10-K 1 nsec-12312011x10k.htm NSEC-12.31.2011-10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
FORM 10-K

 
 (Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
GE ACT OF 1934
For the fiscal Period Ended December 31, 2011

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

Securities registered pursuant to Section 12 (b) of the Act:
 
None
 
Securities registered pursuant to Section 12 (g) of the Act:
 
Common Stock, par value $1.00 per share        The NASDAQ Global Market (EXCHANGE)

           
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o    No  þ

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).     Yes þ    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange 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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of the last business day of the registrant's most recently completed second fiscal quarter, based upon the bid price of these shares on NASDAQ on such date, was $17,315,106.
 

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the close of the period covered by this report.



Class
 
Outstanding March 26, 2012
 
 
 
Common Stock $1.00 par value
 
2,466,600 shares






THE NATIONAL SECURITY GROUP, INC.

TABLE OF CONTENTS
 
Page No.
PART I
 
PART II
 
               Disclosure
PART III
 
PART IV
 
 
 
 
 
Certifications
 


DOCUMENTS INCORPORATED BY REFERENCE

1.
Definitive proxy statement for the 2012 Annual Meeting of Stockholders to be held May 18, 2012 is incorporated by reference into Part III of this report. The proxy statement will be filed no later than 120 days from December 31, 2011.

2.
Current Report on Form 8-K for event occurring on March 26, 2012 is incorporated into Part IV of this report.



PART I

Item 1. Business

Summary Description of The National Security Group, Inc.

The National Security Group, Inc. (the Company, NSG, we, us, our), an insurance holding company, was incorporated in Delaware on March 20, 1990. Our common stock is traded on the NASDAQ Global Market under the symbol NSEC.

Pursuant to regulations of the United States Securities and Exchange Commission (SEC), we are considered a “Smaller Reporting Company” as defined by SEC rules that became effective in the first quarter of 2008. We have elected to utilize an “a la carte” scaled disclosure which permits smaller reporting companies to elect to comply with scaled financial and non-financial disclosure requirements on an item by item basis. The most significant reporting difference permitted under the scaled disclosures which we have utilized is to include two years of audited financial statements.

The Company, through its three wholly owned subsidiaries, operates in two industry segments; property and casualty insurance and life insurance.

The property and casualty subsidiaries of the Company, National Security Fire and Casualty (NSFC), and Omega One Insurance Company (Omega), primarily write personal lines coverage including dwelling fire and windstorm, homeowners, mobile homeowners, and personal non-standard automobile lines of insurance in eleven states. Property and casualty insurance is the most significant industry segment, accounting for 88% of total premium revenues.

The Company's life insurance subsidiary, National Security Insurance Company (NSIC), offers a basic line of life and health and accident insurance products in six states.

The majority of our assets and investments are held in the operating insurance companies.

The Company's website address is: www.nationalsecuritygroup.com. The “Investors” section of our website (http://www.nationalsecuritygroup.com/public/Investors/Investors.aspx) provides numerous resources for investors seeking additional information about us. Our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K are made available on our website soon after filing with the SEC. Additionally, stock trades by insiders as filed on Forms 3, 4, and 5 are posted to the website after filing with the SEC. The website also provides information regarding corporate governance, stock quotes and press releases. Investors are encouraged to visit our website for additional information about the Company.

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.

1



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 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.




2


Industry Segment and Geographical Area Information

Property and Casualty Insurance Segment
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 segment will be referred to throughout this report as NSFC, property-casualty segment or P&C segment. NSFC is licensed to write insurance in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Oklahoma, South Carolina, Tennessee and West Virginia, and operates on a surplus lines basis in the states of Louisiana, Missouri, and Texas. Omega is licensed to write insurance in Alabama and Louisiana.

The following table indicates allocation percentages of direct written premium by state for the two years ended December 31, 2011 and 2010:
State
 
Percent of Direct Written Premium
 
 
2011
 
2010
Alabama
 
28.13
%
 
27.59
%
Arkansas
 
6.34
%
 
6.82
%
Georgia
 
7.79
%
 
6.94
%
Louisiana
 
15.47
%
 
19.39
%
Mississippi
 
17.16
%
 
15.93
%
South Carolina
 
10.76
%
 
9.62
%
Florida
 
0.16
%
 
0.15
%
Missouri
 
0.65
%
 
0.83
%
Oklahoma
 
4.44
%
 
4.05
%
Tennessee
 
5.72
%
 
5.92
%
Texas
 
3.38
%
 
2.76
%
 
 
100.00
%
 
100.00
%
In general, the property-casualty insurance business involves the transfer by the insured, to an insurance company of all or a portion of certain risks for the payment, by the insured, of a premium to the insurance company. A portion of such risks is often retained by the insured in the form of deductibles, which vary from policy to policy, but are typically in the range of $500 to $1,000 on NSFC and Omega's primary dwelling and automobile lines of business.

The premiums or payments to be made by the insured for direct products of the property and casualty subsidiaries are based upon expected costs of providing benefits, writing and administering the policies. In determining the premium to be charged, the property and casualty subsidiaries utilize data from past claims experience and anticipated claims estimates along with commissions and general expenses.

The operating results of the property-casualty insurance industry are subject to significant fluctuations from quarter-to-quarter and from year-to-year. These fluctuations are often due to the effect of competition on pricing, unpredictable losses incurred in connection with weather-related and other catastrophic events, general economic conditions and other factors, such as changes in tax laws and the regulatory environment.


3


The following table sets forth the premiums earned and pre-tax income during the periods reported for the property and casualty insurance segment (dollars in thousands):
 
Year Ended December 31,
 
2011
 
2010
Net premiums earned:
 
 
 
Fire, allied lines and homeowners
$
45,166

 
$
48,271

Automobile
3,357

 
4,984

Other
850

 
981

 
$
49,373

 
$
54,236

Income (loss) before taxes
$
(4,389
)
 
$
7,331

Property and Casualty Loss Reserves
Our property and casualty insurance subsidiaries are required to maintain reserves to cover their ultimate liability for losses and adjustment expenses. Our staff periodically conducts reviews throughout the year of projected loss development information in order to adjust estimates. The liability for loss and adjustment expense reserves consists of an estimated liability for the ultimate settlement of claims that have been reported as well as an estimate of loss and adjustment expenses for incurred claims that have not yet been reported (IBNR). IBNR estimates are based primarily on historical development patterns using quantitative data generated from statistical information and qualitative analysis of legal developments, economic conditions and development caused by events deemed to be infrequent in occurrence. The reserves are based on an estimate made by management. Management estimates are based on an analysis of historical paid and incurred loss development patterns for the previous ten loss years. Prior year period-to-period loss development factors are applied to latest reported loss reserve estimates in order to estimate the ultimate incurred losses for each given loss year. The amount of loss reserves estimated in excess of current reported case losses are recorded as IBNR reserves.

In addition to loss and loss adjustment expense reserves for specific claims, both reported and unreported, we establish reserves for loss adjustment expenses that are not attributable to specific claims. These reserves consist of estimates for Defense and Cost Containment (DCC) and Adjusting and Other Expenses (AO). These reserves are established for the estimated expenses of internal claims staff and the cost of outside experts, such as attorneys representing our interest, in the final settlement of incurred claims that are still in process of settlement. We conduct annual and interim reviews over the course of each year in order to insure that no significant changes have occurred in our loss development that might adversely impact our loss reserving methodology.

The following Loss Reserve Re-estimates table illustrates the change over time of the net reserves established for property-liability insurance claims and claims expense at the end of the last 10 calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows retroactive re-estimates of the original recorded reserve as of the end of each successive year. These re-estimates are the result of the Company's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The third section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that year's reserve liability. The last section compares the latest re-estimated reserve to the reserve originally established and indicates whether the original reserve was adequate to cover the estimated costs of unsettled claims. The Loss Reserve Re-estimates table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.

While the information in the table provides a historical perspective on the adequacy of unpaid losses and loss adjustment expenses established in previous years, it should not be assumed to be predictive of redundancies or deficiencies on current year unpaid losses in future periods. Company management believes that the reserves established at the end of 2011 are adequate. However, due to inherent uncertainties in the loss reserve estimation process, management cannot guarantee that current year reserve balances will prove to be adequate. Due to the relatively short tail nature of the property and casualty subsidiaries' claim liabilities, the Company does not discount loss reserves for the time value of money. Dollar amounts are in thousands.





4


 
 
2001
 
2002
 
2003
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
Gross unpaid losses per
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Consolidated Balance Sheet
$
11,489

 
$
11,513

 
$
11,343

 
$
13,094

 
$
19,511

 
$
12,498

 
$
11,973

 
$
14,436

 
$
12,646

 
$
13,184

 
$
14,386

Ceded reserves
 
(2,396
)
 
(1,555
)
 
(1,232
)
 
(2,611
)
 
(8,560
)
 
(1,783
)
 
(555
)
 
(2,421
)
 
(549
)
 
(1,329
)
 
(2,381
)
Net unpaid losses
 
$
9,093

 
$
9,958

 
$
10,111

 
$
10,483

 
$
10,951

 
$
10,715

 
$
11,418

 
$
12,015

 
$
12,097

 
$
11,855

 
$
12,005

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative net payments:
1 year later
$
3,362

 
$
4,342

 
$
5,567

 
$
5,584

 
$
7,384

 
$
6,438

 
$
4,797

 
$
5,636

 
$
5,349

 
$
5,738

 

 
2 years later
4,416

 
5,520

 
6,765

 
7,006

 
9,063

 
8,103

 
6,496

 
6,350

 
6,305

 

 

 
3 years later
5,076

 
5,865

 
7,038

 
7,521

 
10,198

 
9,652

 
6,767

 
6,725

 

 

 

 
4 years later
5,221

 
5,945

 
7,274

 
7,811

 
11,439

 
10,094

 
6,976

 

 

 

 

 
5 years later
5,106

 
6,136

 
7,351

 
8,018

 
11,763

 
10,360

 

 

 

 

 

 
6 years later
5,164

 
6,167

 
7,390

 
8,006

 
11,900

 

 

 

 

 

 

 
7 years later
5,180

 
6,183

 
7,398

 
8,024

 

 

 

 

 

 

 

 
8 years later
5,193

 
6,192

 
7,400

 

 

 

 

 

 

 

 

 
9 years later
5,195

 
6,194

 

 

 

 

 

 

 

 

 

 
10 years later
5,195

 

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Liability re-estimated:
1 year later
6,805

 
7,334

 
9,186

 
9,042

 
11,844

 
11,817

 
9,046

 
9,438

 
8,621

 
11,443

 

 
2 years later
6,017

 
7,165

 
8,607

 
9,118

 
11,827

 
11,061

 
8,739

 
7,916

 
8,869

 

 

 
3 years later
5,856

 
6,906

 
8,098

 
8,669

 
12,161

 
11,121

 
7,739

 
8,179

 

 

 

 
4 years later
5,699

 
6,509

 
7,863

 
8,404

 
12,337

 
10,792

 
7,792

 

 

 

 

 
5 years later
5,436

 
6,499

 
7,629

 
8,274

 
12,178

 
11,089

 

 

 

 

 

 
6 years later
5,413

 
6,313

 
7,570

 
8,135

 
12,372

 

 

 

 

 

 

 
7 years later
5,297

 
6,314

 
7,484

 
8,184

 

 

 

 

 

 

 

 
8 years later
5,308

 
6,278

 
7,500

 

 

 

 

 

 

 

 

 
9 years later
5,260

 
6,294

 

 

 

 

 

 

 

 

 

 
10 years later
5,272

 

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net cumulative redundancy (deficiency)
$
3,821

 
$
3,664

 
$
2,611

 
$
2,299

 
$
(1,421
)
 
$
(374
)
 
$
3,626

 
$
3,836

 
$
3,228

 
$
412

 

Our reported results, financial position and liquidity would be affected by likely changes in key assumptions that determine our loss reserves. The table below illustrates the change to equity that would occur as a result of a change in loss reserves and reserves for loss adjustment expense:
For the Years Ended December 31,
 
2011
 
2010
Change in Loss and LAE Reserves
Adjusted Loss and LAE Reserves
% Change in Equity
 
Adjusted Loss and LAE Reserves
% Change in Equity
*Loss and LAE reserves are in thousands
↓10.0%
12,947

↑3.78%
 
$
11,866

↑3.02%
↓ 7.5%
13,307

↑2.84%
 
12,195

↑2.26%
↓ 5.0%
13,667

↑1.89%
 
12,525

1.51%
↓ 2.5%
14,026

↑0.95%
 
12,854

0.76%
Reported
14,386

 
13,184

↑ 2.5%
14,746

 ↓0.95%
 
13,514

 ↓ 0.76%
↑ 5.0%
15,105

 ↓1.89%
 
13,843

 ↓ 1.51%
↑ 7.5%
15,465

 ↓2.84%
 
14,173

 ↓ 2.26%
↑10.0%
15,825

 ↓3.78%
 
14,502

 ↓ 3.02%
While our reserve estimates have had more significant variability in the past, we believe that the scenarios presented above are most reasonably likely as our methodology has become more seasoned, and we have maintained continuity of staff involved in the reserving process.


