8. Share-Based Payment Arrangements

Our 2005 Long Term Incentive Plan (“2005 LTIP”) is a stock compensation plan for key employees and non-employee directors that was initially approved by the shareholders on May 26, 2005. There are 2,000,000 shares authorized for issuance under the 2005 LTIP. As of March 31, 2015, there were outstanding incentive stock options to purchase 683,810 shares of our common stock, non-qualified stock options to purchase 304,157 shares of our common stock and restricted stock units representing the right to receive up to 312,099 shares of our common stock. There are 520,293 shares reserved for future issuance under the 2005 LTIP. The exercise price of all such outstanding stock options is equal to the fair market value of our common stock on the date of grant.

Stock Options:

Incentive stock options granted under the 2005 LTIP prior to 2009 vest 10%, 20%, 30% and 40% on the first, second, third and fourth anniversary dates of the grant, respectively, and terminate five to ten years from the date of grant. Incentive stock options granted in 2009 vest in equal annual increments on each of the first seven anniversary dates and terminate ten years from the date of grant. One grant of 25,000 incentive stock options in 2010 vests in equal annual increments on each of the first three anniversary dates and terminates ten years from the date of grant. Non-qualified stock options granted under the 2005 LTIP generally vest 100% six months after the date of grant and terminate ten years from the date of grant. One grant of 200,000 non-qualified stock options in 2009 vests in equal annual increments on each of the first seven anniversary dates and terminates ten years from the date of grant.

A summary of the status of our stock options as of March 31, 2015 and changes during the three months ended is presented below:



				Average
		Weighted		Remaining	Aggregate
		Average		Contractual	Intrinsic
	Number of	Exercise		Term	Value
	Shares	Price		(Years)	($000)

Outstanding at January 1, 2015	1,062,134	$	9.51
Granted	-
Exercised	(28,449)	$	7.10
Forfeited or expired	(45,718)	$	11.48
Outstanding at March 31, 2015	987,967	$	9.49	3.1	$	1,841
Exercisable at March 31, 2015	880,109	$	9.84	3.0	$	1,411

The following table details the intrinsic value of options exercised, total cost of share-based payments charged against income before income tax benefit and the amount of related income tax benefit recognized in income for the periods indicated (in thousands):



	Three Months Ended
	March 31,
	2015		2014

Intrinsic value of options exercised	$	114	$	-

Cost of share-based payments (non-cash)	$	39	$	48

Income tax benefit of share-based payments recognized in income	$	8	$	8

As of March 31, 2015, there was $164 thousand of total unrecognized compensation cost related to non-vested stock options granted under our plans, of which $123 thousand is expected to be recognized during the remainder of 2015 and $41 thousand is expected to be recognized in 2016.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of Hallmark’s and similar companies’ common stock for a period equal to the expected term. The risk-free interest rates for periods within the contractual term of the options are based on rates for U.S. Treasury Notes with maturity dates corresponding to the options’ expected lives on the dates of grant. Expected term is determined based on the simplified method as we do not have sufficient historical exercise data to provide a basis for estimating the expected term. There were no stock options granted during the first quarter of 2015 or 2014.

Restricted Stock Units:

The 2005 LTIP was amended by the stockholders on May 30, 2013 to authorize the grant of restricted stock units, in addition to the other types of awards available thereunder. Restricted stock units represent the right to receive shares of common stock upon the satisfaction of vesting requirements, performance criteria and other terms and conditions. On July 27, 2012 and April 10, 2013, an aggregate of 129,463 and 122,823 restricted stock units, respectively, were conditionally granted to certain employees of the Company subject to shareholder approval of the amendments to the 2005 LTIP at the May 30, 2013 shareholder meeting. One conditional grant of 9,280 restricted stock units was forfeited prior to approval at the shareholder meeting. Subsequently on September 8, 2014, an aggregate of 175,983 restricted stock units were granted to certain employees.

The performance criteria for all restricted stock units require that the Company achieve certain compound average annual growth rates in book value per share over the vesting period in order to receive shares of common stock in amounts ranging from 50% to 150% of the number of restricted stock units granted. In addition, certain restricted stock units contain an additional performance criteria related to the attainment of an average combined ratio percentage over the vesting period. Grantees of restricted stock units do not have any rights of a stockholder of the Company, and do not participate in any distributions to common stockholders of the Company until the award fully vests upon satisfaction of the vesting schedule, performance criteria and other conditions set forth in the agreement. Therefore, unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per Share,” and are not included in the calculation of basic or diluted earnings per share.

On April 1, 2015, 8,616 shares of common stock were issued with respect to 8,616 restricted stock units which were granted on July 27, 2012 and vested on March 31, 2015. If and to the extent specified performance criteria have been achieved, the restricted stock units granted on April 10, 2013 will vest on March 31, 2016, the restricted stock units granted on September 8, 2014 (except for one grant) will vest on March 31, 2017 and one grant of restricted stock units granted on September 8, 2014 will vest on March 31, 2018.

Compensation cost is measured as an amount equal to the fair value of the restricted stock units and is expensed over the vesting period if achievement of the performance criteria is deemed probable, with the amount of the expense recognized based on the Company’s best estimate of the ultimate achievement level. The grant date fair value of the restricted stock units granted in 2012 and 2013 is $9.20 per unit. The grant date fair value of the restricted stock units granted in 2014 is $9.66 per unit. The Company incurred compensation expense of $332 thousand and $62 thousand related to the restricted stock units during the three months ended March 31, 2015 and 2014, respectively. The Company recorded an income tax benefit of $116 thousand and $22 thousand related to the restricted stock units during the three months ended March 31, 2015 and 2014, respectively.

A summary of the status of our restricted stock units as of March 31, 2015 and changes during the three months then ended is presented below:



		Number of
		Restricted
		Stock Units

Non-vested at January 1, 2015		285,216
Granted		-
Vested		(8,616)
Forfeited		(68,534)
Non-vested at March 31, 2015		208,066

As of March 31, 2015, there was $1.0 million of total unrecognized compensation cost related to non-vested restricted stock units granted under our 2005 LTIP, of which $0.4 million is expected to be recognized during the remainder of 2015, $0.4 million is expected to be recognized in 2016, $0.2 million is expected to be recognized in 2017 and $35 thousand is expected to be recognized in 2018.