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 June 30, 2020

or      

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

For the transition period from           to          .

Commission File Number 0-18649

The National Security Group, Inc.

(Exact name of registrant as specified in its charter)

Delaware		63-1020300
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)
661 East Davis Street
Elba,	Alabama	36323
(Address of principal executive offices)		(Zip-Code)

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

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

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

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 August 13, 2020
Common Stock $1.00 par value	2,531,448 shares

1

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, 2019 AMOUNTS)	5
		Condensed Consolidated Statements of Operations (UNAUDITED)	6
		Condensed Consolidated Statements of Comprehensive Income (Loss) (UNAUDITED)	7
		Condensed Consolidated Statements of Changes in Shareholders’ Equity (UNAUDITED)	8
		Condensed Consolidated Statements of Cash Flows (UNAUDITED)	10
		Notes to Condensed Consolidated Financial Statements (UNAUDITED EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)	11
		Review Report of Independent Registered Public Accounting Firm	35
	Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations		36
	Item 3.  Quantitative and Qualitative Disclosures about Market Risk		52
	Item 4.  Controls and Procedures		53
PART II. OTHER INFORMATION
	Item 1.    Legal Proceedings		53
	Item 1A. Risk Factors		53
	Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities		53
	Item 3.    Defaults Upon Senior Securities		54
	Item 4. Mine Safety Disclosures		54
	Item 5.    Other Information		54
	Item 6.    Exhibits		54
SIGNATURE			54

2

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 are adversely affected by increases in policy claims received by the Company. While a manageable risk, this fluctuation is often unpredictable.

▪The Company's investments are subject to a variety of risks. Investments are subject to defaults and changes in market value. Market value can be affected by changes in interest rates, market performance and the economy.

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

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

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

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

3

PART I

Item 1. Financial Statements

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

($ in thousands)	June 30, 2020		December 31, 2019
ASSETS	(UNAUDITED)
Investments
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2020 -       $1,265; 2019 - $1,345)	$	1,165	$	1,290
Fixed maturities available-for-sale, at estimated fair value (cost: 2020 -       $94,573; 2019 - $97,102)	99,623		100,260
Equity securities, at estimated fair value (cost: 2020 - $2,127; 2019 - $2,127)	4,807		5,303
Trading securities	145		149
Receivable for securities sold	2		56
Mortgage loans on real estate, at cost	146		147
Investment real estate, at book value	2,934		2,934
Policy loans	1,887		1,895
Company owned life insurance	4,695		4,655
Other invested assets	2,146		2,280
Total Investments	117,550		118,969
Cash and cash equivalents	8,860		11,809
Accrued investment income	679		706
Policy receivables and agents' balances, net	13,663		12,028
Reinsurance recoverable	284		276
Deferred policy acquisition costs	7,721		7,666
Property and equipment, net	1,602		1,630
Income tax recoverable	1,107		—
Other assets	1,251		850
Total Assets	$	152,717	$	153,934
LIABILITIES AND SHAREHOLDERS' EQUITY
Property and casualty benefit and loss reserves	$	7,383	$	7,199
Accident and health benefit and loss reserves	3,949		4,046
Life and annuity benefit and loss reserves	34,511		34,269
Unearned premiums	33,483		30,555
Policy and contract claims	965		1,053
Other policyholder funds	1,326		1,350
Short-term notes payable and current portion of long-term debt	500		500
Long-term debt	13,671		13,664
Accrued income taxes	—		226
Deferred income tax liability	130		96
Other liabilities	8,348		7,515
Total Liabilities	104,266		100,473
Contingencies
Shareholders' equity
Common stock	2,533		2,532
Additional paid-in capital	5,626		5,602
Accumulated other comprehensive income	3,319		2,443
Retained earnings	37,001		42,891
Treasury stock, at cost	(28)		(7)
Total Shareholders' Equity	48,451		53,461
Total Liabilities and Shareholders' Equity	$	152,717	$	153,934

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

4

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

($ in thousands, except per share)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
REVENUES
Net premiums earned	$	15,172	$	14,990	$	30,127	$	29,708
Net investment income	961		957		1,925		1,919
Investment gains (losses)	548		117		(442)		2,237
Other income	143		146		288		292
Total Revenues	16,824		16,210		31,898		34,156
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits and settlement expenses	16,736		10,900		27,319		19,923
Amortization of deferred policy acquisition costs	848		839		1,913		1,819
Commissions	2,047		1,978		4,122		4,011
General and administrative expenses	2,493		2,416		3,887		4,748
Taxes, licenses and fees	594		599		1,315		1,286
Interest expense	199		291		460		586
Total Benefits, Losses and Expenses	22,917		17,023		39,016		32,373
Income (Loss) Before Income Taxes	(6,093)		(813)		(7,118)		1,783
INCOME TAX EXPENSE (BENEFIT)
Current	(1,280)		(148)		(1,333)		97
Deferred	(87)		(78)		(199)		(170)
	(1,367)		(226)		(1,532)		(73)
Net Income (Loss)	$	(4,726)	$	(587)	$	(5,586)	$	1,856
INCOME (LOSS) PER COMMON SHARE BASIC AND DILUTED	$	(1.87)	$	(0.23)	$	(2.21)	$	0.73
DIVIDENDS DECLARED PER SHARE	$	0.06	$	0.05	$	0.12	$	0.10

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

5

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

($ in thousands)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Net income (loss)	$	(4,726)	$	(587)	$	(5,586)	$	1,856
Other comprehensive income (loss), net of tax
Changes in:
Unrealized gains (losses) on securities, net of reclassification adjustment of $13 and $12 for 2020 and 2019, respectively	3,435		1,752		1,495		3,486
Unrealized gain (loss) on interest rate swap	(74)		20		(619)		45
Other comprehensive income, net of tax	3,361		1,772		876		3,531
Comprehensive income (loss)	$	(1,365)	$	1,185	$	(4,710)	$	5,387

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

6

THE NATIONAL SECURITY GROUP, INC.

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

For the six months ended June 30, 2020

($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income		Common Stock		Additional Paid-in Capital		Treasury Stock
Balance at December 31, 2019	$	53,461	$	42,891	$	2,443	$	2,532	$	5,602	$	(7)
Common stock reacquired	(21)		—		—		—		—		(21)
Comprehensive loss:
Net loss for June 30, 2020	(5,586)		(5,586)		—		—		—		—
Other comprehensive income (net of tax)	876		—		876		—		—		—
Common stock issued	25		—		—		1		24		—
Cash dividends	(304)		(304)		—		—		—		—
Balance at June 30, 2020	$	48,451	$	37,001	$	3,319	$	2,533	$	5,626	$	(28)

For the three months ended June 30, 2020

($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Common Stock		Additional Paid-in Capital		Treasury Stock
Balance at March 31, 2020	$	49,958	$	41,879	$	(42)	$	2,532	$	5,602	$	(13)
Common stock reacquired	(15)		—		—		—		—		(15)
Comprehensive loss:
Net loss for June 30, 2020	(4,726)		(4,726)		—		—		—		—
Other comprehensive income (net of tax)	3,361		—		3,361		—		—		—
Common stock issued	25		—		—		1		24		—
Cash dividends	(152)		(152)		—		—		—		—
Balance at June 30, 2020	$	48,451	$	37,001	$	3,319	$	2,533	$	5,626	$	(28)

7

THE NATIONAL SECURITY GROUP, INC.

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

For the six months ended June 30, 2019

($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Common Stock		Additional Paid-in Capital		Treasury Stock
Balance at December 31, 2018	$	45,866	$	39,355	$	(1,570)	$	2,527	$	5,554	$	—
Comprehensive income:
Net income for June 30, 2019	1,856		1,856		—		—		—		—
Other comprehensive income (net of tax)	3,531		—		3,531		—		—		—
Common stock issued	53		—		—		5		48		—
Cash dividends	(253)		(253)		—		—		—		—
Balance at June 30, 2019	$	51,053	$	40,958	$	1,961	$	2,532	$	5,602	$	—

For the three months ended June 30, 2019

($ in thousands)	Total		Retained Earnings		Accumulated Other Comprehensive Income		Common Stock		Additional Paid-in Capital		Treasury Stock
Balance at March 31, 2019	$	49,942	$	41,672	$	189	$	2,527	$	5,554	$	—
Comprehensive income:
Net loss for June 30, 2019	(587)		(587)		—		—		—		—
Other comprehensive income (net of tax)	1,772		—		1,772		—		—		—
Common stock issued	53		—		—		5		48		—
Cash dividends	(127)		(127)		—		—		—		—
Balance at June 30, 2019	$	51,053	$	40,958	$	1,961	$	2,532	$	5,602	$	—

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

8

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

($ in thousands)	Six months ended June 30,
	2020		2019
Cash Flows from Operating Activities
Net income (loss)	$	(5,586)	$	1,856
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation expense and amortization/accretion, net	123		143
Net (gains) losses on investments	442		(2,237)
Deferred income taxes	(199)		(170)
Amortization of deferred policy acquisition costs	1,913		1,819
Changes in assets and liabilities:
Change in receivable for securities sold	54		—
Change in accrued investment income	27		17
Change in reinsurance recoverable	(8)		1,446
Policy acquisition costs deferred	(1,968)		(1,880)
Change in accrued income taxes	(1,333)		470
Change in net policy liabilities and claims	1,527		(485)
Change in other assets/liabilities, net	(261)		472
Other, net	(13)		5
Net cash provided by (used in) operating activities	(5,282)		1,456
Cash Flows from Investing Activities
Purchase of:
Available-for-sale securities	(13,194)		(9,925)
Trading securities and short-term investments	(2)		(26)
Property and equipment	(32)		(3)
Proceeds from sale or maturities of:
Held-to-maturity securities	138		62
Available-for-sale securities	15,739		6,650
Real estate held for investment	3		11
Other invested assets, net	9		2,014
Net cash provided by (used in) investing activities	2,661		(1,217)
Cash Flows from Financing Activities
Change in other policyholder funds	(24)		(35)
Dividends paid	(304)		(253)
Net cash used in financing activities	(328)		(288)
Net change in cash and cash equivalents	(2,949)		(49)
Cash and cash equivalents, beginning of year	11,809		5,676
Cash and cash equivalents, end of period	$	8,860	$	5,627

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

9

Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

Principles of Consolidation and Basis of Presentation

The accompanying condensed 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, 2019, 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these condensed 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 condensed 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 2,530,745 at June 30, 2020 and 2,528,233 at June 30, 2019. The Company did not have any dilutive securities as of June 30, 2020 and 2019.

