CONFORMED COPY
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Quarterly report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 2002
Commission file number 0-16090
Nevada 87-0447375
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
14651 Dallas Parkway, Suite 900 Dallas, Texas 75240
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(Address of principal executive offices) (Zip Code)
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Issuer's telephone number, including area code: (972) 404-1637
Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date:
Common Stock, par value $.03 per share - 11,049,133 shares
outstanding as of October 31, 2002.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Consolidated Balance Sheets at September 30, 2002 3 (unaudited) and December 31, 2001 Consolidated Statements of Operations 4 (unaudited) for the three and nine months Consolidated Statements of Cash Flows 5 (unaudited) for the nine months ended Notes to Consolidated Financial Statements 6 (unaudited) |
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
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September 30 December 31
ASSETS 2002 2001
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(Unaudited)
Investments:
Debt securities, held-to-maturity,
at amortized cost $ 8,280 $ 876
Equity securities, available-for-sale,
at market value 93 144
Short-term investments, at cost which
approximates market value 6,442 15,203
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Total investments 14,815 16,223
Cash and cash equivalents 6,361 5,533
Restricted cash 1,607 1,990
Prepaid reinsurance premiums 9,068 11,611
Premiums receivable from lender for financed
premiums (net of allowance for doubtful
Accounts of $172 in 2002 and $208 in 2001) 11,510 13,740
Premiums receivable 891 414
Reinsurance recoverable 13,272 16,871
Deferred policy acquisition costs 1,246 761
Excess of cost over net assets acquired 4,431 4,431
Current federal income taxes recoverable - 696
Deferred federal income taxes 279 425
Accrued investment income 69 6
Other assets 733 904
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$ 64,282 $ 73,605
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LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 12,317 $ 13,933
Unpaid losses and loss adjustment expenses 17,202 20,089
Unearned premiums 15,367 16,793
Reinsurance balances payable 3,217 4,426
Drafts outstanding 610 890
Accrued ceding commission refund 2,217 4,598
Accounts payable and other accrued expenses 2,506 2,508
Current federal income taxes payable 67 -
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Total liabilities 53,503 63,237
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Stockholders' equity
Common stock, $.03 par value, authorized
100,000,000 shares Issued 11,855,610
in 2002 and 2001 356 356
Capital in excess of par value 10,875 10,875
Retained earnings 591 180
Treasury stock, 806,477 shares in 2002
and 2001, at cost (1,043) (1,043)
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Total stockholders' equity 10,779 10,368
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$ 64,282 $ 73,605
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The accompanying notes are an integral part of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except earnings per share)
Three Months Ended Nine Months Ended
September 30 September 30
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2002 2001 2002 2001
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Gross premiums written $ 12,123 $ 9,085 $ 37,542 $ 38,919
Ceded premiums written (7,001) (6,146) (22,131) (26,409)
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Net premiums written $ 5,122 $ 2,939 $ 15,411 $ 12,510
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Revenues:
Gross premiums earned 13,193 12,087 38,682 37,580
Ceded premiums earned (7,986) (8,185) (24,388) (24,972)
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Net premiums earned 5,207 3,902 14,294 12,608
Investment income, net of expenses 146 275 417 817
Finance charges 514 763 1,804 2,457
Processing and service fees 121 246 335 975
Other income 92 184 257 291
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Total revenues 6,080 5,370 17,107 17,148
Benefits, losses and expenses:
Losses and loss adjustment expenses 9,316 10,223 26,584 34,392
Reinsurance recoveries (5,634) (6,486) (15,908) (22,017)
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Net losses and loss adjustment expenses 3,682 3,737 10,676 12,375
Acquisition costs, net (36) (261) (486) (351)
Other acquisition and underwriting expenses
(net of year-to-date ceding commission of
$5,795 in 2002 and $7,176 in 2001) 1,626 902 4,001 2,724
Operating expenses 490 822 1,662 2,832
Interest expense 205 266 630 816
Amortization of intangible assets - 39 - 118
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Total benefits, losses and expenses 5,967 5,505 16,483 18,514
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Income (loss) from operations before
federal income taxes 113 (135) 624 (1,366)
Federal income tax expense (benefit) 38 (31) 213 (453)
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Net income (loss) $ 75 $ (104) $ 411 $ (913)
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Basic and diluted earnings (loss) per share $ 0.01 $ (0.01) $ 0.04 $ (0.08)
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Common stock shares outstanding 11,049,133 11,049,133 11,049,133 11,049,133
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The accompanying notes are an integral part
of the consolidated financial statements
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HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended
September 30
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2002 2001
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Cash flows from operating activities:
Net income (loss) $ 411 $ (913)
Adjustments to reconcile net income (loss) to
cash flows used in operating activities:
Depreciation and amortization expense 120 216
Change in deferred federal income taxes 146 57
Change in prepaid reinsurance premiums 2,543 (1,438)
Change in premiums receivable (477) (18)
Change in deferred policy acquisition costs (485) (351)
Change in unpaid losses and loss
adjustment expenses (2,887) (481)
Change in unearned premiums (1,426) 1,339
Change in reinsurance recoverable 3,599 (99)
Change in reinsurance balances payable (1,209) 948
Change in current federal income
tax payable/recoverable 763 (419)
Change in accrued ceding commission refund (2,381) 1,793
Change in litigation cost - (1,386)
Change in all other liabilities (282) 59
Change in all other assets 138 (265)
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Net cash used in operating activities (1,427) (958)
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Cash flows from investing activities:
Purchases of property and equipment (150) (205)
Premium finance notes originated (31,243) (39,337)
Premium finance notes repaid 33,473 38,234
Change in restricted cash 383 2,056
Purchase of debt securities (10,638) -
Maturities and redemptions
of investment securities 3,285 4,962
Purchase of short-term investments (20,961) (17,972)
Maturities of short-term investments 29,722 12,751
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Net cash provided by investing activities 3,871 489
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Cash flows from financing activities:
Net advances from lender (1,616) 455
Repayment of borrowings - (546)
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Net cash used in financing activities (1,616) (91)
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Increase (decrease) in cash and cash equivalents 828 (560)
Cash and cash equivalents at beginning of period 5,533 6,831
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Cash and cash equivalents at end of period $ 6,361 $ 6,271
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The accompanying notes are an integral part of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Item 1. Notes to Consolidated Financial Statements (Unaudited).
Note 1 - Summary of Accounting Policies
In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting primarily of normal recurring adjustments, necessary to present fairly the financial position of Hallmark Financial Services, Inc. and subsidiaries (the "Company") as of September 30, 2002 and the consolidated results of operations and cash flows for the periods presented. The accompanying financial statements have been prepared by the Company without audit.
Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States ("GAAP") have been condensed or omitted. Reference is made to the Company's annual consolidated financial statements for the year ended December 31, 2001 for a description of accounting policies and certain other disclosures. Certain items in the 2001 interim financial statements have been reclassified to conform to the 2002 presentation.
The results of operations for the period ended September 30, 2002 are not necessarily indicative of the operating results to be expected for the full year.
Note 2 - Reinsurance
The Company is involved in the assumption and cession of reinsurance from/to other companies. The Company remains obligated to its policyholders in the event that reinsurers do not meet their obligations under the reinsurance agreements.
