Edgar Filing: NATIONAL SECURITY GROUP INC

SEC Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



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

For Quarterly Period Ended March 31, 2016



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

For the transition period from to .

Commission File Number 0-18649

The National Security Group, Inc.

(Exact name of registrant as specified in its charter)



Delaware		63-1020300
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

661 East Davis Street Elba, Alabama		36323
(Address of principal executive offices)		(Zip-Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in rule 12b-2 of the Act). (Check One) : Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ

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

As of May 13, 2016, there were 2,512,425 shares, $1.00 par value, of the registrant’s common stock outstanding.

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THE NATIONAL SECURITY GROUP, INC.

TABLE OF CONTENTS



PART I. FINANCIAL INFORMATION
			Page No.
	Item 1. Financial Statements

		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Income	5
		Condensed Consolidated Statements of Comprehensive Income	6
		Condensed Consolidated Statements of Changes in Shareholders’ Equity	7
		Condensed Consolidated Statements of Cash Flows	8
		Notes to Condensed Consolidated Financial Statements	9
		Review Report of Independent Registered Public Accounting Firm	30

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

	Item 3. Quantitative and Qualitative Disclosures about Market Risk		39

	Item 4. Controls and Procedures		40


PART II. OTHER INFORMATION

	Item 1. Legal Proceedings		40
	Item 1A. Risk Factors		40
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		40
	Item 3. Defaults Upon Senior Securities		40
	Item 4. Mine Safety Disclosures		40
	Item 5. Other Information		40
	Item 6. Exhibits		40

			41
SIGNATURE

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Cautionary Statement Regarding Forward-Looking Statements

Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. The following report contains forward-looking statements that are not strictly historical and that involve risks and uncertainties. Such statements include any statements containing the words “expect,” “plan,” “estimate,” “anticipate” or other words of a similar nature. Management cautions investors about forward-looking statements. Forward-looking statements involve certain evaluation criteria, such as risks, uncertainties, estimates, and/or assumptions made by individuals informed of the Company and industries in which we operate. Any variation in the preceding evaluation criteria could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These risks and uncertainties include, without limitation, the following:


▪	The insurance industry is highly competitive and the Company encounters significant competition in all lines of business from other insurance companies. Many of the competing companies have more abundant financial resources than the Company.


▪	Insurance is a highly regulated industry. It is possible that legislation may be enacted which would have an adverse effect on the Company's business.


▪	The Company is subject to regulation by state governments for each of the states in which it conducts business. The Company cannot predict the subject of any future regulatory initiative(s) or its (their) impact on the Company's business.


▪	The Company is rated by various insurance rating agencies. If a rating is downgraded from its current level by one of these agencies, sales of the Company's products and stock price could be adversely impacted.


▪	The Company's financial results are adversely affected by increases in policy claims received by the Company. While a manageable risk, this fluctuation is often unpredictable.


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

▪

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

▪

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

▪

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


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

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PART I. Financial Information

Item 1. Financial Statements

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)



	March 31, 2016		December 31, 2015
	(UNAUDITED)
ASSETS
Investments
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2016 - $2,475; 2015 - $2,504)	$	2,370	$	2,439
Fixed maturities available-for-sale, at estimated fair value (cost: 2016 - $93,990; 2015 - $92,077)	95,319		91,812
Equity securities available-for-sale, at estimated fair value (cost: 2016 - $2,420; 2015 - $2,420)	5,057		4,897
Trading securities	107		107
Mortgage loans on real estate, at cost	190		202
Investment real estate, at book value	3,291		3,291
Policy loans	1,676		1,655
Company owned life insurance	4,932		4,898
Other invested assets	3,185		3,256
Total Investments	116,127		112,557
Cash	4,163		6,763
Accrued investment income	848		797
Policy receivables and agents' balances, net	11,776		11,296
Reinsurance recoverable	1,446		1,660
Deferred policy acquisition costs	8,542		8,485
Property and equipment, net	2,004		1,946
Deferred income tax asset, net	3,141		3,824
Other assets	565		513
Total Assets	$	148,612	$	147,841
LIABILITIES AND SHAREHOLDERS' EQUITY
Property and casualty benefit and loss reserves	$	8,244	$	9,645
Accident and health benefit and loss reserves	3,173		3,197
Life and annuity benefit and loss reserves	32,016		31,962
Unearned premiums	30,543		29,852
Policy and contract claims	856		826
Other policyholder funds	1,584		1,561
Short-term notes payable and current portion of long-term debt	857		857
Long-term debt	17,102		17,100
Accrued income taxes	172		101
Other liabilities	7,298		7,857
Total Liabilities	101,845		102,958
Contingencies
Shareholders' equity
Common stock	2,512		2,512
Additional paid-in capital	5,341		5,341
Accumulated other comprehensive income	1,581		525
Retained earnings	37,333		36,505
Total Shareholders' Equity	46,767		44,883
Total Liabilities and Shareholders' Equity	$	148,612	$	147,841

