UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

  (Mark One)

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

For Quarterly Period Ended March 31, 2014

or      

o 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

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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, or a non-accelerated filer (as defined in rule 12b-2 of the Act).  (Check One) :    Large accelerated filer o Accelerated filer  o Non-accelerated filer  o Smaller reporting company  þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No  þ

As of May 14, 2014, there were 2,494,480 shares, $1.00 par value, of the registrant’s common stock outstanding.

1

THE NATIONAL SECURITY GROUP, INC.

INDEX

PART I. FINANCIAL INFORMATION
			Page No.
	Item 1.  Financial Statements
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Income (Loss)	5
		Condensed Consolidated Statements of Comprehensive Income	6
		Condensed Consolidated Statements of Changes in Shareholders’ Equity	7
		Condensed Consolidated Statements of Cash Flows	8
		Notes to Condensed Consolidated Financial Statements	9
		Review Report of Independent Registered Public Accounting Firm	30
	Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
	Item 3.  Quantitative and Qualitative Disclosures about Market Risk		38
	Item 4.  Controls and Procedures		39
PART II. OTHER INFORMATION
	Item 1.    Legal Proceedings		39
	Item 1A. Risk Factors		39
	Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds		39
	Item 3.    Defaults Upon Senior Securities		40
	Item 4. Mine Safety Disclosures		40
	Item 5.    Other Information		40
	Item 6.    Exhibits		40
SIGNATURE			41

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.

▪ 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. Financial Information

Item 1.  Financial Statements

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)

	March 31, 2014		December 31, 2013
	(UNAUDITED)
ASSETS
Investments
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2014 -       $821; 2013 - $853)	$	772	$	812
Fixed maturities available-for-sale, at estimated fair value (cost: 2014 - $79,452; 2013 -$79,074)	81,322		79,434
Equity securities available-for-sale, at estimated fair value (cost: 2014 - $2,420; 2013 - $2,420)	4,490		4,374
Trading securities	19		19
Mortgage loans on real estate, at cost	331		333
Investment real estate, at book value	4,217		4,218
Policy loans	1,452		1,443
Company owned life insurance	5,888		5,858
Other invested assets	3,459		3,559
Total Investments	101,950		100,050
Cash	6,739		4,987
Accrued investment income	836		817
Policy receivables and agents' balances, net	11,081		10,276
Reinsurance recoverable	1,278		1,501
Deferred policy acquisition costs	8,734		8,776
Property and equipment, net	1,990		2,077
Accrued income tax recoverable	—		6
Deferred income tax asset, net	3,945		4,654
Other assets	925		836
Total Assets	$	137,478	$	133,980
LIABILITIES AND SHAREHOLDERS' EQUITY
Property and casualty benefit and loss reserves	$	9,419	$	8,734
Accident and health benefit and loss reserves	2,577		2,651
Life and annuity benefit and loss reserves	30,847		30,696
Unearned premiums	28,424		27,301
Policy and contract claims	833		842
Other policyholder funds	1,466		1,447
Short-term notes payable and current portion of long-term debt	1,166		1,866
Long-term debt	21,164		20,889
Accrued income taxes	32		—
Other liabilities	6,157		6,082
Total Liabilities	102,085		100,508
Contingencies
Shareholders' equity
Common stock	2,495		2,495
Additional paid-in capital	5,147		5,147
Accumulated other comprehensive income	1,933		936
Retained earnings	25,818		24,894
Total Shareholders' Equity	35,393		33,472
Total Liabilities and Shareholders' Equity	$	137,478	$	133,980

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

4

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)

(In thousands, except per share amounts)

	Three Months Ended March 31,
	2014		2013
REVENUES
Net premiums earned	$	13,824	$	12,934
Net investment income	948		1,045
Net realized investment gains	88		27
Other income	154		172
Total Revenues	15,014		14,178
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits and settlement expenses	7,864		9,551
Amortization of deferred policy acquisition costs	898		942
Commissions	2,027		1,982
General and administrative expenses	2,026		1,803
Taxes, licenses and fees	530		486
Interest expense	386		442
Total Benefits, Losses and Expenses	13,731		15,206
Income (Loss) Before Income Taxes	1,283		(1,028		)
INCOME TAX EXPENSE (BENEFIT)
Current	88		132
Deferred	196		(751		)
	284		(619		)
Net Income (Loss)	$	999	$	(409	)
INCOME (LOSS) PER COMMON SHARE BASIC AND DILUTED	$	0.40	$	(0.17	)
DIVIDENDS DECLARED PER SHARE	$	0.03	$	0.025

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 (UNAUDITED)

(In thousands)

	Three months ended March 31,
	2014			2013
Net income (loss)	$	999		$	(409	)
Other comprehensive income, net of tax
Changes in:
Unrealized gains on securities, net of reclassification adjustment of $59 and $18 for 2014 and 2013, respectively	1,073			526
Unrealized gain (loss) on interest rate swap	(76		)	52
Other comprehensive income, net of tax	997			578
Comprehensive income	$	1,996		$	169

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)

(In thousands)

	Total			Retained Earnings			Accumulated Other Comprehensive Income		Common Stock		Additional Paid-in Capital
Balance at December 31, 2013 (AUDITED)	$	33,472		$	24,894		$	936	$	2,495	$	5,147
Net income for the three months ended March 31, 2014	999			999
Other comprehensive income (net of tax)	997						997
Cash dividends	(75		)	(75		)
Balance at March 31, 2014	$	35,393		$	25,818		$	1,933	$	2,495	$	5,147

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

7

THE NATIONAL SECURITY GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands)

	Three months ended March 31,
	2014			2013
Cash Flows from Operating Activities
Net income (loss)	$	999		$	(409	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation expense and amortization/accretion, net	134			202
Increase in cash surrender value of company owned life insurance	(30		)	(50		)
Net realized gains on investments	(88		)	(27		)
Deferred income taxes	196			(751		)
Amortization of deferred policy acquisition costs	898			942
Changes in assets and liabilities:
Change in accrued investment income	(19		)	(80		)
Change in reinsurance recoverable	223			(23		)
Policy acquisition costs deferred	(856		)	(814		)
Change in accrued income taxes	38			32
Change in net policy liabilities and claims	1,066			(661		)
Change in other assets/liabilities, net	(71		)	386
Other, net	8			9
Net cash provided by (used in) operating activities	2,498			(1,244		)
Cash Flows from Investing Activities
Purchase of:
Available-for-sale securities	(2,707		)	(6,678		)
Property and equipment	(4		)	(36		)
Proceeds from sale or maturities of:
Held-to-maturity securities	39			188
Available-for-sale securities	2,370			3,236
Real estate held for investment	—			207
Property and equipment	3			36
Other invested assets, net	34			4
Net cash used in investing activities	(265		)	(3,043		)
Cash Flows from Financing Activities
Change in other policyholder funds	19			(5		)
Change in long-term debt	275			300
Change in short-term notes payable	(700		)	—
Dividends paid	(75		)	(62		)
Net cash (used in) provided by financing activities	(481		)	233
Net change in cash and cash equivalents	1,752			(4,054		)
Cash and cash equivalents, beginning of year	4,987			6,779
Cash and cash equivalents, end of year	$	6,739		$	2,725

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

8

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries:  National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO).  NSFC includes a wholly-owned subsidiary, Omega One Insurance Company (Omega).  The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).  In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated.  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, 2013, which includes information and disclosures not presented herein.