Effective March 1, 1992, the Company entered into a reinsurance arrangement with State & County Mutual Fire Insurance Company ("State & County"), an unaffiliated company, to assume 100% of the nonstandard auto business produced by the Company and underwritten by State & County. The arrangement is supplemented by a separate retrocession agreement effective July 1, 2000 between the Company and Dorinco Reinsurance Company ("Dorinco"). Under the agreement, the Company, upon mutual agreement with Dorinco, may elect on a quarterly basis to retain 30% to 45% of the risk. The Company currently retains 40% of the risk and cedes 60% to Dorinco. For the period of January 1, 2002 through March 31, 2002, the Company retained 35% of the risk and ceded 65% to Dorinco. Prior to January 1, 2002, the Company retained 30% of the risk and ceded 70% to Dorinco.
Note 3 - Intangible Assets
When the Company's primary operating subsidiaries were purchased, the excess cost over the fair value of the net assets acquired was recorded as goodwill and was amortized on a straight-line basis over forty years. Other intangible assets consist of a trade name, a managing general agent's license and non-compete arrangements, all of which were fully amortized at September 30, 2002.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations", and No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS 141 supersedes Accounting Principles Board Opinion ("APB") No. 16, "Business Combinations". SFAS 141 (1) requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) provides specific criteria for the initial recognition and measurement of intangible assets apart from goodwill, and (3) requires that unamortized negative goodwill be written off immediately as an extraordinary gain. SFAS 142 supersedes APB No. 17, "Intangible Assets," and is effective for fiscal years beginning after December 15, 2001. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. SFAS 142 (1) prohibits the amortization of goodwill and indefinite-lived intangible assets, (2) requires testing of goodwill and indefinite-lived intangible assets on an annual basis for impairment (and more frequently if the occurrence of an event or circumstance indicates an impairment), (3) requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill, and (4) removes the forty-year limitation on the amortization period of intangible assets that have finite lives.
The Company adopted the provisions of SFAS 142 during the first quarter of 2002 and immediately ceased recording amortization expense of its goodwill. A reconciliation of net income and earnings per share as reported to illustrate the impact of goodwill amortization for the nine months ended September 30, 2002 and 2001 is as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(In thousands except for earnings 2002 2001 2002 2001
per share amounts) ----- ----- ----- -----
Reported net income (loss) $ 75 $ (104) $ 411 $ (913)
Add back: Goodwill amortization - 39 - 118
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Adjusted net income (loss) $ 75 $ (65) $ 411 $ (795)
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Basic and diluted earnings per share:
Reported net income (loss) $ 0.01 $(0.01) $ 0.04 $(0.08)
Add back: Goodwill amortization - - - 0.01
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Adjusted net income (loss) $ 0.01 $(0.01) $ 0.04 $(0.07)
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SFAS 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to determine reporting units and compare the fair value of each reporting unit as of the beginning of the fiscal year with its carrying amount (including goodwill) to identify any potential impairment. The Company has completed this first step and determined that an impairment of goodwill exists.
The second step of the goodwill impairment test under SFAS 142 is to quantify the amount of any impairment loss as of the beginning of the fiscal year. This process must be completed not later than the end of the fiscal year. In accordance with SFAS 142, the Company presently expects to record a significant charge to earnings resulting from the completion of this transitional impairment test. Although the amount of such charge cannot presently be reasonably estimated, the Company anticipates that the implementation of this mandatory change in accounting principle will have a material adverse impact on net income when recognized. The cumulative effect of the change in accounting principle will be recognized as of January 1, 2002.
Item 2. Management's Discussion and Analysis or Plan of Operation.
Introduction. Hallmark Financial Services, Inc. ("HFS") and its wholly owned subsidiaries (collectively referred to herein as the "Company") engage in the sale of property and casualty insurance products. The Company's business primarily involves marketing, underwriting and premium financing of non-standard automobile insurance, as well as claims adjusting and other insurance related services.
The Company pursues its business activities through an integrated insurance group (collectively, the "Insurance Group") the members of which are an authorized Texas property and casualty insurance company, American Hallmark Insurance Company of Texas ("Hallmark"); a managing general agency, American Hallmark General Agency, Inc. ("AHGA"); a network of four insurance agencies known as the American Hallmark Agencies ("Hallmark Agencies"); a premium finance company, Hallmark Finance Corporation ("HFC"); and a claims handling and adjustment firm, Hallmark Claims Service, Inc. ("HCS"). The Company operates only in Texas.
Hallmark provides non-standard automobile liability and physical damage insurance through a reinsurance arrangement with an unaffiliated company, State and County Mutual Fire Insurance Company ("State & County"). Through State & County, Hallmark provides insurance primarily for high-risk drivers who do not qualify for standard-rate insurance. Under a supplementary quota- share reinsurance agreement with Dorinco Reinsurance Company ("Dorinco"), Hallmark, upon mutual agreement with its reinsurer, may elect on a quarterly basis to retain 30% to 45% of the risk while ceding the remaining percentage to its reinsurer. HFC finances annual and six-month policy premiums through its premium finance program. AHGA manages the marketing of Hallmark policies through the Hallmark Agencies and independent agents. Additionally, AHGA provides premium processing, underwriting, reinsurance accounting and cash management for unaffiliated managing general agents ("MGAs"). HCS provides fee-based claims adjustment, salvage, subrogation recovery and litigation services to Hallmark and unaffiliated MGAs.
Financial Condition and Liquidity
The Company's sources of funds are principally derived from insurance related operations. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), ceding commissions, and premium finance charges. Other sources of funds are from financing and investment activities, as well as service fees.
At September 30, 2002 and December 31, 2001, the Company's consolidated liquid assets consisting of cash, cash equivalents and investments (excluding restricted cash) were $21.2 million and $21.8 million, respectively. The Company's liquidity decreased 3% during the first nine months of 2002 as compared to December 31, 2001 principally due to the payment of an annual ceding commission adjustment with its reinsurer in the amount of $3.4 million during the first quarter of 2002.
Net cash used by operating activities was $1.4 million for the nine months ended September 30, 2002 as compared to approximately $1.0 million for the same period of 2001. The approximate $3.4 million ceding commission adjustment paid to reinsurers during the first quarter of 2002 was partially offset by an increase in the Company's retention of State & County business to 40% (from 35% at January 1, 2002 and 30% prior to 2002) effective April 1, 2002 under the Company's quota share retrocession agreement with Dorinco and by an increase in monthly policy production.
Cash provided by investing activities during the first nine months of 2002 increased approximately $3.4 million as compared to the first nine months of 2001. This increase in cash provided by investing activities was primarily the combined result of an increase in maturities of short-term investments and an increase in repayments of premium finance notes when netted against originations of premium finance notes during the first nine months of 2002 as compared to the first nine months of 2001. This increase was partially offset by reinvestment in both intermediate and short-term investments during the first nine months of 2002.
Cash used by financing activities increased by $1.5 million during the first nine months of 2002 as compared to the first nine months of 2001 primarily due to a decrease in net advances from the Company's premium finance lender. The decrease in net advances was attributable to decreased production of annual policies during 2002 as compared to 2001.