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands, except per share amounts)



	Three months ended March 31,
	2016		2015
REVENUES
Net premiums earned	$	15,165	$	14,706
Net investment income	991		1,002
Net realized investment gains	7		142
Other income	154		158
Total Revenues	16,317		16,008
BENEFITS, LOSSES AND EXPENSES
Policyholder benefits and settlement expenses	9,047		8,262
Amortization of deferred policy acquisition costs	787		899
Commissions	2,108		2,055
General and administrative expenses	2,129		2,031
Taxes, licenses and fees	600		655
Interest expense	345		320
Total Benefits, Losses and Expenses	15,016		14,222

Income Before Income Taxes	1,301		1,786

INCOME TAX EXPENSE
Current	221		471
Deferred	139		7
	360		478

Net Income	$	941	$	1,308

INCOME PER COMMON SHARE BASIC AND DILUTED	$	0.37	$	0.52

DIVIDENDS DECLARED PER SHARE	$	0.045	$	0.04

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

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THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)



	Three months ended March 31,
	2016			2015

Net income	$	941		$	1,308

Other comprehensive income (loss), net of tax
Changes in:
Unrealized gains on securities, net of reclassification adjustment of $12 and $94 for 2016 and 2015, respectively	1,158			365
Unrealized loss on interest rate swap	(102		)	(117		)

Other comprehensive income, net of tax	1,056			248

Comprehensive income	$	1,997		$	1,556

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

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THE NATIONAL SECURITY GROUP, INC.

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

(In thousands)



	Total			Retained Earnings			Accumulated Other Comprehensive Income		Common Stock		Additional Paid-in Capital

Balance at December 31, 2015 (AUDITED)	$	44,883		$	36,505		$	525	$	2,512	$	5,341

Net income for March 31, 2016	941			941

Other comprehensive income (net of tax)	1,056						1,056

Cash dividends	(113		)	(113		)

Balance at March 31, 2016	$	46,767		$	37,333		$	1,581	$	2,512	$	5,341

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

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THE NATIONAL SECURITY GROUP, INC.

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



	Three months ended March 31,
	2016			2015
Cash Flows from Operating Activities
Net income	$	941		$	1,308
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation expense and amortization/accretion, net	85			79
Increase in cash surrender value of company owned life insurance	(34		)	(44		)
Net realized gains on investments	(7		)	(142		)
Deferred income taxes	139			7
Amortization of deferred policy acquisition costs	787			899
Changes in assets and liabilities:
Change in accrued investment income	(51		)	(45		)
Change in reinsurance recoverable	214			(571		)
Policy acquisition costs deferred	(844		)	(893		)
Change in accrued income taxes	71			5
Change in net policy liabilities and claims	(1,137		)	1,075
Change in other assets/liabilities, net	(695		)	1,247
Other, net	8			8
Net cash provided by (used in) operating activities	(523		)	2,933
Cash Flows from Investing Activities
Purchase of:
Available-for-sale securities	(4,613		)	(7,582		)
Property and equipment	(97		)	(69		)
Proceeds from sale or maturities of:
Held-to-maturity securities	74			346
Available-for-sale securities	2,666			5,256
Other invested assets, net	(17		)	383
Net cash used in investing activities	(1,987		)	(1,666		)
Cash Flows from Financing Activities
Change in other policyholder funds	23			15
Repayments of long-term debt	—			(500		)
Dividends paid	(113		)	(100		)
Net cash used in financing activities	(90		)	(585		)
Net change in cash and cash equivalents	(2,600		)	682
Cash and cash equivalents, beginning of year	6,763			6,426
Cash and cash equivalents, end of period	$	4,163		$	7,108

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

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries: National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO). NSFC includes a wholly-owned subsidiary, Omega One Insurance Company (Omega). The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the condensed consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated. The financial information presented herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, which includes information and disclosures not presented herein.

