wind and hail losses were down $16,000 for the three months ended March 31, 2022 compared to the same period in 2021. Reported non-catastrophe wind and hail losses, in the first quarter of 2022, totaled $1,277,000 and added 8.9 percentage points to the first quarter 2021 combined ratio. In comparison, non-catastrophe wind and hail losses reported in the first quarter of 2021 totaled $1,293,000 and added 9.4 percentage points to the first quarter 2021 combined ratio. Partially offsetting these decreases was an increase in reported fire losses of $262,000 during the first quarter of 2022 compared to the first quarter of 2021. Reported fire losses totaled $3,532,000, for the three months ended March 31, 2022, and added 24.7 percentage points to the 2022 combined ratio. In comparison, in the first quarter of 2021, reported fire losses totaled $3,270,000 and added 23.7 percentage points to the 2021 combined ratio.

Overview - Balance Sheet highlights at March 31, 2022 compared to December 31, 2021


Selected Balance Sheet Highlights	March 31, 2022		December 31, 2021
($ in thousands, except per share)	Unaudited
Invested Assets	$	104,979	$	111,819
Cash	$	12,941	$	10,034
Total Assets	$	149,339	$	151,683
Policy Liabilities	$	86,185	$	84,864
Total Debt	$	13,193	$	13,190
Accumulated Other Comprehensive Income (Loss)	$	(2,253)	$	2,021
Shareholders' Equity	$	40,339	$	43,802
Book Value Per Share	$	15.93	$	17.29

Invested Assets:

Invested assets at March 31, 2022 were $104,979,000 compared to $111,819,000 at December 31, 2021; a decrease of 6.1%. The decrease in invested assets was primarily due to a decline in market value of available-for-sale fixed maturity investments, of $5,410,000. This decline in market value of fixed maturity investments was primarily driven by an increase in short and intermediate term market interest rates during the first quarter of 2022.

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Cash:

The Company, primarily through its insurance subsidiaries, had $12,941,000 in cash and cash equivalents at March 31, 2022, compared to $10,034,000 at December 31, 2021. Cash increased $2,907,000 in the first quarter of 2022, compared to December 31, 2021, primarily due to positive cash flow from insurance operations.

Total Assets:

Total assets at March 31, 2022 were $149,339,000 compared to $151,683,000 at December 31, 2021. Due to an increase in market interest rates, fixed maturity investments classified as available-for-sale decreased in market value, reducing total assets as of March 2022.

Policy Liabilities:

Policy related liabilities were $86,185,000 at March 31, 2022, compared to $84,864,000 at December 31, 2021; an increase of $1,321,000 or 1.6%. The primary reason for the increase in policy liabilities was a $995,000 increase in P&C segment unearned premium, in the first quarter of 2022, compared to year end 2021. This increase in unearned premium is primarily seasonal as we typically issue and renew a larger number of annual insurance contracts during the first and second quarters of each year compared to the remainder of the year.

Debt Outstanding:

Total debt was virtually unchanged at $13,193,000 as of March 31, 2022 compared to $13,190,000 at December 31, 2021. Our debt is held at the holding company level.

Shareholders' Equity:

Shareholders' equity as of March 31, 2022 was $40,339,000, down $3,463,000, compared to December 31, 2021 Shareholders' equity of $43,802,000. Book value per share was $15.93 at March 31, 2022, compared to $17.29 per share at December 31, 2021; a decline of 7.9% or $1.36 per share. The primary factors contributing to the decrease in both book value per share and Shareholders' equity were a decrease in accumulated other comprehensive income of $4,274,000 and shareholder dividends paid of $152,000. These decreases were offset by net income of $963,000.

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Three Months Ended March 31, 2022 compared to Three Months Ended March 31, 2021

Premium Revenue:

The table below provides earned premium revenue by segment for the three months ended March 31, 2022 and 2021:


($ in thousands)	Three months ended March 31,				Percent
	2022		2021		increase (decrease)
Life, accident and health segment premiums earned:
Traditional life insurance	$	1,030	$	1,042	(1.2)	%
Accident and health insurance	377		391		(3.6)	%
Gross life, accident and health	1,407		1,433		(1.8)	%
Reinsurance premium ceded	(53)		(43)		23.3	%
Net life, accident and health premiums earned	$	1,354	$	1,390	(2.6)	%