A substantial portion of the Company's liquid assets is held by Hallmark and is not available for general corporate purposes. Of the Company's consolidated liquid assets of $21.2 million at September 30, 2002 and $21.8 million at December 31, 2001, $2.1 million and $1.9 million, respectively, represented non-restricted cash. Since state insurance regulations restrict financial transactions between an insurance company and its affiliates, HFS is limited in its ability to use Hallmark funds for its own working capital purposes. Furthermore, dividends and loans by Hallmark to the Company are restricted and subject to Texas Department of Insurance ("TDI") approval. Although TDI has sanctioned the payment of management fees, commissions and claims handling fees by Hallmark to HFS and affiliates, since the second half of 2000, Hallmark has chosen not to pay all of the commissions allowed to AHGA. These steps were taken to preserve Hallmark's surplus. During the first nine months of 2002, Hallmark paid $243,000 of management fees to HFS. Management anticipates that Hallmark may pay management fees during the fourth quarter of 2002. The Company has never received a dividend from Hallmark, and there is no immediate plan to pay a dividend.
Ceding commission income represents a significant source of funds to the Company. Ceding commission income for the first nine months of 2002 decreased $1.4 million (representing a 19% decrease) as compared to the similar period of 2002. This decrease was the result of the combined effect of (1) less favorable reinsurance terms during 2002 compared to 2001, (2) a decrease in core State & County premium volume, and (3) an increase in Hallmark's risk retention to 40% effective April 1, 2002 and to 35% effective January 1, 2002 from 30% prior to January 1, 2002. In accordance with GAAP, a portion of ceding commission income and policy acquisition costs is deferred and recognized as income and expense, respectively, as related net premiums are earned. Deferred policy acquisition costs (net of deferred ceding commission) increased to $1.2 million at September 30, 2002 from $0.8 million at December 31, 2001. The increase in net deferred acquisition costs was principally due to the decrease in ceding commission partially offset by a decrease in underwriting expenses.
At September 30, 2002, Hallmark's statutory capital and surplus was approximately $6.5 million, which reflects an increase of $0.5 million since December 31, 2001. Hallmark's premium to surplus ratio for the twelve months ended September 30, 2002 was 2.9 to 1 as compared to 2.62 for the twelve months ended December 31, 2001. Effective January 1, 2001, TDI adopted the Codification of Statutory Accounting Principles (the "Codification"), which replaced the National Association of Insurance Commissioners primary guidance on statutory accounting. As a result of the implementation of the Codification, Hallmark recognized a deferred tax asset which is recognized by TDI as an increase to surplus.
The Company provides on-going program administration and claims handling for unaffiliated MGAs. The Company currently provides these services for one unaffiliated MGA which continues to produce new business. Hallmark assumes a pro-rata share of the business produced under this unaffiliated MGA program, and Dorinco assumes the remainder. Three other unaffiliated MGAs for whom the Company provided similar services have discontinued writing new business due to the inability to obtain reinsurance and are in run-off.
Management is continuing to investigate opportunities to enhance and expand the Company's operations. While additional capital or strategic alliances may be required to fund future expansion, operational enhancements through increased information technology capabilities are in progress. During the summer of 2001, the Company rolled out its web-based information system (named e-Integrity and referred to as the "Integrity System") which is designed to enhance Company and agency relationships by improving content and timeliness of information to support agents in servicing their customers. The second phase of the Integrity System is composed of two parts. Part One relates to electronic reporting and communication capabilities, and Part Two encompasses, among other things, payment and new business upload to support agents in more promptly and efficiently producing new business, as well as to improve the quality and timeliness of service to existing policyholders. Part One alleviates certain manual processes and results in daily communication of time-sensitive information to agents, thus decreasing labor, supplies and postage costs and increasing the agent's likelihood of policyholder retention. This phase was completed during the first quarter of 2002. Payment upload by the agents, which is included in Part Two, was introduced during August 2002. The remainder of Part Two, which will further reduce processing costs, is targeted to be completed by year-end 2002 with related cost savings to commence in 2003.
Results of Operations
Overview
The Company had profitable results for the first nine months of 2002 principally due to its focus on rate adequacy, underwriting discipline and agent management. For the first nine months ended September 30, 2002, net income was $0.4 million compared to a net loss of $0.9 million for the same period of 2001. Gross premiums written for the first nine months of 2002 decreased approximately 4% as compared to 2001, while net premiums written for the first nine months of 2002 increased by 23% to $15.4 million for 2002 compared to $12.5 million in 2001. Net premiums earned of $14.3 million for the first nine months of 2002 increased 13% in relation to net premiums earned of $12.6 million for the comparable period of 2001.
The Company's net incurred loss ratios declined to 74.7% for the first nine months of 2002 from 98.2% for the first nine months of 2001. Certain key financial operational ratios follow:
Qtr Qtr YTD YTD
ended ended ended ended
9/30/02 9/30/01 9/30/02 9/30/01
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GAAP Incurred Loss Ratio
(excluding storm and loss corridor) 68.4% 83.7% 67.0% 88.5%
GAAP Loss Corridor Incurred
Loss Ratio (1) 1.7% 10.2% 6.2% 6.5%
GAAP Storm\Flood Incurred
Loss Ratio (2) 0.6% 1.9% 1.5% 3.2%
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GAAP Incurred Loss Ratio 70.7% 95.8% 74.7% 98.2%
GAAP Expense Ratio (3) 29.6% 21.2% 23.8% 18.6%
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GAAP Combined Ratio 100.3% 117.0% 98.5% 116.8%
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(1) Effective April 1, 2001, the Company's reinsurance agreement was amended to include a loss corridor provision. Losses incurred within the loss corridor range are retained 100% by the Company. Losses incurred within the loss corridors for the three months ended September 30, 2002 and 2001 were $0.1 million and $0.4 million, respectively. Losses incurred within the loss corridors for the nine months ended September 30, 2002 and 2001 were $0.9 million and $0.8 million, respectively.
(2) Net storm losses retained by the Company were approximately $0.03 million and $0.1 million for the three months ended September 30, 2002 and 2001, respectively. Net storm losses retained by the Company were approximately $0.2 million and $0.4 million for the nine months ended September 30, 2002 and 2001, respectively.
(3) The GAAP expense ratio represents underwriting expenses and other income less certain expenses as a percentage of net premiums written. The principal reason for the increased GAAP expense ratio is the decrease in ceding commission income. As a percentage of net premiums written, ceding commission income for the three months ended September 30, 2002 declined 21.8%. As a percentage of net premiums written, ceding commission income for the nine months ended September 30, 2002 declined 19.8%, as discussed in the Financial Condition and Liquidity section.