Use of Estimates

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

Earnings Per Share

Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding were 2,512,425 at March 31, 2016 and 2,507,452 at March 31, 2015. The Company did not have any dilutive securities as of March 31, 2016 and 2015.

Reclassifications

Certain 2015 amounts have been reclassified from the prior year condensed consolidated financial statements to conform to the 2016 presentation.

Concentration of Credit Risk

The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts subject to FDIC insured limits of $250,000 per entity. At March 31, 2016, the net amount exceeding FDIC insured limits was $2,099,000 at one financial institution. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of financial institutions on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.

Policy receivables are reported at unpaid balances. Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk. Receivables from agents, less provision for credit losses, are composed of balances due from independent agents. At March 31, 2016, the single largest balance due from one agent totaled $902,000.

Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet their obligation could result in losses to the insurance subsidiaries. Allowances for losses are established if amounts are believed to be uncollectible. At March 31, 2016 and December 31, 2015, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At March 31, 2016, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

Change in Accounting Principle:

Effective January 1, 2016, the Company elected to change its method of presentation relating to placement fees associated with the issuance of trust preferred securities in accordance with FASB ASU 2015-03. Prior to 2016, the Company’s policy was to present these fees in Other Assets on the balance sheet, net of accumulated amortization. Beginning in 2016, the Company has presented these fees as a direct reduction in the related note payable.

Accounting Changes Not Yet Adopted

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (FASB) issued guidance on a comprehensive new revenue recognition standard. This standard will not impact accounting for insurance contracts, leases, financial instruments and guarantees. For those contracts that are impacted by the new guidance, the guidance will require an entity to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to, in exchange for those goods or services. The guidance requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued a deferral of the effective date by one year. This guidance is effective retrospectively for fiscal years beginning after December 15, 2017 and interim periods within those years. Early adoption of this standard is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Although insurance contracts are specifically scoped out of this new guidance, the Company has minor services that may be subject to the new revenue recognition guidance and are still in the process of evaluating the impact, if any, the guidance may have on its condensed consolidated financial statements.

Presentation of Financial Statements - Going Concern

In August 2014, the FASB issued guidance on determining when and how to disclose going concern uncertainties in the financial statements, and requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. The updated guidance is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company does not expect the adoption to have a material impact on its financial position, results of operations or disclosures.

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued guidance that requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The guidance requires entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset. The guidance eliminates the requirement for public companies to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. This guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Leases

In February 2016, the FASB issued guidance that requires lessees (for capital and operating leases) to recognize the lease liability and right-of-use asset at the commencement date of the lease. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Contingent Put and Call Options in Debt Instruments

In March 2016, the FASB issued guidance that clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

those years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Recently Adopted Accounting Standards

Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items

In January 2015, the FASB issued guidance that eliminates from GAAP the concept of extraordinary items. The Company adopted this standard on January 1, 2016. This guidance did not have a material effect on results of operations or financial position.

Amendments to the Consolidation Analysis

In February 2015, the FASB issued additional guidance regarding the consolidation of certain legal entities. The guidance modifies the evaluation of whether or not limited partnerships and similar legal entities are variable interest entities (VIEs) and the consolidation analysis of entities involved with VIEs, particularly those that have fee arrangements and related party relationships. The Company adopted this standard on January 1, 2016. This guidance did not have a material effect on results of operations or financial position.

Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs.

In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability. The Company adopted this standard retrospectively on January 1, 2016, which resulted in the reclassification of $258,000 of unamortized debt issuance costs related to Company borrowings from other assets to long-term debt within our condensed consolidated balance sheet as of December 31, 2015. The adoption also resulted in the reclassification of $3,000 from general expenses to interest expense for the three months ended March 31, 2015.

Disclosure about Short-Duration Contracts

In May 2015, the FASB issued guidance that enhances disclosure about short-duration insurance liabilities to help users understand the nature, amount, timing and uncertainty of future cash flows related to insurance liabilities and the effect of those cash flows on the statement of comprehensive income. The Company adopted this standard on January 1, 2016. Required disclosures will be included in the notes to consolidated financial statements included in the Company's 2016 Annual Report on Form 10-K and in interim reports beginning in 2017.

Simplifying the Accounting for Measurement-Period Adjustments

In September 2015, the FASB issued guidance that requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer must record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The guidance requires an entity to present on the face of the income statement or to disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this standard on January 1, 2016. This guidance did not have a material effect on results of operations or financial position.