5


Life Insurance Segment
National Security Insurance Company (NSIC), a wholly owned subsidiary organized in 1947, conducts the Company's life insurance business. This segment will be referred to throughout this report as NSIC, Life Company, or Life segment. NSIC is licensed to write insurance in six states: Alabama, Florida, Georgia, Mississippi, South Carolina, and Texas.


The following table indicates NSIC's percentage of direct premiums collected by state for the two years ended December 31, 2011 and 2010:
State
 
Percentage of Total Direct Premiums
 
 
2011
 
2010
Alabama
 
58.19
%
 
57.41
%
Georgia
 
20.49
%
 
20.94
%
Mississippi
 
10.03
%
 
9.99
%
South Carolina
 
7.37
%
 
7.62
%
Texas
 
2.60
%
 
2.60
%
Florida
 
1.32
%
 
1.44
%
 
 
100.00
%
 
100.00
%
NSIC has two primary methods of distribution of insurance products, independent agents and home service (career) agents.  The independent agent distribution method accounts for 63.8% of total premium revenue in the life insurance segment. Approximately 237 agents of the Company's independent agents produced new business during 2011. The home service distribution method of life insurance products accounts for 32.3% of total premium revenue in the life insurance segment. Home service life products consist of products marketed directly at the home or other premises of the insured by an employee agent.  The Company employed nine career agents and one regional manager as of December 31, 2011. The remaining 3.9% of premium revenue consists of the following:  a book of business acquired from a state guaranty association in 2000 (1.4%), premium generated through direct sales of school accident insurance (1%), and other miscellaneous business serviced directly through the home office (1.5%).

NSIC's primary products are life insurance, both term and whole life, and health and accident insurance.   NSIC does not sell annuities, interest sensitive whole life or universal life insurance products.  Term life insurance policies provide death benefits if the insured's death occurs during the specific premium paying term of the policy.  The policies generally do not provide a savings or investment element included as part of the policy premium.  Whole-life insurance policies demand a higher premium than term life, but provide death benefits which are payable under effective policies regardless of the time of the insured's death and have a savings and investment element which may result in the accumulation of a cash surrender value.  Our accident and health insurance policies provide coverage for losses sustained through sickness or accident and include individual hospitalization and accident policies, group supplementary health policies, and specialty products, such as cancer policies.  Our line of health and accident products feature specified fixed benefits, so rapidly rising health care costs do not have as great an impact on our health and accident line as they do on comparable products offered by other companies. 

The following table displays a schedule of 2011 life segment premium produced by product and distribution method (dollars in thousands):
Line of Business
Home Service Agent
 
Independent Agent
 
Other
Industrial
$
84

 
$

 
$
61

Ordinary
1,844

 
2,884

 
3

Group Life

 
11

 
66

A&H Group

 

 
88

A&H Other
289

 
1,487

 
53

Total Premium by Distribution Method
$
2,217

 
$
4,382

 
$
271






6


The following table sets forth certain information with respect to the development of the Life Company's business (dollars in thousands):
 
Year Ended December 31,
 
2011
 
2010
Life insurance in force at end of period:
 
 
 
Ordinary-whole life
$
174,200

 
$
173,200

Term life
23,600

 
23,700

Industrial life
20,200

 
20,900

Other

 

 
$
218,000

 
$
217,800

Life insurance issued:
 
 
 
Ordinary-whole life
$
31,000

 
$
47,000

Term life

 

Industrial life

 

Other

 

 
$
31,000

 
$
47,000

Net premiums earned:
 
 
 
Life insurance
$
4,953

 
$
5,058

Accident and health insurance
1,917

 
1,969

 
$
6,870

 
$
7,027


Life Insurance Segment Reserves
We engage Wakely Actuarial Services of Clearwater, Florida as consulting actuary to calculate our reserves for traditional life insurance products. The methodology used requires that the present value of future benefits to be paid under life insurance policies less the present value of future net premiums be calculated. The calculation uses assumptions including estimates of any adverse deviation, investment yields and changes in investment yields, mortality, maintenance expenses and any non-forfeiture options or termination benefits. The assumptions determine the level and sufficiency of reserves and reserves are calculated and reviewed by our consulting actuary at the end of each quarter. The independent consulting actuary also reviews our estimates for other insurance products including claims reserves under accident and health contracts. Management believes that the reserve amounts reflected in the accompanying consolidated financial statements are adequate.

Investments
A significant percentage of the total income for the Company is tied to the performance of its investments. Assets that will eventually be used to pay reserve liabilities and other policyholder obligations along with Company capital are invested to generate investment income while held by the Company. Our investment income is comprised primarily of interest and dividend income on debt and equity securities and realized capital gains and losses generated by debt and equity securities. At December 31, 2011, investments comprise 77% of total assets and investment income (including realized gains) comprises 8% of total revenues evidencing the significant impact investments can have on financial results. Because the Company's insurance subsidiaries are regulated as to the types of investments they may make and the amount of funds they may maintain in any one type of investment, the Company has developed a conservative value oriented investment philosophy, in order to meet regulatory requirements. The Company's investment goals are to conserve capital resources and assets, obtain the necessary investment income threshold to meet reserves, and provide a reasonable return. Current yield from invested assets and capital appreciation of investments create this return.

Marketing and Distribution
As mentioned earlier in this report, NSIC products are marketed through a field force of agents who are employees of the Life Company and through a network of independent agents. The Company's use of independent agents is expected to be more cost effective in the long term and has become the fastest growing method of distribution over the past decade. In an effort to boost productivity and better educate agents on the products and services of NSIC, the Life Company marketing team travels extensively throughout our service areas holding training sessions for agents.

7


We also offer our best agents the opportunity to periodically attend retreats to network with the home office staff that help serve them and our policyholders. In addition, the retreat provides agents with additional knowledge of the products we offer, and serves as a forum for feedback on how we can better serve our agency force and policyholders.

NSFC and Omega products are marketed through a network of independent agents and brokers, who are independent contractors and generally maintain relationships with one or more competing insurance companies. NSFC employs three field marketing representatives who visit in the offices of our independent agent force regularly to give the agents opportunities for feedback. Our NSFC marketing representatives also host training seminars throughout our service areas. The goal of these seminars is to educate the independent agent sales force about our products and services.

Agents receive compensation for their sales efforts. In the case of life insurance agents, compensation is paid in the form of sales commissions plus a servicing commission. Commissions paid by NSIC in 2011 averaged approximately 8% of premiums. Commissions paid by NSFC in 2011 averaged approximately 15% of premiums. During 2011, one independent agent, accounted for more than 10% of total net earned premium of the property-casualty insurance subsidiaries. The net earned premium from this general agent totaled $6,580,000 or 13.33% of total P&C segment net earned premium. NSFC also offers a “profit sharing bonus plan” to independent agents in order to promote better field underwriting and encourage retention of profitable business. This plan not only rewards our agents but also enhances profitability by giving the agent a vested interest in our success and also aids in maintaining price stability for all our customers as agents have a financial incentive to use good field underwriting practices when completing an application for insurance.

At December 31, 2011, NSIC employed nine career agents and one regional manager. NSIC also had approximately 237 independent agents actively producing new business.

At December 31, 2011, NSFC had contracts with approximately 1,500 independent agencies in eleven states.

Competition
In both of our insurance segments, we operate in a very competitive environment. There are numerous insurance companies competing in the various states in which we offer our products. Many of the companies with which we compete are much larger, have significantly larger volumes of business, offer much broader ranges of products and have more significant financial resources than we do. We compete directly with many of these companies, not only in the sale of products to consumers, but also in the recruitment and retention of qualified agents. We believe the main areas in which a smaller company, like us, can compete is in the areas of providing niche products in under-served areas of the insurance market at competitive prices while providing excellent service to our agents and policyholders during the entire insurance product life cycle from policy issuance to final payment of a claim. We pride ourselves on being accessible to our independent agent force and maintain a presence through the efforts of a field marketing staff and easy access to home office staff. We believe we have made significant advancements in developing a competitive advantage, especially over the last decade. We also have longstanding relationships with many of our agents. We believe we compete effectively within the markets we serve and continue to evolve our processes and procedures in order to garner further competitive advantages.

NSFC and Omega's primary insurance products are dwelling fire, homeowners, including mobile homeowners, and private passenger auto coverage. Dwelling fire and homeowners, collectively referred to as the dwelling property line of business, is the largest segment of property and casualty operations composing 90% of total property and casualty premium revenue. We focus on providing niche insurance products within the markets we serve. We are in the top twenty dwelling property insurance carriers in our two largest states, Alabama and Mississippi. However, due to the large concentration of business among the top five carriers, our total market share in the dwelling fire line of business is approximately 3% in Alabama and 2% in Mississippi. In the homeowners line of business, our market share in both Alabama and Mississippi is less than 1%. The homeowners markets are even more concentrated with the top three homeowners carriers in both Alabama and Mississippi controlling over 50% of the market share.

We have actively sought competitive advantages over the last decade in the area of technological advancement. We have replaced our primary policy administration systems in both our property and casualty and life insurance subsidiaries. We replaced our legacy policy administration system in our life subsidiary in 2002. In late 2006 and throughout 2007, we began the process in transitioning to a new policy administration system in our property and casualty subsidiary. In 2010, we converted to our current property and casualty claims administration system.

The property and casualty administration system is an internally developed end-to-end system that we believe enhances our ability to compete with larger carriers in the market we serve. The system features a web based portal that allows

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our independent agents to rate, quote and issue policies directly in their office. The system streamlines the underwriting process with automation of many previous manual processes and enhances our agents' ability to provide excellent service to their clients. The system also enhances the efficiency of our underwriting process allowing for a more thorough evaluation of risks.

Our property and casualty claims administration system automates processes and workflows throughout the claims process and provides a single view of the activity that has occurred on a claim.  The system also has an adjuster web portal, which allows adjusters to view policy limits, see reserve history and policy information, and view prior claims and loss history.  Communications between adjusters and examiners are centralized on the web portal allowing for any messages to be viewed securely as part of the claims history.  Computerized issuance of field checks by staff adjusters was also implemented enforcing reserve and policy limits while reducing the error rates of the previously used hand written checks issued in the field.

Regulation
Our insurance subsidiaries are directly regulated by the insurance department in our state of domicile, Alabama. We are subject to the Alabama Insurance Holding Company System Regulatory Act and report to the Alabama Department of Insurance. Consequently, we are subject to periodic examination and regulation under Alabama Insurance Laws.

Our insurance subsidiaries are also subject to licensing and supervision by the various governmental agencies in the jurisdictions in which we do business. The nature and extent of such regulation varies, but generally has its source in state statutes which bestow regulatory, supervisory and administrative authority to State Insurance Commissioners and their respective insurance departments. The regulations may require the Company to meet and maintain standards of solvency, comply with licensing requirements, periodically examine market conditions and financial activities and report on the condition of operations and finances. In addition, most of our insurance rates are subject to regulation and approval by regulatory authorities within the respective states in which we offer our products.