Analysis
Gross premiums written (prior to reinsurance) for the three months ended September 30, 2002 increased 33% as compared to the same period of 2001, while gross premium written for the nine months ended September 30, 2002 decreased approximately 4% over the same period of 2001. The 33% increase in gross premiums written during the third quarter of 2002 compared to the same period in 2001 is principally due to unusually low premium volume in 2001 as a result of (1) a one-third reduction in the agent base during the last 12 months, a significant portion of the business of the terminated agents ran-off early in the third quarter of 2001 (2) successive rate increases in June and July 2001, and (3) temporary disruption of insurance purchasing patterns as a result of the terrorist attacks of September 11, 2001. The overall year to date decrease in gross premiums written from 2001 to 2002 was principally due to the Company's strategic focus on underwriting profitability rather than market share. This focus included increased attention to rate adequacy, agent performance and underwriting discipline. Net premiums written (after reinsurance) for the three and nine months ended September 30, 2002 increased 74% and 23%, respectively, over the same periods in 2001. The disparity between gross premiums written and net premiums written is primarily due to the increase in the Company's retention of premiums from 30% to 35% effective January 1, 2002 and further to 40% effective April 1, 2002.
Despite the decrease in gross premiums written compared to 2001, gross premiums earned (prior to reinsurance) for the three and nine months ended September 30, 2002 increased 9% and 3%, respectively, as compared to the same periods of 2001. This was principally due to the combined effect of a shift in policy mix from annual to monthly policies and the continued earnings of annual premiums written at a higher volume level during 2001. For the three and nine months ended September 30, 2002, net premiums earned (after reinsurance) increased 33% and 13%, respectively, as compared to the same periods of 2001. The disproportionate change in premiums earned prior to and after reinsurance is due to the impact of the increased retention of core State & County premium volume which has reduced ceded premiums and ultimately increased net premiums written and earned.
Net incurred loss ratios (computed on net premiums earned after reinsurance) for the three and nine months ended September 30, 2002 were approximately 70.7% and 74.7%, respectively, compared to 95.8% and 98.2% for the same periods of 2001. During the second quarter of 2001, the Company's reinsurance agreement was amended to include a loss corridor provision which increases net losses incurred by the Company between certain loss ratio levels. If the loss corridor had not been in place during the first nine months of 2002 and the second and third quarters of 2001, the year to date net incurred loss ratios would have been 68.5% and 91.7%, respectively. Additionally, severe storms occurring in the spring of 2002 and the Houston flood of May 2001 impacted the 2002 and 2001 loss ratios. Excluding the impact of storms and the loss corridor, the year to date loss ratios for 2002 and 2001 would have been 67.0% and 88.5%, respectively. The significant improvement in the loss ratio in 2002 compared to 2001 is principally the result of the Company's increasing focus on underwriting profitability during 2001 which is now reflected in 2002 results. Specific strategies implemented in late 2000 and 2001 to improve the Company's loss ratio included multiple rate increases, more restrictive underwriting guidelines, reductions in agency force and emphasis on faster payment of claims.
Investment income decreased 47% and 49% during the first three and nine months of 2002, respectively, compared to the same periods of 2001. The decrease is attributable to the combined effect of the decreased yield currently available in the marketplace and maturities/calls of higher yield investments.
Finance charges, which decreased approximately $0.2 million (33%) and $0.7 million (27%) during the first three and nine months of 2002, respectively, as compared to the same periods of 2001, represent interest earned on premium notes issued by HFC. This decrease is directly correlated to the decrease in annual policy premium volume.
Processing and service fees represent fees earned on third party processing and servicing contracts with unaffiliated MGAs. Processing and service fees for the three and nine months ended September 30, 2002 decreased $0.1 million (51%) and $0.6 million (66%), respectively, compared to the same periods of 2001, as a result of cancellation of the service contracts with three unaffiliated MGAs (which are currently in run-off).
Acquisition costs, net, represents the amortization of acquisition costs (and credits) deferred over the past twelve months and the deferral of acquisition costs (and credits) incurred in the current period. The $0.1 million decrease in acquisition costs, net, is primarily due to the combined effect of a decrease in ceding commission income due to changes in the Company's reinsurance terms and an increase in the deferral rate as a result of the Company increasing its retention of State & County business under its quota share retrocession agreement.
Other acquisition and underwriting expenses for the three and nine months ended September 30, 2002 increased 80% and 47%, respectively, as compared to the same periods of 2001. The increase in expenses is primarily attributable to decreased ceding commission income as a result of increases in the Company's retention of its core business since year end 2001, less favorable reinsurance terms, and decreased core State & County annual premium volume.
Operating expenses include expenses related to premium finance operations, general corporate overhead, and third party administrative and claims handling contracts. Related revenues are derived from finance charges and processing and service fees. Operating expenses during the three and nine months ended September 30, 2002, decreased 40% and 41%, respectively, as compared to the same periods of 2001. The majority of this decrease in operating expenses is attributable to decreased operating costs related to third party processing and claims handling, and to a lesser extent, decreased operating costs related to premium finance.
Interest expense during the three and nine months ended September 30, 2002, decreased approximately $0.1 million and $0.2 million respectively, as compared to 2001. This decrease is principally the result of a decrease in the effective interest rate related to the premium finance line of credit and to lower premium note volume as a result of lower annual premium volume.
Recent Developments
The Company's retrocession reinsurance agreement with Dorinco has been modified effective October 1, 2002 with modestly improved terms. The threshold of the loss corridor has been raised to a loss ratio of 65.5% from a loss ratio of 65.01%. In addition, the ceiling of the loss corridor has been lowered to a loss ratio of 75.5%, resulting in a narrowing of the corridor from 15 percentage points to 10 percentage points. The minimum ceding commission has been increased by 0.5%, and the loss ratio threshold for minimum commissions has been raised by 0.5%. Further, Dorinco has waived any deficit loss carryforward. A deficit loss carryforward results when the loss ratio exceeds an established benchmark and the deficit is carried forward into subsequent ceding commission adjustments. As a result of the wavier of the deficit loss carryforward effective October 1, 2002, the Company will be able to recognize additional ceding commission above the minimum commission at established loss ratios below 65.5%. If the deficit loss carryforward had not been waived, any potential additional commission would have been applied to the deficit loss carryforward accumulated through September 30, 2002.
Risks Associated with Forward-Looking Statements Included in this Form
10-QSB
This Form 10-QSB contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. These statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of the Company's business activities and availability of funds. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, regulatory framework, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-QSB will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.
Item 3. Controls and Procedures.
The Chief Executive Officer and Chief Financial Officer of the Company have evaluated the Company's disclosure controls and procedures as of a date within 90 days of the filing date of this report and have concluded that such controls and procedures are effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
Except for routine litigation incidental to the business of the Company, neither the Company, nor any of the properties of the Company was subject to any material pending or threatened legal proceedings as of the date of this report.
Item 2. Changes in Securities.
None.
Item 3. Defaults upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security-Holders.
None
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibits listed in the Exhibit Index following the signature page are filed herewith.