NOTE 2 – VARIABLE INTEREST ENTITIES

The Company holds a passive interest in a limited partnership that is considered to be a Variable Interest Entity (VIE) under the provisions of ASC 810 Consolidation. The Company is not the primary beneficiary of the entity and is not required to consolidate under ASC 810. The entity is a private placement investment fund formed for the purpose of investing in private equity investments. The Company owns less than 1% of the limited partnership. The carrying value of the investment totals $228,000 and is included as a component of Other Invested Assets in the accompanying condensed consolidated balance sheets.

In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust preferred

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,279,000 of variable rate subordinated debentures issued by the Company. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 7, are reported in the accompanying condensed consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $279,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $3,093,000 unsecured junior subordinated deferrable interest debentures. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $2,995,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the Trust. The Subordinated Debentures, disclosed in Note 7, are reported in the accompanying consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $93,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

NOTE 3 – INVESTMENTS

The amortized cost and aggregate fair values of investments in available-for-sale securities as of March 31, 2016 are as follows (dollars in thousands):



Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities	$	38,378	$	1,157	$	1,173	$	38,362
Mortgage backed securities	14,212		370		103		14,479
Private label asset backed securities	8,866		40		631		8,275
Obligations of states and political subdivisions	13,933		938		3		14,868
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	18,601		744		10		19,335
Total fixed maturities	93,990		3,249		1,920		95,319
Equity securities	2,420		2,747		110		5,057
Total	$	96,410	$	5,996	$	2,030	$	100,376

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of March 31, 2016 are as follows (dollars in thousands):



Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage backed securities	$	2,332	$	102	$	—	$	2,434
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	38		3		—		41
Total	$	2,370	$	105	$	—	$	2,475

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2015 are as follows (dollars in thousands):



Available-for-sale securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities	$	38,245	$	747	$	1,728	$	37,264
Mortgage backed securities	15,324		157		224		15,257
Private label asset backed securities	6,029		24		380		5,673
Obligations of states and political subdivisions	14,654		869		47		15,476
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	17,825		413		96		18,142
Total fixed maturities	92,077		2,210		2,475		91,812
Equity securities	2,420		2,590		113		4,897
Total	$	94,497	$	4,800	$	2,588	$	96,709

The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2015 are as follows (dollars in thousands):



Held-to-maturity securities:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage backed securities	$	2,395	$	62	$	—	$	2,457
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	44		3		—		47
Total	$	2,439	$	65	$	—	$	2,504

The amortized cost and aggregate fair value of debt securities at March 31, 2016, by contractual maturity, are presented in the following table (dollars in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



(Dollars in Thousands)	Amortized Cost		Fair Value
Available-for-sale securities:
Due in one year or less	$	2,038	$	2,069
Due after one year through five years	15,799		16,127
Due after five years through ten years	34,131		33,956
Due after ten years	42,022		43,167
Total	$	93,990	$	95,319

Held-to-maturity securities:
Due in one year or less	$	—	$	—
Due after one year through five years	66		69
Due after five years through ten years	99		108
Due after ten years	2,205		2,298
Total	$	2,370	$	2,475

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

A summary of securities available-for-sale with unrealized losses as of March 31, 2016, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows (dollars in thousands):



	Less than 12 months				12 months or longer				Total
March 31, 2016	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	$	8,769	$	284	$	4,349	$	889	$	13,118	$	1,173	25
Mortgage backed securities	2,393		79		710		24		3,103		103		11
Private label asset backed securities	4,985		414		1,790		217		6,775		631		10
Obligations of state and political subdivisions	—		—		339		3		339		3		1
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	995		3		352		7		1,347		10		3
Equity securities	—		—		1,176		110		1,176		110		1
	$	17,142	$	780	$	8,716	$	1,250	$	25,858	$	2,030	51

There were no securities held-to-maturity with unrealized losses as of March 31, 2016.

A summary of securities available-for-sale with unrealized losses as of December 31, 2015, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows (dollars in thousands):



	Less than 12 months				12 months or longer				Total
December 31, 2015	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	$	18,205	$	821	$	3,783	$	907	$	21,988	$	1,728	44
Mortgage backed securities	9,069		161		675		63		9,744		224		20
Private label asset backed securities	4,962		379		84		1		5,046		380		10
Obligations of state and political subdivisions	1,920		36		331		11		2,251		47		5
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	6,131		70		1,452		26		7,583		96		12
Equity securities	—		—		1,173		113		1,173		113		1
	$	40,287	$	1,467	$	7,498	$	1,121	$	47,785	$	2,588	92

There were no securities held-to-maturity with unrealized losses as of December 31, 2015.

