CONFORMED COPY
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Quarterly report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 2001
Commission file number 0-16090
Hallmark Financial Services, Inc.
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(Exact name of small business issuer as specified in its charter)
Nevada 87-0447375
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
14651 Dallas Parkway, Suite 900 Dallas, Texas 75240
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (972) 404-1637
Check whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act
during the past 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date:
Common Stock, par value $.03 per share - 11,049,133 shares
outstanding as of August 12, 2001.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
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Consolidated Balance Sheets at June 30, 2001 3
(unaudited) and December 31, 2000
Consolidated Statements of Income (unaudited) for 4
the three and six months ended June 30, 2001 and
Consolidated Statements of Cash Flows (unaudited) 5
for the six months ended June 30, 2001 and June
Notes to Consolidated Financial Statements 6
(unaudited)
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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June 30 December 31
ASSETS 2001 2000
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(Unaudited)
Investments:
Debt securities, held-to-maturity,
at amortized cost $ 2,341,049 $ 7,243,373
Equity securities, available-for-sale,
at market value 143,901 145,302
Short-term investments, at cost which
approximates market value 12,128,700 6,188,764
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Total investments 14,613,650 13,577,439
Cash and cash equivalents 5,664,667 6,830,712
Restricted cash 2,614,783 4,276,397
Prepaid reinsurance premiums 14,420,074 10,943,902
Premiums receivable from lender (net of
allowance for doubtful accounts of 17,797,145 13,544,985
$278,199 in 2001 and $168,648 in 2000)
Premiums receivable 118,351 799,140
Reinsurance recoverable 20,733,052 19,212,172
Deferred policy acquisition costs 4,766,736 3,867,033
Excess of cost over net assets acquired (net
of accumulated amortization of $1,720,600
in 2001 and $1,642,093 in 2000) 4,509,614 4,588,121
Current federal income tax recoverable 322,522 95,232
Deferred federal income taxes 676,008 572,112
Accrued investment income 18,665 108,364
Other assets 864,375 642,205
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$ 87,119,642 $ 79,057,814
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LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 13,430,494 $ 13,032,999
Unpaid losses and loss adjustment expenses 23,136,573 22,297,816
Unearned premiums 21,051,825 16,710,581
Reinsurance balances payable 5,664,646 3,341,437
Deferred ceding commissions 4,315,070 3,505,421
Drafts outstanding 952,419 1,534,721
Accrued ceding commission refund 3,994,811 2,503,128
Accounts payable and other accrued expenses 3,884,967 3,258,475
Accrued litigation costs - 1,385,840
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Total liabilities 76,430,805 67,570,418
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Stockholders' equity
Common stock, $.03 par value, authorized
100,000,000 shares issued 11,855,610
shares in 2001 and 2000 355,668 355,668
Capital in excess of par value 10,875,432 10,875,432
Retained earnings 500,904 1,309,934
Accumulated other comprehensive income - (10,471)
Treasury stock, 806,477 shares, at cost (1,043,167) (1,043,167)
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Total stockholders' equity 10,688,837 11,487,396
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$ 87,119,642 $ 79,057,814
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The accompanying notes are an integral part
of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Six Months Ended
June 30 June 30
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2001 2000 2001 2000
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Gross premiums written $ 14,087,294 $ 12,870,742 $ 29,834,269 $ 26,098,589
Ceded premiums written (9,704,123) (7,662,205) (20,262,920) (15,401,396)
------------ ------------ ------------ ------------
Net premiums written $ 4,383,171 $ 5,208,537 $ 9,571,349 $ 10,697,193
============ ============ ============ ============
Revenues:
Gross premiums earned 13,062,063 11,863,434 25,493,025 22,511,182
Ceded premiums earned (8,731,329) (6,831,799) (16,786,748) (12,933,169)
------------ ------------ ------------ ------------