Property and Casualty segment premiums earned:
Dwelling fire & extended coverage	$	11,512	$	10,178	13.1	%
Homeowners (Including mobile homeowners)	4,724		5,362		(11.9)	%
Other liability	476		537		(11.4)	%
Gross property and casualty premium earned	16,712		16,077		3.9	%
Reinsurance premium ceded	(2,551)		(2,405)		6.1	%
Net property and casualty premiums earned	$	14,161	$	13,672	3.6	%

Consolidated gross premiums earned	$	18,119	$	17,510	3.5	%
Reinsurance premium ceded	(2,604)		(2,448)		6.4	%
Consolidated net premiums earned	$	15,515	$	15,062	3.0	%

Consolidated net premium earned was up 3.0% for the quarter ended March 31, 2022, at $15,515,000 compared to $15,062,000 for the same period last year. The increase in net premium earned was due to a 3.6% increase in net premium earned in the P&C segment. The increase in P&C segment net earned premium was primarily attributable to a 13.1% increase in gross earned premium in our dwelling fire program. As mentioned previously, this increase was due to rate increases in the program over the past twelve months and additional premium generated by our re-underwriting project in the dwelling fire program. Gross earned premium was offset by a 6.1% increase in reinsurance premium ceded primarily attributable to an increase in reinsurance cost related to our 2022 catastrophe reinsurance contract renewal.

The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. With our 2022 catastrophe contract placement, our single event catastrophe retention remained unchanged from the prior year at $4 million. In our 2022 contract, we maintained our underlying catastrophe aggregate coverage of $2 million in excess of $2 million, subject to a $2 million aggregate annual deductible. This additional coverage effectively lowers our second event retention to $2 million. Also unchanged from last year, we maintain catastrophe reinsurance covering incurred claims of a single catastrophe event up to $72.5 million. Our catastrophe reinsurance has a reinstatement provision for one event and covers the cost of a second event up to the same $72.5 million upper limit. 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 (net of reinsurance). It is noted, however, that hurricane models are subject to significant risk and are only a tool to estimate the impact of catastrophe events. The Company also has risk associated with multiple catastrophe events that individually may not exceed our $4 million retention and would not be covered under our catastrophe reinsurance contract.

To summarize our catastrophe reinsurance structure, under the catastrophe reinsurance program in 2022, the Company retains the first $4 million in losses from a first event (exceeding $4 million in insured losses) and $2 million in losses from a second event.

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Reinsurance coverage is 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
Catastrophe Aggregate			100% of $2,000,000 in excess of $2,000,000

We purchase reinstatement premium protection on the first two layers of our primary catastrophe excess reinsurance (layers one and two above) for one reinstatement. Our catastrophe aggregate coverage is subject to a $2 million aggregate annual deductible and has a contract provision for two reinstatements. Additional details regarding the structure of our 2022 catastrophe reinsurance program can be found in Note 9 to the Condensed Consolidated Financial Statements.

Investment Income:

The table below provides the major categories of investment income, primarily dividend and interest income, for the three months ended March 31, 2022 and 2021:


($ in thousands)	Three months ended March 31,
		2022		2021
Fixed maturities		$	814	$	757
Equity securities		42		49
Mortgage loans on real estate		2		2

Policy loans		33		34

Other		16		2
		907		844
Less: Investment expenses		39		40
Net investment income		$	868	$	804

For the three months ended March 31, 2022, net investment income was $868,000 compared to $804,000 for the same period in 2021; an increase of $64,000 or 8.0%. An increase in interest rates along with an increase in bond portfolio investments throughout 2022 were the primary factors contributing to this increase in net investment income.

Investment Gains (Losses):

The table below provides investment gains and losses for the three months ended March 31, 2022 and 2021:


($ in thousands)	Three months ended March 31,
		2022		2021
Realized gains on fixed maturities		$	3	$	—
Realized gains on equity securities		—		357
Gains (losses) on trading securities		(12)		7
Change in fair value of equity securities		106		3
Change in surrender value of company owned life insurance		(369)		(57)



Net investment gains (losses)		$	(272)	$	310

Net investment losses, for the three months ended March 31, 2022, were $272,000 compared to net investment gains of $310,000 for the same period in 2021; a decrease of $582,000. A primary reason for the net investment losses, in the first quarter of 2022, compared to net investment gains in the first quarter of 2021, was a $312,000 increase in net investment losses related to the change in surrender value of company owned life insurance. In addition, we had no realized gains on the sale of equity securities during the first quarter of 2022 compared to $357,000 in realized gains on the sale of equity securities for the same period in 2021.