Our insurance subsidiaries are subject to various statutory restrictions and limitations relating to the payment of dividends or distributions to stockholders. The restrictions are generally based on certain levels of surplus, net income or operating income as determined by statutory accounting practices. Alabama law permits dividends in any year which, together with other dividends made within the preceding 12 months do not exceed the greater of (1) 10% of statutory surplus as of the end of the preceding year or (2) for property and casualty insurers, statutory net income for the preceding year or for life companies, statutory net gain from operations for the preceding year. Dividends in excess of the restricted amounts are payable only after obtaining expressed regulatory approval. Future dividends from the insurance subsidiaries may be limited by business or regulatory considerations. The Company relies on the ability of the insurance subsidiaries to pay dividends to fund stockholder dividends and for payment of most operating expenses of the group, including interest and principal payments on debt. Further discussion of dividend payment capacity of subsidiaries can be found in Note 12 of the Consolidated Financial Statements included herein.

Our insurance subsidiaries are subject to risk based capital requirements adopted by the National Association of Insurance Commissioners (NAIC). These requirements direct our insurance companies to calculate and report information according to a risk based formula which attempts to measure statutory capital and surplus needs based on the risk in our product mix and investment portfolio. The formula is designed to allow state insurance regulators to identify companies that are potentially inadequately capitalized. Under the formula, the Company calculates Risk Based Capital (RBC) by taking into account certain risks inherent in an insurer's assets, including investments and an insurer's liabilities. Risk based capital rules provide for different levels of action depending on the ratio of a company's total adjusted capital to its “authorized control level” RBC. Based on calculations made by each of our insurance subsidiaries at December 31, 2011, each subsidiary exceeds any levels that would require regulatory actions.

A.M. Best Rating
A.M. Best Company is a leading provider of insurance company financial strength ratings and insurance company issuer credit ratings. Best's financial strength ratings and issuer credit ratings provide an independent opinion based on comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile. The Company currently has an issuer credit rating of “bb” with a negative outlook. The property and casualty companies currently carry an A.M. Best group financial strength rating of B++ (Good) with a negative outlook. This rating of B++ has remained the same for the past twelve years. The property and casualty group maintains an issuer credit rating of “bbb” with a negative outlook. The standalone financial strength rating for property and casualty subsidiary Omega One is currently B+ (Good) and Omega's issuer credit rating is “bbb-" with a stable outlook. National Security Insurance Company maintains a company specific financial strength rating of B (Fair) with a stable outlook and an issuer credit rating of “bb+” with a stable outlook. A.M. Best maintained a negative outlook

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on the property and casualty and group ratings citing uncertainty related to the Company's exposure to pending legal actions regarding the sale of its investment in Mobile Attic, Inc. in 2007 and adverse operating results of the property and casualty insurance subsidiaries in 2011. See Note 15 to the Consolidated Financial Statements and the Management Discussion and Analysis included herein for additional information on this matter. For the latest ratings, you can access www.ambest.com.
  
Employees
The Company itself has no management or operational employees. Instead, all human resource activities are within the subsidiary National Security Insurance Company. NSIC employed 117 staff members as of December 31, 2011. The Company and its property and casualty subsidiary have a Management Service Agreement (“Agreement”) with The National Security Insurance Company whereby the Company and the property and casualty subsidiaries reimburse NSIC for salaries and expenses of employees provided under the Agreement. Involved are employees in the areas of Underwriting, Customer Service, Policy Services, Accounting, Marketing, Administration, Document Management, Data Processing, Programming, Personnel, Claims, and Management. The Company, through NSIC, is represented by 9 employee agents in Alabama. The Company's property and casualty subsidiaries had approximately 1,500 independent (non-employee) agents producing business at December 31, 2011. We consider our employee relations to be good.

Additional information with respect to The National Security Group's Business
We maintain a website (www.nationalsecuritygroup.com). The National Security Group, Inc.'s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports that we file or furnish pursuant to Section 13(a) of the Securities Exchange Act of 1934 are available through our website, free of charge, as soon as reasonably practical upon having been electronically filed or furnished to the Securities and Exchange Commission.

Our code of ethical conduct is also available on our website and in print to any stockholder who requests copies by contacting The National Security Group, Attn: Investor Relations, P. O. Box 703, Elba, AL 36323.

Any of the materials we file with the SEC may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the SEC's Public Reference Room may be obtained by calling the SEC at 1.800.SEC.0330. Our periodic reports filed with the SEC, which include Forms 3, 4 and 5, Form 10-K, Form 10-Q, Form 8-K and any amendments thereto may also be accessed free of charge from the SEC's website at www.sec.gov.

Item 1A. Risk Factors

As a “Smaller Reporting Company,” we are not required to provide any disclosure under Item 1A. In providing these risk factors, we do not represent, and no inference should be drawn, that the disclosures so provided comply with all requirements of Item 1A if we were subject to them. Risk factors are events and uncertainties over which the Company has limited or no control and which can have a material adverse impact on our financial condition or results of operations. We are subject to a variety of risk factors. The following information sets forth our evaluation of the risk factors we deem to be most material. We work to actively manage these risks, but the reader should be cautioned that we are only able to mitigate the impact of most risk factors, not eliminate the risk. Also, there may be other risks which we do not presently deem material that may become material in the future.

Underwriting and product pricing

The insurance subsidiaries maintain underwriting departments that seek to evaluate the risks associated with the issuance of an insurance policy. NSIC accepts standard risks and, to an extent, substandard risks and engages medical doctors who review certain applications for insurance. In the case of the property and casualty subsidiaries, the underwriting staff attempts to assess, in light of the type of insurance sought by an applicant, the risks associated with a prospective insured or insurance situation. Depending upon the type of insurance involved, the process by which the risks are assessed will vary. In the case of automobile liability insurance, the underwriting staff assesses the risks involved in insuring a particular driver, and in the case of dwelling insurance, the underwriting staff assesses the risks involved in insuring a particular dwelling. Where possible, the underwriting staff of the property-casualty insurance subsidiary utilizes standard procedures as guides that quantify the hazards associated with a particular occupancy. In general, the property and casualty subsidiaries specialize in writing nonstandard risks.

The nonstandard market in which the property and casualty subsidiaries operate reacts to general economic conditions

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in much the same way as the standard market. When insurers' profits and equity are strong, companies sometimes cut rates or do not seek increases. Also, underwriting rules are less restrictive. As profit and/or capital fall, companies may tighten underwriting rules, and seek rate increases. Premiums in the nonstandard market are higher than the standard market because of the increased risk of the insured, which generally comprises more frequent claims. Drivers of autos who have prior traffic convictions are one such increased risk that warrants higher premiums. Lower valued dwellings and mobile homes also warrant higher premiums because of the nature of the risk. The costs of placing such nonstandard policies and making risk determinations are similar to those of the standard market. The added costs due to more frequent claims servicing is reflected in the generally higher premiums that are charged.

Our ability to maintain profitability is contingent upon our ability to actively manage our rates and underwriting procedures. Premium rate inadequacy may not become apparent quickly, and we will incur lag-time to correct. If our rates or underwriting processes become inadequate, our results of operations and financial condition could be adversely impacted.

Approval of rates

Most lines of business written by our property and casualty insurers are subject to prior approval of premium rates in the majority of the states in which we operate. The process of obtaining regulatory approval can be expensive and time consuming and can impair our ability to make necessary rate adjustments due to changes in loss experience, cost of reinsurance or other factors. If our requests to regulatory bodies for rate increases are not approved in an adequate or timely manner, our results of operations and financial condition may be adversely impacted.

Reinsurance

Both insurance subsidiaries customarily reinsure with other insurers certain portions of the insurance risk. The primary purpose of such reinsurance arrangements is to enable the Company to limit its risk on individual policies, and in the case of property insurance, limit its risk in the event of a catastrophe in various geographic areas. A reinsurance arrangement does not discharge the issuing company from primary liability to the insured, and the issuing company is required to discharge its liability to the insured even if the reinsurer is unable to meet its obligations under the reinsurance arrangements. Reinsurance, however, does make the reinsurer liable to the issuing company to the extent of any reinsurance in force at the time of the loss. Reinsurance arrangements also decrease premiums retained by the issuing company since that company pays the reinsuring company a portion of total premiums based upon the amount of liability reinsured. NSIC generally reinsures all risks in excess of $50,000 with respect to any one insured. NSFC and Omega generally reinsure with third-parties any liability in excess of $225,000 on any single policy. In addition, the property and casualty subsidiaries have catastrophe excess reinsurance, which provided protection in part with respect to aggregate property losses arising out of a single catastrophe, such as a hurricane.

In 2011, the property and casualty subsidiaries had catastrophe protection up to a $72.5 million aggregate loss. Under the property and casualty subsidiaries reinsurance arrangement in force during 2011, the Company retained the first $3.5 million of insured losses from any single catastrophic event. The next $14 million in insured losses from any single event was 95% reinsured with the Company's net retention being 5%. The third layer of reinsurance protection provided coverage for 100% of insured losses exceeding $17.5 million and up to $42.5 million. The fourth layer of reinsurance protection provided coverage for 100% of insured losses in excess of $42.5 million up to $72.5 million. The amount of catastrophe reinsurance protection purchased by the Company was based on computer modeling of actual Company exposure. The Company generally seeks catastrophe protection for scenarios based on the computer modeling that mitigates losses up to at least a near term 1 in 100 year event, further described as an amount at which the probability of not exceeding is not less than 99%. NSFC and Omega had a provision for one reinstatement (coverage for two catastrophic events) during 2011.

Our inability to procure reinsurance, primarily catastrophe reinsurance, could adversely impact our ability to maintain our level of premium revenue. The increased frequency of catastrophic events also increases our cost of reinsurance pressuring the profit margins of our insurance products. It is generally cost prohibitive to maintain deductibles below levels currently in place. Our current $3.5 million catastrophe deductible will materially adversely impact underwriting results earnings in years in which we incur losses from a major hurricane.

Risk of loss from catastrophic events and geographic concentration

As described above, we maintain catastrophe reinsurance in amounts that provides protection to the Company's financial condition in all but the most remote likelihood of occurrences. Our most critical catastrophe risk is from

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hurricanes due to our proximity to the Atlantic Ocean and the Gulf of Mexico. Our results of operations are very likely to be materially impacted in the event of the landfall of a major hurricane striking the Northern Gulf Coast or Southern Atlantic Coast in Georgia or South Carolina where we maintain significant concentrations of business. We are also exposed to the risk of significant tornado activity in many of the states in which we operate. Our most significant catastrophic event risk is the risk of a loss in excess of the Company's upper catastrophe limit which could adversely impact the Company's financial condition if such an event occurs. We are also subject to assessments from windstorm underwriting pools in various states. These risks are often difficult to measure and in the event of a major catastrophe, could exceed the upper limits of our available reinsurance protection. We also face risk from a high frequency of catastrophe events. While these events may not reach the lower limits of our catastrophe reinsurance protection, a large number of smaller events can materially impact our results of operations.

Catastrophe modeling results play a major role in our decision making process regarding the upper limits of our catastrophe reinsurance protection. There are risks inherent in the modeling process and the process is constantly evolving. We believe the chance of a catastrophe event exceeding the upper limits of our reinsurance protection is very remote. However, Hurricane Katrina exceeded the upper limits of our coverage in 2005. We have since increased the upper limits of our coverage but should a future event exceed the upper limits of our reinsurance coverage by a material amount, our financial condition could be adversely impacted.

Climate change

Scientific evidence supports that there have been and continue to be significant changes in climate including temperature, precipitation and wind resulting from various natural factors, processes, and human activities. Rising temperatures and changes in weather patterns could impact storm frequency and severity in our coverage areas. Increases in storm frequency and severity could negatively impact reinsurance costs impacting product pricing and the areas in which we offer our products. With respect to our property and casualty segment, climate change may impact the types of storms that impact our coverage areas as well as the frequency and severity of storms thereby impacting reinsurance placement and affordability. With respect to our life insurance segment, climate change may impact life expectancies thereby influencing mortality assumptions used in pricing assumptions and reserve calculations. Climate change could impact future product offerings, exclusions and/or policy limitations.