Net premiums earned 4,330,734 5,031,635 8,706,277 9,578,013
Investment income, net of expenses 232,005 292,550 542,440 518,347
Finance charges 861,853 712,355 1,694,250 1,551,386
Processing and service fees 306,000 605,982 728,595 1,138,943
Other income 60,296 82,033 106,287 166,760
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Total revenues 5,790,888 6,724,555 11,777,849 12,953,449
------------ ------------ ------------ ------------
Benefits, losses and expenses:
Losses and loss adjustment expenses 13,277,866 11,571,810 24,168,647 21,118,143
Reinsurance recoveries (8,447,013) (7,654,285) (15,530,827) (14,044,111)
------------ ------------ ------------ ------------
Net losses and loss adjustment expenses 4,830,853 3,917,525 8,637,820 7,074,032
Acquisition costs, net (147,064) 83,546 (90,054) 17,531
Other acquisition and underwriting
expenses (net of ceding commission of
$5,566,090 in 2001 and $4,381,989 in 2000) 983,966 958,248 1,822,197 2,123,396
Operating expenses 900,724 1,137,221 2,010,465 2,282,175
Interest expense 255,779 273,273 549,523 504,747
Amortization of intangible assets 39,253 39,253 78,507 78,507
------------ ------------ ------------ ------------
Total benefits, losses and expenses 6,863,511 6,409,066 13,008,458 12,080,388
------------ ------------ ------------ ------------
Income (loss) from operations before
federal income taxes (1,072,623) 315,489 (1,230,609) 873,061
Federal income tax expense (benefit) (362,344) 120,362 (421,579) 324,088
------------ ------------ ------------ ------------
Net income (loss) $ (710,279) $ 195,127 $ (809,030) $ 548,973
============ ============ ============ ============
Basic and diluted earnings (loss) per share $ (0.06) $ 0.02 $ (0.07) $ 0.05
============ ============ ============ ============
Common stock shares outstanding 11,049,133 11,048,133 11,049,133 11,048,133
============ ============ ============ ============
The accompanying notes are an integral part
of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30
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2001 2000
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Cash flows from operating activities:
Net income (loss) $ (809,030) $ 548,973
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Depreciation and amortization expense 142,663 164,443
Change in deferred Federal income taxes (103,896) (112,668)
Change in prepaid reinsurance premiums (3,476,172) (2,468,228)
Change in premiums receivable 680,789 (789,803)
Change in deferred policy acquisition costs (899,703) (725,366)
Change in deferred ceding commissions 809,649 742,897
Change in unpaid losses and loss
adjustment expenses 838,757 2,918,050
Change in unearned premiums 4,341,244 3,587,408
Change in reinsurance recoverable (1,520,880) (3,072,056)
Change in reinsurance balances payable 2,323,209 972,193
Change in current federal income
tax payable/recoverable (227,290) (38,348)
Change in litigation cost (1,385,840) -
Change in accrued ceding commission refund 1,491,683 238,433
Change in all other liabilities 44,190 1,426,052
Change in all other assets (62,574) (524,190)
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Net cash provided by operating activities 2,186,799 2,867,790
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Cash flows from investing activities:
Purchases of property and equipment (133,780) (85,604)
Premium finance notes originated (29,408,199) (18,295,128)
Premium finance notes repaid 25,156,039 15,275,384
Change in restricted cash 1,661,614 (18,000)
Purchases of debt securities - (3,101,030)
Maturities and redemptions
of investment securities 4,913,922 985,831
Purchase of short-term investments (10,439,935) (9,559,589)
Maturities of short-term investments 4,500,000 9,000,000
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Net cash used in investing activities (3,750,339) (5,798,136)
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Cash flows from financing activities:
Repayment of borrowings (364,000) (215,298)
Net advances from lender 761,495 1,799,223
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Net cash provided by financing activities 397,495 1,583,925
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Decrease in cash and cash equivalents (1,166,045) (1,346,421)
Cash and cash equivalents at beginning of period 6,830,712 5,786,069
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Cash and cash equivalents at end of period $ 5,664,667 $ 4,439,648
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements
Item 1. Notes to Consolidated Financial Statements (Unaudited).