The Company conducts periodic reviews to identify and evaluate securities in an unrealized loss position in order to identify other-than-temporary impairments. For securities in an unrealized loss position, the Company assesses whether the Company has the intent to sell the security or more-likely-than-not will be required to sell the security

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

before the anticipated recovery. If either of these conditions is met, the Company is required to recognize an other-than-temporary impairment with the entire unrealized loss reported in earnings. For securities in an unrealized loss position that do not meet these conditions, the Company assesses whether the impairment of a security is other-than-temporary. If the impairment is determined to be other-than-temporary, the Company is required to separate the other-than-temporary impairments into two components: the amount representing the credit loss and the amount related to all other factors. The credit loss is the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of other-than-temporary impairments is reported in earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes.

Management has evaluated each security in a significant unrealized loss position. The Company has no material exposure to sub-prime mortgage loans and less than 5.14% of the fixed income investment portfolio is rated below investment grade. In evaluating whether or not the equity loss positions were other-than-temporary impairments, Management evaluated financial information on each company and where available, reviewed analyst reports from at least two independent sources. Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments.

For the three months ended March 31, 2016 and year ended December 31, 2015, the Company realized no other-than-temporary impairments. At March 31, 2016, the single largest loss not realized as an impairment was in the bond portfolio and totaled $247,000. The second largest loss position was in the bond portfolio and totaled $245,000. The third largest loss position was in the bond portfolio and totaled $196,000. At December 31, 2015, the single largest loss not realized as an impairment was in the bond portfolio and totaled $252,000. The second largest loss position was in the bond portfolio and totaled $211,000. The third largest loss position was in the bond portfolio and totaled $186,000.

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



	Three months ended March 31,
	2016		2015
Fixed maturities	$	901	$	894
Equity securities	28		30
Mortgage loans on real estate	1		4
Investment real estate	2		2
Policy loans	32		29
Company owned life insurance change in surrender value	34		44
Other	49		42
	1,047		1,045
Less: Investment expenses	56		43
Net investment income	$	991	$	1,002

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



	Three months ended March 31,
	2016			2015
Fixed maturities	$	17		$	142
Other, principally real estate	(10		)	—
Net realized investment gains	$	7		$	142

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

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



	March 31, 2016			December 31, 2015
Net change in unrealized appreciation on available-for-sale securities before deferred tax	$	1,754		$	(3,225	)
Deferred income tax	(596		)	1,097
Net change in unrealized appreciation on available-for-sale securities	$	1,158		$	(2,128	)

NOTE 4 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

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

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

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

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

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

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

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

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

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

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

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

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

Assets/Liabilities Measured at Fair Value on a Recurring Basis

Financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2016 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):



	Fair Value Measurements at Reporting Date Using
Description	Total			Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
Corporate debt securities	$	38,362		$	—	$	38,362	$	—
Mortgage backed securities	14,479			—		14,479		—
Private label asset backed securities	8,275			—		8,275		—
Obligations of states and political subdivisions	14,868			—		14,868		—
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	19,335			19,335		—		—
Trading securities	107			107		—		—
Equity securities available-for-sale	5,057			3,881		—		1,176
Total Financial Assets	$	100,483		$	23,323	$	75,984	$	1,176
Financial Liabilities
Interest rate swap	$	(1,574	)	$	—	$	—	$	(1,574	)
Total Financial Liabilities	$	(1,574	)	$	—	$	—	$	(1,574	)

The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below.

Fixed maturities available-for-sale — The fair values of the Company’s public fixed maturity securities are generally based on prices obtained from independent pricing services. Consistent with the fair value hierarchy described above, securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.

Trading securities — Trading securities consist primarily of mutual funds whose fair values are determined consistent with similar instruments described above under “Fixed Maturities” and below under “Equity Securities.”

Equity securities — Equity securities consist principally of investments in common and preferred stock of publicly traded companies and privately traded securities. The fair values of our publicly traded equity securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy.

Estimated fair values for our privately traded equity securities require a substantial level of judgment. Privately traded equity securities are classified within Level 3.

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

As of March 31, 2016, Level 3 fair value measurements of assets include $1,176,000 of equity securities in a local community bank whose value is based on an evaluation of the financial statements of the entity. The Company does not develop the unobservable inputs used in measuring fair value.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

As of March 31, 2016, Level 3 fair value measurements of liabilities include $1,574,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party broker who utilizes financial modeling tools and assumptions on interest and other factors. The Company does not develop the unobservable inputs used in measuring fair value. Additional information regarding the interest rate swap agreements is provided in Note 7.