Use of Estimates

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

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 2,494,480 in 2014 and 2,466,600 in 2013.

Reclassifications

Certain 2013 amounts have been reclassified from the prior year consolidated financial statements to conform to the 2014 presentation.

Concentration of Credit Risk

The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts. Through December 31, 2012, these balances were insured by the FDIC with no balance limits. On January 1, 2013, $250,000 per entity account balance limits were reinstated. At March 31, 2014, the net amount exceeding FDIC insured limits was $2,913,000 at one financial institution. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of the financial institution on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.

Policy receivables are reported at unpaid balances. Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk. Receivables from agents, less provision for credit losses, are composed of balances due from independent agents. At March 31, 2014, the single largest balance due from one agent totaled $953,000.

Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet their obligation could result in losses to the insurance subsidiaries. Allowances for losses are established if amounts are believed to be uncollectible. At March 31, 2014 and 2013, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At March 31, 2014, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.

Recently Adopted Accounting Standards

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists

9

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

In July 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss ("NOL") carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. This guidance is effective for fiscal years beginning after December 15, 2013. The Company adopted this standard on January 1, 2014. This guidance did not have a material effect on results of operations or financial position.

NOTE 2 – VARIABLE INTEREST ENTITIES

The Company holds a passive interest in a limited partnership that is considered to be a Variable Interest Entity (VIE) under the provisions of ASC 810 Consolidation. The Company is not the primary beneficiary of the entity and is not required to consolidate under ASC 810. The entity is a private placement investment fund formed for the purpose of investing in private equity investments. The Company owns less than 1% of the limited partnership. The carrying value of the investment totals $325,000 and is included as a component of Other Invested Assets in the accompanying 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 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 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 (TPS) 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 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 consolidated balance sheets.

10

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

NOTE 3 – INVESTMENTS

The amortized cost and aggregate fair values of investments in available-for-sale securities as of March 31, 2014 are as follows (dollars in thousands):

Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities	$	35,794	$	1,980	$	289	$	37,485
Trust preferred securities	538		48		—		586
Mortgage backed securities	8,546		90		388		8,248
Private label mortgage backed securities	1,921		43		7		1,957
Obligations of states and political subdivisions	15,209		664		95		15,778
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	17,444		284		460		17,268
Total fixed maturities	79,452		3,109		1,239		81,322
Equity securities	2,420		2,452		382		4,490
Total	$	81,872	$	5,561	$	1,621	$	85,812

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of March 31, 2014 are as follows (dollars in thousands):

Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage backed securities	$	676	$	43	$	—	$	719
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	96		6		—		102
Total	$	772	$	49	$	—	$	821

The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2013 are as follows (dollars in thousands):

Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities	$	35,831	$	1,698	$	713	$	36,816
Trust preferred securities	538		33		—		571
Mortgage backed securities	7,622		75		557		7,140
Private label mortgage backed securities	2,152		38		4		2,186
Obligations of states and political subdivisions	16,412		524		195		16,741
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	16,519		169		708		15,980
Total fixed maturities	79,074		2,537		2,177		79,434
Equity securities	2,420		2,365		411		4,374
Total	$	81,494	$	4,902	$	2,588	$	83,808

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2013 are as follows (dollars in thousands):

Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage backed securities	$	706	$	34	$	—	$	740
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	106		7		—		113
Total	$	812	$	41	$	—	$	853

11

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

The amortized cost and aggregate fair value of debt securities at March 31, 2014, by contractual maturity, are presented in the following table (dollars in thousands).  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	(Dollars in Thousands)
	Amortized Cost		Fair Value
Available-for-sale securities:
Due in one year or less	$	1,782	$	1,821
Due after one year through five years	15,258		16,462
Due after five years through ten years	27,505		28,023
Due after ten years	34,907		35,016
Total	$	79,452	$	81,322
Held-to-maturity securities:
Due in one year or less	$	—	$	—
Due after one year through five years	225		237
Due after five years through ten years	165		177
Due after ten years	382		407
Total	$	772	$	821

A summary of securities available-for-sale with unrealized losses as of March 31, 2014, 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 (dollars in thousands):

	Less than 12 months				12 months or longer				Total
March 31, 2014	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Total Securities in a Loss Position
Fixed maturities
Corporate debt securities	$	5,215	$	181	$	2,881	$	108	$	8,096	$	289	17
Mortgage backed securities	2,785		211		2,471		177		5,256		388		18
Private label mortgage backed securities	462		7		—		—		462		7		3
Obligations of state and political subdivisions	1,113		40		887		55		2,000		95		5
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	9,027		317		1,060		143		10,087		460		18
Equity securities	—		—		904		382		904		382		1
	$	18,602	$	756	$	8,203	$	865	$	26,805	$	1,621	62

12

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

A summary of securities available-for-sale with unrealized losses as of December 31, 2013, 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 (dollars in thousands):

	Less than 12 months				12 months or longer				Total
December 31, 2013	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Total Securities in a Loss Position
Fixed maturities
Corporate debt securities	$	10,589	$	600	$	1,548	$	113	$	12,137	$	713	26
Mortgage backed securities	3,215		427		1,796		130		5,011		557		18
Private label mortgage backed securities	472		4		—		—		472		4		3
Obligations of state and political subdivisions	3,545		165		325		30		3,870		195		11
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	11,534		600		390		108		11,924		708		21
Equity securities	—		—		875		411		875		411		1
	$	29,355	$	1,796	$	4,934	$	792	$	34,289	$	2,588	80

There were no securities held-to-maturity with unrealized losses as of March 31, 2014 and December 31, 2013.

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.  The Company has no material exposure to sub-prime mortgage loans and less than 2.9% of the fixed income investment portfolio is rated below investment grade.  In evaluating whether or not the equity loss positions were other-than-temporary impairments, Management evaluated financial information on each company and where available, reviewed analyst reports from at least two independent sources.  Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments.

For the three months ended March 31, 2014 and 2013, the Company realized no additional other-than-temporary impairments.