Note 1 - Summary of Accounting Policies
In the opinion of management, the accompanying consolidated financial
statements contain all adjustments, consisting primarily of normalrecurring
adjustments, necessary to present fairly the financial position of Hallmark
Financial Services, Inc. and subsidiaries (the "Company") as of June 30,
2001 and the consolidated results of operations and cash flows for the
periods presented. The accompanying financial statements have been prepared
by the Company without audit.
Certain information and disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States ("GAAP") have been condensed or omitted.
Reference is made to the Company's annual consolidated financial statements
for the year ended December 31, 2000 for a description of accounting
policies and certain other disclosures. Certain items in the 2000 interim
financial statements have been reclassified to conform to the 2001
presentation.
The results of operations for the period ended June 30, 2001 are not
necessarily indicative of the operating results to be expected for the full
year.
Note 2 - Reinsurance
The Company is involved in the assumption and cession of reinsurance
from/to other companies. The Company remains obligated to its policyholders
in the event that reinsurers do not meet their obligations under the
reinsurance agreements.
Effective March 1, 1992, the Company entered into a reinsurance
arrangement with State & County Mutual Fire Insurance Company ("State &
County"), an unaffiliated company, to assume 100% of the nonstandard auto
business produced by the Company and underwritten by State & County. The
arrangement is supplemented by a separate retrocession agreement effective
July 1, 2000 between the Company and Dorinco Reinsurance Company
("Dorinco"). Under the agreement, the Company currently retains 30% and
cedes 70% of the risk to Dorinco.
Effective March 1, 2001 the minimum commission rate decreased to 26%
from 31%. The commission rate increases 1:1 to any percentage decrease in
the loss ratio from an established benchmark to a provisional/maximum
commission rate of 41%. Effective April 1, 2001 the provisional commission
rate decreased from 41% to 34% and decreased again to 31% effective July 1,
2001. Additionally, effective April 1, 2001 a loss corridor was added to
the reinsurance agreement affecting losses on policies effective April 1,
2001 and after.
Effective April 1, 2001, the Company's reinsurance agreements with
Dorinco were amended to include a loss corridor provision whereby the
Company retains 100% of losses between a loss ratio corridor of 65% to 77%
on policies effective April 1, 2001. This corridor increased to 65% to 80%
effective July 1, 2001 on policies effective after that date. Further,
Dorinco and the Company have executed a letter of agreement effective July
1, 2001, that among other things, imposes on the Company additional
financial and operational covenants under the Dorinco reinsurance
agreements, provides remedies for the breach of such covenants and grants to
Dorinco certain options to maintain or increase the level of its reinsurance
of Hallmark policies.
Note 3 - Commitments and Contingencies
In March 1997, a jury returned a verdict against the Company and in
favor of a former director and officer of the Company in the amount of
approximately $517,000 on the basis of contractual and statutory
indemnification claims. The court subsequently granted the plaintiff's
motion for attorneys' fees of approximately $271,000, court costs of
approximately $39,000 and pre-judgment and post-judgment interest, and
rendered final judgment on the verdict. The Company believed the outcome in
this case was both legally and factually incorrect and appealed the
judgment. During the fourth quarter of 1997, the Company deposited
$1,248,758 into the registry of the court in order to stay execution on the
judgment pending the result of appeals. The amount on deposit (including
interest) with the court of $1,457,311 as of December 31, 2000 was included
as restricted cash in the accompanying balance sheet. During February 2001,
the court ruled against the Company in its appeal, and $1,388,627 of the
funds on deposit with the court were disbursed to the plaintiff during March
2001. The remaining funds on deposit with the court were refunded to the
Company. There was no financial impact on the Company's earnings in 2001.
Item 2. Management's Discussion and Analysis or Plan of Operation.
Introduction. Hallmark Financial Services, Inc. ("HFS") and its wholly
owned subsidiaries (collectively referred to herein as the "Company") engage
in the sale of property and casualty insurance products. The Company's
business primarily involves marketing, underwriting and premium financing of
non-standard automobile insurance, as well as claims adjusting and other
insurance related services.