(b) The Company did not file any Form 8-K Current Reports during the third quarter of 2002.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: October 31, 2002 /s/ Linda H. Sleeper
---------------------------
Linda H. Sleeper, President
(Chief Executive Officer)
Date: October 31, 2002 /s/ John J. DePuma
---------------------------
John J. DePuma,
Chief Financial Officer
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CERTIFICATIONS
I, Linda H. Sleeper, Chief Executive Officer of Hallmark Financial Services, Inc. (the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-QSB of the Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: October 31, 2002
/s/ Linda H. Sleeper
-----------------------------------------
Linda H. Sleeper, Chief Executive Officer
|
I, John J. DePuma, Chief Financial Officer of Hallmark Financial Services, Inc. (the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-QSB of the Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: October 31, 2002
/s/ John J. DePuma
-----------------------------------------
John J. DePuma, Chief Financial Officer
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10 ( a ) Addendum No. 3 to the Quota Share Retrocession Agreement, effective July 1, 2000, between American Hallmark Insurance Company of Texas and Dorinco Reinsurance Company, effective June 30, 2001.
10 ( b ) Amendment of Article VII of the Amended and Restated
Bylaws of Hallmark Financial Services, Inc., adopted
July 19, 2002.
10 ( c ) Form of Indemnification Agreement between Hallmark
Financial Services, Inc. and its officers and directors,
adopted July 19, 2002.
99 Certification Pursuant to 18 U.S.C. 1350 Enacted by
Section 906 of the Sarbanes-Oxley Act of 2002.
|
EXHIBIT 10 (a)
ADDENDUM NO. 3
to the
QUOTA SHARE RETROCESSION AGREEMENT
Effective: July 1, 2000
entered into by and between
AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS
Dallas, Texas
and
DORINCO REINSURANCE COMPANY
Midland, Michigan
IT IS HEREBY AGREED, effective June 30, 2001, that paragraph B of ARTICLE 10
- DEFINITIONS shall be deleted and the following substituted therefor:
"B. The term "Underwriting Year" as used in this Agreement shall be defined as follows:
1. The first Underwriting Year shall be the period from July 1, 2000 through September 30, 2001;
2. Each subsequent 12-month period commencing on October 1 shall be considered a separate Underwriting Year.
Those Policies with an inception, renewal or anniversary date during the Underwriting Periods within a given Underwriting Year shall be considered "attached" to that Underwriting Year. All premium attributable to, and all loss arising out of such Policies until expiration, cancellation, or next anniversary, whichever occurs first, will be ascribed to that Underwriting Year."
IT IS FURTHER AGREED, effective July 1, 2001, with respect to policies
issued or renewed on or after that date, that the fifth paragraph of ARTICLE
16 - EXTRA CONTRACTUAL OBLIGATIONS AND EXCESS OF POLICY LIMITS (as amended
by Addendum No. 2) shall be deleted and the following substituted therefor:
"Notwithstanding the above, as respects any loss under policies attaching prior to July 1, 2001 which includes either Extra Contractual Obligations or Excess of Policy Limits or both, the Reinsurer's limit of liability for Extra Contractual Obligations and/or Excess of Policy Limits shall be limited to $2,000,000 each loss in addition to the indemnity loss. As respects any loss under policies attaching during the period from July 1, 2001 through September 30, 2001 and any loss under policies attaching to the second and subsequent Underwriting Years hereunder which include Extra Contractual Obligations and/or Excess of Policy Limits, the Reinsurer's limit of liability for Extra Contractual Obligations and/or Excess of Policy Limits shall be limited to $700,000 (i.e., 70% of $1,000,000) each loss in addition to the indemnity loss."
IT IS ALSO AGREED, effective October 1, 2001, that the second paragraph of ARTICLE 3 - COMMENCEMENT AND TERMINATION shall be deleted and the following substituted therefor:
"Either the Company or the Reinsurer shall have the right to terminate this Agreement as of 12:01 a.m., Central Standard Time, any January 1, April 1, July 1 or October 1, by giving 60 days prior notice in writing."
IT IS ALSO AGREED, effective October 1, 2001, with respect to policies attaching to Underwriting Periods commencing on or after that date, that ARTICLE 2 - COVER (as amended by Addendum No. 2) shall be deleted and the following substituted therefor:
At the end of each Underwriting Period (as defined in Article 10), the Company may request that the quota share percentage applicable to Policies attaching during that Period be adjusted back to the beginning of the Period to a minimum of 55% or a maximum of 70%. Any such request shall be made as soon as practicable after the end of the Underwriting Period and be based solely on the Company's desire to achieve a certain net written premium to policyholders surplus ratio, not its loss ratio. Any and all retroactive quota share percentage adjustments must be agreed by the Reinsurer, which agreement will not be unreasonably withheld. The Reinsurer agrees to communicate to the Company its acceptance or rejection of the Company's request within two working days after receipt. In the event of a retroactive adjustment, the additional or return premium, ceding commission and paid losses shall be reflected in the Company's next monthly report.
In no event shall the combined ceded net written premium and ceded collected net written premium hereunder for any Underwriting Year exceed $30,000,000.
Notwithstanding the above, the Reinsurer shall have no liability for the amount by which incurred losses and loss adjustment expenses for any Underwriting Year is between 65% and 80% of ceded premium for the same Underwriting Year. This "loss ratio corridor" between 65% and 80% shall be held net and unreinsured by the Company, and in addition to its quota share retention set forth above."
IT IS ALSO AGREED, effective October 1, 2001, that this Contract shall be amended as follows:
1. Paragraph A of ARTICLE 7 - ACCOUNTS AND REMITANCES (as amended by Addendum No. 2) shall be deleted and the following substituted therefor:
"A. Within 60 days following the end of each month, the Company will render a net account to the Reinsurer for the current Underwriting Year, segregated by Underwriting Period. Prior Underwriting Years having activity during the month will be accounted for separately in a similar manner. Such account will contain the following:
1. Ceded net written premium (i.e., ceded gross written premium, including the Reinsurer's share of 100% of the collected Policy fees, less returns and cancellations), under non- Direct Bill Policies attaching to each Underwriting Period; plus
2. Ceded collected net written premium (i.e., the portion of the ceded gross written premium, including the Reinsurer's share of 100% of the collected Policy fees, less returns and cancellations, which is actually received by the Company), under Direct Bill Policies attaching to each Underwriting Period; less
3. The ceding commission as provided for in this Agreement; less
4. Loss and loss expense paid under Policies attaching to each Underwriting Period; plus
5. Subrogation, salvage, or other recoveries attributable to Policies attaching to each Underwriting Period.
Within 60 days following the end of the month the debtor party will remit to the creditor party any balance due.
This account will also bear a notation advising of the following information, separately for each Underwriting Period:
1. Outstanding loss and loss expense reserve at the end of the month;
2. The unearned premium reserve at the end of the month;
3. Should loss attributable to an ISO catastrophe(s) be involved, the ISO number(s) and the paid loss and loss expense and the outstanding loss and loss expenses applicable."
2. ARTICLE 8 - CEDING COMMISSION (as amended by Addendum No. 2) shall be deleted and the following substituted therefor:
A. For the period from July 1, 2000 to March 31, 2001, 41.0%;
B. For the period from April 1, 2001 to June 30, 2001, 34.0%;
C. For the period from July 1, 2001 to September 30, 2001, 31.0%;
D. As respects the second and subsequent Underwriting Years hereunder, 31.0%.
Return commission shall be allowed on return premiums at the same rate for the same period."