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Other Income:

Other income was $122,000 for the three months ended March 31, 2022, compared to $136,000 for the same period last year; a decrease of $14,000. 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 0.8% in the first quarter of 2022 compared to 0.9% in the first quarter of 2021.

Policyholder Benefits:

Policyholder claims in the property and casualty segment were $7,742,000 in the first quarter of 2022, compared to $7,956,000 for the same period last year; a decrease of $214,000 or 2.7%. Claims as a percentage of premium earned was 54.7% in the first quarter of 2022 compared to 58.2% in the first quarter of 2021. The primary reason for the decrease was claims reported from non-weather and non-fire perils which declined $325,000, in the first quarter of 2022, compared to the same period last year. In addition, reported losses from weather related events were down $65,000. These decreases were offset by an increase in fire claims totaling $262,000.

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 three-month periods ended March 31, 2022 and 2021:


For the three months ended March 31, 2022				For the three months ended March 31, 2021
($ in thousands) Catastrophe event	Reported Losses & LAE		Claim Count	Catastrophe event	Reported Losses & LAE		Claim Count
Cat 2211 (Jan 1-3)	$	436	111	Cat 2113 (Jan 25-26)	$	132	6
Cat 2212 (Jan 15-17)	193		33	Cat 2117 (Feb 16-20)	760		196
Cat 2215 (Feb 16-28)	149		44	Cat 2120 (Mar 15-19)	282		66
Cat 2218 (Mar 11-12)	118		26	Cat 2122 (Mar 24-26)	494		85
Cat 2220 (Mar 21-23)	413		54
Cat 2221 (Mar 29-Apr 1)	248		62
















Misc cats less than $100k	130		30	Misc cats less than $100k	68		16
Total Cat losses	$	1,687	360	Total Cat losses	$	1,736	369



Non-cat wind & hail	$	1,277	350	Non-cat wind & hail	$	1,293	294

During the first quarter of 2022, the P&C segment was impacted by nine catastrophe events producing 360 policyholder claims totaling $1,687,000. In comparison, the P&C segment was impacted by six catastrophe events during the first quarter of 2021 from 369 claims totaling $1,736,000. During the first quarter of 2022, the P&C segment had reported losses from Cat 2211 totaling $436,000 from 111 claims and Cat 2220 totaling $413,000 from 54 claims. These cat events accounted for 50.3% of total reported losses from cat events during the first quarter of 2022 and added 5.9 percentage points to the first quarter 2022 P&C segment loss ratio. During the first quarter of 2021, the P&C segment had reported losses from Cat 2117 (winter storm) totaling $760,000 from 196 claims. This cat event accounted for 43.8% of total reported losses from cat events during the first quarter of 2021 and added 5.5 percentage points to the first quarter 2021 P&C segment loss ratio. Claims reported from all first quarter 2022 cat events contributed 11.8 percentage points to the first quarter 2022 P&C segment loss ratio. Claims reported from all first quarter 2021 cat events contributed 12.6 percentage points to the first quarter 2021 P&C segment loss ratio.

Non-catastrophe wind and hail claims reported in the first quarter of 2022 totaled $1,277,000 compared to non-catastrophe wind and hail claims reported in the first quarter of 2021 totaling $1,293,000; a decrease of $16,000. During the first quarter of 2022, the P&C segment had 350 non-cat wind and hail claims reported (an average of $3,600 per claim) compared to 294 non-cat wind and hail claims reported during the first quarter of 2021 (an average of $4,400 per claim). Non-cat wind and hail claims reported during the first quarter of 2022 accounted for 16.5% of total P&C segment incurred losses in the current year and added 8.9 percentage points to the 2022 P&C segment combined ratio. Non-cat wind and hail claims reported during the first quarter of 2021 accounted for 16.3% of total P&C segment incurred losses in 2021 and added 9.4 percentage points to the 2021 P&C segment combined ratio.

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Reported fire losses in the first quarter of 2022 were up $262,000 or 8.0% compared to fire losses reported during the first quarter of 2021. The P&C segment had 103 fire losses reported in the first quarter of 2022 totaling $3,532,000 compared to 120 claims reported in the first quarter of 2021 totaling $3,270,000. The average cost per claim was $34,300 for fire losses reported in the first quarter of 2022 compared to $27,300 for fire losses reported in the first quarter of 2021. Fire losses reported during the first quarter of 2022 added 24.7 percentage points to the P&C segment combined ratio while fire losses reported during the first quarter of 2021 added 23.7 percentage points to the P&C segment combined ratio.