The Company may be impacted by domestic legislation and regulation related to climate change. Governmental mandates could impede our ability to make a profit with our current product offerings, limit the products we can offer and/or impact the geographic locations in which we offer our products.

The impact of climate change cannot be quantified at this time.

Reserve liabilities

NSIC maintains life insurance reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are calculated to be sufficient to meet policy and contract obligations as they arise. Liabilities for future policy benefits are calculated using assumptions for interest, mortality, morbidity, expense and withdrawals determined at the time the policies were issued. As of December 31, 2011, the total reserves of NSIC (including the reserves for accident and health insurance) were approximately $31.7 million. We believe, based on current available information, reserves for future policy benefits are adequate. However, we are currently in a period of record low interest rates and should this period of low rates be sustained over the long term it can impair our ability to make sufficient returns to cover future policy liabilities. Also, should actual mortality, morbidity, expense or withdrawal assumption differ materially from assumptions, our operating results could be negatively impacted.

The property and casualty subsidiaries are also required to maintain loss reserves (claim liabilities) for all lines of insurance. Such reserves are intended to cover the probable ultimate cost of settling all claims, including those incurred but not yet reported. The reserves of the property and casualty subsidiaries reflect estimates of the liability with respect to incurred claims and are determined by evaluating reported claims on an ongoing basis and by estimating liabilities for incurred but not reported claims. Such reserves include adjustment expenses to cover the cost of investigating losses and defending lawsuits. The establishment of accurate reserves is complicated by the fact that claims in some lines of insurance are settled many years after the policies have been issued, thus raising the possibility that inflation may have a significant effect on the amount of ultimate loss payment, especially when compared to initial loss estimates. The subsidiaries, however, attempt to restrict their writing to risks that settle within one to four years of issuance of the policy. As of December 31, 2011, the property and casualty subsidiaries had reserves for unpaid claims of approximately $14.4 million before subtracting unpaid claims, due from reinsurers of $2,381,000 leaving net unpaid claims of $12

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million. The reserves are not discounted for the time value of money. No changes were made in the assumptions used in estimating the reserves during the years ending December 31, 2011 or 2010. The Company believes, based on current available information, such reserves are adequate to provide for settlement of claims.

We incur the risk that we may experience excessive losses due to unanticipated claims frequency, severity or both that may not be factored into our loss reserve liabilities. Unexpected frequency and severity can be adversely impacted by outcomes of claims litigation; adverse jury verdicts related to claims settlements and adverse interpretations of insurance policy provisions which result in increased liabilities. We are also subject to the risk of unanticipated assessments from state underwriting associations or windstorm pools related to losses in excess of the associations or pool's ability to pay. Such costs are often allocated to companies operating in the jurisdiction of the association or windstorm pool and the likelihood and amount of such assessments are difficult to predict. These events could adversely impact our historical loss reserving methodology and cause financial adjustments that could materially impact our financial condition and results of operations.

Financial Ratings

The insurance subsidiaries are rated by A.M. Best Company, an insurance company-rating agency. NSFC is rated B++ (Good), Omega is rated B+ (Good) and NSIC is rated B (Fair) by A.M. Best Company. A downgrade in our A.M. Best ratings could adversely impact our ability to maintain existing business or generate new business. See page 9-10 of this Form 10-K for additional information on our current A.M. Best rating.

Regulation

The insurance subsidiaries are each subject to regulation by the insurance departments of those states in which they are licensed to conduct business. Although the extent of regulation varies from state to state, the insurance laws of the various states generally establish supervisory departments having broad administrative powers with respect to, among other matters: the granting and revocation of licenses to transact business, the licensing of agents, the establishment of standards of financial solvency (including reserves to be maintained), the nature of investments and in most cases premium rates, the approval of forms and policies, and the form and content of financial statements. The primary purpose of these regulations is the protection of policyholders. Compliance with regulations does not necessarily confer a benefit upon shareholders.

Many states in which the insurance subsidiaries operate, including Alabama, have laws requiring that insurers become members of guaranty associations. These associations guarantee that benefits due policyholders of insurance companies will continue to be provided even if the insurance company which wrote the business is financially unable to fulfill its obligations. To provide these benefits, the associations assess the insurance companies licensed in a state that write the line of insurance for which coverage is guaranteed. The amount of an insurer's assessment is generally based on the relationship between that company's premium volume in the state and the premium volume of all companies writing the particular line of insurance in the state. The Company has paid no material amounts to guaranty associations over the past three years. These payments, when made, are principally related to association costs incurred due to the insolvency of various insurance companies. Future assessments depend on the number and magnitude of insurance company insolvencies, and such assessments are therefore difficult to predict.

Most states have enacted legislation or adopted administrative rules and regulations covering such matters as the acquisition of control of insurance companies, transactions between insurance companies and the persons controlling them. The National Association of Insurance Commissioners has recommended model legislation on these subjects and all states where the Company's subsidiaries transact business have adopted, with some modifications, that model legislation. Among the matters regulated by such statutes are the payments of dividends. These regulations have a direct impact on the Company since its cash flow is substantially derived from dividends from its subsidiaries and adverse operating results in the insurance subsidiaries or the development of significant additional obligations in the holding company could adversely impact liquidity at the holding company level. Statutory limitations of dividend payments by subsidiaries are disclosed in Note 12 of the accompanying Consolidated Financial Statements.

While most regulation is at the state level, the federal government has increasingly expressed an interest in regulating aspects of the insurance industry. All of these regulations at various levels of government increase the cost of conducting business through increased compliance expenses. Also, existing regulations are constantly evolving through administrative and court interpretations, and new regulations are often adopted. It is difficult to predict what impact changes in regulation may have on the Company in the future. Changes in regulations could occur that might adversely impact our ability to achieve acceptable levels of profitability and limit our growth.

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Competition

The insurance subsidiaries are engaged in a highly competitive business and compete with many insurance companies of substantially greater financial resources, including stock and mutual insurance companies. Mutual insurance companies return profits, if any, to policyholders rather than shareholders; therefore, mutual insurance companies may be able to charge lower net premiums than those charged by stock insurers. Accordingly, stock insurers must attempt to achieve competitive premium rates through greater volume, efficiency of operations and control of expenses.

NSIC primarily markets its life and health insurance products through the home service system and independent producers. Direct competition comes from home service companies and other insurance companies that utilize independent producers to sell insurance products, of which there are many. NSIC's life and health products also compete with products sold by ordinary life companies. NSIC writes policies primarily in Alabama, Georgia and Mississippi. The market share of the total life and health premiums written is small because of the number of insurers in this highly competitive field. The primary methods of competition in the field are service and price.

Because of the increased costs associated with a home service company, premium rates are generally higher than ordinary products; as a result, competition from these ordinary insurers must be met through service. Initial costs of distribution through independent agents are generally more than through home service distribution methods, but lower commissions are paid in years subsequent to the first year of the policy so costs decline rapidly as policies renew after the first year. The primary factor in controlling cost under the independent agent distribution method is maintaining a high persistency rate. The persistency rate is the rate at which new business is maintained in renewal periods subsequent to the first year. If a high persistency rate can be maintained, the overall costs of distribution are lowered due to lower commission rate payments on policies in force subsequent to the first year.

The property and casualty subsidiaries market their products through independent agents and brokers, concentrating primarily on dwelling fire, homeowners and nonstandard auto coverage. NSFC, though one of the larger writers of lower value dwelling fire insurance in Alabama, nevertheless faces a number of competitors in this niche market. Moreover, larger general line insurers also compete with NSFC. The market share in states other than Alabama is small. Price is the primary method of competition. Because the Company utilizes independent agents, commission rates and service to the agent are also important factors in whether the independent agent agrees to offer NSFC products over those of its competitors.

Significant changes in the competitive environment in which we operate could materially impact our financial condition or results of operations.

Inflation

The Company shares the same risks from inflation as other companies. Inflation causes operating expenses to increase and erodes the purchasing power of the Company's assets. A large portion of the Company's assets is invested in fixed maturity investments. The purchasing power of these investments will be less at maturity because of inflation. This is generally offset by the reserves that are a fixed liability and will be paid with cheaper dollars. Also, inflation tends to increase investment yields, which may reduce the impact of the increased operating expenses caused by inflation.

Investment Risk and Liquidity

Our invested assets are managed by company personnel. The majority of these investments consist of fixed maturity securities. These securities are subject to price fluctuations due to changes in interest rates and unfavorable changes could materially reduce the market value of the Company's investment portfolio and adversely impact our financial condition and results of operations. Fixed maturity investments are managed in light of anticipated liquidity needs. Should we experience a significant change in liquidity needs for any reason, we may be forced to sell fixed maturity securities at a loss to cover these liquidity needs. Changes in general economic conditions, the stock market and various other external factors could also adversely impact the value of our investments and consequently our results of operations and financial condition.



Impact of economic and credit market conditions on our investments

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Our investment portfolio is exposed to economic and financial market risks, including changes in interest rates, credit markets and prices of marketable equity and fixed-income securities. Events that unfolded in the latest recession had a material impact on the valuations of our investments. Economic and credit market conditions during the recession adversely affected the ability of some issuers of investment securities to repay their obligations and affected and may further affect the values of investment securities. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could materially harm our results of operations and financial condition.

Litigation

As described in Item 3 of this report, the Company is a party to litigation involving the sale of its stock in Mobile Attic, Inc. The Company is vigorously defending the claims in the litigation but is unable to predict the probability or extent of its liability in this litigation. The litigation involves claims of a significant amount against the Company and is scheduled for trial in June 2012. If the Company is found to be liable, the liability to pay the claim could have an adverse effect on the Company's liquidity and capital resources. See "Management's Discussion and Analysis - Liquidity and Capital Resources" for additional information.
Dependence of the Company on Dividends from Insurance Subsidiaries

The Company is an insurance holding company with no significant operations and limited outside sources of income. The primary asset of the Company is its stock in the insurance subsidiaries. The Company relies on dividends from the insurance subsidiaries in order to pay operating expenses and to provide liquidity for the payment of dividends to shareholders. The ability of the insurance subsidiaries to pay dividends is subject to regulatory restrictions discussed in detail in Note 12 of the Consolidated Financial Statements included herein. Should the insurance subsidiaries become subject to restrictions imposed by insurance regulations regarding the payment of dividends, the ability of the Company to pay expenses, meet debt service requirements and pay cash dividends to shareholders could be adversely impacted. Additionally, should business conditions in the current economic environment persist or deteriorate, we could be forced to further limit or suspend dividend payments in order to protect our capital position.

Low common stock trading volume and liquidity limitations

We are a small public company with a large percentage of common stock outstanding owned by founding family members, employees, officers and directors. Consequently, our average daily trading volume is very low with no shares traded on some days and only a few hundred shares trading in a typical day. This low trading volume can lead to significant volatility in our share price and limit a shareholders ability to dispose of large quantities of stock in a short period of time.

Debt covenants

Should we become unable to remain current on interest payments on our long term debt, under our debt covenants we would be forced to suspend the payment of dividends to stockholders until interest payments are current.

Technology

Our insurance subsidiaries are dependent on computer technology and internet based platforms in the delivery of insurance products. Our ability to innovate and manage technological change is a key to remaining competitive in the insurance industry. A breakdown in major systems or failure to maintain up to date technology could adversely impact our ability to write new business and service existing policyholders which would adversely impact our results of operations and financial condition. The occurrence of computer viruses, information security breaches, disasters, or unanticipated events could affect the data processing systems of the Company or its service providers which could damage the Company's business and adversely affect our financial condition and results of operations.