The Company pursues its business activities through an integrated
insurance group, (collectively, the "Insurance Group"), the members of which
are an authorized Texas property and casualty insurance company, American
Hallmark Insurance Company of Texas ("Hallmark"); a managing general agent,
American Hallmark General Agency, Inc. ("AHGA"); a network of affiliated
insurance agencies known as the American Hallmark Agencies ("Hallmark
Agencies"); a premium finance company, Hallmark Finance Corporation ("HFC");
and a claims handling and adjustment firm, Hallmark Claims Service, Inc.
("HCS"). The Company operates only in Texas.
Hallmark provides non-standard automobile liability and physical damage
insurance through reinsurance arrangements with several unaffiliated
companies. Through arrangements with State & County Mutual Fire Insurance
Company ("State & County"), Hallmark provides insurance primarily for high-
risk drivers who do not qualify for standard-rate insurance. Under the
supplementary quota-share reinsurance agreement, Hallmark , upon mutual
agreement with its current reinsurer, may elect on a quarterly basis to
retain 30% to 45% of the risk while ceding the remaining percentage to its
reinsurer. The Company's principal reinsurer, Dorinco Reinsurance Company
("Dorinco"), currently assumes 70% of Hallmark's risk. HFC finances annual
and six-month policy premiums through its premium finance program. AHGA
manages the marketing of Hallmark policies through a network of retail
insurance agencies which operate under the American Hallmark Agencies name,
and through independent agents operating under their own respective names.
Additionally, AHGA provides premium processing, underwriting, reinsurance
accounting and cash management for unaffiliated managing general agencies
("MGAs"). HCS provides fee-based claims adjustment, salvage, subrogation
recovery and litigation services to Hallmark and unaffiliated MGAs.
Reinsurance Term Changes
Effective April 1, 2001, the Company's reinsurance agreements with
Dorinco were amended to include a loss corridor provision whereby the
Company retains 100% of losses between a loss ratio corridor of 65% to 77%
on policies effective April 1, 2001. This corridor increased to 65% to 80%
effective July 1, 2001 on policies effective after that date. The
provisional ceding commission rate was decreased from 41% to 34% on April 1,
2001 and further decreased to 31% on July 1, 2001. Further, Dorinco and the
Company have executed a letter of agreement effective July 1, 2001, that
among other things, imposes on the Company additional financial and
operational covenants under the Dorinco reinsurance agreements, provides
remedies for the breach of such covenants and grants to Dorinco certain
options to maintain or increase the level of its reinsurance of Hallmark
policies.
Financial Condition and Liquidity
The Company's sources of funds are principally derived from insurance
related operations. Major sources of funds from operations include premiums
collected (net of policy cancellations and premiums ceded), ceding
commissions, premium finance service charges, and processing fees. Other
sources of funds are from financing and investment activities.
On a consolidated basis, the Company's liquidity remained almost the
same during the first six months of 2001 as compared to the same period
of 2000. The Company's total cash, cash equivalents and investments
(excluding restricted cash of $2.6 million) at June 30, 2001 and December
31, 2000 were $20.3 million and $20.4 million, respectively.
Net cash provided by the Company's consolidated operating activities
decreased approximately $0.7 million during the first six months of 2001
compared to the first six months of 2000. The net decrease in net cash
provided by operations is primarily attributable to several factors. During
the first quarter of 2001, the Company exhausted its appeals of a 1997
lawsuit and subsequently paid approximately $1.4 million of restricted funds
which had been held by the court for several years (See Note 3 to the
Consolidated Financial Statements). During the second quarter of 2001,
weather-related claims significantly impacted losses. Further, the addition
of a loss corridor provision in the Company's reinsurance agreement
effective April 1, 2001, increased the adverse financial impact of the
weather-related losses as well as a portion of other second quarter losses.