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2016 (in thousands):



For the three months ended March 31, 2016	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	1,173	$	(1,419	)
Total gains or losses (realized and unrealized):
Included in earnings	—		—
Included in other comprehensive income	3		(155		)
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,176	$	(1,574	)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of March 31, 2016:	$	—	$	—

For the three months ended March 31, 2016, there were no assets or liabilities measured at fair values on a nonrecurring basis.

Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):



	Fair Value Measurements at Reporting Date Using
Description	Total			Level 1		Level 2		Level 3
Financial Assets
Fixed maturities available-for-sale
Corporate debt securities	$	37,264		$	—	$	37,264	$	—
Mortgage backed securities	15,257			—		15,257		—
Private label asset backed securities	5,673			—		5,673		—
Obligations of states and political subdivisions	15,476			—		15,476		—
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	18,142			18,142		—		—
Trading securities	107			107		—		—
Equity securities available-for-sale	4,897			3,724		—		1,173
Total Financial Assets	$	96,816		$	21,973	$	73,670	$	1,173
Financial Liabilities
Interest rate swap	$	(1,419	)	$	—	$	—	$	(1,419	)
Total Financial Liabilities	$	(1,419	)	$	—	$	—	$	(1,419	)

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2015 (in thousands):



For the year ended December 31, 2015	Equity Securities Available-for-Sale		Interest Rate Swap
Beginning balance	$	1,116	$	(1,238	)
Total gains or losses (realized and unrealized):
Included in earnings	—		—
Included in other comprehensive income	57		(181		)
Purchases:	—		—
Sales:	—		—
Issuances:	—		—
Settlements:	—		—
Transfers in/(out) of Level 3	—		—
Ending balance	$	1,173	$	(1,419	)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of December 31, 2015:	$	—	$	—

For the year ended December 31, 2015, there were no assets or liabilities measured at fair values on a nonrecurring basis.

The Company is exposed to certain risks in the normal course of its business operations. The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings. This risk is managed through the use of interest rate swap agreements which are designated as cash flow hedges. For cash flow hedges, the effective portion of the gain or loss on the interest rate swap is included as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings. The Company does not hold or issue derivatives that are not designated as hedging instruments. See Note 7 for additional information about the interest rate swap agreements.

The following methods and assumptions were used to estimate fair value of each class of financial instrument for which it is practical to estimate that value:

Cash and cash equivalents — the carrying amount is a reasonable estimate of fair value.

Fixed maturities held-to-maturity — the carrying amount is amortized cost; the fair values of the Company’s public fixed maturity securities that are classified as held-to-maturity are generally based on prices obtained from independent pricing services.

Mortgage loans — the carrying amount is a reasonable estimate of fair value due to the restrictive nature and limited marketability of the mortgage notes.

Policy loans — the carrying amount is a reasonable estimate of fair value.

Company owned life insurance — the carrying amount is a reasonable estimate of fair value.

Other invested assets — the carrying amount is a reasonable estimate of fair value.

Other policyholder funds — the carrying amount is a reasonable estimate of fair value.

Debt — the carrying amount is a reasonable estimate of fair value.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

The carrying amount and estimated fair value of the Company’s financial instruments as of March 31, 2016 and December 31, 2015 are as follows (in thousands):



	March 31, 2016				December 31, 2015
Assets and related instruments	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Held-to-maturity securities	$	2,370	$	2,475	$	2,439	$	2,504
Mortgage loans	190		190		202		202
Policy loans	1,676		1,676		1,655		1,655
Company owned life insurance	4,932		4,932		4,898		4,898
Other invested assets	3,185		3,185		3,256		3,256
Liabilities and related instruments
Other policyholder funds	1,584		1,584		1,561		1,561
Short-term notes payable and current portion of long-term debt	857		857		857		857
Long-term debt	17,102		17,102		17,100		17,100

NOTE 5 – PROPERTY AND EQUIPMENT

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



	March 31, 2016		December 31, 2015
Building and improvements	$	3,348	$	3,350
Electronic data processing equipment	1,726		1,631
Furniture and fixtures	533		529
	5,607		5,510
Less accumulated depreciation	3,603		3,564
Property and equipment, net	$	2,004	$	1,946

Depreciation expense for the three months ended March 31, 2016 was $39,000 ($168,000 for the year ended December 31, 2015).