Reclassifications

Certain 2019 amounts have been reclassified from the prior year condensed consolidated financial statements to conform to the 2020 presentation.

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 June 30, 2020, the net amount exceeding FDIC insured limits was $4,644,000 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 June 30, 2020, the single largest balance due from one agent totaled $822,000.

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 June 30, 2020 and December 31, 2019, 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 June 30, 2020, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.

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Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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 (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.

Simplifying the Accounting for Income Taxes

In December 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance removes certain exceptions to general principles in the income tax guidance and amends existing guidance to improve consistent application. The guidance is effective for fiscal years beginning after December 15, 2020. The Company is currently evaluating the impact of this new guidance. The Company does not expect the adoption 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, 2023 and interim periods within those fiscal years beginning after December 15, 2024. 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

Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued guidance that removes, modifies and adds to the disclosure requirements related to fair value measurements. The guidance removes the requirements to disclose the amount and reasons for transfers between Level 1 and Level 2 assets, the policy for timing and transfers between levels and the valuation process for Level 3 fair value measurements. The guidance modifies disclosure requirements for investments in certain entities that calculate net asset value and clarifies the purpose of the measurement uncertainty disclosure. The guidance adds requirements to disclose changes in unrealized gains or losses included in other comprehensive income for recurring Level 3 fair value measurements and to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The Company adopted this guidance on January 1, 2020. The adoption of this guidance did not have a material impact on its financial position or results of operations.

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Table of Contents

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

Contingent Put and Call Options in Debt Instruments

In March 2016, the FASB issued guidance that clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those years. The Company adopted this guidance on January 1, 2020. The adoption of this guidance did not have a material impact on its financial position or results of operations.

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 $375,000 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.

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 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. Changes in fair value of equity securities are reported in investment gains/losses as a component of net income.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

The amortized cost and aggregate fair values of investments in available-for-sale securities as of June 30, 2020 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	$	4,561	$	356	$	—	$	4,917
Agency mortgage backed securities	27,761		1,489		15		29,235
Asset backed securities	9,570		102		499		9,173
Private label mortgage backed securities	8,219		760		12		8,967
Corporate bonds	38,716		2,899		352		41,263
States, municipalities and political subdivisions	4,911		210		—		5,121
Foreign governments	835		112		—		947
Total Fixed Maturities	94,573		5,928		878		99,623
Equity securities	2,127		2,682		2		4,807
Total	$	96,700	$	8,610	$	880	$	104,430

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of June 30, 2020 are as follows:

($ in thousands) Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Agency mortgage backed securities	$	1,165	$	100	$	—	$	1,265
Total	$	1,165	$	100	$	—	$	1,265

The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2019 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	$	4,131	$	150	$	—	$	4,281
Agency mortgage backed securities	32,283		861		157		32,987
Asset backed securities	10,307		71		104		10,274
Private label mortgage backed securities	6,815		441		4		7,252
Corporate bonds	36,074		1,816		70		37,820
States, municipalities and political subdivisions	6,669		109		1		6,777
Foreign governments	823		46		—		869
Total Fixed Maturities	97,102		3,494		336		100,260
Equity securities	2,127		3,176		—		5,303
Total	$	99,229	$	6,670	$	336	$	105,563

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2019 are as follows:

($ in thousands) Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Agency mortgage backed securities	$	1,290	$	55	$	—	$	1,345
Total	$	1,290	$	55	$	—	$	1,345

The amortized cost and aggregate fair value of debt securities at June 30, 2020, 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.

($ in thousands)	Amortized Cost		Fair Value
Available-for-sale securities:
Due in one year or less	$	760	$	754
Due after one year through five years	17,149		17,920
Due after five years through ten years	28,162		29,423
Due after ten years	48,502		51,526
Total	$	94,573	$	99,623
Held-to-maturity securities:
Due after one year through five years	$	23	$	24
Due after five years through ten years	4		4
Due after ten years	1,138		1,237
Total	$	1,165	$	1,265

A summary of securities available-for-sale with unrealized losses as of June 30, 2020, 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
June 30, 2020	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	$	1,251	$	7	$	7	$	8	$	1,258	$	15	3
Asset backed securities	3,924		277		1,259		222		5,183		499		7
Private label mortgage backed securities	935		12		—		—		935		12		1
Corporate bonds	5,718		338		486		14		6,204		352		12
Equity securities	6		2		—		—		6		2		1
	$	11,834	$	636	$	1,752	$	244	$	13,586	$	880	24

There were no securities held-to-maturity with unrealized losses as of June 30, 2020.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

A summary of securities available-for-sale with unrealized losses as of December 31, 2019, 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, 2019	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	$	5,663	$	104	$	1,751	$	53	$	7,414	$	157	18
Asset backed securities	4,241		33		1,579		71		5,820		104		9
Private label mortgage backed securities	1,060		4		—		—		1,060		4		1
Corporate bonds	6,363		54		1,484		16		7,847		70		14
States, municipalities and political subdivisions	512		1		—		—		512		1		1
	$	17,839	$	196	$	4,814	$	140	$	22,653	$	336	43

There were no securities held-to-maturity with unrealized losses as of December 31, 2019.

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, net of taxes.

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, other than the impairment described below, the securities in an accumulated loss position in the portfolio were temporary impairments.

For the six months ended June 30, 2020, the Company realized no other-than-temporary impairments. For the year ended December 31, 2019, the Company realized no other-than-temporary impairments. At June 30, 2020, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $195,000, $133,000 and $114,000. After evaluation by management, it was determined that each of these losses were driven by changes in market interest rates and, in some cases, a lack of liquidity in some sectors driven by market dislocation in late March of 2020 associated with the initial market shocks from COVID-19. However, management currently has the intent and ability to hold these investments until recovery so no other-than-temporary impairments were recognized. At December 31, 2019, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $60,000, $23,000 and $20,000.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

Major categories of investment income are summarized as follows:

($ in thousands)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Fixed maturities	$	956	$	934	$	1,872	$	1,871
Equity securities	31		20		72		47
Mortgage loans on real estate	2		2		4		4
Investment real estate	—		1		1		3
Policy loans	36		35		72		69
Other	(26)		4		(22)		7
	999		996		1,999		2,001
Less: Investment expenses	38		39		74		82
Net investment income	$	961	$	957	$	1,925	$	1,919

Major categories of investment gains and losses are summarized as follows:

($ in thousands)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Realized gains on fixed maturities	$	133	$	5	$	16	$	15
Gains (losses) on trading securities	19		5		(6)		8
Change in fair value of equity securities	104		26		(495)		152
Change in surrender value of company owned life insurance	291		81		40		270
Realized gain on company owned life insurance	—		—		—		1,792
Other gains principally real estate	1		—		3		—
Net investment gains (losses)	$	548	$	117	$	(442)	$	2,237

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

($ in thousands)	June 30, 2020		December 31, 2019
Fixed maturities	$	1,892	$	4,910
Deferred income tax	(397)		(1,031)
Change in net unrealized gains on available-for-sale securities	$	1,495	$	3,879

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 condensed 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

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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 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 floating-rate notes, corporate bonds, and municipal bonds.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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, 2020 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	$	4,917	$	4,917	$	—	$	—
Agency mortgage backed securities	29,235		15,750		13,485		—
Asset backed securities	9,173		2,499		6,674		—
Corporate bonds	41,263		—		41,263		—
Private label asset backed securities	8,967		936		8,031		—
States, municipalities and political subdivisions	5,121		—		5,121		—
Foreign governments	947		947		—		—
Trading securities	145		145		—		—
Equity securities	4,807		3,405		—		1,402
Total Financial Assets	$	104,575	$	28,599	$	74,574	$	1,402
Financial Liabilities
Interest rate swap	$	(848)	$	—	$	—	$	(848)
Total Financial Liabilities	$	(848)	$	—	$	—	$	(848)

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.

Interest rate swaps — Interest rate swaps are recorded at fair value either as assets, within other assets or as liabilities, within other liabilities. The fair values of our interest rate swaps are provided by a third-party broker and are classified within Level 3.

As of June 30, 2020, Level 3 fair value measurements of assets include $1,402,000 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 CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

As of June 30, 2020, Level 3 fair value measurements of liabilities include $848,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party that utilizes financial modeling tools and assumptions on interest and other factors. The Company does not develop the unobservable inputs used in measuring fair value. Additional information regarding the interest rate swap agreements is provided in Note 7.

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, 2020:

($ in thousands) For the six months ended June 30, 2020	Equity Securities		Interest Rate Swap
Beginning balance	$	1,315	$	(65)
Total gains or losses (realized and unrealized):
Included in earnings	87		—
Included in other comprehensive income	—		(783)
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,402	$	(848)
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, 2020:	$	—	$	—

For the six months ended June 30, 2020, 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, 2019 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	$	4,281	$	4,281	$	—	$	—
Agency mortgage backed securities	32,987		19,330		13,657		—
Asset backed securities	10,274		2,601		7,673		—
Corporate bonds	37,820		—		37,820		—
Private label asset backed securities	7,252		1,060		6,192		—
States, municipalities and political subdivisions	6,777		—		6,777		—
Foreign governments	869		869		—		—
Trading securities	149		149		—		—
Equity securities available-for-sale	5,303		3,988		—		1,315
Total Financial Assets	$	105,712	$	32,278	$	72,119	$	1,315
Financial Liabilities
Interest rate swap	$	(65)	$	—	$	—	$	(65)
Total Financial Liabilities	$	(65)	$	—	$	—	$	(65)

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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, 2019:

($ in thousands) For the year ended December 31, 2019	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	1,125	$	(234)
Total gains or losses (realized and unrealized):
Included in earnings	645		—
Included in other comprehensive income	—		169
Purchases:	—		—
Sales:	(455)		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,315	$	(65)
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, 2019:	$	—	$	—

For the year ended December 31, 2019, there were no assets or liabilities measured at fair values on a nonrecurring basis.

The Company is exposed to certain risks in the normal course of its business operations.  The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings.  This risk is managed through the use of interest rate swap agreements 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 swap agreements.