13

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

Major categories of investment income are summarized as follows (dollars in thousands):

	Three months ended March 31,
	2014		2013
Fixed maturities	$	859	$	825
Equity securities	29		28
Mortgage loans on real estate	4		7
Investment real estate	2		40
Policy loans	27		24
Company owned life insurance change in surrender value	30		50
Other, principally short-term investments	54		119
	1,005		1,093
Less: Investment expenses	57		48
Net investment income	$	948	$	1,045

Major categories of investment gains and losses are summarized as follows (dollars in thousands):

	Three months ended March 31,
	2014			2013
Fixed maturities	$	90		$	23
Equity securities	—			—
Trading securities	—			—
Other, principally real estate	(2		)	4
Other-than-temporary impairments	—			—
Net realized investment gains	$	88		$	27

An analysis of the net change in unrealized appreciation on available-for-sale securities follows (dollars in thousands):

	March 31, 2014			December 31, 2013
Net change in unrealized appreciation on available-for-sale securities before deferred tax	$	1,626		$	(4,243	)
Deferred income tax	(553		)	1,442
Net change in unrealized appreciation on available-for-sale securities	$	1,073		$	(2,801	)

NOTE 4 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

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

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

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

14

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

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

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

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

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

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

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

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

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

15

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 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 March 31, 2014 are summarized in the following table by the type of inputs applicable to the fair value measurements (unaudited) (in thousands):

	Fair Value Measurements at Reporting Date Using
Description	Total		Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
Corporate debt securities	$	37,485	$	—	$	37,485	$	—
Trust preferred securities	586		—		586		—
Mortgage backed securities	8,248		—		8,248		—
Private label mortgage backed securities	1,957		—		1,957		—
Obligations of states and political subdivisions	15,778		—		15,778		—
U.S. Treasury securities and obligations of U.S.    Government corporations and agencies	17,268		17,268		—		—
Trading securities	19		19		—		—
Equity securities available-for-sale	4,490		3,586		—		904
Total Financial Assets	$	85,831	$	20,873	$	64,054	$	904
Financial Liabilities
Interest rate swap	$	1,012	$	—	$	—	$	1,012
Total Financial Liabilities	$	1,012	$	—	$	—	$	1,012

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 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 March 31, 2014, Level 3 fair value measurements of assets include $904,000 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.

As of March 31, 2014, Level 3 fair value measurements of liabilities include $1,012,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party broker who utilizes financial modeling

16

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

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 three months ended March 31, 2014 (in thousands):

For the three months ended March 31, 2014	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	875	$	(897	)
Total gains or losses (realized and unrealized):
Included in earnings	—		—
Included in other comprehensive income	29		(115		)
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	904	$	(1,012	)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of March 31, 2014:	$	—	$	—

For the three months ended March 31, 2014, 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, 2013 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):

	Fair Value Measurements at Reporting Date Using
Description	Total		Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
Corporate debt securities	$	36,816	$	—	$	36,816	$	—
Trust preferred securities	571		—		571		—
Mortgage backed securities	7,140		—		7,140		—
Private label mortgage backed securities	2,186		—		2,186		—
Obligations of states and political subdivisions	16,741		—		16,741		—
U.S. Treasury securities and obligations of U.S.    Government corporations and agencies	15,980		15,980		—		—
Trading securities	19		19		—		—
Equity securities available-for-sale	4,374		3,499		—		875
Total Financial Assets	$	83,827	$	19,498	$	63,454	$	875
Financial Liabilities
Interest rate swap	$	897	$	—	$	—	$	897
Total Financial Liabilities	$	897	$	—	$	—	$	897

17

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 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, 2013 (in thousands):

For the year ended December 31, 2013	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	829	$	(1,521	)
Total gains or losses (realized and unrealized):
Included in earnings	—		—
Included in other comprehensive income	46		624
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	875	$	(897	)
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, 2013:	$	—	$	—

For the year ended December 31, 2013, 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.

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.

18

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

The carrying amount and estimate fair value of the Company’s financial instruments as of March 31, 2014 and December 31, 2013 are as follows (in thousands):

	March 31, 2014				December 31, 2013
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Assets and related instruments
Mortgage loans	$	331	$	331	$	333	$	333
Policy loans	1,452		1,452		1,443		1,443
Company owned life insurance	5,888		5,888		5,858		5,858
Other invested assets	3,459		3,459		3,559		3,559
Liabilities and related instruments
Other policyholder funds	1,466		1,466		1,447		1,447
Short-term notes payable and current portion of long-term debt	1,166		1,166		1,866		1,866
Long-term debt	21,164		21,164		20,889		20,889

NOTE 5 – PROPERTY AND EQUIPMENT

Major categories of property and equipment are summarized as follows (dollars in thousands):

	March 31, 2014		December 31, 2013
Building and improvements	$	3,185	$	3,185
Electronic data processing equipment	1,826		1,822
Furniture and fixtures	845		874
	5,856		5,881
Less accumulated depreciation	3,866		3,804
Property and equipment, net	$	1,990	$	2,077

Depreciation expense for the three months ended March 31, 2014 was $85,000 ($386,000for the year ended December 31, 2013).

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 2010. Tax returns have been filed through the year 2012. Extensions have been filed for 2013.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.  Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets.  The Company recognized net deferred tax asset positions of $3,945,000 at March 31, 2014 and $4,654,000 at December 31, 2013.

The tax effect of significant differences representing deferred tax assets and liabilities are as follows (dollars in thousands):

19

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

	As of March 31, 2014			As of December 31, 2013
General expenses	$	1,331		$	1,326
Unearned premiums	1,931			1,855
Claims liabilities	742			700
Litigation settlement	3,173			3,173
AMT credit	335			335
NOL carryforward	474			849
Unrealized loss on interest rate swaps	345			305
Deferred tax assets	8,331			8,543
Depreciation	(77		)	(119		)
Deferred policy acquisition costs	(2,970		)	(2,984		)
Unrealized gains on securities available-for-sale	(1,339		)	(786		)
Deferred tax liabilities	(4,386		)	(3,889		)
Net deferred tax asset	$	3,945		$	4,654

The appropriate income tax effects of changes in temporary differences are as follows (dollars in thousands):

	Three months ended March 31,
	2014			2013
Deferred policy acquisition costs	$	(14	)	$	(43	)
Trading securities	—			(1		)
Unearned premiums	(76		)	(26		)
General expenses	(5		)	(57		)
Depreciation	(42		)	(11		)
Claim liabilities	(42		)	(109		)
NOL carryforward	375			(504		)
Deferred income tax expense (benefit)	$	196		$	(751	)

20

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

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

	Three months ended March 31,
	2014		2013
Federal income tax rate applied to pre-tax income/loss	34.0	%	(34.0	)%
Dividends received deduction and tax-exempt interest	(2.4	)%	(3.2	)%
Company owned life insurance	(0.8	)%	(1.6	)%
Small life deduction	(11.4	)%	(15.4	)%
AMT	1.9	%	—	%
Other, net	0.8	%	(6.0	)%
Effective federal income tax rate	22.1	%	(60.2	)%

At March 31, 2014, the Company has approximately $1,396,000 of net operating loss carryforwards available ($474,000 tax benefit) to be applied to future periods.  These carryforwards expire in 2031 and 2032.