Policy Acquisition Cost (Commissions and Amortization of Deferred Acquisition Cost):

For the three months ended March 31, 2022, policy acquisition costs were $3,090,000 compared to $3,107,000 for the same period last year; a decrease of $17,000. Policy acquisition costs consist of amortization of previously capitalized distribution costs and current commission payments to agents. As a percentage of premium revenue, policy acquisition costs were comparable at 19.9% in the first quarter of 2022 compared to 20.6% for the same period last year.

General Expenses:

General and administrative expenses were $2,119,000 in the first quarter of 2022 compared to $2,304,000 for the same period last year. As a percent of earned premium, general and administrative expenses were 13.7% and 15.3% at March 31, 2022 and 2021, respectively. The $185,000 decrease in general and administrative expenses, in the first quarter of 2022 compared to the first quarter of 2021, was due to a $458,000 reduction in costs associated with director's expenses, employee benefits and litigation expenses. Partially offsetting these decreases was a $155,000 increase in consulting fees in the first quarter of 2022 compared to the first quarter of 2021. The primary reason for the increase in consulting fees was expenses associated with the issuance of a fairness opinion.

Taxes, Licenses and Fees:

For the three months ended March 31, 2022, insurance taxes, licenses and fees were $770,000, compared to $536,000 for the same period in 2021; an increase of $234,000. The primary reason for the increase was a $155,000 credit received during the first quarter of 2021 that reduced prior year tax expense. No credit was received in the first quarter of 2022. As a percent of earned premium, insurance taxes, licenses and fees were 5.0% in the first quarter of 2022 and 3.6% in the first quarter of 2021.

Interest Expense:

Interest expense was comparable at $147,000 for the three months ended March 31, 2022, compared to $138,000 for the three months ended March 31, 2021.

Income Tax Expense:

For the three months ended March 31, 2022, the Company had income before income taxes of $1,315,000 compared to income before income taxes of $924,000 for the same period last year. The $352,000 tax expense for the first quarter of 2022 consisted of current tax expense of $63,000 and deferred tax expense of $289,000. The $202,000 tax expense for the first quarter of 2021 consisted of current tax benefit of $32,000 and deferred tax expense of $234,000. The effective tax rate for the first quarter of 2022 was 26.8% compared to 21.9% for the first quarter of 2021.

Net Income:

The Company ended the first quarter of 2022 with net income of $963,000 compared to net income of $722,000 for the same period last year. The primary factor contributing to the $241,000 increase was the $453,000 increase in net premiums earned coupled with the $511,000 decrease in policyholder benefits and settlement expenses, primarily in the P&C segment, discussed in detail in the preceding commentary in this discussion. The increase in net premiums earned and reduction in claims was offset by a $582,000 decline in investment gains during the first quarter of 2022 compared to the same period last year.

Liquidity and Capital Resources:

Due to regulatory restrictions, the majority of the Company's cash is required to be invested primarily in investment-grade securities to provide protection for policyholders. The liabilities of the property and casualty insurance subsidiaries are of various terms, and therefore, those subsidiaries invest in securities with various effective maturities spread over periods usually not exceeding 10 years with an average portfolio duration typically of less than 5 years. The liabilities of the life insurance subsidiary are typically of a longer duration, and therefore, a higher percentage of securities in the life insurance subsidiary are invested for periods exceeding 10 years.

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The liquidity requirements for the Company are primarily met by funds generated from operations of the life insurance and property and casualty insurance subsidiaries. All operations and virtually all investments are maintained by the insurance subsidiaries. Premium and investment income as well as maturities and sales of invested assets provide the primary sources of cash for both the life and property/casualty businesses, while applications of cash are applied by both businesses to the payment of policy benefits, the cost of acquiring new business (principally commissions), operating expenses, purchases of new investments, and in the case of life insurance, policy loans.