Key Personnel

As a small company within the insurance industry, we could be adversely impacted by the loss of key personnel. Our ability to remain competitive is contingent upon our ability to attract and retain qualified personnel in all aspects of our operations.


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Accounting Standards

Our financial statements are prepared based upon generally accepted accounting standards issued by the Financial Accounting Standards Board along with standards set by other regulatory organizations. We are required to adopt newly issued or revised accounting standards that are issued periodically. Future changes could impact accounting treatment applied to financial statements and could have a material adverse impact on the Company's results of operations and financial conditions. Potential changes in accounting standards that are currently expected to impact the Company are disclosed in the Notes to Financial Statements included herein.

Item 1B. Unresolved Staff Comments

As a smaller reporting company, the Company is not required to furnish the information required in Item 1B.

Item 2. Properties

Our principal executive offices, owned by NSIC, are located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 with an addition added in 2008. The Company expansion and renovation project completed in early 2008, added an additional 4,684 square feet and renovated 3,017 square feet of the existing structure. The executive offices total approximately 30,700 square feet. The Company believes this space to be adequate for its immediate needs.

The Company's subsidiaries own certain real estate investment properties. We own approximately 2,950 acres of undeveloped timberland in Pike, Coffee and Covington counties in Alabama. The only depreciable improvements on this land include a small pavilion with current accumulated depreciation of $23,000. The timber is accounted for as a natural resource and depleted in accordance with applicable accounting standards, which identify total costs as including acquisition costs, exploration costs, development costs, production costs and support equipment and facilities cost.  We include in total costs timberland purchases and reforestation costs and other costs associated with the planting and growing of timber, such as site preparation, growing or purchases of seedlings, planting, fertilization, herbicide application and the thinning of tree stands to improve growth.  We allocate total cost of the timberland over periods benefited by means of depletion.  Timber related sales during 2011 totaled $14,000 compared to $2,000 during 2010. Gains on timber sales during 2011 totaled $12,000 compared to $1,000 in 2010.

We also own approximately 100 acres of undeveloped commercial real estate in Greenville, Alabama. We sell undeveloped lots from this development and the development has no depreciable improvements.

Capitalized along with the cost of the timberland and the Greenville property are site preparation costs, including clearing, filling and leveling of land. There are no improvements such as paving, parking lots or fencing that would be recorded as land improvements and depreciated over the appropriate useful life.

Item 3. Legal Proceedings

In April 2007, the Company sold substantially all of its 50% interest in Mobile Attic, Inc., to Bagley Family Revocable Trust (the "Purchaser"). The Company, Peter L. Cash and Russell L. Cash (collectively the "Sellers") sold to Purchaser 61% of the outstanding stock of Mobile Attic under the terms of a Stock Purchase Agreement dated April 5, 2007, executed by Sellers, Mobile Attic and Purchaser's assignor, James W. Bagley (the "Stock Purchase Agreement"). Under the terms of the Stock Purchase Agreement, the Sellers made certain warranties to Purchaser regarding the financial condition of Mobile Attic and agreed to jointly and severally indemnify Purchaser for any damages resulting from a breach of any of the warranties.

On January 9, 2009, Mobile Attic, Inc., Mobile Attic Manufacturing Company, Inc. and the Purchaser filed a complaint against Peter L. Cash and others in the U.S. District Court for the Middle District of Alabama, Southern Division, in which Plaintiffs asserted, among other claims, a claim for damages resulting from a breach of certain of the warranties regarding the financial statements of Mobile Attic and other financial information provided by Mobile Attic. Purchaser then notified the Company of its claim for breach of warranty under the Stock Purchase Agreement and requested indemnity from the Company. On July 9, 2009, the Company filed a complaint in intervention requesting the Court to find that the Company is not liable for indemnity under the Stock Purchase Agreement, or in the alternative, to award damages to the Company for any loss suffered as a result of the fraudulent actions of Peter Cash and as a result of the negligence of Mobile Attic and its auditors in the preparation of Mobile Attic's financial statements. [Mobile Attic, Inc., MA Manufacturing Company, Inc. and Bagley Family Revocable Trust, plaintiffs, v. Peter L. Cash, Cash Brothers

16


Leasing, Inc., Bridgeville Trailers, Inc., and Barfield, Murphy, Shank & Smith, P.C, defendants, v. The National Security Group, Inc., intervenor plaintiff, v. Peter L. Cash, Barfield, Murphy, Shank & Smith, P.C. and Bagley Family Revocable Trust, intervenor defendants, U.S. District Court, Middle District of Alabama, Eastern Division, Civil Action No. 09-cv-00024.]

On August 13, 2009, the Court granted the Company's motion to intervene. At the request of the Court, each party filed an amended complaint on or before August 23, 2010. The Purchaser has asserted counterclaims against the Company for losses incurred as a result of failure to disclose material facts or alleged innocent, negligent or reckless false representations made to induce Purchaser to enter into the Stock Purchase Agreement, breach of the Stock Purchase Agreement and indemnification of Purchaser's losses and damages as a result of the breach of representations and warranties in the Stock Purchase Agreement. Among the specific allegations in the Purchaser's amended counterclaims against the Company, the Purchaser contends that the balance sheet and depreciation schedule of Mobile Attic included an overstatement of portable storage containers of more than $3,000,000 and that the balance sheet of Mobile Attic included a note receivable from an affiliate of Mobile Attic and Peter Cash in the amount of approximately $1.8 million that was not generated in the ordinary course of business and that was not collectible.

Under the terms of the Stock Purchase Agreement, the Purchaser paid the Company $2,700,000 for 45% of the total outstanding stock of Mobile Attic and paid the other Sellers $960,000 for an additional 16% of the total outstanding stock in Mobile Attic, thus obtaining a controlling interest of 61% of the outstanding stock. The Stock Purchase Agreement provided that Purchaser was to use his best efforts to cause the Company to be released from its guaranty of a bank loan to Mobile Attic having an outstanding principle balance of approximately $9,400,000. The bank loan was secured by portable storage containers of Mobile Attic.

The Purchaser has asserted that the Company is jointly and severally liable with the other Sellers (whom the Company believes have limited resources) for all losses suffered by Purchaser as a result of Sellers' misrepresentations. Purchaser claims that the misrepresentations caused Purchaser to purchase the stock of Mobile Attic, Inc. with the result that Sellers should be liable for all of Purchaser's losses resulting from the transaction, which include the value paid for the stock of Mobile Attic, Inc., the losses suffered on the assumption of the bank loan, the operating losses funded by Purchaser after the transaction, and attorneys' fees incurred by Purchaser to enforce its claim for indemnity.

The Company has denied the allegations supporting Purchaser's claims. The financial records of Mobile Attic have been in the possession of Purchaser since Purchaser acquired the stock of Mobile Attic in early 2007 and are only available to the Company through discovery in the litigation. The Company is actively conducting discovery in defense of Purchaser's claims and has requested Purchaser to provide the financial information supporting the allegations made in its complaint. Fact-based and expert discovery have concluded, but pre-trial investigation continues with the case set for trial in June of 2012. The Company believes that the Purchaser's claim for damages is unreasonable and excessive even if the Purchaser is able to prove the alleged misrepresentations in Mobile Attic's financial statements. The Company has filed motions for summary judgment requesting a court ruling, among others, as to how the damages should be measured in this transaction. Until these legal issues are resolved it is difficult to determine the probability and extent of liability in this action.

Item 4. Mine Safety Disclosures

This section is not applicable.

17


PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The capital stock of the Company is traded in the NASDAQ Global Market. Quotations are furnished by the National Association of Security Dealers Automated Quotations System (NASDAQ). The trade symbol is NSEC.

The following table sets forth the high and low sales prices per share, as reported by NASDAQ during the period indicated:
 
Stock Closing Prices
 
High
 
Low
2011
 
 
 
  First Quarter
$
13.13

 
$
11.18

  Second Quarter
$
13.82

 
$
10.00

  Third Quarter
$
11.84

 
$
9.51

  Fourth Quarter
$
10.93

 
$
7.62

2010
 
 
 
  First Quarter
$
14.00

 
$
11.10

  Second Quarter
$
13.63

 
$
11.49

  Third Quarter
$
13.35

 
$
10.00

  Fourth Quarter
$
12.67

 
$
10.00

Shareholders
The number of shareholders of the Company's common stock was approximately 1,200, and the Company had 2,466,600 shares of common stock outstanding on March 26, 2012.

Dividends
The following table sets forth quarterly dividend payment information for the Company for the periods indicated:
 
Dividends Per Share
2011
 
  First Quarter
$
0.15

  Second Quarter
$
0.15

  Third Quarter
$
0.15

  Fourth Quarter
$
0.10

2010
 
  First Quarter
$
0.15

  Second Quarter
$
0.15

  Third Quarter
$
0.15

  Fourth Quarter
$
0.15

Discussion regarding dividend restrictions may be found on page 34 of the Managements' Discussion and Analysis as well as in Note 12 of the Consolidated Financial Statements.

The payment of shareholder dividends is subject to the discretion of our Board of Directors and is dependent upon many factors including our operating results, financial condition, capital requirements and general economic conditions. Total shareholder dividends paid in 2011 totaled $1,357,000.

Future dividends are dependent on future earnings, the Company's financial condition and other factors evaluated periodically by management and the Board of Directors. The Company is an insurance holding company and depends upon the dividends from the insurance subsidiaries to pay operating expenses and to provide liquidity for the payment of shareholder dividends. The payment of shareholder dividends is subject to the profitability of the insurance subsidiaries and the ability of the insurance subsidiaries to pay dividends to the holding company. Dividends from the

18


insurance subsidiaries are subject to approval of the regulator in the state of domicile, the Alabama Department of Insurance.

Item 6. Selected Financial Data

Under smaller reporting company rules we are not required to disclose information required under Item 6. However, in order to provide information to our investors, we have elected to provide certain selected financial data.

Five-Year Financial Information:
(Dollars in thousands, except per share)
Operating Results:
2011
 
2010
 
2009
 
2008
 
2007
Net premiums earned
$
56,243

 
$
61,263

 
$
59,594

 
$
56,264

 
$
62,250

Net investment income
4,261

 
5,089

 
5,289

 
4,368

 
4,749

Net realized investment (losses) gains
669

 
1,879

 
357

 
(1,049
)
 
1,493

Other income
919

 
1,161

 
764

 
1,107

 
1,071

Total revenues
$
62,092

 
$
69,392

 
$
66,004

 
$
60,690

 
$
69,563

Net (loss) income
$
(4,956
)
 
$
3,265

 
$
4,224

 
$
(5,204
)
 
$
6,040

Net (loss) income per share
$
(2.01
)
 
$
1.32

 
$
1.71

 
$
(2.11
)
 
$
2.45

Other Selected Financial Data:
2011
 
2010
 
2009
 
2008
 
2007
Total shareholders' equity
$
38,015

 
$
43,710

 
$
41,168

 
$
34,648

 
$
48,447

Book value per share
$
15.41

 
$
17.72

 
$
16.69

 
$
14.04

 
$
19.64

Dividends per share
$
0.550

 
$
0.600

 
$
0.600

 
$
0.900

 
$
0.900

Net change in unrealized
 
 
 
 
 
 
 
 
 
  capital gains (net of tax)
$
1,258

 
$
847

 
$
3,520

 
$
(6,147
)
 
$
(664
)
Total assets
$
132,454

 
$
136,867

 
$
131,396

 
$
124,890

 
$
135,585

Quarterly Information:
 Premiums
 
 Investment & Other Income
 
 Realized Investment Gains (Losses)
 
 Claims and Benefit Payments
 
 Net Income (Loss)
 
 Net Income (Loss) Per Share
2011
 
 
 
 
 
 
 
 
 
 
 
First Quarter
$
14,870

 
$
1,397

 
$
770

 
$
9,322

 
$
995

 
$
0.40

Second Quarter
13,321

 
1,513

 
261

 
15,682

 
(4,945
)
 
(2.00
)
Third Quarter
14,340

 
982

 
(203
)
 
10,045

 
(650
)
 
(0.26
)
Fourth Quarter
13,712

 
1,288

 
(159
)
 
8,976

 
(356
)
 
(0.15
)
 
$
56,243

 
$
5,180


$
669

 
$
44,025

 
$
(4,956
)
 
$
(2.01
)
2010
 
 
 
 
 
 
 
 
 
 
 
First Quarter
$
15,038

 
$
1,625

 
$
669

 
$
8,473

 
$
1,894

 
$
0.77

Second Quarter
15,903

 
1,451

 
689

 
11,061

 
814

 
0.33

Third Quarter
15,248

 
1,434

 
75

 
10,096

 
223

 
0.09

Fourth Quarter
15,074

 
1,740

 
446

 
9,401

 
334

 
0.13

 
$
61,263

 
$
6,250

 
$
1,879

 
$
39,031

 
$
3,265

 
$
1.32


Item 7. 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 NSG) 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

19


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 two year period ended December 31, 2011.