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 CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

The carrying amount and estimated fair value of the Company’s financial instruments as of June 30, 2020 and December 31, 2019 are as follows:

($ in thousands)	June 30, 2020				December 31, 2019
Assets and related instruments	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Held-to-maturity securities	$	1,165	$	1,265	$	1,290	$	1,345
Mortgage loans	146		146		147		147
Policy loans	1,887		1,887		1,895		1,895
Company owned life insurance	4,695		4,695		4,655		4,655
Other invested assets	2,146		2,146		2,280		2,280
Liabilities and related instruments
Other policyholder funds	1,326		1,326		1,350		1,350
Short-term notes payable and current portion of long-term debt	500		500		500		500
Long-term debt	13,671		13,671		13,664		13,664

NOTE 5 – PROPERTY AND EQUIPMENT

Major categories of property and equipment are summarized as follows:

($ in thousands)	June 30, 2020		December 31, 2019
Building and improvements	$	3,472	$	3,472
Electronic data processing equipment	1,501		1,470
Furniture and fixtures	483		483
	5,456		5,425
Less accumulated depreciation	3,854		3,795
Property and equipment, net	$	1,602	$	1,630

Depreciation expense for the six months ended June 30, 2020 was $60,000 ($124,000 for the year ended December 31, 2019).

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 2014. Tax returns have been filed through the year 2018.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The Company recognized a net deferred tax liability positions of $130,000 at June 30, 2020 and $96,000 at December 31, 2019.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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

($ in thousands)	As of June 30, 2020		As of December 31, 2019
General expenses	$	1,249	$	1,269
Unearned premiums	1,407		1,288
Claims liabilities	633		645
Impairment on real estate owned	109		119
Unrealized losses on trading securities	1		—
Unrealized loss on interest rate swaps	178		14
Deferred tax assets	3,577		3,335
Unrealized gains on trading securities	—		(1)
Depreciation	(90)		(93)
Deferred policy acquisition costs	(1,630)		(1,610)
Pre-1984 policyholder surplus account	(364)		(397)
Unrealized gains on securities available-for-sale	(1,060)		(663)
Unrealized gains on equity securities	(563)		(667)
Deferred tax liabilities	(3,707)		(3,431)
Net deferred tax liability	$	(130)	$	(96)

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

($ in thousands)	Six months ended June 30,
	2020		2019
Deferred policy acquisition costs	$	20	$	13
Other-than-temporary impairments	10		—
Trading securities	(2)		1
Unearned premiums	(119)		(91)
General expenses	20		(75)
Depreciation	(3)		(4)
Claims liabilities	12		(13)
Impact of repeal of special provision on pre-1984 policyholder surplus	(33)		(33)
Unrealized gains (losses) on equity securities	(104)		32
Deferred income tax benefit	$	(199)	$	(170)

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 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:

	Six months ended June 30,
	2020		2019
Federal income tax rate applied to pre-tax income (loss)	21.0	%	21.0	%
Dividends received deduction and tax-exempt interest	0.1	%	(0.5)	%
Company owned life insurance	0.1	%	(24.3)	%
Other, net	0.3	%	(0.2)	%
Effective federal income tax rate	21.5	%	(4.0)	%

NOTE 7 – NOTES PAYABLE AND LONG-TERM DEBT

Short-term debt and current portion of long-term debt consisted of the following as of June 30, 2020 and December 31, 2019:

($ in thousands)	June 30,		December 31,
	2020		2019
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 June 30, 2020 and December 31, 2019:

($ in thousands)	June 30,		December 31,
	2020		2019
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.	$	1,500	$	1,500
Subordinated debentures issued on December 15, 2005 with floating rate interest equal to 3-Month LIBOR plus 375 basis points; net of $145,000 in debt issuance cost ($150,000 in 2019); maturity December 15, 2035.  Interest payable quarterly.  Redeemable prior to maturity. Unsecured.	9,134		9,129
Subordinated debentures issued on June 21, 2007 with floating rate interest equal to 3-Month LIBOR plus 340 basis points; net of $56,000 in debt issuance cost ($58,000 in 2019); maturity June 15, 2037. Interest payable quarterly.  Redeemable prior to maturity. Unsecured.	3,037		3,035
	$	13,671	$	13,664

The Company has entered into various swap agreements related to the trust preferred securities. On February 26, 2020, the Company entered into a forward swap effective March 16, 2020, with a notional amount of $3,000,000 and designated the swap as a hedge against changes in cash flows attributable to changes in the benchmark interest rate (LIBOR) associated with the subordinated debentures issued June 21, 2007. Quarterly, commencing June 15, 2020, under the terms of the forward swap, the Company pays interest at a fixed rate of 4.93% until March 15, 2030. On February 26, 2020, the Company entered into a forward swap with a notional amount of $9,000,000 effective March 16, 2020, which hedges against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing June 15, 2020 under the terms of the forward swap, the Company pays interest at a fixed rate of 5.28% until March 15, 2030. On May 26, 2010, the Company entered into a forward swap with a

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

notional amount of $9,000,000 effective December 15, 2015, which hedges against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company paid interest at a fixed rate of 8.49% until March 15, 2020.

The interest rate swaps have fair values of $212,000 (liability) and $636,000 (liability), respectively, for a total liability of $848,000 at June 30, 2020 ($65,000 at December 31, 2019).  The swap liability is reported as a component of other liabilities on the condensed consolidated balance sheets.  A net valuation loss of $619,000 (net of tax) is included in accumulated other comprehensive income related to the swap agreements at June 30, 2020.  A net valuation gain of $134,000 (net of tax) was included in accumulated other comprehensive income related to the swap at December 31, 2019.

We use dollar offset at the hedge's inception and for each reporting period thereafter to assess whether the derivative used in a hedging transaction is expected to be, and has been, effective in offsetting changes in the fair value of the hedged item. Since inception, no portion of the hedged item has been deemed ineffective. For all hedges, we discontinue hedge accounting if it is determined that a derivative is not expected to be, or has ceased to be, effective as a hedge.

The Company’s interest rate swaps include provisions requiring the Company to post collateral when the derivative is in a net liability position.  At June 30, 2020, the Company has securities on deposit with fair market values of $1,228,000 (all of which is posted as collateral). At December 31, 2019, the Company had securities on deposit with fair market values of $294,000 (all of which was posted as collateral). See Note 4 for additional information about the interest rate swaps.

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.

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

($ in thousands)	Six months ended June 30,
	2020		2019
Summary of claims and claim adjustment expense reserves
Balance, beginning of year	$	7,199	$	8,208
Less reinsurance recoverable on unpaid losses	249		1,384
Net balances at beginning of year	6,950		6,824
Net losses:
Provision for claims and claim adjustment expenses for claims arising in current year	25,956		18,491
Estimated claims and claim adjustment expenses for claims arising in prior years	(544)		(943)
Total increases	25,412		17,548
Claims and claim adjustment expense payments for claims arising in:
Current year	21,320		14,392
Prior years	3,889		3,162
Total payments	25,209		17,554
Net balance at end of period	7,153		6,818
Plus reinsurance recoverable on unpaid losses	230		202
Claims and claim adjustment expense reserves at end of period	$	7,383	$	7,020

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

Claims and claim adjustment expense reserves before reinsurance recoverable at June 30, 2020 were up moderately compared to the same period last year. An increase in spring storm activity in the second quarter of 2020 was the primary factor contributing to the increase in end of period claims and claim adjustment expense reserves at June 30, 2020 compared to June 30, 2019. The estimate for claims arising in prior years was reduced $544,000 in 2020 (reduced $943,000 in 2019) 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 $369,000 at June 30, 2020 ($417,000 at December 31, 2019). These claims are a component of policy and contract claims which totaled $965,000 at June 30, 2020 ($1,053,000 at December 31, 2019).

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.

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
Underlying 2nd Event	100% of $2,000,000 in excess of $2,000,000 retention

Each reinsurance layer covers events occurring from January 1 through December 31 of the contract year.  All significant reinsurance companies under the program carry A.M. 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.

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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 June 30, 2020, the largest reinsurance recoverable of a single reinsurer was $10,000 ($10,000 at December 31, 2019). 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 six months ended June 30, 2020 and 2019 amounted to $92,000 and $90,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limits.

The Company established a non-qualified 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 six months ended June 30, 2020 and 2019 amounted to an approximate decrease of $31,000 and increase of $346,000 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 contributions of $100,000 during the six months ended June 30, 2020 and no contributions were made during the six months ended June 30, 2019. 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.

NOTE 11 – SHAREHOLDERS' EQUITY

During the six months ended June 30, 2020 and year ended December 31, 2019, changes in shareholders' equity consisted of net loss of $5,586,000 and net income of $4,067,000, respectively; dividends paid of $304,000 in 2020 and $531,000 in 2019; other comprehensive income of $876,000 in 2020 and $4,013,000 in 2019; common stock issued of $25,000 in 2020 and $53,000 in 2019; and the purchase of treasury shares of $21,000 in 2020 and $7,000 2019.  Other comprehensive income/loss consisted of changes in accumulated unrealized gains/losses on securities available-for-sale and changes in accumulated unrealized losses on interest rate swaps.

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

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

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 June 30, 2020 and December 31, 2019:

	June 30, 2020
	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	2,533,315	1,867	2,531,448

	December 31, 2019
	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	2,531,552	436	2,531,116

On May 22, 2020, 1,763 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 expires November 30, 2020.

During the six months ended June 30, 2020, the Company purchased 1,431 shares of common stock and which were placed in treasury stock. During the year ended December 31, 2019, the Company purchased 436 shares of common stock which were placed in treasury stock.

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 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)	Six months ended June 30,
	2020		2019
Unrealized Gains (Losses) on Cash Flow Hedges
Balance at beginning of period	$	(51)	$	(185)
Other comprehensive income (loss) for period:
Other comprehensive gain (loss) before reclassifications	(619)		45
Net current period other comprehensive income (loss)	(619)		45
Balance at end of period	$	(670)	$	(140)
Unrealized Gains (Losses) on Available-for-Sale Securities
Balance at beginning of period	$	2,494	$	(1,385)
Other comprehensive income (loss) for period:
Other comprehensive income (loss) before reclassifications	1,508		3,498
Amounts reclassified from accumulated other comprehensive income (loss)	(13)		(12)
Net current period other comprehensive income	1,495		3,486
Balance at end of period	$	3,989	$	2,101
Total Accumulated Other Comprehensive Income at end of period	$	3,319	$	1,961

The following table presents the amounts reclassified out of AOCI for the six months ended June 30, 2020:

($ 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 and Losses on Available-for-Sale Securities	$	16	Net investment gains
	16		Total before tax
	(3)		Tax expense
	$	13	Net of Tax

The following table presents the amounts reclassified out of AOCI for the six months ended June 30, 2019:

($ 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 and Losses on Available-for-Sale Securities	$	15	Net investment gains
	15		Total before tax
	(3)		Tax expense
	$	12	Net of Tax

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 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 June 30, 2020 and December 31, 2019 are summarized below:

($ in thousands) Assets by industry segment	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations
June 30, 2020	$	152,717	$	81,847	$	66,313	$	4,557
December 31, 2019	$	153,934	$	83,917	$	65,605	$	4,412