Cash used by investing activities during the first six months of 2001
decreased $2.0 million as compared to the first six months of 2000. This
decrease in cash used in investing activities was primarily the result of
the release of funds during the first quarter previously deposited in the
registry of the court and higher proceeds from maturities and calls of
investments, as partially offset by an increase in originations of premium
finance notes when netted against repayments of premium finance notes.
Cash provided by financing activities decreased by $1.2 million during
the first six months of 2001 as compared to the first six months of 2000
primarily due to a decrease in net advances from the Company's premium
finance lender. This was principally due to a change in the timing of
funding of premium finance notes during 2001. Previously, funding of notes
occurred almost daily. In 2001, funding of premium finance notes occurred
approximately on a weekly basis. Additionally, during 2001, the Company
began funding a portion of the premium finance notes internally.
A substantial portion of the Company's liquid assets is held by
Hallmark and is not available for general corporate purposes. Of the
Company's consolidated liquid assets of $20.3 million at June 30, 2001, $1.9
million (as compared to approximately $1.4 million at December 31, 2000)
represents non-restricted cash. Since state insurance regulations restrict
financial transactions between an insurance company and its affiliates, HFS
is limited in its ability to use Hallmark funds for its own working capital
purposes. Furthermore, dividends and loans by Hallmark to the Company are
restricted and subject to Texas Department of Insurance ("TDI") approval.
Although TDI has sanctioned the payment of management fees, commissions and
claims handling fees by Hallmark to HFS and affiliates, since the second
half of 2000, Hallmark has chosen not to pay all of the commissions allowed
to AHGA. Additionally, during the first six months of 2001, Hallmark did
not pay any management fees to HFS. These steps were taken to preserve
Hallmark's surplus principally to accommodate increased premium volume.
During the first six months of 2000, Hallmark accrued $100,000 of management
fees to HFS. Management anticipates that Hallmark may pay management fees
periodically during the remainder of 2001. The Company has never received a
dividend from Hallmark, and there is no immediate plan to pay a dividend.
During the first six months of 2001, the amount of funding available to
fund premium finance notes under the secured financing arrangement with the
unaffiliated third party was increased to $12.5 million from $11.0 million.
As of June 30, 2001, HFC had an outstanding balance on advances under the
financing arrangement of approximately $12.1 million at an interest rate of
7.25%. Under the financing arrangement, the maximum additional advances
available to HFC at June 30, 2001 were $0.4 million.
As of June 30, 2001, the Company had approximately $2.1 million
outstanding on notes payable under a loan agreement with Dorinco. For the
fiscal quarter ended June 30, 2001, Dorinco waived compliance with certain
financial covenants of the loan agreement which were adversely impacted by
changes to the Dorinco reinsurance treaties and other factors effecting the
loss ratio of the Company. (See "Reinsurance Term Changes" and "Results of
Operations".)
Commissions from the Company's annual policy program for independent
agents represent a source of unrestricted liquidity when annual policy
production is level or increasing from the most recent previous quarters.
Under this program, AHGA offers independent agents the ability to write
annual policies and six-month policies, but commissions to substantially all
independent agents are paid monthly on an "earned" basis. However,
consistent with customary industry practice, Hallmark pays total commissions
up-front to AHGA based on the entire annual/six-months premiums written.
Independent agent production of annual policies was $17.8 million during the
first six months of 2001 as compared to $12.2 million during the first six
months of 2000. During the first six months of 2001, AHGA received $2.6
million in commissions related to this program from Hallmark and paid earned
commissions of approximately $2.3 million to independent agents. During the
first six months of 2000, AHGA received $2.5 million in commissions related
to this program from Hallmark, and paid earned commissions of $1.5 million
to independent agents. As noted above, Hallmark did not pay all of the
commissions allowed to AHGA as evidenced by the small difference between the
commissions paid to AHGA during 2001, and the commissions paid to AHGA
during 2000 despite a $5.6 million increase in annual policies during 2001.
This was done to preserve Hallmark's surplus.