NOTE 6 – INCOME TAXES

The Company recognizes tax-related interest and penalties as a component of tax expense. The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is not subject to examinations by authorities related to its U.S. federal or state income tax filings for years prior to 2010. Tax returns have been filed through the year 2014.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The Company recognized net deferred tax asset positions of $3,141,000 at March 31, 2016 and $3,824,000 at December 31, 2015.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

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



	As of March 31, 2016			As of December 31, 2015
General expenses	$	1,487		$	1,569
Unearned premiums	2,082			2,039
Claims liabilities	724			730
Litigation settlement	1,748			1,748
AMT credit	742			816
Impairment on real estate owned	187			187
Unrealized loss on interest rate swaps	535			483
Deferred tax assets	7,505			7,572

Depreciation	(112		)	(111		)
Deferred policy acquisition costs	(2,904		)	(2,885		)
Unrealized gains on securities available-for-sale	(1,348		)	(752		)
Deferred tax liabilities	(4,364		)	(3,748		)
Net deferred tax asset	$	3,141		$	3,824

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



	Three months ended March 31,
	2016			2015
Deferred policy acquisition costs	$	19		$	(2	)
Unearned premiums	(43		)	(48		)
General expenses	82			(44		)
Depreciation	1			(4		)
Claims liabilities	6			(14		)
AMT credit	74			119
Deferred income tax expense	$	139		$	7

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



	Three months ended March 31,
	2016		2015
Federal income tax rate applied to pre-tax income/loss	34.0	%	34.0	%
Dividends received deduction and tax-exempt interest	(1.8	)%	(1.5	)%
Company owned life insurance	(0.9	)%	(0.8	)%
Small life deduction	(4.4	)%	(3.2	)%
Other, net	0.8	%	(1.8	)%
Effective federal income tax rate	27.7	%	26.7	%

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

NOTE 7 – NOTES PAYABLE AND LONG-TERM DEBT

Short-term debt and current portion of long-term debt consisted of the following as of March 31, 2016 and December 31, 2015 (dollars in thousands):



	March 31,		December 31,
	2016		2015
Current portion of installment note payable due November 2016 with variable interest rate equal to the WSJ prime rate plus 1%. Unsecured.	857		857
	$	857	$	857

Long-term debt consisted of the following as of March 31, 2016 and December 31, 2015 (dollars in thousands):



	March 31,		December 31,
	2016		2015
Line of credit with variable interest rate equal to the WSJ prime rate, subject to a 5.0% floor; maturity March 2018. Interest payments due quarterly. Unsecured.	$	700	$	700

Line of credit, $1,000,000 available, with variable interest rate equal to the WSJ prime rate, subject to a 4.5% floor; maturity September 2017. Interest payments due monthly. Secured.	—		—

Long term portion of installment note with variable interest rate equal to the WSJ prime rate plus 1% and adjustable each November; maturity November 2021. Interest payable annually with principal payable in equal annual installments. Next principal installment on long term portion due November 2016. Unsecured.	4,286		4,286

Subordinated debentures issued on December 15, 2005 with fixed interest rate of 8.83% each distribution period thereafter until December 15, 2015 when the coupon rate shall equal the 3-Month LIBOR plus 3.75% applied to the outstanding principal; net of $185,000 in debt issuance cost ($187,000 in 2015); maturity December 2035. Interest payments due quarterly. All may be redeemed at any time following the tenth anniversary of issuance. Unsecured.	9,094		9,092

Subordinated debentures issued on June 21, 2007 with a floating interest rate equal to the 3-Month LIBOR plus 3.40% applied to the outstanding principal; applied to the outstanding principal; net of $70,000 in debt issuance cost ($71,000 in 2015); maturity June 15, 2037. Interest payments due quarterly. All may be redeemed at any time following the fifth anniversary of issuance. Unsecured.	3,022		3,022
	$	17,102	$	17,100

The Company has entered into various swap agreements related to the trust preferred securities. On March 19, 2009, the Company entered into a forward swap effective September 17, 2012, with a notional amount of $3,000,000 and designated the swap as a hedge against changes in cash flows attributable to changes in the benchmark interest rate (LIBOR) associated with the subordinated debentures issued June 21, 2007. Quarterly, commencing September 17, 2012, under the terms of the forward swap, the Company will pay interest at a fixed rate of 7.02% until March 15, 2019. On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which hedges against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company pays interest at a fixed rate of 8.49% until March 15, 2020.