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

Net income (loss) by business segment for the three months ended June 30, 2020 and 2019 is summarized below:

($ in thousands) Three months ended June 30, 2020	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter- company Eliminations		Total
REVENUE
Net premiums earned	$	13,688	$	1,484	$	—	$	—	$	15,172
Net investment income	355		726		15		(135)		961
Investment gains	453		76		19		—		548
Other income	142		329		291		(619)		143
	14,638		2,615		325		(754)		16,824
BENEFITS AND EXPENSES
Policyholder benefits paid	15,822		1,124		—		(210)		16,736
Amortization of deferred policy acquisition costs	681		167		—		—		848
Commissions	1,990		57		—		—		2,047
General and administrative expenses	2,065		442		530		(544)		2,493
Taxes, licenses and fees	557		37		—		—		594
Interest expense	—		10		189		—		199
	21,115		1,837		719		(754)		22,917
Income (Loss) Before Income Taxes	(6,477)		778		(394)		—		(6,093)
INCOME TAX EXPENSE (BENEFIT)	(1,422)		137		(82)		—		(1,367)
Net Income (Loss)	$	(5,055)	$	641	$	(312)	$	—	$	(4,726)

($ in thousands) Three months ended June 30, 2019	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter-company Eliminations		Total
REVENUE
Net premiums earned	$	13,467	$	1,523	$	—	$	—	$	14,990
Net investment income	442		639		11		(135)		957
Investment gains	18		83		16		—		117
Other income	146		217		284		(501)		146
	14,073		2,462		311		(636)		16,210
BENEFITS AND EXPENSES
Policyholder benefits paid	9,566		1,448		—		(114)		10,900
Amortization of deferred policy acquisition costs	681		158		—		—		839
Commissions	1,920		58		—		—		1,978
General and administrative expenses	2,196		467		275		(522)		2,416
Taxes, licenses and fees	539		60		—		—		599
Interest expense	—		11		280		—		291
	14,902		2,202		555		(636)		17,023
Income (Loss) Before Income Taxes	(829)		260		(244)		—		(813)
INCOME TAX EXPENSE (BENEFIT)	(192)		23		(57)		—		(226)
Net Income (Loss)	$	(637)	$	237	$	(187)	$	—	$	(587)

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 AMOUNTS)

Net income (loss) by business segment for the six months ended June 30, 2020 and 2019 is summarized below:

($ in thousands) Six months ended June 30, 2020	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter- company Eliminations		Total
REVENUE
Net premiums earned	$	27,210	$	2,917	$	—	$	—	$	30,127
Net investment income	780		1,389		26		(270)		1,925
Investment gains (losses)	15		(451)		(6)		—		(442)
Other income	287		587		522		(1,108)		288
	28,292		4,442		542		(1,378)		31,898
BENEFITS AND EXPENSES
Policyholder benefits paid	25,413		2,262		—		(356)		27,319
Amortization of deferred policy acquisition costs	1,362		551		—		—		1,913
Commissions	3,980		142		—		—		4,122
General and administrative expenses	3,886		842		181		(1,022)		3,887
Taxes, licenses and fees	1,176		139		—		—		1,315
Interest expense	—		19		441		—		460
	35,817		3,955		622		(1,378)		39,016
Income (Loss) Before Income Taxes	(7,525)		487		(80)		—		(7,118)
INCOME TAX EXPENSE (BENEFIT)	(1,590)		75		(17)		—		(1,532)
Net Income (Loss)	$	(5,935)	$	412	$	(63)	$	—	$	(5,586)

($ in thousands) Six months ended June 30, 2019	P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations		Inter-company Eliminations		Total
REVENUE
Net premiums earned	$	26,728	$	2,980	$	—	$	—	$	29,708
Net investment income	851		1,314		24		(270)		1,919
Investment gains	2,041		177		19		—		2,237
Other income	282		463		519		(972)		292
	29,902		4,934		562		(1,242)		34,156
BENEFITS AND EXPENSES
Policyholder benefits paid	17,548		2,613		—		(238)		19,923
Amortization of deferred policy acquisition costs	1,362		457		—		—		1,819
Commissions	3,876		135		—		—		4,011
General and administrative expenses	4,130		940		682		(1,004)		4,748
Taxes, licenses and fees	1,131		155		—		—		1,286
Interest expense	—		21		565		—		586
	28,047		4,321		1,247		(1,242)		32,373
Income (Loss) Before Income Taxes	1,855		613		(685)		—		1,783
INCOME TAX EXPENSE (BENEFIT)	(43)		119		(149)		—		(73)
Net Income (Loss)	$	1,898	$	494	$	(536)	$	—	$	1,856

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(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 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 and six months ended June 30, 2020 and 2019, respectively:

($ in thousands)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Life, accident and health operations premiums written:
Traditional life insurance	$	1,025	$	1,032	$	2,083	$	2,089
Accident and health insurance	385		348		792		753
Gross life, accident and health	1,410		1,380		2,875		2,842
Reinsurance premium ceded	(22)		(15)		(57)		(53)
Net life, accident and health premiums written	$	1,388	$	1,365	$	2,818	$	2,789
Property and Casualty operations premiums written:
Dwelling fire & extended coverage	$	11,142	$	10,411	$	21,394	$	20,339
Homeowners (Including mobile homeowners)	5,893		5,892		10,728		10,863
Other liability	612		607		1,191		1,182
Gross property and casualty	17,647		16,910		33,313		32,384
Reinsurance premium ceded	(1,783)		(1,927)		(3,548)		(3,225)
Net property and casualty written	$	15,864	$	14,983	$	29,765	$	29,159
Consolidated gross premiums written	$	19,057	$	18,290	$	36,188	$	35,226
Reinsurance premium ceded	(1,805)		(1,942)		(3,605)		(3,278)
Consolidated net premiums written	$	17,252	$	16,348	$	32,583	$	31,948

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 and six months ended June 30, 2020 and 2019, respectively:

($ in thousands)	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,121	$	1,151	$	2,187	$	2,241
Accident and health insurance	385		387		787		792
Gross life, accident and health	1,506		1,538		2,974		3,033
Reinsurance premium ceded	(22)		(15)		(57)		(53)
Net life, accident and health premiums earned	$	1,484	$	1,523	$	2,917	$	2,980
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	9,836	$	9,477	$	19,488	$	18,757
Homeowners (Including mobile homeowners)	5,080		5,211		10,161		10,407
Other liability	555		553		1,109		1,094
Gross property and casualty	15,471		15,241		30,758		30,258
Reinsurance premium ceded	(1,783)		(1,774)		(3,548)		(3,530)
Net property and casualty earned	$	13,688	$	13,467	$	27,210	$	26,728
Consolidated gross premiums earned	$	16,977	$	16,779	$	33,732	$	33,291
Reinsurance premium ceded	(1,805)		(1,789)		(3,605)		(3,583)
Consolidated net premiums earned	$	15,172	$	14,990	$	30,127	$	29,708

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2019 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's property & casualty subsidiaries had one action remaining in Texas filed in the aftermath of Hurricane Ike which was favorably resolved in the second quarter of 2020 with no material impact on these consolidated financial statements.

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. There are no individual actions deemed material by management based upon evaluation of information presently available.

NOTE 15 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest during the six months ended June 30, 2020 was $419,000 ($518,000 in 2019). There was no cash received or paid from income taxes during the six months ended June 30, 2020. Cash received from income taxes during the six months ended June 30, 2019 was $373,000.

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

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 June 30, 2020, and the related condensed consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity for the three-month and six-month periods ended June 30, 2020 and 2019, and the condensed consolidated statements of cash flows for the six-month periods then ended, 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, 2019, 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 19, 2020, 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, 2019, 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

Birmingham, Alabama

August 13, 2020

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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 condensed 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 and six month periods ended June 30, 2020 and 2019 and should be read in conjunction with the 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, 2019, 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 63.5% 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 91.2% of gross earned premium for the six month period ended June 30, 2020.  The P&C segment operates in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.  

•The Life segment accounted for 8.8% of gross premium revenue for the six month period ended June 30, 2020. 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 A.M. Best Co (Best). On April 21, 2020, A. M. 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, A.M. Best affirmed the FSR of B+ (Good) and Long-Term ICR of "bbb-" of Omega. The A.M. Best outlook for the ratings is "stable" for NSFC and Omega. A.M. Best upgraded the FSR to B++ (Good) and the Long-Term ICR to "bbb" for NSIC. The outlook for the ratings of NSIC is "stable". A.M. Best also affirmed the Long-Term ICR of "bb" of the parent holding company, NSEC, with a "stable" outlook.

The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On May 21, 2020, 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.

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These storm systems or other natural disasters are 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.

In order to present information as analyzed by Company management, the P&C segment combined ratio in this Management Discussion and Analysis is presented before certain intercompany eliminations. These intercompany eliminations, which are presented in Note 13 to the Condensed Consolidated Financial Statements, primarily include management and service fees paid by each subsidiary to NSEC, along with fees and expenses of the Company's employee claims adjusters. Claims adjusters are employees of NSIC but provide claim adjustment services to NSFC at rates comparable to those paid to independent (non-employee) adjusters utilized by NSFC. Management believes that the analysis of the P&C segment combined ratio prior to elimination of the intercompany transactions provides a more realistic view of performance and is consistent with our internal evaluation of operating performance.

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 June 30, 2020, the Company had a net loss of $4,726,000, $1.87 loss per share, compared to a net loss of $587,000, $0.23 loss per share, for the three months ended June 30, 2019; a quarterly decline of $4,139,000. The increase in net loss was driven by an increase in claims; primarily in the P&C segment. Pretax loss from operations for the second quarter of 2020 totaled $6,641,000 compared to a pretax loss from operations of $930,000 in the second quarter of 2019. The primary reason for the $5,711,000 increase in pretax loss from operations in the second quarter of 2020, compared to the same period in 2019, was a $5,836,000 increase in policyholder claims.

The Company ended the second quarter of 2020 with claims totaling $16,736,000 compared to $10,900,000 for the same period last year. The P&C segment was the primary source of this increase with claims, up $6,256,000 in second quarter 2020 compared to second quarter 2019. The primary component of this increase was claims reported from catastrophe events which increased $7,831,000, in the second quarter of 2020, compared to the same period last year.