NOTE 7 – NOTES PAYABLE AND LONG-TERM DEBT

Short-term debt and current portion of long-term debt consisted of the following as of March 31, 2014 and December 31, 2013 (dollars in thousands):

	2014		2013
Line of credit with variable interest rate equal to the Wall Street Journal (WSJ) prime rate, subject to a 5.0% floor; maturity February 2014.  Interest payments due quarterly.  Unsecured.	$	—	$	700
Current portion of installment note payable due November 2014 with variable interest rate equal to the WSJ prime rate plus 1%; Unsecured	1,166		1,166
	$	1,166	$	1,866

Long-term debt consisted of the following as of March 31, 2014 and December 31, 2013 (dollars in thousands):

	2014		2013
Line of credit with variable interest rate equal to the WSJ prime rate, subject to a 5.0% floor; maturity February 2016.  Interest payments due quarterly.  Unsecured.	$	275	$	—
Line of credit with variable interest rate equal to the WSJ prime rate, subject to a 4.5% floor; maturity September 2017.  Interest payments due monthly.  Secured.	350		350
Long term portion of installment note with variable interest rate equal to the WSJ prime rate plus 1% and adjustable each November; maturity November 2021. Interest payable annually with principal payable in equal annual installments. Next principal installment on long term portion due November 2015. Unsecured.	8,167		8,167
Subordinated debentures issued on December 15, 2005 with fixed interest rate of 8.83% each distribution period thereafter until December 15, 2015 when the coupon rate shall equal the 3-Month LIBOR plus 3.75% applied to the outstanding principal; maturity December 2035.  Interest payments due quarterly.  All may be redeemed at any time following the tenth anniversary of issuance.  Unsecured.	9,279		9,279
Subordinated debentures issued on June 21, 2007 with a floating interest rate equal to the 3-Month LIBOR plus 3.40% applied to the outstanding principal; maturity June 15, 2037. Interest payments due quarterly.  All may be redeemed at any time following the fifth anniversary of issuance.  Unsecured.	3,093		3,093
	$	21,164	$	20,889

21

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which will hedge 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 will pay interest at a fixed rate of 8.49% until March 15, 2020.

The swaps entered into in 2009 and 2010 have fair values of $278,000 (liability) and $734,000 (liability), respectively, for a total liability of $1,012,000 at March 31, 2014 ($897,000 at December 31, 2013).  The swap liability is reported as a component of other liabilities on the consolidated balance sheets.  A net valuation loss of $76,000 (net of tax) is included in accumulated other comprehensive income related to the swap agreements for the current period.  A net valuation gain of $412,000 (net of tax) was included in accumulated other comprehensive income related to the swap at December 31, 2013.

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 March 31, 2014, the Company has securities on deposit with fair market values of $1,450,000 (all of which is posted as collateral). At December 31, 2013, the Company had securities on deposit with fair market values of $1,422,000 (all of which is posted as collateral). See Note 4 for additional information about the interest rate swaps.

NOTE 8 – REINSURANCE

The Company's insurance operations utilize reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term coverage. Property and casualty reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of re-insurers to honor their obligations could result in 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 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.

Under the catastrophe reinsurance program, the Company retains the first $4,000,000 in losses from each catastrophe event.  Catastrophe reinsurance coverage is maintained in four layers as follows:

Layer	Reinsurers' Limits of Liability
First Layer	100% of $6,000,000 in excess of $4,000,000
Second Layer	100% of $7,500,000 in excess of $10,000,000
Third Layer	100% of $25,000,000 in excess of $17,500,000
Fourth Layer	100% of $30,000,000 in excess of $42,500,000

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.

22

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

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 strengthen the Company's capital position by reducing the modeled 100 year event net cost.

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

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

At March 31, 2014, the largest reinsurance recoverable of a single reinsurer was $115,000 ($214,000 at December 31, 2013). Amounts reported as ceded incurred losses in both 2014 and 2013 were related to the development of losses from prior year catastrophes.

NOTE 9 – EMPLOYEE BENEFIT PLANS

The Company and its subsidiaries have an established retirement savings plan (401K Plan). All full-time employees are eligible to participate, and all employer contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Company matching contributions for the three months endedMarch 31, 2014 and 2013 amounted to $46,000 and $48,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.

In January 2006, the Company established a non-qualified plan under which directors are allowed to defer all or a portion of directors' fees into various investment options.

The supplemental executive retirement plan (SERP) became effective March 1, 2008 and 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 credited of the non-qualified deferred compensation plans for the three months endedMarch 31, 2014 and 2013 amounted to approximately $30,000 and $76,000, respectively.

The Company and its subsidiaries established an Employee Stock Ownership Plan (ESOP) in January 2010, to enable its 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 $50,000 in costs incurred during the first three months of 2014 and no costs incurred for the first three months of 2013 related to the ESOP. All contributions were made in cash for purchase of Company shares in the open market. The Company has not allocated shares directly to the plan and the plan has no debt.

NOTE 10 – SHAREHOLDERS' EQUITY

During the three months ended March 31, 2014, and year ended December 31, 2013, changes in shareholders' equity consisted of net income of $999,000 and net income of $5,658,000, respectively; dividends paid of $75,000 in 2014 and $248,000 in 2013; changes in accumulated other comprehensive income, net of applicable taxes, of $997,000 in 2014 and other comprehensive loss, net of applicable taxes, of $2,389,000 in 2013.  Other comprehensive loss consists of accumulated unrealized gains and losses on securities and unrealized gains and losses on interest rate swaps.

The table below provides information regarding the Company's preferred and common stock as of March 31, 2014 and December 31, 2013:

23

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

	Authorized	Issued	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	2,494,480	2,494,480

NOTE 11 – ACCUMULATED OTHER COMPREHENSIVE INCOME

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 (dollars in thousands):

	Three Months Ended March 31,
	2014			2013
Gains and Losses on Cash Flow Hedges
Balance at beginning of period	$	(591	)	$	(1,003	)
Other comprehensive income (loss) for period:
Other comprehensive income (loss) before reclassifications	(76		)	52
Amounts reclassified from accumulated other comprehensive income	—			—
Net current period other comprehensive income (loss)	(76		)	52
Balance at end of period	$	(667	)	$	(951	)
Unrealized Gains and Losses on Available-for-Sale Securities
Balance at beginning of period	$	1,527		$	4,328
Other comprehensive income (loss) for period:
Other comprehensive income before reclassifications	1,132			544
Amounts reclassified from accumulated other comprehensive income	(59		)	(18		)
Net current period other comprehensive income	1,073			526
Balance at end of period	$	2,600		$	4,854
Total Accumulated Other Comprehensive Income (loss) at end of period	$	1,933		$	3,903

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2014 (dollars 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	$	88		Net realized investment gains
	88			Total before tax
	(29		)	Tax (expense) or benefit
	$	59		Net of Tax

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2013 (dollars in thousands):

24

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

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	$	27		Net realized investment gains
	27			Total before tax
	(9		)	Tax (expense) or benefit
	$	18		Net of Tax

NOTE 12 – 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. The Company has ceased writing ocean marine, private passenger auto liability, commercial auto liability and auto physical damage coverages over the past two years with no policies remaining in-force at December 31, 2013 in the lines of business.  