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 of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related notes included in this Form 10-K. Please refer to our note regarding forward-looking statements on pages 1-2 of this report.

Summary of Consolidated Results of Operations

Condensed revenue and income information follows:
 
Year ended December 31,
 
2011
 
2010
Premium Earned
$
56,243,000

 
$
61,263,000

Investment Income
4,261,000

 
5,089,000

Realized Investment Gains
669,000

 
1,879,000

Other Income
919,000

 
1,161,000

Total Revenues
$
62,092,000

 
$
69,392,000

Net (Loss) Income
$
(4,956,000
)
 
$
3,265,000

 
 
 
 
Net (Loss) Income Per Share
$
(2.01
)
 
$
1.32

For the year ended December 31, 2011, total revenues were $62,092,000 compared to $69,392,000 for the same period last year; a decrease of 10.5%. A decrease in earned premium in the P&C segment along with a decline in net realized investment gains were the primary contributing factors to the decrease in total revenue for 2011 over 2010.

The Company ended the year 2011 with a net loss totaling $4,956,000 compared to net income of $3,265,000 in 2010. The Company ended 2011 with a net loss per share of $2.01 compared to net income per share of $1.32 in 2010. A 12.8% increase in policyholder benefits was the primary factor contributing to the net loss in the current year. For the year 2011, policyholder benefits were 78.3% of earned premium compared to 63.7% in 2010, an increase of 14.6 percentage points. Losses and loss adjustment expenses incurred in the P&C segment from increased storm activity during 2011 combined with losses and adjustment expenses from an automobile program were the primary reasons for the increase compared to the same period last year.

Results of Operations for Years Ended December 31, 2011 and 2010
The Company ended 2011 with premiums earned totaling $56,243,000 compared to $61,263,000 for the same period last year. Premium revenue is generated from our two operating segments: P&C segment and Life segment. The P&C segment accounts for approximately 88% of total premium revenue while our Life segment contributes the remaining 12%. The P&C segment operates in personal lines insurance products primarily generating premium revenue from dwelling fire, allied lines and homeowners policies. Our Life segment produces premium revenue primarily from whole life, accident and critical illness insurance policies.

Net investment income totaled $4,261,000 in 2011 compared to $5,089,000 in 2010; a decrease 16.3%. The primary reason for the decline in investment income was the decrease in invested assets in 2011 compared to the same period last year. The Company ended 2011 with invested assets of $101,972,000 compared to $109,682,000 in 2010; a 7% or $7,710,000 decrease. The decline was primarily related to selling of securities from our investment portfolio in 2011 to raise cash for claim payments from increased tornado and windstorm activity in the spring of 2011. In addition to the decline in invested assets, the subsidiaries continue to reinvest matured investments at interest rates substantially below the average book yield of the total portfolio. This trend will continue as long as the current record low interest rate environment persists and will continue to put downward pressure on investment income.

20



Net realized investment gains totaled $669,000 in 2011 compared to $1,879,000 in 2010; a decrease of 64.4%. Negatively impacting realized investment gains was $398,000 in other-than-temporary impairments recognized in the bond portfolio. However, these impairments were offset by realized gains stemming from recoveries of previously recognized other-than-temporary impairments totaling $384,000. The primary reason for the decline in net realized investment income in 2011 compared to 2010 was management's decision to sell fewer securities due to market conditions.

Other income was $919,000 for the period ended December 31, 2011 compared to $1,161,000 for the same period last year; a $242,000 decrease. Other income consists primarily of billing, payment and policy fees related to the issuance of our property and automobile insurance policies in the P&C segment as well as other, primarily non-recurring, miscellaneous income. The primary reason for the decrease was a decline in fee income related to a reduction in policy issuance in the automobile program in the P&C segment during 2011 compared to 2010.

Policyholder benefits paid (claims) increased 12.8%, ending 2011 at $44,025,000 compared to $39,031,000 for the same period last year. Claims as a percentage of net premiums earned totaled 78.3% for 2011 compared to 63.7% in 2010. The primary reason for the $4,994,000 increase was higher claims activity in the P&C segment associated with an increase in storm activity during 2011 coupled with increased claims in the automobile line of business.
  
The gross losses and loss adjustment expenses (LAE) incurred in the P&C segment from claims associated with storm systems classified as "catastrophic" (referred to as cat events hereafter), totaled $14,040,000 in 2011 compared to $1,709,000 in 2010. The current year claims were incurred from seventeen separate cat events and accounted for 31.9% of total claims during the year compared to 4.4% of claims from ten cat events during the prior year.

Prior to April 2011, the single worst tornadic outbreak affecting the P&C segment occurred in April 2009 and produced $1,526,000 in incurred losses and incurred LAE for that month. In comparison, the tornado and windstorms during the month of April 2011 produced incurred losses and incurred LAE totaling $12,260,000 which was over eight times worse than the April 2009 storms.

A cat event on April 25th-27th, 2011 (catastrophe 46) was the primary source of the overall losses and LAE incurred during April 2011. The incurred losses and LAE from this single cat event totaled $10,432,000 or 85% of the total claims reported during the month of April in the current year. The P&C segment maintains catastrophe reinsurance to reduce risk associated with losses from cat events. The reinsurance is structured with a $3,500,000 deductible with 5% coinsurance retained on the first two layers of coverage. Any claim activity exceeding the first two layers is 100% reinsured up to $72,500,000 in ultimate incurred losses and LAE. Because the P&C segment incurred losses and LAE from catastrophe 46 that exceeded the reinsurance deductible, the P&C segment recovered $6,204,000 from reinsurers. The P&C segment retained $4,228,000 of the incurred losses and incurred LAE from catastrophe 46.

In addition to the incurred losses and LAE from cat events, we also incurred significant losses and adjustment expenses from our automobile program. The automobile program added an additional $4,226,000 to claims during 2011 and $5,327,000 during 2010. This program had loss ratios of 141.2% and 118.8%, respectively for the year ended December 31, 2011 and 2010. When coupled with commission and general expenses, the pre-tax underwriting losses were in excess of $2,000,000 for both years. The Company discontinued the automobile program in the fourth quarter of 2011. The discontinuance of the automobile program is expected to positively impact overall underwriting results provided we do not experience any further adverse development on reported claims, many of which are liability coverage claims which tend to take longer to settle.

Amortization of deferred policy acquisition costs (DAC) and commissions totaled $12,168,000 compared to $11,815,000 for the same period last year; an increase of $353,000. DAC and commission expenses were 21.6% of premium revenue (before cat reinstatement premium) in 2011 compared to 19.3% for the same period last year. The primary reason for the increase was a higher contingent commission accrual in the current year compared to the prior year.

General and administrative expenses decreased $212,000 in 2011 compared to the same period last year. General expenses were down primarily due to various cost saving measures implemented during the year coupled with an overall decline in revenue. With the discontinuation of the automobile program in late 2011, further reductions in general expenses in the insurance subsidiaries are expected in 2012.

Taxes, licenses and fees were $1,885,000 in 2011, down 9.4% compared to $2,081,000 for the same period last year. The primary reason for the decrease was the reduction in expenses paid in 2011 related to insurance examination

21


fees compared to the prior year.

Interest expense for the year ended December 31, 2011 was virtually unchanged from the prior year at $1,153,000 compared to $1,156,000 in 2010.

The Company had an income tax benefit totaling $2,643,000 in 2011 compared to income tax expense of $1,372,000 in 2010. Income tax benefit as a percent of net loss before taxes was 34.8% in 2011. The primary reason for the tax benefit in the current year was the operating losses incurred in the P&C segment, coupled with litigation cost in the holding company. The Company ended 2010 with an effective tax rate of 29.6%.

The Company ended 2011 with a net loss of $4,956,000 compared to net income of $3,265,000 for the same period last year. The claims incurred from cat events and adverse underwriting results in the automobile program were the primary contributing factor to the net loss in 2011 compared to net income in 2010. As mentioned previously, policyholder claims increased $4,994,000 compared to the same period last year. In addition, net premiums earned decreased $5,020,000 while net investment income declined $828,000 compared to 2010.

Stockholder Equity and Book Value per Share

Stockholders equity for the year ended December 31, 2011 was $38,015,000 compared to $43,710,000 at December 31, 2010; a decrease of $5,695,000 or 13%. The change in stockholders equity is composed of dividends paid to shareholders of $1,357,000 and a net loss of $4,956,000 as well as accumulated other comprehensive income, primarily increases in accumulated unrealized capital gains, totaling $1,258,000 and unrealized losses on interest rate swap totaling $640,000. Year-end book value per share, defined as stockholders equity divided by common shares outstanding of 2,466,600, was $15.41 at December 31, 2011 compared to $17.72 at December 31, 2010.

Industry Segment Data

Premium revenues for The National Security Group's two operating segments (Life segment, Property and Casualty segment) is summarized as follows (amounts in thousands):
Premium revenues:
 
 
 
 
 
 
 
 
2011
 
%
 
2010
 
%
Life, accident and health insurance
$
6,870

 
12.2
%
 
$
7,027

 
11.5
%
Property and casualty insurance
49,373

 
87.8
%
 
54,236

 
88.5
%
 
$
56,243

 
100.0
%
 
$
61,263

 
100.0
%
The property and casualty segment composed 87.8% of total premium revenue in 2011 compared to 88.5% in 2010. The P&C segment is primarily composed of dwelling fire, allied lines and homeowners lines of business. The life segment composed 12.2% of premium revenue in 2011 compared to 11.5% in 2010 with revenue produced primarily from life, accident and supplemental health insurance products.

The following discussion outlines more specific information with regard to the individual operating segments of the Company along with non-insurance related information (primarily administration expenses) associated with the insurance holding company.


22


Life and Accident and Health Insurance Operations:
Our life segment is the smaller of our insurance segments contributing 12.2% of total insurance premium revenue in 2011 and 11.5% in 2010. Premium revenues and operating income for the life segment for the year ended December 31, 2011 and 2010 are summarized below (amounts in thousands):
 
2011
 
2010
REVENUE
 
 
 
Net premiums earned
$
6,870

 
$
7,027

Net investment income
1,939

 
2,116

Net realized investment gains
43

 
420

Other income
3

 
3

 
8,855

 
9,566

BENEFITS AND EXPENSES
 
 
 
Policyholder benefits paid or provided
5,189

 
5,286

Amortization of deferred policy acquisition costs
774

 
590

Commissions
533

 
552

General and administrative expenses
2,081

 
2,166

Insurance taxes, licenses and fees
316

 
387

Interest expense
60

 
65

 
8,953

 
9,046

 
 
 
 
INCOME BEFORE INCOME TAXES
$
(98
)
 
$
520

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010:

NSIC premium accounted for 12.2% of total consolidated premium revenue for 2011.  As mentioned above, NSIC operates using two primary methods of distribution: home service employee agents and independent agents.  While the Company has used the traditional home service distribution method since its founding in 1947, the independent agent distribution method has become the largest source of renewal business and new business production over the past decade. For 2011, the home service and independent agent distribution methods accounted for 32.3% and 63.8%, respectively of NSIC premium revenue.  