Ceding commission income represents a significant source of funds to
the Company. A portion of ceding commission income and policy acquisition
costs is deferred and recognized as income and expense, respectively,
as related net premiums are earned. Deferred ceding commission income
increased to $4.3 million at June 30, 2001 from $3.5 million at December 31,
2000. Deferred policy acquisition costs as of June 30, 2001 increased $0.9
million as compared to December 31, 2000. The increase in deferred ceding
commission income and deferred policy acquisition costs is primarily due to
the increase in Hallmark's core State & County annual premium volume.
Premium receivable from lender increased $4.3 million during 2001 as
compared to December 31, 2000 as a result of financing increased annual
policy production during 2001. Prepaid reinsurance premiums, reinsurance
recoverable, unpaid losses and LAE, unearned premiums, reinsurance balances
payable and accounts payable and other accrued expenses increased as
expected in relation to increased premium writings.
At June 30, 2001, Hallmark's reported statutory capital and surplus of
$6.3 million which reflects a slight decrease from the balance reported at
December 31, 2000. While Hallmark experienced a statutory net loss of $0.6
million during the first six months of 2001, surplus did not decrease
accordingly. Effective January 1, 2001, TDI adopted the Codification of
Statutory Accounting Principles ("Codification") guidance, which replaces
the National Association of Insurance Commissioners primary guidance on
statutory accounting. As a result of the implementation of Codification,
Hallmark recognized a deferred tax asset in the amount of $0.5 million
during the first six months of 2001. In accordance with Codification, the
deferred tax asset was established and a corresponding increase to surplus
was made. The deferred tax adjustment required by Codification is
recognized by TDI as an increase to surplus; however, certain rating
agencies, such as A.M. Best, do not recognize the adjustment as an increase
to surplus. Under Codification, Hallmark's premium to surplus ratio for the
twelve months ended June 30, 2001 was 2.84 to 1 as compared to 2.98 to 1 at
December 31, 2000 and June 30, 2000, respectively. Hallmark's premium to
surplus ratio, without Codification, for the twelve months ended June 30,
2001 was 3.11 to 1. Management does not presently expect Hallmark to
require additional capital during 2001 to fund existing operations.
The Company provides on-going program administration and claims
handling for one unaffiliated MGA and has three similar contracts in run-
off. The Company will continue to perform functions as defined in the
respective contracts during the run-off periods. For the one unaffiliated
MGA program which continues to produce new business, the Company, as program
administrator, performs certain administrative functions, including cash
management, underwriting and rate-setting reviews, underwriting, policy
processing and claims handling. Hallmark assumes a 20% pro-rata share of
the business produced under this unaffiliated MGA program, and Dorinco
assumes the remainder.
Management is continuing to investigate opportunities to enhance and
expand its operations. While additional capital or strategic alliances may
be required to fund future company expansion, operational enhancements
through increased information technology capabilities is in progress. The
first phase is designed to enhance Company and agency relationships
by improving content and timeliness of information to support agents
in servicing their customers. Full implementation of this web-based
information system (named e-Integrity and referred to as the "Integrity
System") was initiated and completed during the second quarter of 2001.
Additional enhancements not in the scope of the original first phase have
been developed during the second quarter and will be fully implemented
during the third quarter of 2001. The second phase of the Integrity System
is to implement point-of-sale technology to support agents in more promptly
and efficiently producing new business, as well as to improve the quality
and timeliness of servicing existing policyholders. Due to the increase in
scope of Phase I, implementation of Phase II is targeted to commence in
Spring 2002 with full roll-out to be completed in Summer 2002.
Results of Operations
Gross premiums written (prior to reinsurance) for the three and six
months ended June 30, 2001 increased 9% and 14%, respectively, in relation
to gross premiums written during the same periods in 2000. Net premiums
written (after reinsurance) for the three and six months ended June 30, 2001
decreased approximately 16% and 11%, respectively, over the same periods in
2000. The increase in gross premiums written was due to the increase in the
core State & County premium volume partially offset by a decrease in premium
volume from assumed business produced by unaffiliated MGAs as compared to
the prior year. The disparity between gross premiums written and net
premiums written is due to the combined effect of a decrease in policy fees
retained by the Company (30% retained during the first six months of 2001 as
compared to 100% during the first six months of 2000) and the decrease in
assumed business produced by the unaffiliated MGAs.