For the six months ended June 30, 2020, the Company had a net loss of $5,586,000, $2.21 loss per share, compared to a net income of $1,856,000, $0.73 income per share, for the six months ended June 30, 2019. The year to date pretax loss from operations, in 2020, totaled $6,676,000 compared to a pretax loss from operations of $454,000 in 2019. The primary reason for the $6,222,000 increase in pretax loss from operations in 2020, compared to the same period in 2019, was a $7,396,000 increase in policyholder benefits; primarily driven by an increase in claims in the P&C segment. Results for the first six months of 2020 were negatively impacted by investment losses and increased claim activity in the P&C segment. Results for the first six months of 2019 were positively impacted by investment gains of $2,237,000.

For the six months ended June 30, 2020, the Company had claims totaling $27,319,000 compared to $19,923,000 for the same period last year. The P&C segment was the primary source of this increase with claims up $7,865,000 in 2020, compared to 2019. The primary component of this increase was claims reported from catastrophe events which increased $9,128,000 for the six months ended June 30 2020, compared to the same period in 2019. Partially offsetting the increase in claims was a decrease in general and administrative expenses. The Company ended the first six months of 2020 with a decrease in general and administrative expenses of $861,000 compared to the same period last year. The primary reason for this decrease was a decline in the company's liability in deferred compensation plans and actuarial fees.

For the six months ended June 30, 2020, the Company had investment losses of $442,000 compared to investment gains of $2,237,000 for the same period in 2019; a decrease of $2,679,000. The primary reason for the investment losses, in 2020, was a $495,000 loss due to change in value of equity securities compared to a gain due to change in value of equity securities of $152,000 for the same period last year. In addition, in 2019, we had a gain on our COLI investment totaling $1,792,000 which was the primary contributor to investment gains for the six months ended June 30, 2019.

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Financial results for the three and six months ended June 30, 2020 and 2019 were as follows:

Unaudited Consolidated Financial Summary	Three months ended June 30,				Six months ended June 30,
($ in thousands, except per share)	2020		2019		2020		2019
Gross premiums written	$	19,057	$	18,290	$	36,188	$	35,226
Net premiums written	$	17,252	$	16,348	$	32,583	$	31,948
Net premiums earned	$	15,172	$	14,990	$	30,127	$	29,708
Net investment income	961		957		1,925		1,919
Net investment gains (losses)	548		117		(442)		2,237
Other income	143		146		288		292
Total Revenues	16,824		16,210		31,898		34,156
Policyholder benefits and settlement expenses	16,736		10,900		27,319		19,923
Amortization of deferred policy acquisition costs	848		839		1,913		1,819
Commissions	2,047		1,978		4,122		4,011
General and administrative expenses	2,493		2,416		3,887		4,748
Taxes, licenses and fees	594		599		1,315		1,286
Interest expense	199		291		460		586
Total Benefits, Losses and Expenses	22,917		17,023		39,016		32,373
Income (Loss) Before Income Taxes	(6,093)		(813)		(7,118)		1,783
Income tax benefit	(1,367)		(226)		(1,532)		(73)
Net Income (Loss)	$	(4,726)	$	(587)	$	(5,586)	$	1,856
Income (Loss) Per Common Share	$	(1.87)	$	(0.23)	$	(2.21)	$	0.73
Reconciliation of Net Loss to non-GAAP Measurement
Net income (loss)	$	(4,726)	$	(587)	$	(5,586)	$	1,856
Income tax benefit	(1,367)		(226)		(1,532)		(73)
Investment (gains) losses, net	(548)		(117)		442		(2,237)
Pretax Loss From Operations	$	(6,641)	$	(930)	$	(6,676)	$	(454)

We provide a reconciliation of net income to the non-GAAP measurement "pretax income (loss) 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 June 30, 2020, net premiums earned were up $182,000 at $15,172,000 compared to $14,990,000 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 $221,000 or 1.6%. The increase in P&C segment net earned premium was primarily attributable to a 3.8% increase in gross earned premium in our dwelling fire program due to rate increases in the program over the past twelve months. With the increased frequency of weather events over the past five years, the Company continues to increase rates in states and programs that have been most impacted by this persistent pattern of severe weather.

Investment Gains (Losses):

Investment gains for the three-month period ended June 30, 2020 were $548,000 compared to investment gains of $117,000 for the same period last year. Contributing to the second quarter 2020 gain, we had an increase in value of our equity investments totaling $104,000 compared to unrealized gains in equity investments of $26,000, in the second quarter of 2019. In addition, we had investment gains from an increase in underlying investments in our COLI of $291,000, in the second quarter of 2020, compared to $81,000 for the same period last year. Furthermore,

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in the second quarter of 2020, we had realized gains on sale of fixed maturities of $133,000 compared to $5,000 for the same period last year.

Net Income (Loss):

For the three months ended June 30, 2020, the Company had a net loss of $4,726,000, $1.87 loss per share, compared to a net loss of $587,000, $0.23 loss per share, for the same period last year. As mentioned previously, the primary reason for the increase in net loss in the second quarter 2020, compared to the second quarter 2019, was an increase in P&C segment claims driven by an increase in insured losses from cat events, primarily during the month of April. During April of 2020, the P&C segment was impacted by three cat events that were the primary reason for the elevated insured losses in the second quarter. These storm systems caused damage from strong winds, hail and tornadoes and accounted for $7,396,000 or 75.9% of all reported losses from catastrophe events during the second quarter of 2020. P&C segment catastrophe event losses were also the primary reason for the net loss in the second quarter of 2019.

Pretax Income (Loss) from Operations:

For the three months ended June 30, 2020, our pretax loss from operations was $6,641,000 compared to a pretax loss from operations of $930,000 for the three months ended June 30, 2019; an increase in pretax loss of $5,711,000. We experienced elevated weather related losses in both years, however, as discussed above, an increase in cat losses in our P&C segment was the primary reason for the higher loss from operations, in the second quarter of 2020, compared to the same period last year.

P&C Segment Combined Ratio:

The P&C segment ended the second quarter of 2020 with a GAAP basis combined ratio of 152.7%. Reported catastrophe losses totaled $9,739,000 for the quarter and added 70.4 percentage points to the combined ratio. In comparison, the P&C segment ended the second quarter of 2019 with a GAAP basis combined ratio of 109.5% with $1,908,000 in reported catastrophe losses increasing the combined ratio by 14.0 percentage points. Partially offsetting the increase in reported catastrophe losses in the second quarter of 2020 was a reduction in reported non-catastrophe wind and hail losses of $1,125,000. Reported non-catastrophe wind and hail losses for the second quarter of 2020 totaled $1,978,000 and added 14.3 percentage points to the second quarter 2020 combined ratio. In comparison, second quarter 2019 reported non-catastrophe wind and hail losses totaled $3,103,000 and added 22.8 percentage points to the second quarter 2019 combined ratio. In addition, reported fire losses were down $484,000, in the second quarter of 2020, compared to the same period last year. Reported fire losses for the second quarter of 2020 totaled $3,019,000 and added 21.8 percentage points to the second quarter 2020 combined ratio. In comparison, second quarter 2019 reported fire losses totaled $3,503,000 and added 25.7 percentage points to the second quarter 2019 combined ratio.

Six-month period ended June 30, 2020 compared to six-month period ended June 30, 2019

Premium Revenue:

For the six-month period ended June 30, 2020, net premiums earned were up $419,000 at $30,127,000 compared to $29,708,000 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 $482,000 or 1.8%. The increase in P&C segment net earned premium was primarily attributable to a 3.9% increase in gross earned premium in our dwelling fire program due to rate increases in the program over the past twelve months. As mentioned previously, the increased frequency of weather related losses over the past five years has driven the need to increase rates in states and programs that have been most impacted by this persistent pattern of severe weather.

Investment Gains (Losses):

Investment losses for the si- month period ended June 30, 2020 were $442,000 compared to investment gains of $2,237,000 for the same period last year. The primary reason for the investment loss, in 2020, was a decline in value of our equity investments totaling $495,000 compared to an increase in value of equity investments of $152,000, in 2019. In the first six months of 2020, an increase in value of COLI investments totaled $40,000 compared to an increase of $270,000 for the same period last year. Investment gains in 2019 were also positively impacted by a realized gain on COLI of $1,792,000.

Net Income (Loss):

For the six months ended June 30, 2020, the Company had a net loss of $5,586,000, $2.21 loss per share, compared to net income of $1,856,000, $0.73 income per share, for the same period last year. As mentioned previously, the primary reason for the 2020 net loss, compared to the 2019 net income, was a significant increase in

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property and casualty insured losses. The increase in P&C subsidiary losses was primarily driven by an increase in catastrophe losses from severe weather events in April of 2020.

Pretax Income (Loss) from Operations:

For the six months ended June 30, 2020, our pretax loss from operations was $6,676,000 compared to a pretax loss from operations of $454,000 for the six months ended June 30, 2019; an increase in pretax loss of $6,222,000. As discussed above, an increase in claim activity in our P&C segment was the primary reason for the loss from operations, in the first six months of 2020, compared to the same period last year.

P&C Segment Combined Ratio:

The P&C segment ended the first six months of 2020 with a GAAP basis combined ratio of 130.3%. Reported catastrophe losses totaled $11,991,000 and added 43.6 percentage points to the combined ratio. In comparison, the P&C segment ended the first six months of 2019 with a GAAP basis combined ratio of 103.8% with $2,863,000 in reported catastrophe losses increasing the combined ratio by 10.6 percentage points. Partially offsetting the increase in reported catastrophe losses, in the first half of 2020, was a reduction in reported non-catastrophe wind and hail losses of $1,596,000. Reported non-catastrophe wind and hail losses for the first six months of 2020 totaled $3,588,000 and added 13.0 percentage points to the 2020 combined ratio. In comparison, non-catastrophe wind and hail losses reported during the first six months of 2019 totaled $5,184,000 and added 19.2 percentage points to the 2019 combined ratio.

COVID-19:

In March 2020, it became apparent that we would not be able to contain the spread of the COVID-19 virus in the United States and the adverse worldwide impact became more visible. The COVID-19 pandemic has had a profound impact on our daily living, the worldwide economy and global financial markets that would have been beyond comprehension at the start of 2020. Along with joining the global effort to slow the spread of COVID-19, our primary goals are to mitigate the impact of this disease on our staff and their families while continuing to provide excellent service to our policyholders and agents. Fortunately, the geographic location of our home office allows employees to easily commute without the use of public transportation and efficiency efforts of the past decade has allowed us to better utilize our office space to facilitate social distancing. To further mitigate risk of spread, we have facilitated the broader use of remote work arrangements. We have remained fully operational through "shelter in place", "safer at home" and similar directives. We have also limited staff travel deemed non-essential.