Virtually all invested assets of the Company are held in the insurance subsidiaries. As of March 31, 2022, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows:


($ in thousands) Maturity	Available- for-Sale		Held-to-Maturity		Total		Percentage of Total
Maturity in less than 1 year	$	3,103	$	—	$	3,103	3.34	%
Maturity in 1-5 years	20,896		6		20,902		22.52	%
Maturity in 5-10 years	21,688		3		21,691		23.37	%
Maturity after 10 years	46,549		572		47,121		50.77	%
	$	92,236	$	581	$	92,817	100.00	%

It should be noted that the above table represents maturities based on stated/contractual maturity. Due to call and prepayment features inherent in some fixed maturity securities, actual repayment, or effective maturities, will differ from stated maturities. The Company routinely evaluates the impact of changing interest rates on the projected maturities of bonds in the portfolio and actively manages the portfolio in order to minimize the impact of interest rate risk. However, due to other factors, both regulatory and those associated with good investment management practices associated with asset/liability matching, we do have exposure to changes in market values of securities due to changes in interest rates. Currently, a 100 basis point immediate increase in interest rates would generate approximately a $4,866,000, or 5.4%, decline in the market value of fixed maturity investments. Alternatively, a 100 basis point decrease in interest rates will generate approximately $4,865,000, or 5.4%, increase in market value of fixed income investments. Management has attempted, to the extent possible, to reduce risk in a rising rate environment. However, due to asset/liability matching requirements, particularly in the life subsidiary portfolio, interest rate risk can not be eliminated and exposure to market volatility can cause some variability in our accumulated other comprehensive income, total return on investments, total shareholders' equity and book value per share.

At March 31, 2022, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $40,339,000, down $3,463,000, compared to $43,802,000 at December 31, 2021. During the three months ended March 31, 2022, components of the change in shareholders' equity included net income of $963,000, a comprehensive loss due to changes in value of fixed maturity securities of $4,274,000 and cash dividends paid totaling $152,000.

As discussed above, changing interest rates can have a significant impact on the market value of fixed maturity investments. Fixed maturity securities classified as available-for-sale increase the liquidity resources of the Company as they can be sold at any time to pay claims or meet other Company obligations. However, these securities are required to be carried at market value with net of tax change in accumulated unrealized gains and losses directly impacting shareholder's equity. While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 6.1% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.

The Company, primarily through its insurance subsidiaries, had $12,941,000 in cash and cash equivalents at March 31, 2022, compared to $17,242,000 at March 31, 2021. Cash provided by operating activities increased cash by $3,131,000 during the three months ended March 31, 2022. The increase in cash from operating activities in the first quarter of 2022 was primarily related to net income for the period coupled with the collection of receivables and a decrease in claims paid. Cash provided by operating activities increased cash by $4,976,000 for

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the three months ended March 31, 2021. The increase in cash from operating activities was primarily related to reinsurance recoveries on paid losses related to 2020 hurricane events and net income for the period. Net cash used in investing activities totaled $83,000 for the three months ended March 31, 2022, compared to cash used in investing activities of $7,480,000 in 2021. The decrease in cash from investing activities during the three months ended March 31, 2022 was related to reinvestment of cash on hand from maturities of fixed maturity securities. Net cash used in investing activities in 2021 was related to reinvestment of cash on hand from maturities of fixed maturity securities and reinsurance recoveries. Net cash used in financing activities totaled $141,000 for the three months ended March 31, 2022 and 2021. During the three months ended March 31, 2022 and 2021, the Company paid $152,000 in dividends to shareholders.

The Holding Company had $2,407,000 in cash at March 31, 2022. The Holding Company primarily relies on cash from subsidiaries to meet its obligations, including payment of dividends to shareholders along with interest and principal on outstanding debt. Without consideration of the impact of the pending acquisition by VR Insurance Holdings, the Holding Company currently has adequate liquidity on hand to meet its anticipated obligations through at least the next 18 months without additional dividend payments from subsidiaries. Cash and cash equivalents held by subsidiaries at March 31, 2022 totaled $10,534,000.

The Company had a total of $12,693,000 of long-term debt outstanding as of March 31, 2022, compared to $12,690,000 at December 31, 2021, which includes $12,372,000 in trust preferred securities issued by the Company in addition to the installment note. Current year and prior year amounts were reduced by the unamortized portion of the placement fees associated with the issuance of the trust preferred securities, $179,000 and $182,000, respectively.

The ability of the Company to meet its commitments for timely payment of claims and other expenses depends, in addition to current cash flow, on the liquidity of its investments. The Company has limited exposure to below investment grade fixed income investments, which might be especially subject to liquidity limitations due to thinly traded markets.