3. Paragraph B of ARTICLE 9 - COMMISSION ADJUSTMENT (as amended by Addenda Nos. 1 and 2) shall be deleted and the following substituted therefor:
"B. The adjusted ceding commission shall be calculated as follows:
1. As respects the first Underwriting Year calculation, the following shall apply:
a. For the period from July 1, 2000 to December 31, 2000, if the ratio of losses incurred to premium earned is 64.5% or higher, then the adjusted ceding commission shall be 31.0%. If the ratio of losses incurred to premium earned is less than 64.5%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 41.0% at a loss ratio of 54.5% or less. If the ratio of losses incurred to premium earned is greater than 64.5% or less than 54.5%, the difference between the actual loss ratio and 64.5% or 54.5%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
b. For the period from January 1, 2001 to February 28, 2001, if the ratio of losses incurred to premium earned is 64.0% or higher, then the adjusted ceding commission shall be 31.0%. If the ratio of losses incurred to premium earned is less than 64.0%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 41.0% at a loss ratio of 54.0% or less. If the ratio of losses incurred to premium earned is greater than 64.0% or less than 54.0%, the difference between the actual loss ratio and 64.0% or 54.0%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
c. For the period from March 1, 2001 to March 31, 2001, if the ratio of losses incurred to premium earned is 69.0% or higher, then the adjusted ceding commission shall be 26.0%. If the ratio of losses incurred to premium earned is less than 69.0%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 41.0% at a loss ratio of 54.0% or less. If the ratio of losses incurred to premium earned is greater than 69.0% or less than 54.0%, the difference between the actual loss ratio and 69.0% or 54.0%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
d. For the period from April 1, 2001 to June 30, 2001, if the ratio of losses incurred to premium earned is 65.0% or higher, then the adjusted ceding commission shall be 26.0%. If the ratio of losses incurred to premium earned is less than 65.0%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 34.0% at a loss ratio of 50.0% or less. If the ratio of losses incurred to premium earned is greater than 65.0% or less than 50.0%, the difference between the actual loss ratio and 65.0% or 50.0%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
e. For the period from July 1, 2001 to September 30, 2001, if the ratio of losses incurred to premium earned is 65.0% or higher, then the adjusted ceding commission shall be 26.0%. If the ratio of losses incurred to premium earned is less than 65.0%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 31.0% at a loss ratio of 50.0% or less. If the ratio of losses incurred to premium earned is greater than 65.0% or less than 50.0%, the difference between the actual loss ratio and 65.0% or 50.0%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
2. As respects the second and subsequent Underwriting Years hereunder, if the ratio of losses incurred to premium earned is 65.0% or higher, then the adjusted ceding commission shall be 26.0%. If the ratio of losses incurred to premium earned is less than 65.0%, then the adjusted commission shall be determined by adding one percentage point to the ceding commission for each percentage point reduction loss ratio subject to a ceding commission of 31.0% at a loss ratio of 60.0% or less. If the ratio of losses incurred to premium earned is greater than 65.0% or less than 60.0%, the difference between the actual loss ratio and 65.0% or 60.0%, as the case may be, will be multiplied by the earned premium for the Underwriting Year and carried forward as a debit or credit to the ensuing Underwriting Year calculation.
Following termination of this Agreement any debit or credit carryforward remaining after the final adjustment of the concluding Underwriting Year will be null and void."
The provisions of this Agreement shall remain otherwise unchanged.
IN WITNESS WHEREOF the parties hereto have caused this Addendum to be executed by their duly authorized representatives at:
Dallas, Texas, this ___________ day of ________________________, 20__.
Midland, Michigan, this __________ day of _____________________, 20__.
EXHIBIT 10 (b)
AMENDMENT OF ARTICLE VII
OF THE
AMENDED AND RESTATED BYLAWS
OF
HALLMARK FINANCIAL SERVICES, INC.
The Amended and Restated Bylaws of the Hallmark Financial Services, Inc. (the "Corporation") are amended by deleting the current Article VII in its entirety and substituting therefor the following new Article VII:
ARTICLE VII.
INDEMNIFICATION OF DIRECTORS, OFFICERS AND OTHER PERSONS
Section 1. Scope of Indemnification. To the fullest extent authorized, permitted or required by NRS Section 78.7502 (as now in effect or as subsequently amended or superseded), but subject to the procedural requirements stated in NRS Section 78.751, the Corporation shall indemnify each director, officer, employee and agent of the Corporation and each other person identified in NRS Section 78.7502 against all judgments, fines, settlements, costs, expenses and other monetary obligations such person may suffer, sustain or incur as the result of actions taken or omitted by such person under circumstances and in situations described or defined in, or contemplated by, NRS Section 78.7502.
Section 2. Expense Advances. The expenses of officers and directors of the Corporation incurred in defending a civil or criminal action, suit or proceeding shall be paid by the Corporation as they are incurred and in advance of the final disposition of the action, suit or proceeding, upon receipt of an undertaking by or on behalf of the director or officer to repay the amount if it is ultimately determined by a court of competent jurisdiction that he or she is not entitled to be indemnified by the Corporation. The provisions of this Section 2 do not affect any rights to advancement of expenses to which corporate personnel other than directors or officers may be entitled under any contract or otherwise by law.
Section 3. Insurance, Other Financial Arrangements. The Corporation may, but will have no obligation to, purchase and maintain errors and omissions insurance or make other financial arrangements for the benefit of any or all of its directors, officers, employees or agents or other persons identified in NRS Section 78.752. Under no circumstances will the Corporation have or incur any liability to any person on account of its decision not to purchase or maintain any such insurance or make any other such financial arrangements.
Section 4. Enforceability. The provisions of this Article VII are to be deemed an element of the contract or engagement between the Corporation and each person who holds a position giving rise to indemnification. Subject to the conditions and limitations expressed herein and in NRS Sections 78.7502, 78.751 and 78.752, the indemnification provided in this Article VII may thus be enforced against the Corporation as a matter of contractual right.
The undersigned Secretary of the Corporation hereby certifies that the foregoing amendment was duly adopted by the Board of Directors of the Corporation on July ____, 2002.
Raymond A. Kilgore, Secretary
EXHIBIT 10 (c)
INDEMNIFICATION AGREEMENT
This Agreement is made as of the _____ day of ________________, 2002, by and between HALLMARK FINANCIAL SERVICES, INC., a Nevada corporation (the "Corporation"), and _____________ ("Indemnitee"), a director and/or officer of the Corporation.
WHEREAS, it is essential to the Corporation to retain and attract the most capable persons available to serve as its directors and officers , and
WHEREAS, the substantial increase in corporate litigation subjects directors and officers to expensive litigation risks at the same time that the availability of directors' and officers' liability insurance has been severely limited, and
WHEREAS, it is now and has always been the policy of the Corporation to indemnify its directors and officers to the fullest extent permitted by law, and
WHEREAS, the Corporation does not regard the protection currently available to Indemnitee to be adequate in the present circumstances, and realizes that Indemnitee may not be willing to serve or continue to serve as a director and/or officer without additional protection, and
WHEREAS, the Corporation desires Indemnitee to serve, or continue to serve, as a director and/or officer of the Corporation.