Management organizes the business utilizing a niche strategy focusing on lower valued dwellings.  Our chief decision makers (Chief Executive Officer, Chief Financial Officer and President) review results and operating plans making decisions on resource allocations on a company-wide basis.  The Company’s products are primarily produced through 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 accident and health insurance.

Total assets by industry segment at March 31, 2014 and at December 31, 2013 are summarized below (dollars in thousands):

	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations
March 31, 2014
	$	137,478	$	75,439	$	54,926	$	7,113
December 31, 2013
	$	133,980	$	71,003	$	53,831	$	9,146

25

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

Premium revenues and operating income by business segment for the three months ended March 31, 2014 and 2013 are summarized below (dollars in thousands):

Three months ended March 31, 2014	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations
REVENUE
Net premiums earned	$	13,824	$	12,173	$	1,651	$	—
Net investment income	948		455		474		19
Net realized investment gains	88		48		40		—
Other income	154		153		1		—
	15,014		12,829		2,166		19
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits paid	7,864		6,664		1,200		—
Amortization of deferred policy acquisition costs	898		641		257		—
Commissions	2,027		1,945		82		—
General and administrative expenses	2,026		1,457		460		109
Taxes, licenses and fees	530		464		66		—
Interest expense	386		—		17		369
	13,731		11,171		2,082		478
Income (Loss) Before Income Taxes	$	1,283	$	1,658	$	84	$	(459	)

Three months ended March 31, 2013	Total			P&C Insurance Operations			Life Insurance Operations		Non-Insurance Operations
REVENUE
Net premiums earned	$	12,934		$	11,188		$	1,746	$	—
Net investment income	1,045			477			549		19
Net realized investment gains	27			2			25		—
Other income	172			170			2		—
	14,178			11,837			2,322		19
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits paid	9,551			8,553			998		—
Amortization of deferred policy acquisition costs	942			661			281		—
Commissions	1,982			1,886			96		—
General and administrative expenses	1,803			1,245			402		156
Taxes, licenses and fees	486			412			74		—
Interest expense	442			—			21		421
	15,206			12,757			1,872		577
Income (Loss) Before Income Taxes	$	(1,028	)	$	(920	)	$	450	$	(558	)

26

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

The following table presents the Company’s gross and net premiums written for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2014 and 2013, respectively:

	Three months ended March 31,
	2014			2013
Life, accident and health operations premiums written:
Traditional life insurance	$	1,179		$	1,218
Accident and health insurance	444			444
Gross life, accident and health	1,623			1,662
Reinsurance premium ceded	(23		)	(19		)
Net life, accident and health premiums written	$	1,600		$	1,643
Property and Casualty operations premiums written:
Dwelling fire & extended coverage	$	8,329		$	7,559
Homeowners (Including mobile homeowners)	5,749			5,421
Ocean marine	—			92
Other liability	469			408
Private passenger auto liability	—			—
Commercial auto liability	—			—
Auto physical damage	—			—
Gross property and casualty	14,547			13,480
Reinsurance premium ceded	(1,755		)	(2,132		)
Net property and casualty written	$	12,792		$	11,348
Gross premiums written	$	16,170		$	15,142
Reinsurance premium ceded	(1,778		)	(2,151		)
Net premiums written	$	14,392		$	12,991

27

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

The following table presents the Company’s gross and net premiums earned for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2014 and 2013, respectively:

	Three months ended March 31,
	2014			2013
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,243		$	1,316
Accident and health insurance	431			449
Gross life, accident and health	1,674			1,765
Reinsurance premium ceded	(23		)	(19		)
Net life, accident and health premiums earned	$	1,651		$	1,746
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	7,670		$	7,018
Homeowners (Including mobile homeowners)	5,831			5,681
Ocean marine	—			256
Other liability	427			373
Private passenger auto liability	—			—
Commercial auto liability	—			—
Auto physical damage	—			—
Gross property and casualty	13,928			13,328
Reinsurance premium ceded	(1,755		)	(2,140		)
Net property and casualty earned	$	12,173		$	11,188
Gross premiums earned	$	15,602		$	15,093
Reinsurance premium ceded	(1,778		)	(2,159		)
Net premiums earned	$	13,824		$	12,934

NOTE 13 – CONTINGENCIES

The Company and its subsidiaries continue to be named individually as parties to litigation related to the conduct of their insurance operations.  These suits 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. 

The Company's property & casualty subsidiaries are defending a limited number of matters filed in the aftermath of Hurricanes Katrina in Mississippi and Louisiana as well as Gustav and Ike in Texas.  These actions include individual lawsuits with allegations of underpayment of hurricane-related claims.

The various suits seek a variety of remedies, including actual and/or punitive damages in unspecified amounts and/or declaratory relief.  The Company has reserves set up on litigated claims and the reserves are included in benefit and loss reserves.

NOTE 14 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest during the three months ended March 31, 2014 was $289,000 ($323,000 in 2013). Cash paid for income taxes during the three months ended March 31, 2014 was $50,000 ($100,000 in 2013).

28

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED EXCEPT FOR DECEMBER 31, 2013 AMOUNTS)

NOTE 15 – SUBSEQUENT EVENTS

Management has evaluated subsequent events and their potential effects on these consolidated financial statements through the filing date of this Form 10-Q.

29

REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

The National Security Group, Inc.

We have reviewed the condensed consolidated balance sheet of The National Security Group, Inc. as of March 31, 2014, and the related condensed consolidated statements of income (loss), comprehensive income and cash flows for the three-month periods ended March 31, 2014 and 2013, and the related condensed consolidated statement of changes in shareholders' equity for the three-month period ended March 31, 2014.   These condensed consolidated financial statements are the responsibility of the company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The National Security Group, Inc. as of December 31, 2013, and the related consolidated statements of income (loss), shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated March 21, 2014, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. 

/s/ Warren Averett, LLC

Birmingham, Alabama

May 14, 2014

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

Overview

The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) and its subsidiaries. We are a “smaller reporting company” under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general, the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the three-month periods ended March 31, 2014 and 2013.

The National Security Group, Inc. is made up of two segments: the Life segment and the P&C segment. The Company's life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. The Company's property and casualty insurance business is 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 National Security Fire & Casualty Company organized in 1992.

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and with our audited consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

Information in this discussion is presented in whole dollars rounded to the nearest thousand. Tabular amounts are presented in thousands.

The National Security Group operates in the property and casualty and life, accident and supplemental health insurance businesses and markets products primarily through independent agents.  The Company operates in ten states with 50.3% of total premium revenue generated in the states of Alabama and Mississippi.  Property and casualty insurance is the most significant segment, accounting for 89.3% of gross insurance premium revenue in 2014.  Revenue generated from the life segment accounted for 10.7% of gross insurance premium revenue in 2014.

National Security Insurance Company (NSIC) is a life, accident and health insurance company founded in 1947.  The premium revenue produced in NSIC from the traditional life products and accident and health products accounted for 8.0% and 2.7%, respectively, of total gross premium revenue.  All references to NSIC in the remainder of this management discussion and analysis will refer to the combined life, accident and health insurance operations and will compose the life segment of the Company.  NSIC is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.