Our life subsidiary, NSIC, does have exposure to an increase in death claims associated with COVID-19. While we have paid death claims associated with COVID-19 we have not experienced a notable increase in the overall frequency of death claims. While the virus continues to pose some risk to increased claims in our life insurance operations, we believe this impact is mitigated due to our low leverage and small face value life insurance policies in-force. Our typical life insurance policy carries face amounts of $10,000 or less, though we do retain face amounts up to $50,000. We maintain reinsurance coverage in NSIC for whole life policies in excess of $50,000. To further mitigate risk during the pandemic, we have added additional underwriting procedures and limited new business sale promotions.

Changes in business practice and economic factors will continue to present the primary risk in our P&C operations. For our P&C subsidiary (NSFC), we do not have any exposure to business interruption, workers compensation or other commercial coverage types that could pose substantial increases in our risk profile or claims settlement practices. In the last two weeks of March, as COVID-19 emergency orders were put in place by most states in our coverage areas, new business application counts declined by approximately 50%. A similar decline continued into April with new business production down approximately 30% as most emergency orders in the states in which we operate were elevated to "shelter in place" or similar directives. These directives limited economic activity including consumer demand to seek new insurance coverage. While new business production has started to recover, the long-term economic uncertainty, including high levels of unemployment, could continue to impact our business. Along with new business production, a decrease in retention of existing business continue to be a concern.  As unemployment rates remain elevated it is inevitable that some of our policyholders will continue to be impacted by job loss.

The effects of the COVID-19 pandemic continue to evolve and we cannot predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted. We expect that the most significant impact on our financial condition and results of operations will likely result from developments in the overall economy and the effect on financial markets, the investments we hold, premiums and demand for our insurance products and our ability to collect insurance premiums. We believe our current capital and liquidity positions are

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adequate but the duration of this pandemic creates significant uncertainty surrounding the ultimate impact on our results of operations.

Overview - Balance Sheet highlights at June 30, 2020 compared to December 31, 2019

Selected Balance Sheet Highlights	June 30, 2020		December 31, 2019
($ in thousands, except per share)	UNAUDITED
Invested Assets	$	117,550	$	118,969
Cash	$	8,860	$	11,809
Total Assets	$	152,717	$	153,934
Policy Liabilities	$	81,617	$	78,472
Total Debt	$	14,171	$	14,164
Accumulated Other Comprehensive Income	$	3,319	$	2,443
Shareholders' Equity	$	48,451	$	53,461
Book Value Per Share	$	19.14	$	21.12

Invested Assets:

Invested assets as of June 30, 2020 were $117,550,000 compared to $118,969,000 as of December 31, 2019; a decrease of 1.2%. The decrease in invested assets was primarily due to the decline in market value of available-for-sale fixed maturity securities and equity securities during the first six months of 2020 compared to December 31, 2019. The market value of our available-for-sale fixed maturity securities decreased $3,018,000 as of June 30, 2020 compared to December 31, 2019.

Cash:

The Company, primarily through its insurance subsidiaries, had $8,860,000 in cash and cash equivalents at June 30, 2020, compared to $11,809,000 at December 31, 2019. Cash declined $2,949,000 in the first six months of 2020 primarily due to an increase in weather related losses in our P&C subsidiary and an increase of investments in fixed maturity securities in our investment portfolio.

Total Assets:

Total assets as of June 30, 2020 were $152,717,000 compared to $153,934,000 at December 31, 2019. The $2,949,000 decrease in cash was the primary contributor to the $1,217,000 decrease in total assets in the first six months of 2020 compared to total assets at December 31, 2019. This decrease was partially offset by a $1,635,000 increase in policy receivables and agents' balances.

Policy Liabilities:

Policy related liabilities were $81,617,000 at June 30, 2020, compared to $78,472,000 at December 31, 2019; an increase of $3,145,000 or 4.0%. The primary reason for the increase in policy liabilities was an increase in unearned premiums of $2,928,000. Due to the timing of insurance renewals and new business issuance across our entire book of P&C segment business, unearned premium tends to peak during the second and third quarters and decline during the fourth quarter when new policy issuance and annual policy renewals reach a seasonal low. This was the primary factor contributing to the increase in unearned premium at June 30, 2020 compared to December 31, 2019.

Debt Outstanding:

Total debt at June 30, 2020 was virtually unchanged at $14,171,000 compared to $14,164,000 at December 31, 2019.

Shareholders' Equity:

Shareholders' equity as of June 30, 2020 was $48,451,000, down $5,010,000, compared to December 31, 2019 Shareholders' equity of $53,461,000. Book value per share was $19.14 at June 30, 2020, compared to $21.12 per share at December 31, 2019; a decline of 9.4% or $1.98 per share. The primary factors contributing to the decrease in both book value per share and Shareholders' equity were a net loss of $5,586,000 and shareholder dividends paid of $304,000. Partially offsetting these decreases was accumulated other comprehensive income of $876,000. The accumulated comprehensive income was primarily driven by increases in market value of our corporate bond investments available-for-sale.

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Three Months Ended June 30, 2020 compared to Three Months Ended June 30, 2019

Premium Revenue:

The table below provides earned premium revenue by segment for the three months ended June 30, 2020 and 2019:

($ in thousands)	Three months ended June 30,				Percent
	2020		2019		increase (decrease)
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,121	$	1,151	(2.6)	%
Accident and health insurance	385		387		(0.5)	%
Gross life, accident and health	1,506		1,538		(2.1)	%
Reinsurance premium ceded	(22)		(15)		46.7	%
Net life, accident and health premiums earned	$	1,484	$	1,523	(2.6)	%
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	9,836	$	9,477	3.8	%
Homeowners (Including mobile homeowners)	5,080		5,211		(2.5)	%
Other liability	555		553		0.4	%
Gross property and casualty	15,471		15,241		1.5	%
Reinsurance premium ceded	(1,783)		(1,774)		0.5	%
Net property and casualty premiums earned	$	13,688	$	13,467	1.6	%
Consolidated gross premiums earned	$	16,977	$	16,779	1.2	%
Reinsurance premium ceded	(1,805)		(1,789)		0.9	%
Consolidated net premiums earned	$	15,172	$	14,990	1.2	%

Consolidated net premium earned was up 1.2% for the quarter ended June 30, 2020, at $15,172,000 compared to $14,990,000 for the same period last year. The increase in net premium earned was due to a 1.6% increase in net premium earned in the P&C segment. The increase in P&C segment net earned premium was primarily attributable to a 3.8% increase in gross earned premium in our dwelling fire program. Rate increases implemented in areas impacted by increased severe weather over the past five years was the primary driver of the increase in premium revenue.

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Investment Income:

The table below provides the major categories of investment income, primarily dividend and interest income, for the three months ended June 30, 2020 and 2019:

($ in thousands)	Three months ended June 30,
	2020		2019
Fixed maturities	$	956	$	934
Equity securities	31		20
Mortgage loans on real estate	2		2
Investment real estate	—		1
Policy loans	36		35
Company owned life insurance change in surrender value	—		—
Other	(26)		4
	999		996
Less: Investment expenses	38		$	39
Net investment income	$	961	$	957

For the three months ended June 30, 2020, net investment income was $961,000 compared to $957,000 for the same period in 2019; a slight increase of $4,000 or 0.4%.

Investment Gains (Losses):

The table below provides investment gains and losses for the three months ended June 30, 2020 and 2019:

($ in thousands)	Three months ended June 30,
	2020		2019
Realized gains on fixed maturities	$	133	$	5
Gains (losses) on trading securities	19		5
Change in fair value of equity securities	104		26
Change in surrender value of company owned life insurance	291		81
Other gains principally real estate	1		—
Net investment gains (losses)	$	548	$	117

Net investment gains, for the three months ended June 30, 2020, were $548,000 compared to net investment gains of $117,000 for the same period in 2019; an increase of $431,000. A primary reason for the increase in second quarter 2020 investment gains, compared to second quarter 2019 investment gains, was an increase in surrender value of our COLI investment of $210,000. In addition, in the second quarter of 2020, we had unrealized gains due to change in market value of our equity investments totaling $104,000 compared to unrealized gains in equity investments of $26,000 in the second quarter of 2019. In second quarter 2020, we also recognized an increase in realized gains on fixed maturities investments totaling $133,000 compared to $5,000 for the same period last year.

Other Income:

Other income was comparable at $143,000 for the three months ended June 30, 2020, compared to $146,000 for the same period last year; a decrease of $3,000. Other income consists primarily of fees related to the issuance of our property insurance policies as well as other miscellaneous income.

Policyholder Benefits:

Policyholder claims were $16,736,000 for the second quarter of 2020, compared to $10,900,000 for the same period last year; an increase of $5,836,000 or 53.5%. Claims as a percentage of premium earned was 110.3% in the second quarter of 2020 compared to 72.7% in the second quarter of 2019. The primary reason for the increase in claims was a $6,256,000 increase in P&C segment catastrophe weather claims. This increase was partially offset by a decrease in non-catastrophe weather claims totaling $1,125,000 and a decrease in fire losses totaling $484,000.

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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 June 30, 2020 and 2019:

For the three months ended June 30, 2020				For the three months ended June 30, 2019
($ in thousands) Catastrophe event	Reported Losses & LAE		Claim Count	Catastrophe event	Reported Losses & LAE		Claim Count
Cat 2012 (Jan 10-12)	$	18	3	Cat 1916 (Feb 23-26)	$	34	5
Cat 2014 (Feb 5-8)	—		2	Cat 1918 (Mar 3-4)	26		7
Cat 2016 (Mar 2-4)	48		10	Cat 1923 (Apr 12-15)	562		118
Cat 2018 (Mar 27-30)	357		35	Cat 1924 (Apr 17-20)	303		69
Cat 2019 (Apr 7-9)	177		30	Cat 1926 (Apr 30-May 2)	173		22
Cat 2020 (Apr 10-14)	3,808		543	Cat 1927 (May 7-10)	506		85
Cat 2021 (Apr 18-20)	1,915		294
Cat 2022 (Apr 21-24)	1,673		221
Cat 2023 (Apr 24-26)	100		19
Cat 2024 (Apr 27-30)	133		26
Cat 2025 (May 2-3)	220		30
Cat 2026 (May 4-5)	469		78
Cat 2028 (May 13-15)	110		25
Cat 2030 (May 20-24)	227		51
Cat 2037 (June 6-9)	278		58
Misc cats less than $100k	206		39	Misc cats less than $100k	304		72
Total Cat losses	$	9,739	1,464	Total Cat losses	$	1,908	378
Non-cat wind & hail	$	1,978	402	Non-cat wind & hail	$	3,103	705

During the second quarter of 2020, the P&C segment was impacted by 15 catastrophe events producing 1,464 policyholder claims totaling $9,739,000. In comparison, the P&C segment was impacted by 11 catastrophe events during the second quarter of 2019 from 378 claims totaling $1,908,000. During the second quarter of 2020, NSFC was negatively impacted by multiple severe weather events that contributed to elevated insured losses due to damage from strong winds, hail and tornadoes. April of 2020 was our most active month of any spring storm season since 2011, with six cat events occurring during the month. These six cat events impacted policyholders in every state in which our P&C subsidiary operates and generated $7,806,000 in insured losses during the second quarter of 2020 from 1,133 reported claims through June 30, 2020. These catastrophe events added 56.4 percentage points to the second quarter 2020 P&C combined ratio and accounted for 80.2% of all reported losses from catastrophe events during the second quarter of 2020. In comparison, in April of 2019, we incurred losses from five catastrophe events totaling $1,092,000 from 221 reported claims. The reported losses from these storms added 8 percentage points to the second quarter 2019 P&C combined loss ratio and accounted for 57.2% of all reported losses from catastrophe events during the second quarter of 2019.