Gross premiums earned (prior to reinsurance) for the three and six
months ended June 30, 2001 increased 10% and 13%, respectively, as compared
to the same periods of 2000. For the three and six months ended June 30,
2001, net premiums earned (after reinsurance) decreased approximately 14%
and 9%, respectively, as compared to the same periods of 2000. The
disparate change in premiums earned prior to and after reinsurance is due to
the change in retention of policy fees and the decreased assumption of
premiums produced by the unaffiliated MGAs.
Net incurred loss ratios (computed on net premiums earned after
reinsurance) for the three and six months ended June 30, 2001 were 111.5%
and 99.2%, respectively, compared to 77.9% and 73.9% for the same periods of
2000. The most significant factor impacting the 2001 loss ratio was various
amendments to Hallmark's reinsurance treaties. During the second half of
2000, the reinsurance treaties were changed to include 100% of policy fees
in the reinsurance treaty base (i.e. Hallmark retained 30% of policy fees
during 2001 and 100% during 2000), thus reducing net earned premium in 2001.
Reinsurance terms were further amended effective April 1, 2001 to include a
loss corridor provision, thus increasing losses incurred by the Company. If
these changes to reinsurance treaties had not occurred, the loss ratios for
the three and six months ended June 30, 2001 would have been 85.4% and
79.4%, respectively.
Net incurred loss ratios (computed on net premiums earned after
reinsurance) for the three and six months ended June 30, 2001 were also
adversely impacted by extraordinary weather-related losses principally in
connection with a catastrophic storm and flooding in the Houston area of
Texas in June 2001. These weather-related losses impacted both the number
and amount of claims filed which in turn magnified the impact of the loss
corridor. If neither the changes to the reinsurance treaties nor these
extraordinary weather-related losses had occurred, the loss ratios for the
three and six months ended June 30, 2001 would have been 78.9% and 76.2%,
respectively. Additionally, depressed premiums from 2000 (which do not
reflect the full impact of increasing rates) being earned in 2001 and
increasing claim costs (principally due to rising medical, labor and repair
costs) continue to adversely impact the 2001 loss ratio.
Finance charges, which increased $0.1 million (9%) during the first six
months of 2001 as compared to the same period of 2000, represent interest
earned on premium notes issued by HFC. This increase is directly correlated
to the increase in the annual premium volume.
Processing and service fees represent fees earned on third party
processing and servicing contracts with unaffiliated MGAs. Processing and
service fees for the first six months of 2001 decreased $0.4 million (36%)
as a result of cancellation of the service contracts with three unaffiliated
MGAs (which are currently in run-off).
Acquisition costs, net represents the amortization of acquisition costs
(and credits) deferred over the past twelve months and the deferral of
acquisition costs (and credits) incurred in the current period. The
decrease in acquisition costs, net is primarily due to a larger increase in
acquisition costs (debits) than ceding commission income (credits).
Other acquisition and underwriting expenses for the three months ended
June 30, 2001 increased slightly, while other acquisition and underwriting
expenses for the six months ended June 30, 2001 decreased 14% as compared
to the same periods of 2000. The decrease in expenses is primarily
attributable to increased ceding commission income as a result of increased
core State & County premium volume partially offset by an increase in
commission expense, office rental and healthcare costs applicable to
acquisition and underwriting expenses, and certain variable expenses
associated with increased premium volume.
Operating expenses include expenses related to premium finance
operations, general corporate overhead, and third party administrative and
claims handling contracts. Related revenues are derived from finance
charges and processing and service fees. Operating expenses decreased
approximately 21% and 12%, respectively, during the three and six months
ended June 30, 2001 as compared to the same periods of 2000. The majority
of this decrease is attributable to the variable expenses related to the
processing of third party contracts. As three of the unaffiliated MGA
programs are in run-off, staffing and operational costs related to the run-
off of this business have decreased, particularly in the second quarter of
2001. These decreases are partially offset by increased costs related to
corporate office space and healthcare applicable to operating expense.