The property and casualty segment consists of the consolidated operations of two subsidiaries, National Security Fire and Casualty Company and its wholly owned subsidiary, Omega One Insurance Company. There is no material differentiation between the products underwritten by NSFC and Omega as both underwrite primarily dwelling personal lines coverage. The Property and Casualty segment has premium in-force in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.

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 reviewed and approved by each 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 November 20, 2013, Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. Best maintained the negative outlook on both of NSFC's ratings. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The outlook for all of these ratings is stable. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a negative outlook.

The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On November 22, 2013, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.

31

The two primary segments in which we report insurance operations are the personal lines property and casualty segment (NSFC) and the life, accident and health insurance segment (NSIC).  Due to the small amount of earned premium revenue produced by Omega and the fact that Omega is a wholly owned subsidiary of NSFC underwriting similar lines of business, all references to NSFC in the remainder of this management discussion and analysis will include the insurance operations of both NSFC and Omega.  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.

The property and casualty segment can be impacted by severe storm activity resulting in incurred losses and loss adjustment expenses primarily from tornado, wind and hail related damage. These storm systems or other natural disasters are classified as catastrophes (referred to as "cat events" or "catastrophe events" throughout the remainder of this document) by Property Claim Service (PCS) when these events cause $25 million or more in industry wide direct insured losses and affect a significant number of policyholders and insurers.

Summary of Consolidated Results of Operations

Financial Results for the three months ended March 31, 2014 and 2013 were as follows:

(dollars in thousands)	Three months ended March 31,
	2014			2013
REVENUES
Net premiums earned	$	13,824		$	12,934
Net investment income	948			1,045
Net realized investment gains	88			27
Other income	154			172
Total Revenues	15,014			14,178
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits and settlement expenses	7,864			9,551
Amortization of deferred policy acquisition costs	898			942
Commissions	2,027			1,982
General and administrative expenses	2,026			1,803
Taxes, licenses and fees	530			486
Interest expense	386			442
Total Benefits, Losses and Expenses	13,731			15,206
Income (Loss) Before Income Taxes	1,283			(1,028		)
INCOME TAX EXPENSE (BENEFIT)
Current	88			132
Deferred	196			(751		)
	284			(619		)
Net Income (Loss)	$	999		$	(409	)
INCOME (LOSS) PER COMMON SHARE	$	0.40		$	(0.17	)
DIVIDENDS DECLARED PER SHARE	$	0.03		$	0.025
Reconciliation of Net Income (Loss) to non-GAAP Measurement
Net income (loss)	$	999		$	(409	)
Income tax expense (benefit)	284			(619		)
Realized investment (gains) losses, net	(88		)	(27		)
Operating Income (Loss)	$	1,195		$	(1,055	)

The Company ended the first quarter of 2014 with net income of $999,000, $0.40 per share, compared to a net loss of $409,000, $0.17 loss per share, for the same period last year. On a pretax basis, for the three months ended March

32

31, 2014, we had income of $1,283,000 compared to a loss of $1,028,000 for the three months ended March 31, 2013. Our pretax income for the quarter ended March 31, 2014, consisted of income from operations of $1,195,000 and realized investment gains of $88,000. The pretax loss for the quarter ended March 31, 2013, consisted of a loss from operations of $1,055,000 and realized investment gains of $27,000.

The primary factor contributing to the improvement in our insurance operations was a $1,687,000 decrease in policyholder benefits. In the first quarter of 2014 non-catastrophe wind losses were down $710,000 compared to the first quarter of 2013. Also, property and casualty catastrophe related losses were down $1,186,000. The first quarter of 2013 was negatively impacted by significant catastrophe related losses from a late March storm system that generated significant catastrophe losses. Comparatively, the first quarter of 2014 was a very mild quarter with few storm related losses.

Net premium earned increased 6.9% in the first quarter of 2014 compared to the first quarter of last year. A combination of increased direct premium revenue and a decrease in reinsurance cost (ceded premium) were the two primary factors contributing to the increase in net premium earned in the first quarter of 2014. Direct earned premium increased 3.4% due to a combination of a moderate increase in policy issuance and rate increases in our core dwelling and homeowners lines of business. Also, contributing significantly to the increase in net premium earned was an 18.0% decrease in catastrophe reinsurance cost in the P&C segment. While our P&C segment reinsurance structure is unchanged, we were able to realize significant savings in our January 1, 2014 catastrophe reinsurance contract renewal. Annualized savings in reinsurance cost for 2014 is expected to be approximately $950,000.

Shareholders' equity as of March 31, 2014 was $35,393,000 up $1,921,000 compared to $33,472,000 as of December 31, 2013. Book value per share increased $0.77 per share for the period ended March 31, 2014 to $14.19 per share compared to $13.42 per share at December 31, 2013. The primary factors contributing to the increase in shareholders' equity and book value per share were the increase in net income and an increase in market value of available for sale securities; primarily driven by increases in market value of fixed income investments.

Premium revenue:

The table below provides earned premium revenue by segment for the three months ended March 31, 2014

and 2013:

	Three months ended March 31,						Percent
	2014			2013			increase (decrease)
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,243		$	1,316		(5.5	)%
Accident and health insurance	431			449			(4.0	)%
Gross life, accident and health	1,674			1,765			(5.2	)%
Reinsurance premium ceded	(23		)	(19		)	21.1	%
Net life, accident and health premiums earned	$	1,651		$	1,746		(5.4	)%
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	7,670		$	7,018		9.3	%
Homeowners (Including mobile homeowners)	5,831			5,681			2.6	%
Ocean marine	—			256			(100.0	)%
Other liability	427			373			14.5	%
Gross property and casualty	13,928			13,328			4.5	%
Reinsurance premium ceded	(1,755		)	(2,140		)	(18.0	)%
Net property and casualty premiums earned	$	12,173		$	11,188		8.8	%
Gross premiums earned	$	15,602		$	15,093		3.4	%
Reinsurance premium ceded	(1,778		)	(2,159		)	(17.6	)%
Net premiums earned	$	13,824		$	12,934		6.9	%

Consolidated net premium revenue was up 6.9% for the quarter ended March 31, 2014, at $13,824,000 compared to $12,934,000 for the quarter ended March 31, 2013. The primary reason for the increase was 9.3% growth in gross premium earned in the dwelling fire program in the current year compared to the same period last year. In addition, gross premium earned in our homeowners programs was up $150,000 or 2.6% in the first quarter of 2014 compared

33

to the first quarter of 2013. On June 30, 2013, we terminated our ocean marine program, canceling all policies, which lead to the $256,000 decrease in gross premium earned in 2014 compared to 2013.

P&C segment net earned premium was also impacted by a 18.0% decrease in ceded premium associated with a reduction in our catastrophe reinsurance rate under our January 1, 2014 catastrophe contract renewal. Annualized savings from this reinsurance rate reduction is expected to be approximately $950,000 for the full year in 2014. The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. Under our 2014 catastrophe contract renewal terms, our retention remained unchanged at $4 million and we maintain catastrophe reinsurance covering the cost incurred in a single catastrophe event up to $72.5 million after exceeding the $4 million retention.