Non-catastrophe wind and hail claims reported in the second quarter of 2020 totaled $1,978,000 compared to non-catastrophe wind and hail claims reported in the second quarter of 2019 totaling $3,103,000; a decrease of $1,125,000. During the second quarter of 2020, the P&C segment had 402 non-cat wind and hail claims reported (an average of $4,900 per claim) compared to 705 non-cat wind and hail claims reported during the second quarter of 2019 (an average of $4,400 per claim). Non-cat wind and hail claims reported during the second quarter of 2020 accounted for 12.5% of total P&C segment incurred losses in the current year and added 14.3 percentage points to the 2020 P&C segment combined ratio. Non-cat wind and hail claims reported during the second quarter of 2019 accounted for 32.4% of total P&C segment incurred losses in 2019 and added 22.8 percentage points to the 2019 P&C segment combined ratio.

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Reported fire losses in the second quarter of 2020 were down $484,000 or 13.8% compared to fire losses reported during the second quarter of 2019. The P&C segment had 93 fire losses reported in the second quarter of 2020 totaling $3,019,000 compared to 113 claims reported in the second quarter of 2019 totaling $3,503,000. The average cost per claim was $32,500 for fire losses reported in the second quarter of 2020 compared to $31,000 for fire losses reported in the second quarter of 2019. Fire losses reported during the second quarter of 2020 added 21.8 percentage points to the P&C segment combined ratio while fire losses reported during the second quarter of 2019 added 25.7 percentage points to the P&C segment combined ratio.

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

For the three months ended June 30, 2020, policy acquisition costs were $2,895,000 compared to $2,817,000 for the same period last year; an increase of $78,000. 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 19.1% in the second quarter of 2020 compared to 18.8% for the same period last year.

General Expenses:

General and administrative expenses were comparable at $2,493,000 in the second quarter of 2020, compared to $2,416,000 for the same period last year. As a percent of earned premium, general and administrative expenses were 16.4% and 16.1% at June 30, 2020 and 2019, respectively. The $77,000 increase in general and administrative expenses, in the second quarter of 2020, compared to the second quarter of 2019, was primarily due to a decline in actuarial fees.

Taxes, Licenses and Fees:

For the quarter ended June 30, 2020 and 2019, insurance taxes, licenses and fees were comparable at $594,000 and $599,000, respectively. As a percent of earned premium, insurance taxes, licenses and fees were 3.9% in the second quarter of 2020 and 4.0% in the second quarter of 2019.

Interest Expense:

Interest expense was $199,000 for the three months ended June 30, 2020, compared to $291,000 for the three months ended June 30, 2019. A reduction in total debt outstanding over the past twelve months was the primary factor contributing to the $92,000 decrease.

Income Taxes (Benefits):

For the three months ended June 30, 2020, the Company had a pretax loss of $6,093,000 compared to pretax loss of $813,000 for the same period last year. The $1,367,000 tax benefit for the second quarter of 2020 consisted of current tax benefit of $1,280,000 and deferred tax benefit of $87,000. The $226,000 tax benefit for 2019 consisted of current tax benefit of $148,000 and deferred tax benefit of $78,000. The effective tax rate for the second quarter of 2020 was 22.4% compared to 27.8% for the second quarter of 2019.

Net Income (Loss):

The Company ended the second quarter of 2020 with a net loss of $4,726,000 compared to a net loss of $587,000 for the same period last year. The primary factor contributing to the $4,139,000 increase in net loss was the $5,836,000 increase in second quarter 2020 policyholder benefits and settlement expenses, primarily in the P&C segment, mentioned previously.

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Six Months Ended June 30, 2020 compared to Six Months Ended June 30, 2019

Premium Revenue:

The table below provides earned premium revenue by segment for the six months ended June 30, 2020 and 2019:

($ in thousands)	Six months ended June 30,				Percent
	2020		2019		increase (decrease)
Life, accident and health operations premiums earned:
Traditional life insurance	$	2,187	$	2,241	(2.4)	%
Accident and health insurance	787		792		(0.6)	%
Gross life, accident and health	2,974		3,033		(1.9)	%
Reinsurance premium ceded	(57)		(53)		7.5	%
Net life, accident and health premiums earned	$	2,917	$	2,980	(2.1)	%
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	19,488	$	18,757	3.9	%
Homeowners (Including mobile homeowners)	10,161		10,407		(2.4)	%
Other liability	1,109		1,094		1.4	%
Gross property and casualty	30,758		30,258		1.7	%
Reinsurance premium ceded	(3,548)		(3,530)		0.5	%
Net property and casualty premiums earned	$	27,210	$	26,728	1.8	%
Consolidated gross premiums earned	$	33,732	$	33,291	1.3	%
Reinsurance premium ceded	(3,605)		(3,583)		0.6	%
Consolidated net premiums earned	$	30,127	$	29,708	1.4	%

Consolidated net premium earned was up 1.4% for the six month period ended June 30, 2020, at $30,127,000 compared to $29,708,000 for the same period last year. The increase in net premium earned was due to a 1.8% increase in net premium earned in the P&C segment. The increase in P&C segment net earned premium was primarily attributable to a 3.9% increase in gross earned premium in our dwelling fire program.

The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. With our 2020 catastrophe contract placement, our single event catastrophe retention remained unchanged from the prior year at $4 million. In our 2020 contract, we maintained our underlying second event layer of $2 million in excess of $2 million. 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 smaller 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 2020, 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.  Reinsurance coverage is maintained in three layers as follows:

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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
Underlying 2nd Event	100% of $2,000,000 in excess of $2,000,000 retention

Additional details regarding the structure of our 2020 catastrophe reinsurance program can be found in Note 9 to the Consolidated Financial Statements.

Investment Income:

The table below provides the major categories of investment income, primarily dividend and interest income, for the six months ended June 30, 2020 and 2019:

($ in thousands)	Six months ended June 30,
	2020		2019
Fixed maturities	$	1,872	$	1,871
Equity securities	72		47
Mortgage loans on real estate	4		4
Investment real estate	1		3
Policy loans	72		69
Other	(22)		7
	1,999		2,001
Less: Investment expenses	74		82
Net investment income	$	1,925	$	1,919

For the six months ended June 30, 2020, net investment income was $1,925,000 compared to $1,919,000 for the same period in 2019; a slight increase of $6,000 or 0.3%.

Investment Gains (Losses):

The table below provides investment gains and losses for the six months ended June 30, 2020 and 2019:

($ in thousands)	Six months ended June 30,
	2020		2019
Realized gains on fixed maturities	$	16	$	15
Gains (losses) on trading securities	(6)		8
Change in fair value of equity securities	(495)		152
Change in surrender value of company owned life insurance	40		270
Realized gain on company owned life insurance	—		1,792
Other gains principally real estate	3		—
Net investment gains (losses)	$	(442)	$	2,237

Net investment losses, for the six months ended June 30, 2020, were $442,000 compared to net investment gains of $2,237,000 for the same period in 2019; a decrease of $2,679,000. The primary reason for 2020 investment losses, compared to the 2019 investment gains, was a gain on COLI investment of $1,792,000 in the prior year. In addition, in the first six months of 2020, we had unrealized losses due to change in market value of our equity investments totaling $495,000 compared to unrealized gains in equity investments of $152,000 in the first six months of 2019.

Other Income:

Other income was comparable at $288,000 for the six months ended June 30, 2020, compared to $292,000 for the same period last year; a decrease of $4,000. Other income consists primarily of fees related to the issuance of our property insurance policies as well as other miscellaneous income.

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Policyholder Benefits:

Policyholder claims were $27,319,000 for the six months ended June 30, 2020, compared to $19,923,000 for the same period last year; an increase of $7,396,000 or 37.1%. Claims as a percentage of premium earned was 90.7% in 2020 compared to 67.1% in 2019. The primary reason for the increase in claims was a $9,128,000 increase in P&C segment catastrophe weather claims. This increase was partially offset by decreases in reported non-catastrophe weather claims and reported fire losses totaling $1,596,000 and $386,000, respectively.

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 six-month periods ended June 30, 2020 and 2019:

For the six months ended June 30, 2020				For the six months ended June 30, 2019
($ in thousands) Catastrophe event	Reported Losses & LAE		Claim Count	Catastrophe event	Reported Losses & LAE		Claim Count
Cat 2012 (Jan 10-12)	$	1,352	313	Cat 1916 (Feb 23-26)	$	296	81
Cat 2014 (Feb 5-8)	630		159	Cat 1918 (Mar 3-4)	719		72
Cat 2016 (Mar 2-4)	309		71	Cat 1923 (Apr 12-15)	562		118
Cat 2018 (Mar 27-30)	357		35	Cat 1924 (Apr 17-20)	303		69
Cat 2019 (Apr 7-9)	177		30	Cat 1926 (Apr 30-May 2)	173		22
Cat 2020 (Apr 10-14)	3,808		543	Cat 1927 (May 7-10)	506		85
Cat 2021 (Apr 18-20)	1,915		294
Cat 2022 (Apr 21-24)	1,673		221
Cat 2023 (Apr 24-26)	100		19
Cat 2024 (Apr 27-30)	133		26
Cat 2025 (May 2-3)	220		30
Cat 2026 (May 4-5)	469		78
Cat 2028 (May 13-15)	110		25
Cat 2030 (May 20-24)	227		51
Cat 2037 (June 6-9)	278		58
Misc cats less than $100k	233		49	Misc cats less than $100k	304		72
Total Cat losses	$	11,991	2,002	Total Cat losses	$	2,863	519
Non-cat wind & hail	$	3,588	816	Non-cat wind & hail	$	5,184	1,290

During the first six months of 2020, the P&C segment was impacted by 20 catastrophe events producing 2,002 policyholder claims totaling $11,991,000. In comparison, the P&C segment was impacted by 14 catastrophe events during the first six months of 2019 from 519 claims totaling $2,863,000. During 2020, the P&C segment had multiple severe weather events that contributed to elevated insured losses due to damage from strong winds, hail and tornadoes. Reported losses from three of these catastrophe events (all occurring in April) totaled $7,396,000 and accounted for 61.7% of all reported catastrophe event claims through June 30, 2020. The three April 2020 catastrophe events added 26.9 percentage points to the current year P&C segment combined ratio. In comparison, reported losses in the P&C segment from the three largest weather events in 2019 totaled $1,787,000 and accounted for 62.4% of all reported catastrophe event claims through June 30, 2019. The three largest catastrophe events in 2019 added 6.6 percentage points to the 2019 P&C segment combined ratio.