Risks Associated with Forward-Looking Statements Included in this Form
10-QSB
This Form 10-QSB contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, which are intended to be covered by the
safe harbors created thereby. These statements include the plans and
objectives of management for future operations, including plans and
objectives relating to future growth of the Company's business activities
and availability of funds. The forward-looking statements included herein
are based on current expectations that involve numerous risks and
uncertainties. Assumptions relating to the foregoing involve judgments with
respect to, among other things, future economic, competitive and market
conditions, regulatory framework, and future business decisions, all of
which are difficult or impossible to predict accurately and many of which
are beyond the control of the Company. Although the Company believes that
the assumptions underlying the forward-looking statements are reasonable,
any of the assumptions could be inaccurate and, therefore, there can be no
assurance that the forward-looking statements included in this Form 10-QSB
will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by the Company
or any other person that the objectives and plans of the Company will be
achieved.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
Except for routine litigation incidental to the business of
the Company and as described in Note 3 to the Consolidated
Financial Statements of the Company, neither the Company
nor any of the properties of the Company was subject to any
material pending or threatened legal proceedings as of the
date of this report.
Item 2. Changes in Securities.
None.
Item 3. Defaults on Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security-Holders.
( a ) The Company's Annual Meeting of Shareholders was held on
May 23, 2001. Of the 11,049,133 shares of common stock of
the Company entitled to vote at the meeting, 8,775,428
shares were present in person or by proxy.
( b ) The following individuals were elected to serve as directors
for the Company: Ramon D. Phillips, Linda H. Sleeper, James
H. Graves, George R. Manser, Mark E. Schwarz, and Scott T.
Berlin.
( c ) There was no other business to come before the meeting.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibit listed in the Exhibit Index appearing on page 14
is filed herewith.
(b) The Company did not file any Form 8-K Current Reports during
the second quarter of 2001.
Exhibit Index
Exhibit Description
Number
10(a) Claim Account Agreement, by and between GE Reinsurance
Corporation, Lincolnshire, Illinois, Dorinco Reinsurance
Company, Midland, Michigan, American Hallmark Insurance
Company of Texas, Dallas, Texas, and Hallmark Claims
Services, Inc., Dallas, Texas, effective February 1,
2001.
10(b) Addendum No. 1 to Claim Account Agreement, dated
February 1, 2001, by and between GE Reinsurance
Corporation, Lincolnshire, Illinois, Dorinco Reinsurance
Company, Midland, Michigan, American Hallmark Insurance
Company of Texas, Dallas, Texas, and Hallmark Claims
Services, Inc., Dallas, Texas, effective February 1,
2001
10(c) Cut-Through Agreement, dated as of June 26, 2001, by and
among American Hallmark Insurance Company of Texas,
American Hallmark General Agency, Inc., Hallmark Finance
Corporation and FPF, Inc.
10(d) First Modification Agreement to the Cut-Through
Agreement dated as of June 26, 2001, by and among
American Hallmark Insurance Company of Texas, American
Hallmark General Agency, Inc., Hallmark Finance
Corporation and FPF, Inc., entered into June 27, 2001.
10(e) Form of Fourth Amendment to Executive Compensation
Agreement effective June 1, 2001, between Ramon D.
Phillips and Hallmark Financial Services Inc., dated
August 24, 1994.
10(f) Letter of Agreement, dated August 3, 2001, between
Hallmark Financial Services, Inc. and Dorinco
Reinsurance Company.
10(g) Letter of Agreement, dated August 6, 2001, between
Hallmark Financial Services, Inc. and Dorinco
Reinsurance Company.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: August 14, 2001 /s/ Linda H. Sleeper
---------------------------
Linda H. Sleeper, President
(Chief Executive Officer)
Date: August 14, 2001 /s/ John J. DePuma
---------------------------
John J. DePuma,
Chief Financial Officer