NSIC ended 2011 with premium revenue of $6,870,000 compared to $7,027,000 for the same period last year; a decrease of 2.2%.  The $157,000 decrease in premium revenue was primarily due to the 4.6% decline in ordinary business related to the independent agent distribution method. The home service distribution method also contributed to the overall decline in premium revenue ending 2011 down 2.4% compared to the same period last year.

Net investment income was $1,939,000 for the year ended December 31, 2011 compared to $2,116,000 for the same period last year. Investment income in NSIC is generated from securities held in our investment portfolio as well as mortgage and policy loan interest. The $177,000 or 8.4% decrease was primarily attributable to a decline in average portfolio yield due to historically low interest rates.

NSIC ended 2011 with net realized investment gains totaling $43,000 compared to $420,000 in 2010. Although NSIC recognized $398,000 in other-than-temporary impairment losses on two securities in the current year, we also had recoveries from previously recognized other-than-temporary impairments totaling $384,000. NSIC did not recognize any other-than-temporary impairment losses during 2010. The primary reason for the decline in net realized investment income in 2011 compared to 2010 was management's decision to sell fewer securities. This decision was based on an evaluation of current market conditions.

Policyholder claims decreased $97,000 ending 2011 at $5,189,000 compared to $5,286,000 for the same period last year. The primary reason for the decrease was a decline in claims incurred related to ordinary death and maturity benefits.

Deferred policy acquisition costs and commission expenses increased $165,000 for the year ended December 31, 2011 at $1,307,000 compared to $1,142,000 for the same period last year. An adjustment in the estimate of expenses

23


capitalized as a component of DAC was the primary reason for the increase in the current year compared to the prior year.

General and administrative expenses decreased $85,000 in 2011 compared to 2010. The primary reason for the decline was a decrease in professional and consulting fees in the current year compared to the same period last year.

For the year ended December 31, 2011 and 2010, insurance taxes, licenses and fees were $316,000 and $387,000, respectively. The primary reason for the $71,000 decrease was a decline in fees associated with the Alabama Insurance Department Examination which concluded during the first half of 2011.

Interest expense, which is primarily related to life insurance deposit accounts, was down slightly at $60,000 in 2011 compared to $65,000 in 2010.

The life segment ended 2011 with a year to date net loss of $502,000 compared to a net loss of $128,000 for the same period last year. The $157,000 decline in premium revenue coupled with the $554,000 decrease in investment income and capital gains were the primary reasons for the higher net loss in 2011 compared to 2010.

Property & Casualty Operations:
Property and casualty operations constitute our largest segment composing 87.8% and 88.5% of our total premium revenue in 2011 and 2010, respectively. Premium revenues and operating income for the P&C segment for the year ended December 31, 2011 and 2010 are summarized below:
 
2011
 
2010
REVENUE
 
 
 
Net premiums earned
$
49,373

 
$
54,236

Net investment income
2,246

 
2,900

Net realized investment gains
666

 
1,352

Other income
916

 
1,158

 
53,201

 
59,646

BENEFITS AND EXPENSES
 
 
 
Policyholder benefits paid or provided
38,836

 
33,745

Amortization of deferred policy acquisition costs
3,246

 
3,354

Commissions
7,615

 
7,319

General and administrative expenses
6,322

 
6,203

Insurance taxes, licenses and fees
1,569

 
1,694

Interest expense
2

 

 
57,590

 
52,315

 
 
 
 
INCOME BEFORE INCOME TAXES
$
(4,389
)
 
$
7,331

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010:

Property and casualty segment premium revenue for 2011 was $49,373,000 compared to $54,236,000 for the same period last year; a decrease of 9.0%. The primary reasons for the decrease in premium revenue in 2011 compared to 2010 were the discontinuance of the automobile program in addition to declines in new business writing in our property programs. Furthermore, the P&C segment incurred $1,621,000 in catastrophe reinstatement premium ceded during 2011, accounting for three percentage points of the 9% decrease compared to 2010.


24


Production of premium revenue in the P&C segment is primarily driven by our dwelling fire, allied lines and homeowner lines of business. The following table provides premiums earned by line of business:
Line of Business
Premium Earned
2011
 
%
 of NPE 2011
 
Premium Earned
2010
 
%
 of NPE 2010
 
2011
Increase (Decrease) over 2010
Dwelling Fire/Allied Lines
$
27,507,000

 
55.7
 %
 
$
27,233,000

 
50.2
 %
 
1.0
 %
Homeowners
24,910,000

 
50.5
 %
 
26,715,000

 
49.3
 %
 
(6.8
)%
Ocean Marine
1,205,000

 
2.4
 %
 
1,270,000

 
2.3
 %
 
(5.1
)%
Private Passenger Automobile
2,993,000

 
6.1
 %
 
4,532,000

 
8.4
 %
 
(34.0
)%
Commercial Automobile
363,000

 
0.7
 %
 
501,000

 
0.9
 %
 
(27.5
)%
Reinsurance Ceded
(5,984,000
)
 
(12.1
)%
 
(6,015,000
)
 
(11.1
)%
 
(0.5
)%
Reinstatement Premium
(1,621,000
)
 
(3.3
)%
 

 
 %
 
 %
Net Premium Earned
$
49,373,000

 
100.0
 %
 
$
54,236,000

 
100.0
 %
 
(9.0
)%
In our fire, allied lines and homeowner lines of business, we have slowed our rate of growth through a combination of rate increases, stricter underwriting standards and fewer appointments of new agents. We have also limited production of new business in areas in which we have larger concentrations of risk in order to better manage the severity of catastrophe events. These measures have been undertaken in an effort to improve underwriting profitability, particularly in our homeowners line of business. The implementation of the above mentioned changes was the primary reason for the 6.8% decrease in homeowners premium revenue in 2011 compared to 2010.

Due to continued underwriting losses in our private passenger automobile line of business, the program was terminated during the fourth quarter of 2011. The combination of previously implemented rate increases, which slowed the rate of new business growth, and ultimate termination of the program lead to the 34.0% decrease in premium revenue in this line of business for 2011 compared to the same period last year. The commercial automobile program was also evaluated, and based on poor underwriting results in the current period and previous years, this program was also terminated during 2011. Net premium earned from this program was down $138,000 or 27.5% compared to the same period last year.

The catastrophe event in late April 2011, which exceeded our single event retention, triggered additional ceded premium payments (reinstatement premium) in order to reinstate coverage under our catastrophe reinsurance agreement. As mentioned above, this catastrophe reinstatement premium was $1,621,000 and decreased the P&C segment net premium earned three percentage points in 2011. We maintain a catastrophe reinsurance agreement in the P&C segment to cover losses related to a cat event exceeding our deductible of $3,500,000 (details regarding the structure of this agreement can be found in Note 1 to the Consolidated Financial Statements).

Net investment income totaled $2,246,000 in 2011 compared to $2,900,000 in 2010; a decrease of $654,000. The decrease in investment income in the P&C segment was primarily attributable to an $8,769,000 decline in invested assets in 2011 compared to 2010. The decrease in invested assets was driven by selling of securities during the first half of 2011 in order to increase liquidity for the payment of storm claims incurred during the spring storm season of 2011.

The P&C segment ended 2011 with realized capital gains totaling $666,000 compared to $1,352,000 for the same period last year. The primary reason for the decline in realized capital gains was a reduction in selling activity in the current year compared to the same period last year. The P&C segment was not impacted by the write-down of other-than-temporary impairments in 2011 or 2010.

Other income was $916,000 in 2011 compared to $1,158,000 for the same period last year; a $242,000 decrease. Other income consists primarily of fees related to the issuance of our property and automobile insurance policies as well as miscellaneous income. The primary reason for the $242,000 decrease was policy fee income related to the automobile program. The fees associated with the automobile business totaled $202,000 in 2011 compared to $340,000 in 2010; a decrease of $138,000. The decrease in policy fees associated with the automobile line of business accounted for 57% of the total decrease in other income in 2011 compared to 2010.

Claims were $38,836,000 in 2011, up $5,091,000 from $33,745,000 for the same period last year. The primary reasons

25


for the increase were losses from tornado, wind and hail related weather events as well as claims associated with our automobile line of business.

The gross losses and adjustment expenses incurred in the P&C segment from claims associated with cat events during 2011 totaled $14,040,000. These claims were incurred from seventeen separate cat events and accounted for 36.2% of P&C segment claims during the current year. In comparison, the P&C segment incurred gross losses and adjustment expenses from ten cat events during 2010 totaling $1,704,000 or 5.1% of P&C segment claims during the prior year.

The Property Claims Service (PCS) classifies storms and other weather related events that exceed $25 million in insured losses, on an industry-wide basis, as a "catastrophic event". The P&C segment was heavily affected by these catastrophic storm systems during 2011, primarily in the month of April. The storm activity in April 2011 was primarily tornado, wind and hail related, and was ranked the most active tornado month on record and caused widespread damage in the Southeast United States. According to statistics from the National Oceanic and Atmospheric Administration (NOAA), the April storms spawned 753 tornadoes and caused an estimated 364 fatalities (the previous record for tornadoes incurred in a one month period was set in April 1974 with 267 tornadoes). The most significant of the April storm systems swept across Mississippi, Alabama and Georgia from April 25th-27th, 2011. This storm system (classified as catastrophe 46 by PCS) was by far the largest during April and created $10,432,000 in incurred losses and LAE in the P&C segment in 2011. While this event was covered by our catastrophe reinsurance coverage, we incurred significant costs associated with deductibles and reinstatement premium. In our catastrophe reinsurance model results, which we utilize to establish reinsurance coverage limits, this tornado event exceeded a one in 250 year return period, which means that this event had a probability of occurrence in the models of less than four tenths of one percentage point in any given year.

As mentioned previously, the P&C segment incurred losses from all April 2011 cat events totaling $12,260,000 from 2,237 claims. The losses and LAE incurred from the cat events in April 2011 were over eight times higher than claims related to cat events during any prior one month period ever experienced by the P&C companies. The losses from the cat event from April 25th-27th, 2011 (catastrophe 46), which contributed $10,432,000 or 85.1% of the April 2011 incurred losses and LAE, exceeded our $3,500,000 deductible for reinsurance; therefore, we recovered just under $6,204,000 from reinsurers. On a net of reinsurance basis, the claims retained by the P&C segment from catastrophe 46 totaled $4,228,000.

We routinely evaluate our claims frequency and severity statistics in order to better understand the nature of our risks and aid in the loss reserve liability evaluation process. Claims frequency is a measure of the number of claims incurred during a measurement period regardless of amount. Claims severity is a measure of the average dollar amount of claims during a measurement period. The P&C companies incurred 2,874 claims from seventeen cat events in 2011 compared to 485 claims from ten cat events in 2010. The average severity per claim related to the seventeen non-hurricane cat events affecting the P&C companies during 2011 was $4,900 compared to $3,500 per claim from the ten non-hurricane cat events in 2010. The magnitude of the 2011 cat events lead to the 40% increase in severity per claim compared to 2010. The average severity per claim related to the tornado outbreak on April 25th-27th, 2011, catastrophe 46, was $6,300 and contributed significantly to skewing 2011's average severity upward.

The personal lines automobile program ended 2011 with incurred losses and incurred loss adjustment expenses of $4,226,000 compared to $5,327,000 for the same period last year; a decrease of $1,101,000. Although incurred losses were down in 2011 compared to 2010, net premium earned was also down 34.0%. The loss ratio for the automobile program was 141.2% for the year ended December 31, 2011 compared to 118.8% for the same period last year and was the primary reason for incurred underwriting losses in excess of $2,000,000 in each year. Because of the year over year underwriting losses and significant claim activity associated with this program, the decision was made to terminate the program during the fourth quarter of 2011. The automobile policies are six month coverage periods; therefore, we expect the business to run off quickly. The discontinuance of the automobile program, while contributing to a further decline in premium revenue, is expected to positively impact overall underwriting results provided we do not experience any further adverse development on reported claims, many of which are liability coverage claims which tend to take longer to settle.