NOW, THEREFORE, in consideration of the Indemnitee's service as a director and/or officer of the Corporation subsequent to the date hereof, the parties hereby agree as follows:
1. Definitions. As used in this Agreement:
a. The term "Proceeding" shall include any threatened, pending or completed action, suit, arbitration, alternative dispute resolution proceeding, administrative hearing or other proceeding, whether brought by or in the right of the Corporation or otherwise and whether of a civil, criminal, administrative or investigative nature, and any appeal therefrom.
b. The term "Corporate Status" shall mean the status of a person who is or was a director or officer of the Corporation, or is or was serving, or has agreed to serve, at the request of the Corporation, as a director, officer, partner, trustee, member, employee or agent of another corporation, partnership, joint venture, trust, limited liability company or other enterprise.
c. The term "Expenses" shall include, without limitation, attorneys' fees, retainers, court costs, transcript costs, fees and expenses of experts, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees and other disbursements or expenses of the types customarily incurred in connection with investigations, judicial or administrative proceedings or appeals, but shall not include the amount of judgments, fines or penalties against Indemnitee or amounts paid in settlement in connection with such matters.
d. References to "other enterprise" shall include employee benefit plans; references to "fines" shall include any excise tax assessed with respect to any employee benefit plan; references to "serving at the request of the Corporation" shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner such person reasonably believed to be in the interests of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Agreement.
2. Indemnification in Third Party Proceedings. The Corporation shall indemnify Indemnitee in accordance with the provisions of this Paragraph if Indemnitee was or is a party to, is threatened to be made a party to, or is otherwise involved in any Proceeding (other than a Proceeding by or in the right of the Corporation to procure a judgment in its favor) by reason of the Indemnitee's Corporate Status or by reason of any action alleged to have been taken or omitted by Indemnitee in connection therewith, against all Expenses, judgments, fines, penalties and amounts paid in settlement actually and reasonably incurred by or on behalf of Indemnitee in connection with such Proceeding, if Indemnitee acted in good faith and in a manner which Indemnitee reasonably believed to be in, or not opposed to, the best interests of the Corporation and, with respect to any criminal Proceeding, had no reasonable cause to believe that his/her conduct was unlawful. The termination of any Proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that Indemnitee did not act in good faith and in a manner which the Indemnitee reasonably believed to be in, or not opposed to, the best interests of the Corporation or, with respect to any criminal Proceeding, had reasonable cause to believe that his/her conduct was unlawful.
3. Indemnification in Proceedings by or in the Right of the Corporation. The Corporation shall indemnify Indemnitee in accordance with the provisions of this Paragraph if Indemnitee is a party to or threatened to be made a party to or otherwise involved in any Proceeding by or in the right of the Corporation to procure a judgment in its favor by reason of the Indemnitee's Corporate Status or by reason of any action alleged to have been taken or omitted by Indemnitee in connection therewith, against all Expenses and, to the extent permitted by law, amounts paid in settlement actually and reasonably incurred by or on behalf of Indemnitee in connection with such Proceeding, if he acted in good faith and in a manner which he reasonably believed to be in, or not opposed to, the best interests of the Corporation; provided, however, that no indemnification shall be made under this Paragraph in respect of any claim, issue, or matter as to which Indemnitee shall have been adjudged to be liable to the Corporation unless, and then only to the extent, that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of such liability but in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for such Expenses and/or settlement as the other court shall deem proper.
4. Exceptions to Right of Indemnification. Notwithstanding anything to the contrary in this Agreement, except as set forth in Paragraph 9, the Corporation shall not indemnify the Indemnitee in connection with a Proceeding (or part thereof) initiated by the Indemnitee unless the initiation thereof was approved by the Board of Directors of the Corporation. Notwithstanding anything to the contrary in this Agreement, the Corporation shall not indemnify the Indemnitee to the extent the Indemnitee is reimbursed from the proceeds of insurance, and in the event the Corporation makes any indemnification payments to the Indemnitee and the Indemnitee is subsequently reimbursed from the proceeds of insurance, the Indemnitee shall promptly refund such indemnification payments to the Corporation to the extent of such insurance reimbursement.
5. Indemnification of Expenses of Successful Party. Notwithstanding any other provision of this Agreement, to the extent that Indemnitee has been successful, on the merits or otherwise, in defense of any Proceeding or in defense of any claim, issue or matter therein, Indemnitee shall be indemnified against all Expenses incurred by him or on his behalf in connection therewith. Without limiting the foregoing, if any Proceeding or any claim, issue or matter therein is disposed of, on the merits or otherwise (including a disposition without prejudice), without (i) the disposition being adverse to the Indemnitee, (ii) an adjudication that the Indemnitee was liable to the Corporation, (iii) a plea of guilty or NOLO CONTENDERE by the Indemnitee, (iv) an adjudication that the Indemnitee did not act in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and (v) with respect to any criminal proceeding, an adjudication that the Indemnitee had reasonable cause to believe his conduct was unlawful, the Indemnitee shall be considered for the purposes hereof to have been wholly successful with respect thereto.
6. Notification and Defense of Claim. As a condition precedent to his right to be indemnified, the Indemnitee must notify the Corporation in writing as soon as practicable of any Proceeding for which indemnity will or could be sought by him and provide the Corporation with a copy of any summons, citation, subpoena, complaint, indictment, information or other document relating to such Proceeding with which he is served. With respect to any Proceeding of which the Corporation is so notified, the Corporation will be entitled to participate therein at its own expense and/or to assume the defense thereof at its own expense, with legal counsel reasonably acceptable to the Indemnitee. After notice from the Corporation to the Indemnitee of its election so to assume such defense, the Corporation shall not be liable to the Indemnitee for any legal or other expenses subsequently incurred by the Indemnitee in connection with such claim, other than as provided below in this Paragraph 6. The Indemnitee shall have the right to employ his own counsel in connection with such claim, but the fees and expenses of such counsel incurred after notice from the Corporation of its assumption of the defense thereof shall be at the expense of the Indemnitee unless (i) the employment of counsel by the Indemnitee has been authorized by the Corporation, (ii) counsel to the Indemnitee shall have reasonably concluded that there may be a conflict of interest or position on any significant issue between the Corporation and the Indemnitee in the conduct of the defense of such action or (iii) the Corporation shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of counsel for the Indemnitee shall be at the expense of the Corporation, except as otherwise expressly provided by this Agreement. The Corporation shall not be entitled, without the consent of the Indemnitee, to assume the defense of any claim brought by or in the right of the Corporation or as to which counsel for the Indemnitee shall have reasonably made the conclusion provided for in clause (ii) above. The Corporation shall not be required to indemnify the Indemnitee under this Agreement for any amounts paid in settlement of any Proceeding effected without its written consent. The Corporation shall not settle any Proceeding in any manner which would impose any penalty or limitation on Indemnitee without Indemnitee's written consent. Neither the Corporation nor the Indemnitee will unreasonably withhold their consent to any proposed settlement.