Non-catastrophe wind and hail claims reported in 2020 totaled $3,588,000 compared to non-catastrophe wind and hail claims reported in 2019 totaling $5,184,000; a decrease of $1,596,000. During the first six months of 2020, the P&C segment had 816 non-cat wind and hail claims reported (an average of $4,400 per claim) compared to 1,290 non-cat wind and hail claims reported during the first six months of 2019 (an average of $4,000 per claim). Non-cat wind and hail claims reported during 2020 accounted for 14.1% of total P&C segment incurred losses in the current year and added 13.0 percentage points to the 2020 P&C segment combined ratio. Non-cat wind and hail claims

47

reported during 2019 accounted for 29.5% of total P&C segment incurred losses in 2019 and added 19.2 percentage points to the 2019 P&C segment combined ratio.

Reported fire losses in the first six months of 2020 were down $386,000 or 5.6% compared to fire losses reported during the first six months of 2019. The P&C segment had 199 fire losses reported in 2020 totaling $6,559,000 compared to 235 claims reported in 2019 totaling $6,945,000. The average cost per claim was $33,000 for fire losses reported in 2020 compared to $29,600 for fire losses reported in 2019. Fire losses reported during 2020 added 23.9 percentage points to the P&C segment combined ratio while fire losses reported during 2019 added 25.7 percentage points to the P&C segment combined ratio.

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

For the six months ended June 30, 2020, policy acquisition costs were $6,035,000 compared to $5,830,000 for the same period last year; an increase of $205,000. 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 20.0% in the first six months of 2020 compared to 19.6% for the same period last year.

General Expenses:

General and administrative expenses were $3,887,000 in 2020 compared to $4,748,000 for the same period last year. As a percent of earned premium, general and administrative expenses were 12.9% and 16.0% at June 30, 2020 and 2019, respectively. The $861,000 decrease in general and administrative expenses, in 2020 compared to 2019, was primarily due to a decline in the company's liability in deferred compensation plans.

Taxes, Licenses and Fees:

Insurance taxes, licenses and fees were comparable at $1,315,000 for the six months ended June 30, 2020, compared to $1,286,000 for the same period in 2019; an increase of $29,000. As a percent of earned premium, insurance taxes, licenses and fees were 4.4% in the first six months of 2020 and 4.3% for the six months ended June 30, 2019.

Interest Expense:

Interest expense for the first six months of 2020 was $460,000 compared to $586,000 for the same period in 2019; a decrease of 21.5%. A reduction in total debt outstanding over the past twelve months was the primary factor contributing to the $126,000 decrease.

Income Taxes (Benefits):

For the six months ended June 30, 2020, the Company had a pretax loss of $7,118,000 compared to pretax income of $1,783,000 for the same period last year. The $1,532,000 tax benefit for 2020 consisted of current tax benefit of $1,333,000 and deferred tax benefit of $199,000. The $73,000 tax benefit for 2019 consisted of current tax expense of $97,000 and deferred tax benefit of $170,000. The effective tax rate for 2019 was significantly lower compared to 2020 due to the gain on COLI benefits received in 2019 which is not subject to federal income tax.

Net Income (Loss):

The Company ended the first six months of 2020 with a net loss of $5,586,000 compared to net income of $1,856,000 for the same period last year. The primary factor contributing to the $7,442,000 decrease was the $7,396,000 increase in policyholder benefits and settlement expenses, primarily in the P&C segment, mentioned previously.

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.

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

48

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 June 30, 2020, 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	$	760	$	—	$	760	0.79	%
Maturity in 1-5 years	17,149		23		17,172		17.94	%
Maturity in 5-10 years	28,162		4		28,166		29.42	%
Maturity after 10 years	48,502		1,138		49,640		51.85	%
	$	94,573	$	1,165	$	95,738	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 $4,755,000, or 4.8%, decline in the market value of fixed maturity investments. Alternatively, a 100 basis point decrease in interest rates will generate approximately $4,536,000, or 4.6%, 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 June 30, 2020, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $48,451,000, down $5,010,000, compared to $53,461,000 at December 31, 2019.  During the six months ended June 30, 2020, shareholders' equity was decreased by a net loss of $5,586,000, comprehensive income due to changes in value of fixed maturity securities of $1,495,000 and a comprehensive loss of $619,000 related to change in value of interest rate swaps. Equity was also increased by common stock issued of $25,000. Equity was reduced $21,000 by the purchase of 1,431 common stock shares held as treasury stock and by cash dividends paid totaling $304,000.

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 9% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.

The Company, primarily through its insurance subsidiaries, had $8,860,000 in cash and cash equivalents at June 30, 2020, compared to $5,627,000 at June 30, 2019. Cash used in operating activities decreased cash by $5,282,000 during the six months ended June 30, 2020. The decrease in cash from operating activities was primarily related to the net loss for the period which was triggered by an increase in claims and claims related expenses in the P&C segment. Cash provided by operating activities increased cash by $1,456,000 for the six months ended June 30, 2019. The increase in cash provided by operating activities in 2019 was primarily driven by

49

net income from operations and a refund of federal income taxes. Net cash provided by investing activities totaled $2,661,000 for the six months ended June 30, 2020, compared to cash used in investing activities of $1,217,000 in 2019. The increase in cash from investing activities was related to maturities and some increases in prepayments on mortgage backed securities. Net cash used in investing activities in 2019 primarily consisted of new investment in fixed maturity securities. Net cash used in financing activities totaled $328,000 for the six months ended June 30, 2020, compared to $288,000 for the same period last year. During the six months ended June 30, 2020, the Company paid $304,000 in dividends to shareholders. The Company maintains a $700,000 line of credit which matured in March of 2020 and the Company is currently undergoing the renewal process.

The Company had a total of $13,671,000 of long-term debt outstanding as of June 30, 2020, compared to $13,664,000 at December 31, 2019, 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, $201,000 and $208,000, 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 relatively little exposure to below investment grade fixed income investments, which might be especially subject to liquidity problems 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 maintains minimal liquidity in order to maximize liquidity within the insurance subsidiaries in order to support ongoing insurance operations. 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 P&C segment is 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.

Dividends paid 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 2019 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 2020 is statutorily limited to $1,624,000 in the life insurance subsidiary and $3,626,000 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 NSG. 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 NSG substantially below the above referenced regulatory maximums. The Company did not receive any dividends from its subsidiaries during the six months ended June 30, 2020.

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.

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The Company continues to monitor liquidity and subsidiary capital closely. Despite challenging weather patterns in the property and casualty subsidiaries over the past three years, the insurance subsidiaries are well capitalized. However, further strengthening of subsidiary capital continues to be a top priority for 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 $4,807,000. 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 June 30, 2020 value, the fair value of the Company's common stock investments would decrease by approximately $481,000.

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.

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. The extent of short and long term damage from the global shutdown due to this pandemic is currently unknown due to uncertainty surrounding both the duration of the pandemic and speed at which the US and global economies can recover from damage to date. The increased risk associated with the COVID-19 pandemic is difficult to quantify at this point due to these uncertainties.

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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 June 30, 2020. 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 six months ended June 30, 2020, 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 2019

Annual Report filed on Form 10-K.

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 2019 on Form 10-K. Risks related to the COVID-19 pandemic continue to evolve. Additional commentary is included in Part I, Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 3. - Quantitative and Qualitative Disclosures About Market Risk.

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

The following table sets forth information regarding the repurchase of shares of our common stock during the six months ended June 30, 2020:

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (a)	Approximate Dollar Value of Shares that May Yet be Purchased Under the Program (a)
Jan. 1 - Jan. 31, 2020	349	$	15.80	785	$	987,870
Feb. 1 - Feb. 29, 2020	—	—		785	$	987,870
Mar. 1 - Mar. 31, 2020	89	11.01		874	$	986,890
Apr. 1- Apr. 30, 2020	812	15.09		1,686	$	974,639
May 1 - May 21, 2020	33	14.74		1,719	$	974,153
Jun. 1 - Jun. 30, 2020	148	15.15		1,867	$	497,758

(a) On November 20, 2019, our Board of Directors authorized the repurchase of up to $1,000,000 of common stock. Under the repurchase program, the Company is authorized to repurchase shares in open market purchases as well as in privately negotiated transactions from time to time through May 31, 2020. On May 22, 2020, our Board of Directors authorized the repurchase of up to $500,000 of common stock. Under the repurchase program, the Company is authorized to repurchase shares in open market purchases as well as in privately negotiated transactions from time to time through November 30, 2020. Stock purchased under this program will be held as treasury stock and will be available for general corporate purposes. The repurchase program’s terms will comply with applicable securities laws and regulations, including Rule 10b-18 of the Securities Exchange Act of 1934, as amended. The program is also subject to market conditions, applicable legal requirements, alternative cash needs that may arise and other factors, as determined by Company management. The repurchase program does not obligate the Company to acquire a specific number of shares and may be suspended or terminated at any time. Repurchases of the Company’s common stock will be financed primarily through free cash flow.

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Item 3.  Defaults Upon Senior Securities

None

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
April 10, 2020	January 21, 2020	Press release, dated April 10, 2020, issued by The National Security Group, Inc.
May 14, 2020	May 14, 2020	Press release, dated May 14, 2020, issued by The National Security Group, Inc.
May 22, 2020	May 26, 2020	Item 5.01 - announcement of annual meeting voting results
May 22, 2020	May 26, 2020	Item 8.01 - other events: reauthorization of stock repurchase program

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned duly authorized officer, on its behalf and in the capacity indicated.

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 and Director	President, Chief Executive Officer and Director

Date: August 13, 2020

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