Under the catastrophe reinsurance program for 2014, the Company retains the first $4,000,000 in losses from each event.  Reinsurance coverage is maintained in four layers as follows:

Layer	Reinsurers' Limits of Liability
First Layer	100% of $6,000,000 in excess of $4,000,000
Second Layer	100% of $7,500,000 in excess of $10,000,000
Third Layer	100% of $25,000,000 in excess of $17,500,000
Fourth Layer	100% of $30,000,000 in excess of $42,500,000

Additional details regarding the structure of the current year agreement can be found in Note 10 to the consolidated financial statements.

Investment income:

For the three months ended March 31, 2014, net investment income totaled $948,000 compared to $1,045,000 for the same period last year; a decrease of $97,000. The primary factor contributing to the decline in investment income was a reduction in distribution from a private equity investment.

Realized investment gains and losses:

The Company ended the first three months of 2014 with realized capital gains totaling $88,000 compared to $27,000 for the same period last year. The $61,000 change was primarily associated with a $46,000 increase in realized investment gains in the P&C segment compared to the same period last year. The realization of capital gains in the investment portfolio is influenced by both market conditions and liquidity requirements and therefore can vary significantly from quarter to quarter and year to year. Other activities, such as tax planning strategies, may also lead to significant variation in realized capital gains from year to year.

Other income:

Other income was $154,000 in the first three months of 2014 compared to $172,000 for the same period last year; a $18,000 or 10.5% decrease. Other income consists primarily of fees related to the issuance of our property insurance policies as well as miscellaneous income.

Policyholder benefits:

Claims were $7,864,000 for the three months ended March 31, 2014, compared to $9,551,000 for the same period last year; a decrease of $1,687,000 or 17.7%. The primary reason for the decrease was a reduction in reported losses and loss adjustment expenses (LAE) in the P&C segment from cat events as well as a reduction in reported losses and LAE in the P&C segment from non-catastrophe wind and hail claims in the current year compared to the same period last year. Partially offsetting the decline in claims from weather related events was an increase in P&C segment reported fire losses for the three months ended March 31, 2014, compared to the same period last year.

The table below 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 months ended March 31, 2014 and 2013:

34

Three months ended March 31, 2014				Three months ended March 31, 2013
	Reported Losses & LAE		Claim Count		Reported Losses & LAE		Claim Count
Cat event				Cat event
Cat 32	$	4,000	2	Cat 91	$	357,000	82
Cat 34	598,000		328	Cat 92	121,000		37
				Cat 93	1,310,000		336
	$	602,000	330		$	1,788,000	455
Non-cat wind & hail	$	1,220,000	463	Non-cat wind & hail	$	1,930,000	688

During the first three months of 2014, the P&C segment was impacted by two cat events totaling $602,000. The P&C subsidiaries incurred 330 claims from these cat events. These claims contributed 4.9 percentage points to the first quarter 2014 P&C segment loss ratio and had an average cost per claim of $1,800. During the first three months of 2013, the P&C segment was impacted by three cat events totaling $1,788,000 resulting in 455 claims with an average per claim of $3,900. The cat events during the first three months of 2013 increased the prior year P&C segment loss ratio by 16 percentage points. The largest 2013 cat event was Cat 93 with reported losses totaling $1,310,000 from 336 claims. Cat 93 increased the P&C segment loss ratio 11.7 percentage points and accounted for 73.3% of all 2013 reported cat losses. This cat event also had more tornado related losses versus purely wind related losses which contributed to the elevated average cost per claim for first quarter 2013 cat events compared to the first quarter of 2014.

Non-catastrophe wind and hail claims reported in the first three months of 2014 totaled $1,220,000 compared to non-catastrophe wind and hail claims reported in the first three months of 2013 totaling $1,930,000; a decline of $710,000 or 36.8%. During the first quarter of 2014, the P&C segment had 463 non-cat wind and hail claims reported (an average of $2,600 per claim) compared to 688 claims reported during the first quarter of 2013 (an average of $2,800 per claim). Non-cat wind and hail claims reported during 2014 accounted for 18.3% of total incurred losses and LAE in the current year. Non-cat wind and hail claims reported during 2013 accounted for 22.6% of total incurred losses and LAE in the prior year.

Fire losses reported during the first quarter of 2014 were up $837,000 or 25.9% compared to fire losses reported during the first quarter of 2013. The P&C segment had 161 fire losses reported in 2014 totaling $4,071,000 compared to 147 claims reported in 2013 totaling $3,234,000. The average cost per claim was $25,000 for fire losses reported in 2014 compared to $22,000 for fire losses reported in 2013. Fire losses tend to be more frequent in the winter months and more severe cold weather tends to elevate fire related losses. We experienced a much colder than normal winter in 2014 compared to 2013 over much of our coverage area, which contributed to the increase in fire related losses.

Policy acquisition cost (commissions and amortization of deferred acquisition cost):

For the three months ended March 31, 2014, policy acquisition costs were $2,925,000 compared to $2,924,000 for the same period last year; an increase of $1,000. Policy acquisition costs consist of amortization of previously capitalized distribution costs, primarily commissions. Policy acquisition costs were down moderately at 21.2% of premium revenue for the first quarter of 2014 compared to 22.6% of premium revenue for the same period last year.

General Expenses:

General and administrative expenses totaled $2,026,000 in the first quarter of 2014 compared to $1,803,000 in the first quarter of 2013; a 12.4% increase. The primary reason for the $223,000 increase in general and administrative expenses was related to a $106,000 increase in actuarial fees associated with insurance rate filings in the P&C segment and a policy reserve system conversion in the life segment.

Taxes, licenses and fees:

Insurance taxes, licenses and fees were $530,000 through March 31, 2014, compared to $486,000 for the same period last year. As a percentage of net premiums earned, insurance taxes, licenses and fees were 3.8% for the three months ended March 31, 2014 and 2013.

Interest expense:

35

Interest expense for the first quarter of 2014 was $386,000 compared to $442,000 for the same period last year; a decrease of 12.7%. The primary reason for the $56,000 decline was a $52,000 decrease in interest expense at the holding company level due to a reduction in long term debt during 2013.

Income taxes:

For the period ended March 31, 2014, income tax expense was $284,000 compared to income tax benefit of $619,000 for the same period last year. Income tax was composed of current income tax expense totaling $88,000 for the three months ended March 31, 2014, compared to a current income tax expense of $132,000 for the three months ended March 31, 2013. Deferred tax benefit totaled $196,000 for 2014 and $751,000 for 2013. The effective tax rate for the three months ended March 31, 2014 was 22.1% compared to (60.2)% for the same period last year. Deferred tax assets in our life segment from deferred premium and the small life insurance deduction during the three months ended March 31, 2014 and 2013 was the primary contributing factor to the reduction in income tax expense below the 34% statutory rate in both years.