7. Advancement of Expenses. Subject to the provisions of Paragraph 8 below, in the event that the Corporation does not assume the defense pursuant to Paragraph 6 of this Agreement of any Proceeding to which the Indemnitee was or is a party or is threatened to be made a party by reason of his Corporate Status or by reason of any action alleged to have been taken or omitted in connection therewith and of which the Corporation receives notice under this Agreement, any Expenses incurred by the Indemnitee or on his behalf in defending such Proceeding shall be paid by the Corporation in advance of the final disposition of such Proceeding; provided, however, that the payment of such Expenses incurred by the Indemnitee or on his behalf in advance of the final disposition of such Proceeding shall be made only upon receipt of an undertaking by or on behalf of the Indemnitee to repay all amounts so advanced in the event that it shall ultimately be determined that the Indemnitee is not entitled to be indemnified by the Corporation as authorized in this Agreement. Such undertaking shall be accepted without reference to the financial ability of the Indemnitee to make repayment.
8. Procedure for Indemnification. In order to obtain indemnification or advancement of Expenses pursuant to Paragraphs 2, 3, 5 or 7 of this Agreement, Indemnitee shall submit to the Corporation a written request, including in such request such documentation and information as is reasonably available to Indemnitee and is reasonably necessary to determine whether and to what extent Indemnitee is entitled to indemnification or advancement of Expenses. Any such indemnification or advancement of Expenses shall be made promptly, and in any event within 60 days after receipt by the Corporation of the written request of the Indemnitee, unless with respect to requests under Paragraphs 2, 3 or 7 the Corporation determines within such 60-day period that such Indemnitee did not meet the applicable standard of conduct set forth in Paragraph 2 or 3, as the case may be. Such determination, and any determination that advanced Expenses must be repaid to the Corporation, shall be made in each instance (a) by a majority vote of the directors of the Corporation consisting of persons who are not at that time parties to the Proceeding ("disinterested directors"), whether or not a quorum, (b) by a committee of disinterested directors designated by a majority vote of disinterested directors, whether or not a quorum, (c) if there are no disinterested directors, or if the disinterested directors so direct, by independent legal counsel (who may, to the extent permitted by applicable law, be regular legal counsel to the Corporation) in a written opinion to the Board, or (d) by the stockholders.
9. Remedies. The right to indemnification or advancement of Expenses as provided by this Agreement shall be enforceable by the Indemnitee in any court of competent jurisdiction if the Corporation denies such request, in whole or in part, or if no disposition thereof is made within the 60-day period referred to above in Paragraph 8. Unless otherwise required by law, the burden of proving that indemnification is not appropriate shall be on the Corporation. Neither the failure of the Corporation to have made a determination prior to the commencement of such action that indemnification is proper in the circumstances because Indemnitee has met the applicable standard of conduct, nor an actual determination by the Corporation pursuant to Paragraph 8 that Indemnitee has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that Indemnitee has not met the applicable standard of conduct. Indemnitee's Expenses reasonably incurred in connection with successfully establishing his right to indemnification, in whole or in part, in any such Proceeding shall also be indemnified by the Corporation.
10. Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Corporation for some or a portion of the Expenses, judgments, fines, penalties or amounts paid in settlement actually and reasonably incurred by him or on his behalf in connection with any Proceeding but not, however, for the total amount thereof, the Corporation shall nevertheless indemnify Indemnitee for the portion of such Expenses, judgments, fines, penalties or amounts paid in settlement to which Indemnitee is entitled.
11. Subrogation. In the event of any payment under this Agreement, the Corporation shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and take all action necessary to secure such rights, including execution of such documents as are necessary to enable the Corporation to bring suit to enforce such rights.
12. Term of Agreement. This Agreement shall continue until and terminate upon the later of (a) six years after the date that Indemnitee's Corporate Status ceases, or (b) the final termination of all Proceedings pending on the date set forth in clause (a) in respect of which Indemnitee is granted rights of indemnification or advancement of Expenses hereunder and of any Proceeding commenced by Indemnitee pursuant to Paragraph 9 of this Agreement relating thereto.
13. Indemnification Hereunder Not Exclusive. The indemnification and advancement of Expenses provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may be entitled under the Certificate of Incorporation, the By-Laws, any agreement, any vote of stockholders or disinterested directors, the Nevada Revised Statutes, any other law (common or statutory), or otherwise, both as to action in his official capacity and as to action in another capacity while holding office for the Corporation. Nothing contained in this Agreement shall be deemed to prohibit the Corporation from purchasing and maintaining insurance, at its expense, to protect itself or the Indemnitee against any expense, liability or loss incurred by it or him in his Corporate Status or arising out of his Corporate Status, whether or not the Indemnitee would be indemnified against such expense, liability or loss under this Agreement; provided that the Corporation shall not be liable under this Agreement to make any payment of amounts otherwise indemnifiable hereunder if and to the extent that Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise.
14. No Special Rights. Nothing herein shall confer upon Indemnitee any right to continue to serve as an officer or director of the Corporation for any period of time or at any particular rate of compensation.
15. Savings Clause. If this Agreement or any portion thereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify Indemnitee as to Expenses, judgments, fines, penalties and amounts paid in settlement with respect to any Proceeding to the full extent permitted by any applicable portion of this Agreement that shall not have been invalidated and to the fullest extent permitted by applicable law.
16. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall constitute the original.
17. Successors and Assigns. This Agreement shall be binding upon the Corporation and its successors and assigns and shall inure to the benefit of the estate, heirs, executors, administrators and personal representatives of Indemnitee.
18. Headings. The headings of the paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction thereof.
19. Modification and Waiver. This Agreement may be amended from time to time to reflect changes in Nevada law or for other reasons. No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof nor shall any such waiver constitute a continuing waiver.
20. Notices. All notices, requests, demands and other communications
hereunder shall be in writing and shall be deemed to have been given (i)
when delivered by hand or (ii) if mailed by certified or registered mail
with postage prepaid, on the third day after the date on which it is so
mailed:
a. if to the Indemnitee, to:
a. if to the Corporation, to:
Hallmark Financial Services, Inc.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75254
Attn: Board of Directors
or to such other address as may have been furnished to Indemnitee by the Corporation or to the Corporation by Indemnitee, as the case may be.
21. Applicable Law. This Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Nevada.
22. Enforcement. The Corporation expressly confirms and agrees that it has entered into this Agreement in order to induce Indemnitee to serve, or continue to serve, as a director or officer of the Corporation, and acknowledges that Indemnitee is relying upon this Agreement in accepting or continuing such capacity.
23. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supercedes all prior agreements, whether oral or written, by any officer, employee or representative of any party hereto in respect of the subject matter contained herein.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written.
By: _________________________________
Linda H. Sleeper, President and Chief
Executive Officer
CERTIFICATION
PURSUANT TO 18 U.S.C. SECTION 1350
ENACTED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-QSB of Hallmark Financial Services, Inc. (the "Company") for the period ended September 30, 2002, as filed with the Securities and Exchange Commission as of the date hereof (the "Report"), and pursuant to 18 U.S.C. 1350 as enacted by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned Chief Executive Officer and Chief Financial Officer of the Company hereby certify as follows:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: October 31, 2002 /s/ Linda H. Sleeper
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Linda H. Sleeper
Chief Executive Officer
Dated: October 31, 2002 /s/ John J. DePuma
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John J. DePuma
Chief Financial Officer
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