The Company's liquidity requirements are primarily met by funds provided from operations of the insurance subsidiaries. The Company receives funds from its subsidiaries through payment of dividends, management fees, reimbursements for federal income taxes and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used to pay stockholder dividends, principal and interest on debt, corporate administrative expenses, federal income taxes, and for funding investments in the subsidiaries. The Company has no separate source of revenue other than dividends and fees from the insurance subsidiaries. Also, dividends from the insurance subsidiaries are subject to regulatory restrictions and, therefore, are limited depending on capital levels and earnings of the subsidiaries.

Our insurance subsidiaries are the primary source of dividends to the holding company. Consideration of insurance subsidiary growth opportunities, regulatory capital adequacy, rating agency impact and holding company debt reduction, among other items, are factors that influence our subsidiary dividend requirements. While we have made significant progress in recent years, continued strengthening capital levels in the insurance subsidiaries and reduction of debt remains a top priority. However, a decline in combined regulatory capital in our insurance subsidiaries in 2020, primarily due to increased catastrophe loss frequency in our P&C subsidiary, will limit our ability to prepay any debt obligations beyond what is required for over the next two years.

Dividends paid to the holding company from the insurance subsidiaries are subject to regulatory restrictions and prior approval of the Alabama Department of Insurance. As disclosed in Note 12 to the audited Consolidated Financial Statements included in our 2021 Annual Report on Form 10-K, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company during 2022 is statutorily limited to $1,097,000 in the life insurance subsidiary and $3,541,000 in the property/casualty insurance subsidiary. Dividends are limited to the greater of net income (operating income for life subsidiary) or 10% of statutory capital, and regulators consider dividends paid within the preceding twelve months when calculating the available dividend capacity. Therefore, all of the above referenced dividend capacity will not be available for consideration of payment until dividends paid in the preceding twelve months have been considered on a rolling basis. The Company also has to continuously evaluate other factors such as subsidiary operating performance, subsidiary capital requirements and potential impact by rating agencies in making decisions on how much capital can be released from insurance subsidiaries for payment of dividends to the holding company. These factors are considered along with the goal of growing year over year statutory surplus in the subsidiaries, and these considerations along with potential adverse impacts on regulatory surplus, will likely lead to dividend payments to the holding company

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substantially below the above referenced regulatory maximums. The Company did not receive any dividends from its subsidiaries during the three months ended March 31, 2022.

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

The Company continues to monitor liquidity and subsidiary capital closely. Despite periods with challenging weather patterns in the property and casualty subsidiaries over the past six years, the insurance subsidiaries are well capitalized. However, further strengthening of subsidiary capital and improvement in P&C underwriting profitability are top priorities for Company management.

Except as discussed above, the Company is unaware of any known trends, events, or uncertainties reasonably likely to have a material effect on its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under smaller reporting company rules we are not required to disclose information required under Item 3. However, in order to provide information to our investors, we have elected to provide information related to market risk.

The Company's primary objectives in managing its investment portfolio are to maximize investment income and total investment returns while minimizing overall credit risk. Investment strategies are developed based on many factors including changes in interest rates, overall market conditions, underwriting results, regulatory requirements and tax position. Investment decisions are made by management and reviewed by the Board of Directors. Market risk represents the potential for loss due to adverse changes in fair value of securities. The three potential risks related to the Company's fixed maturity portfolio are interest rate risk, prepayment risk and default risk. The primary risk related to the Company's equity portfolio is equity price risk.

Since the Company's assets and liabilities are largely monetary in nature, the Company's financial position and earnings are subject to risks resulting from changes in interest rates at varying maturities, changes in spreads over U.S. Treasuries on new investment opportunities and changes in the yield curve and equity pricing risks.

The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $4,083,000. Our portfolio has historically been highly correlated to the S&P 500 with regard to market risk. Based on an evaluation of the historical risk measure of our portfolio relative to the S&P 500, if the market value of the S&P 500 Index decreased 10% from its March 31, 2022 value, the fair value of the Company's common stock investments would decrease by approximately $408,000.

Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note 4 in the Condensed Consolidated Financial Statements present additional disclosures concerning fair values of Financial Assets and Financial Liabilities and are incorporated by reference herein.

The Company limits the extent of its market risk by purchasing securities that are backed by entities considered to be financially stable, the majority of the assets are issued by U.S. government sponsored entities or corporate entities with debt considered to be "investment grade".