Net income (loss):

The Company ended the first quarter of 2014 with pretax net income of $1,283,000 compared to a pretax net loss of $1,028,000 for the same period last year. As discussed above, much improved operating results in the property and casualty insurance segment was the primary factor contributing to improvement in net income.

Liquidity and capital resources:

Due to regulatory restrictions, the majority of the Company's cash is required to be invested 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. 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/casualty insurance subsidiaries. All operations and virtually all investments are maintained by the insurance subsidiaries. Premium and investment income as well as maturities and sales of invested assets provide the primary sources of cash for both the life and property/casualty businesses, while applications of cash are applied by both businesses to the payment of policy benefits, the cost of acquiring new business (principally commissions), operating expenses, purchases of new investments, and in the case of life insurance, policy loans.

Virtually all invested assets of the Company are held in the insurance subsidiaries. As of March 31, 2014, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows (dollars in thousands):

Maturity	Available- for-Sale		Held-to-Maturity		Total		Percentage of Total
Maturity in less than 1 year	$	1,782	$	—	$	1,782	2.22	%
Maturity in 1-5 years	15,258		225		15,483		19.30	%
Maturity in 5-10 years	27,505		165		27,670		34.49	%
Maturity after 10 years	34,907		382		35,289		43.99	%
	$	79,452	$	772	$	80,224	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 debt securities and principal pay-downs on mortgage backed 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 $4,400,000 decline in the market value of fixed income investment. Alternatively, a 100 basis point decrease in interest rates will generate approximately $4,400,000 in increases in market value of fixed income investments.

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At March 31, 2014, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $35,393,000, up $1,921,000 compared to $33,472,000 at December 31, 2013.  Components of the change in equity were net income of $999,000, increase in accumulated unrealized gains on investments of $1,073,000, a net unrealized loss of $76,000 related to interest rate swaps and cash dividends paid totaling $75,000.

As discussed above, changing interest rates can have a significant impact on the market value of fixed income securities. Fixed income 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 accumulated unrealized gains and losses directly impacting shareholder's equity.

While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 6.2% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.

The Company, primarily through its insurance subsidiaries, had $6,739,000 in cash and cash equivalents at March 31, 2014, compared to $2,725,000 at March 31, 2013. Improved performance in our insurance operations for the period ended March 31, 2014 contributed to the $2,498,000 in cash provided by operations compared to cash used in operations the same period last year totaling $1,244,000. Negative cash flows from operations in the prior year were related to insured losses from spring storms incurred during the first quarter.

Net cash used in investing activities totaled $265,000 for the period ended March 31, 2014, compared to $3,043,000 for the same period last year. In 2014 the Company had little investing activity other than reinvestment of maturing securities while more significant new investments were made during the same period last year.

Net cash used in financing activities totaled $481,000 for the period ended March 31, 2014, compared to net cash provided of $233,000 for the same period last year. During the first quarter of 2014, the Company repaid a $700,000 short-term note payable which was renewed with a two-year term. As of March 31, 2014, a total of $9,333,000 remained outstanding on the note associated with the Mobile Attic settlement with the next installment due in November of 2014 ($1,166,000) included in short-term notes payable. The Company maintains a $1,000,000 operating line of credit which matures in September 2017 as well as a $700,000 line of credit which matures in February of 2016. The Company had $1,075,000 available on lines of credit at March 31, 2014.

The Company had a total of $21,164,000 of long-term debt outstanding as of March 31, 2014, compared to $20,889,000 at December 31, 2013, which includes $12,372,000 in trust preferred securities issued by the Company in addition to the installment note and operating line of credit. The increase in long-term debt outstanding was related to the reclassification of a $700,000 operating line of credit from short-term to long-term debt. The Company had $625,000 drawn on operating lines of credit included in long-term debt at March 31, 2014.

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, 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. Due to a combination of growth opportunities and continued risk of capital exposure to weather related events, management is maintaining a conservative stance with regard to paying of dividends to the holding company. Strengthening capital levels in the insurance subsidiaries remains a priority.

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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 2013 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 2014 is limited to $1,463,000 in the life insurance subsidiary and $2,632,000 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 recent adverse impacts on regulatory surplus, will likely lead to dividend payments to NSG substantially below the above referenced regulatory maximums.

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

The Company continues to monitor liquidity and subsidiary capital closely. Improved underwriting results stemming from the discontinuation of unprofitable lines of business and streamlining of products offered combined with enhancements to the Company's rating process and improvements in the Company's catastrophe reinsurance structure have reduced the pressure on subsidiary capital levels. It is still necessary to remain cautious and protect subsidiary capital.

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.

We have taken and will continue to take corrective action as necessary to improve our profitability and capital position. Over the past decade we have experienced a significant reduction in equity capital due to the adverse effects of six major hurricanes, the financial market meltdown in 2008, continued historically low interest rates, an unprecedented tornado outbreak in April of 2011 and the Mobile Attic litigation. While we are experiencing improvement and have put some major obstacles behind us, we are in a position where we believe it necessary to continue to preserve capital in the near term in order to put our Company in the best position to be successful moving forward. In order to maintain and improve our capital position, we will continue to monitor our dividend policy on a quarterly basis and should we encounter another significant adverse capital event we could take action which could include the suspension of shareholder dividends. Due to various factors discussed herein, we must remain flexible in our dividend policy until we achieve more consistent profitability and capital growth.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under smaller reporting company rules we are not required to disclose information required under Item 7A. 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.

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The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $4.5 million. Our portfolio has historically been highly correlated to the S&P 500 with regard to market risk. Based on an evaluation of the historical risk measure of our portfolio relative to the S&P 500, if the market value of the S&P 500 Index decreased 10% from its March 31, 2014 value, the fair value of the Company's common stock would decrease by approximately $450,000.

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 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 stable collateral, the majority of the assets are issued by U.S. government sponsored entities. Also, the majority of all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higher-risk mortgage backed bonds. To reduce the risk of losing principal should prepayments exceed expectations, the Company does not purchase mortgage backed securities at significant premiums over par value.

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 moderately increased allocations to corporate and tax free bonds. The improved yield spreads on corporate bonds has made this segment more attractive and the risk of investing in corporate bonds versus government bonds is more appropriately priced in our opinion. We have also increased our allocation to tax free securities to further enhance after-tax returns given our improved earnings performance over the last two years.

Item 4. Controls and Procedures

Our management carried out an evaluation, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2014. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13A-15(d) under the Exchange Act that occurred during the three month period ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1.   Legal Proceedings

Please refer to Note 13 to the consolidated financial statements included herein, and the 2013 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 2013 on Form 10-K.

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

None

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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.  Reports on Form 8-K during the quarter ended March 31, 2014:

Date of Report	Date Filed	Description
January 21, 2014	January 21, 2014	Press release, dated January 21, 2014, issued by The National Security Group, Inc.
March 7, 2014	March 7, 2014	Press release, dated March 7, 2014 issued by The National Security Group, Inc.

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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	President, Chief Executive Officer and Director

Date: May 14, 2014

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