Fair Value of Financial Assets and Financial Liabilities

6 Months Ended

Jun. 30, 2011

Fair Value, Assets and Liabilities Measured on Recurring and Nonrecurring Basis [Abstract]

Fair Value Disclosures [Text Block]

FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

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

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

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

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Continued)

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

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

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

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

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

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

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

Marketable debt instruments in this category generally include asset-backed securities and certain of our floating-rate notes, corporate bonds, and municipal bonds.

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Continued)

Assets/Liabilities Measured at Fair Value on a Recurring Basis

Financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 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
Corporate debt securities	$	19,776	$	—	$	19,776	$	—
Mortgage backed securities	7,515				7,515
Private label mortgage backed securities	11,443		—		11,443		—
Obligations of states and political subdivisions	19,017		—		19,017		—
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies	15,470		15,470		—		—
Trading securities	860		860		—		—
Equity securities available-for-sale	8,767		8,035		—		732
Total Financial Assets	$	82,848	$	24,365	$	57,751	$	732
Financial Liabilities
Interest rate swap	$	310	$	—	$	—	$	310
Total Financial Liabilities	$	310	$	—	$	—	$	310

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2011:

	For the six-months ended June 30, 2011
(In Thousands)	Fixed Maturities Available-for-Sale		Equity Securities Available-for-Sale			Interest Rate Swap
Beginning balance	$	—	$	787		$	(227	)
Total gains or losses (realized and
unrealized):
Included in earnings	—		(55		)	—
Included in other comprehensive income	—		—			(83		)
Purchases:	—		—			—
Sales:	—		—			—
Issuances:	—		—			—
Settlements	—		—			—
Transfers in/(out) of Level 3	—		—			—
Ending balance	$	—	$	732		$	(310	)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of
June 30, 2011	$	—	$	—		$	—

For the quarter ended June 30, 2011, there were no assets or liabilities measured at fair values on a nonrecurring basis.

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Continued)

Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):

	Fair Value Measurements at Reporting Date Using
Description	Total		Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
Corporate debt securities	$	23,952	$	—	$	23,952	$	—
Mortgage backed securities	7,275		—		7,275		—
Private label mortgage backed securities	13,106		—		13,106		—
Obligations of states and political subdivisions	18,415		—		18,415		—
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies	15,720		15,720		—		—
Trading securities	705		705		—		—
Equity securities available-for-sale	9,047		8,260		—		787
Total Financial Assets	$	88,220	$	24,685	$	62,748	$	787
Financial Liabilities
Interest rate swap	$	227	$	—	$	—	$	227
Total Financial Liabilities	$	227	$	—	$	—	$	227

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2010:

	For the year ended December 31, 2010
(In Thousands)	Corporate Debt Securities			Equity Securities Available-for-Sale			Interest Rate Swap
Beginning balance	$	577		$	662		$	(60	)
Total gains or losses (realized and
unrealized):
Included in earnings	63			—			—
Included in other comprehensive income	—			(19		)	(167		)
Purchases:	—			144			—
Sales:	(640		)	—			—
Issuances:	—			—			—
Settlements	—			—			—
Transfers in/(out) of Level 3	—			—			—
Ending balance	$	—		$	787		$	(227	)
The amount of total gains or losses for the period included in earnings change in unrealized gains or losses relating attributable to the to assets and liabilities still held as of
December 31, 2010	$	—		$	—		$	—

For the year ended December 31, 2010, there were no assets or liabilities measured at fair values on a nonrecurring basis.

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Continued)

The Company is exposed to certain risks in the normal course of its business operations.  The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings.  This risk is managed through the use of interest rate swaps which are designated as cash flow hedges.  For cash flow hedges, the effective portion of the gain or loss on the interest rate swap is included as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings.  The Company does not hold or issue derivatives that are not designated as hedging instruments.  See Note 7 for additional information about the interest rate swaps.

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

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

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

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

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

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

The carrying amount and estimate fair value of the Company’s financial instruments as of June 30, 2011 and December 31, 2010 are as follows