The Company's investment approach in the equity markets is based primarily on a fundamental analysis of value. This approach requires the investment committee to invest in well managed, primarily dividend paying companies, which have a low debt to capital ratio, above average return on capital for a sustained period of time, and low volatility rating (beta) relative to the market. The dividends provide a steady cash flow to help pay current claim liabilities, and it has been the Company's experience that by following this investment strategy, long-term investment results have been superior to those offered by bonds, while keeping the risk of loss of capital to a minimum relative to the overall equity market.

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As for shifts in investment allocations, the Company has used improved cash flows from insurance operations to increase allocations to fixed maturity securities in order to limit volatility of statutory capital of the insurance subsidiaries.

It should be noted that the impact of the COVID-19 pandemic has added a new element of uncertainty surrounding market risk in our investment portfolio. While we are optimistic that the direct risk due to COVID-19 is waning, the extent of short and long term economic damage and political policy resulting from the pandemic remains unclear. The increased risk associated with the COVID-19 pandemic continues to be difficult to quantify due to these uncertainties.

Item 4. Controls and Procedures

Our management carried out an evaluation, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2022. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13A-15(d) under the Exchange Act that occurred during the three months ended March 31, 2022, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II

Item 1. Legal Proceedings

Please refer to Note 14 to the Condensed Consolidated Financial Statements included herein, and the 2021 Annual Report filed on Form 10-K. In addition to the aforementioned disclosures, on April 14, 2022, a putative class action complaint was filed by Edward Cohen on behalf of himself as a stockholder of the Company and on behalf of all similarly situated holders of common stock of the Company. The complaint was filed in the Delaware Court of Chancery styled as Edward Cohen v. Walter P. Wilkerson, Fred A. Clark, Jr., William L. Brunson, Jr., Donald S. Pittman, Mickey L. Murdock, Frank B. O’Neil, Brian R. McLeod, Brunson White, Charles B. Arnold, Elizabeth B. Crawford, Andrew J. Abernathy, and The National Security Group, Inc., Case Number 2022-0333 (the “Complaint”). The Complaint seeks to enjoin the stockholders’ vote on the approval of the proposed Merger until the Company provides certain disclosures that the Complaint alleges constituted material information that was omitted from the Company’s Preliminary Proxy Statement filed with the SEC on March 31, 2022 (the “Preliminary Proxy Statement”). The Complaint alleges that the Preliminary Proxy Statement failed to disclose the financial projections and operating data that management disclosed to Piper Sandler and that Piper Sandler referenced in rendering its fairness opinion to the Board as the Company’s financial adviser in connection with the Merger. The Complaint also names each of the Company’s directors as defendants and alleges that the directors breached their fiduciary duties to the stockholders by failing to provide this information in the Preliminary Proxy Statement. In addition, the Company received on April 29, 2022, a letter from an attorney purporting to represent another stockholder of the Company and demanding disclosure of the financial projections as well as other information relating to the financial analysis performed by Piper Sandler. The letter also inquires as to whether management had material communications regarding post-transaction employment or benefits and whether the terms of the non-disclosure agreements with other bidders solicited by Piper Sandler included restrictive covenants materially limiting their ability to independently engage in a transaction with the Company.

Item 1A. Risk Factors

There has been no material change in risk factors previously disclosed under Item 1A. of the Company’s Annual Report for 2021 on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities

None

Item 3. Defaults Upon Senior Securities

None

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Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

a. Exhibits


31.1			Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2			Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1			Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS			XBRL Instance Document
101.SCH			XBRL Taxonomy Extension Schema Document
101.CAL			XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF			XBRL Taxonomy Extension Definition Linkbase Document
101.LAB			XBRL Taxonomy Extension Label Linkbase Document
101.PRE			XBRL Taxonomy Extension Presentation Linkbase Document

b. During the last fiscal quarter of the period covered by this Report, the Company filed the following Current

Reports on Form 8-K:

Date of Report

Date Filed

Description

January 26, 2022

January 27, 2022

Item 1.01: Entry into a Material Definitive Agreement and Press release, dated January 26, 2022, issued by The National Security Group, Inc.

January 27, 2022

Press release, dated January 27 , 202 2 , issued by The National Security Group, Inc.

March 4, 2022

Press release, dated March 4 , 2022, issued by The National Security Group, Inc.

SIGNATURE

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

THE NATIONAL SECURITY GROUP, INC.


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

Date: May 16, 2022

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