The P&C segment continued to be involved in litigation pertaining to claims from Hurricane Katrina which impacted our coverage areas in Louisiana and Mississippi in August 2005. The cumulative claims associated with Hurricane Katrina exceeded the $37,500,000 million upper limit of the reinsurance agreement in effect during 2005. As of December 31, 2011, cumulative claims incurred related to Hurricane Katrina exceeded the reinsurance upper limit by $1,550,000. Although the reinsurance for this catastrophe has been exhausted and the ultimate outcome of the remaining open claims is unknown, the company maintains adequate reserves for the remaining 13 open claims based

26


on information available at the present time.

Deferred policy acquisition costs totaled $3,246,000 in 2011 compared to $3,354,000 in 2010. The deferred policy acquisition costs were 6.6% of premium revenue for 2011; up 0.4 percentage points compared to 6.2% of premium revenue for the same period last year. Deferred policy acquisition costs consist of amortization of previously capitalized distribution costs which are primarily commissions.

Commission expense for 2011 was $7,615,000 (15.4% of premium revenue) compared to $7,319,000 (13.5% of premium revenue) for the same period last year. The primary reason for the $296,000 or 4.0% increase in commission expense during 2011 compared to 2010 was an increase in contingent commissions.

General and administrative expenses totaled $6,322,000, or 12.8% of premium revenue in 2011 compared to $6,203,000, or 11.4% of premium revenue, in 2010. The primary reason for the $119,000 increase in general and administrative expenses was an increase in professional and consulting related fees in the current year compared to the same period last year.

Insurance taxes, licenses and fees were $1,569,000 in 2011 compared to $1,694,000 for the same period last year. Insurance taxes, licenses and fees were 3.2% of premium revenue in 2011; virtually unchanged compared to 3.1% in 2010.

The P&C segment ended 2011 with a net loss of $2,125,000 compared to net income of $5,508,000 for the same period last year. The primary reason for the net loss in the current year was the $5,091,000 increase in claims which resulted from the seventeen cat events in 2011 combined with the automobile incurred losses. In addition, net premium revenue was down $4,863,000 in 2011 compared to 2010. The combination of declining revenue and increased claims led to the negative results in the current year compared to the prior year.

Property & Casualty Combined Ratio:
A measure used to analyze a property/casualty insurer's underwriting performance is the combined ratio. It is the sum of two ratios:

a.
The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premium revenue.
b.
The underwriting expense ratio, which measures underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premium revenue.

The results of these ratios for the past two years were:
 
2011
 
2010
Loss and LAE Ratio
79
%
 
62
%
Underwriting Expense Ratio
38
%
 
34
%
Combined Ratio
117
%
 
96
%
Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, and adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi, Louisiana, or Texas could cause the combined ratio to fluctuate materially from prior years. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe; however, prohibitive catastrophe reinsurance costs associated with maintaining lower deductibles prevent us from further mitigating hurricane risks.

During 2011, the P&C segment experienced an increase of 21 percentage points in the combined ratio compared to 2010. The primary reason for the increase was a $5,091,000 increase in incurred losses primarily from tornado, wind and hail related claims as well as incurred losses from the automobile program. The cat events and automobile losses increased the current year combined ratio by 23.5 and 8.9 percentage points, respectively, compared to 2.7 and 9.4 percentage points, respectively in 2010. While cat events are unpredictable and beyond the control of management, measures have been taken to improve underwriting results in the P&C segment. The discontinuance of the private passenger and commercial automobile programs is expected to improve overall P&C segment underwriting results pending no further adverse development related to currently reported claims. Management also continues to evaluate

27


rate adequacy, exposure concentrations and risk management strategies in order to improve underwriting profitability and reduce earnings volatility.

Non-insurance Operations:
 
2011
 
2010
REVENUE
 
 
 
Net premiums earned
$

 
$

Net investment income
76

 
73

Net realized investment gains
(40
)
 
107

Other income

 

 
36

 
180

 
 
 
 
BENEFITS AND EXPENSES
 
 
 
Policyholder benefits paid or provided

 

Amortization of deferred policy acquisition costs

 

Commissions

 

General and administrative expenses
2,057

 
2,303

Insurance taxes, licenses and fees

 

Interest expense
1,091

 
1,091

 
3,148

 
3,394

 
 
 
 
LOSS BEFORE INCOME TAXES
$
(3,112
)
 
$
(3,214
)
The non-insurance operations of the Company consist of our parent company, The National Security Group, Inc. The National Security Group has no material sources of revenue and relies almost entirely on dividends from subsidiaries to pay expenses. Dividends from subsidiaries are subject to insurance department approval and are subject to statutory restrictions. Subsidiary dividends are eliminated upon consolidation of the subsidiaries in the audited financial statements included herein. General and administrative expenses totaled $2,057,000 compared to $2,303,000 for the same period last year; a 10.7% decrease. The expenses of NSG are primarily associated with the public listing of our stock, taxes and fees, and directors' fees. The single most significant recurring expense of NSG is interest expense associated with $12,372,000 in debt. This debt is composed of two trust preferred securities offerings, the first being $9,279,000 issued in the December 2005 and the second being $3,093,000 issued in June 2007. The primary use for these proceeds was to add capital to the property and casualty subsidiaries following the hurricanes of 2004 and 2005. Total interest expense for the Group associated with these borrowings in both 2011 and 2010 was $1,091,000. The primary reason for the decline in general expenses in 2011 compared to 2010 was the change in director deferred compensation which reduced general expenses $346,000 in the current year compared to $162,000 in the prior year. Defense cost related to matters disclosed in Note 15 of the Consolidated Financial Statements, was the most significant factor impacting general expenses in both 2011 and 2010. Defense costs incurred in NSG for the year ended December 31, 2011 and 2010 totaled $1,626,000 (79% of total 2011 general expenses) and $1,542,000 (67% of total 2010 general expenses), respectively.

Investments:

The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. The types of assets in which the Company can invest are influenced by various state insurance laws which prescribe qualified investment assets. While working within the parameters of these prescribed regulatory requirements as well as liquidity and capital needs, the Company considers investment quality, investment return, asset/liability matching and composition of the investment portfolio when choosing investments.

At December 31, 2011, the company's holdings in debt securities amounted to 74.9% of total investments and 57.7% of total assets. The Company utilizes the ratings of various Nationally Recognized Statistical Rating Organizations when classifying fixed maturity investments by quality rating. The most significant shift in quality ratings occurring in 2011 was the downgrade of US Government debt by S&P from their highest rating of AAA to AA+. Moody's and Fitch continued to carry US Government debt at their highest rating throughout 2011. Due to the split ratings of the major

28


rating agencies, US Government and agency debt is shown in the table below in the category of AAA/AA+.
The following is a breakdown of the Company's fixed maturity investments by quality rating:
S&P or Equivalent Ratings
 
% of Total Bond Portfolio 2011
 
% of Total Bond Portfolio 2010
AAA/AA+*
 
47.26%
 
55.71%
AA
 
6.27%
 
4.21%
AA-
 
15.16%
 
7.30%
A+
 
4.39%
 
3.49%
A
 
4.63%
 
7.02%
A-
 
6.61%
 
4.77%
BBB+
 
3.89%
 
3.62%
BBB
 
5.33%
 
4.21%
BBB-
 
2.81%
 
5.81%
Below Investment Grade
 
3.65%
 
3.86%
*Due to the downgrade of United States Government bonds, AAA and AA+ are presented consolidated for comparability. Most of the securities within this combined category are United States Government and Agency bonds, which are now rated AA+.

A summary of debt and equity securities available-for-sale with unrealized losses as of December 31, 2011 along with related fair value, aggregated by length of time that the investments have been in a continuous unrealized loss position follows:
 
 
Less than 12 months
 
12 months or longer
 
Total
 
 
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
 
$
4,703

 
$
166

 
$
899

 
$
101

 
$
5,602

 
$
267

 
15

Trust preferred securities
 
479

 
58

 

 

 
479

 
58

 
1

Mortgage backed securities
 
883

 
21

 
198

 
2

 
1,081

 
23

 
3

Private label mortgage backed securities
 
1,860

 
15

 
1,094

 
47

 
2,954

 
62

 
9

Obligations of state and political subdivisions
 

 

 
1,803

 
15

 
1,803

 
15

 
5

U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
260

 
3

 

 

 
260

 
3

 
1

Equity securities
 
391

 
49

 
802

 
541

 
1,193

 
590

 
6

 
 
$
8,576

 
$
312

 
$
4,796

 
$
706

 
$
13,372

 
$
1,018

 
40

Other-than-temporary impairments and credit quality
At December 31, 2011, 3.65% of total investments in the fixed income portfolio were classified as below investment grade. Management has evaluated each security in a significant unrealized loss position.  For the year ended December 31, 2011, the Company realized $398,000 in other-than-temporary impairments.  Most of the remaining unrealized losses in the fixed income portfolio, for which no impairment has been realized, are interest rate driven as opposed to credit quality driven and management believes no ultimate loss will be realized. 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 remaining securities in an accumulated loss position in the portfolio were temporary impairments.
During 2011, recoveries on securities for a portion of which other-than-temporary impairments were realized totaled

29


$384,000.

The amortized cost and aggregate fair value of debt securities at December 31, 2011, by contractual maturity, are as follows (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.
 
Amortized Cost
 
Fair Value
Available-for-sale securities:

 

Due in one year or less
$
599

 
$
614

Due after one year through five years
10,637

 
11,413

Due after five years through ten years
20,767

 
22,098

Due after ten years
37,977

 
38,949

Total
$
69,980

 
$
73,074

Held-to-maturity securities:
 
 
 
Due in one year or less
$
300

 
$
303

Due after one year through five years
516

 
549

Due after five years through ten years
634

 
675

Due after ten years
1,853

 
1,970

Total
$
3,303

 
$
3,497

The amortized cost and aggregate fair values of investments in securities at December 31, 2011 and December 31, 2010 are as follows (dollars in thousands):
December 31, 2011
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available-for-sale securities:
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
19,907

 
$
1,340

 
$
267

 
$
20,980

Trust preferred securities
 
537

 

 
58

 
479

Mortgage backed securities
 
7,587

 
307

 
23

 
7,871

Private label mortgage backed securities
 
9,716

 
199

 
62

 
9,853

Obligations of states and political subdivisions
 
18,355

 
1,142

 
15

 
19,482

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
13,878

 
534

 
3

 
14,409

Total fixed maturities
 
69,980

 
3,522

 
428

 
73,074

Equity securities
 
4,931

 
4,206

 
590

 
8,547

Total
 
$
74,911

 
$
7,728

 
$
1,018

 
$
81,621

Held-to-maturity securities:
 
 

 
 

 
 

 
 

Mortgage backed securities
 
$
2,026

 
$
125

 
$

 
$
2,151

Private label mortgage backed securities
 
55

 
1

 

 
56

Obligations of states and political subdivisions
 
996

 
50

 

 
1,046

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
226

 
18

 

 
244

Total
 
$
3,303

 
$
194

 
$

 
$
3,497




30


December 31, 2010
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available-for-sale securities:
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
21,869

 
$
1,663

 
$
119

 
$
23,413

Trust preferred securities
 
536

 
3

 

 
539

Mortgage backed securities
 
7,053

 
326

 
104

 
7,275

Private label mortgage backed securities
 
13,313

 
200

 
407

 
13,106

Obligations of states and political subdivisions
 
18,902

 
252

 
739

 
18,415

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
15,446

 
446

 
172

 
15,720

Total fixed maturities
 
77,119

 
2,890

 
1,541

 
78,468

Equity securities
 
5,478

 
4,014

 
445

 
9,047

Total
 
$
82,597

 
$
6,904

 
$
1,986

 
$
87,515

Held-to-maturity securities:
 
 

 
 

 
 

 
 

Mortgage backed securities
 
$
2,669

 
$
126

 
$
1

 
$
2,794

Private label mortgage backed securities
 
118

 
4

 

 
122

Obligations of states and political subdivisions
 
1,837