The swaps entered into in 2009 and 2010 have fair values of $243,000 (liability) and $1,331,000 (liability), respectively, for a total liability of $1,574,000 at March 31, 2016 ($1,419,000 at December 31, 2015). The swap liability is reported as a component of other liabilities on the consolidated balance sheets. A net valuation loss of $102,000 (net of tax)

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

is included in accumulated other comprehensive income related to the swap agreements at March 31, 2016. A net valuation loss of $119,000 (net of tax) was included in accumulated other comprehensive income related to the swap at December 31, 2015.

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

The Company’s interest rate swaps include provisions requiring the Company to post collateral when the derivative is in a net liability position. At March 31, 2016, the Company has securities on deposit with fair market values of $1,515,000 and cash of $230,000 (all of which is posted as collateral). At December 31, 2015, the Company had securities on deposit with fair market values of $1,482,000 and cash of $130,000 (all of which is posted as collateral). See Note 4 for additional information about the interest rate swaps.

NOTE 8 – REINSURANCE

The Company's insurance operations utilize reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term coverage. Property and casualty reinsurance is placed on an excess of loss basis to cover losses from catastrophe events. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of re-insurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurance companies and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the companies to minimize their exposure to significant losses from reinsurance insolvencies.

In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other individually significant large loss events that cause unfavorable underwriting results by re-insuring certain levels of risk in various areas of exposure with reinsurance companies. NSFC maintains a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.

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



Layer	Reinsurers' Limits of Liability
First Layer	100% of $13,500,000 in excess of $4,000,000 retention
Second Layer	100% of $25,000,000 in excess of $17,500,000
Third Layer	100% of $30,000,000 in excess of $42,500,000

Each reinsurance layer covers events occurring from January 1 through December 31 of the contract year. All significant reinsurance companies under the program carry A.M. Best ratings of A- (Excellent) or higher, or equivalent ratings.

The Company's catastrophe reinsurance contract allows for one reinstatement. The Company maintains reinstatement premium protection (RPP) to cover reinstatement premiums incurred. The RPP further reduces risk from a major catastrophe and serves to strengthen the Company's capital position by reducing the modeled 100 year event net cost.

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

In the normal course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to reinsurance companies under excess coverage contracts. NSIC retains a

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

maximum of $50,000 of coverage per individual life. The cost of reinsurance is amortized over the contract period of the reinsurance.

At March 31, 2016, the largest reinsurance recoverable of a single reinsurer was $17,000 ($12,000 at December 31, 2015). Amounts reported as ceded incurred losses in both 2016 and 2015 were related to the development of losses from prior year catastrophes.

NOTE 9 – EMPLOYEE BENEFIT PLANS

The Company and its subsidiaries have an established retirement savings plan (401K Plan). All full-time employees are eligible to participate, and all employer contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Company matching contributions for the three months ended March 31, 2016 and 2015 amounted to $68,000 and $43,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.

In January 2006, the Company established a non-qualified plan under which directors are allowed to defer all or a portion of directors' fees into various investment options. The supplemental executive retirement plan (SERP) became effective March 1, 2008 and covers named executive officers, with the Company contributing 15% of executive compensation to the plan. Contributions to the plan are fully vested upon the earlier of death, disability, change in control, or ten years of participation in the plan. Costs for amounts credited to the non-qualified deferred compensation plans for the three months ended March 31, 2016 and 2015 amounted to approximately $64,000 and $45,000, respectively.

The Company and its subsidiaries established an Employee Stock Ownership Plan (ESOP) in January 2010, to enable its eligible employees to acquire a proprietary interest in the Company's common stock and to provide retirement and other benefits to such employees. There were $150,000 costs incurred in the first quarter of 2016 and no costs incurred in the first quarter of 2015 related to ESOP plan contributions. All contributions were made in cash for purchase of Company shares in the open market. The Company has not allocated shares directly to the plan and the plan has no debt.

NOTE 10 – SHAREHOLDERS' EQUITY

During the three months ended March 31, 2016 and year ended December 31, 2015, changes in shareholders' equity consisted of net income of $941,000 and $4,697,000, respectively; dividends paid of $113,000 in 2016 and $402,000 in 2015; increases in accumulated other comprehensive income, net of applicable taxes, of $1,056,000 in 2016 and decreases in accumulated other comprehensive income, net of applicable taxes, of $2,247,000 in 2015. Other comprehensive gains and loss consisted of accumulated unrealized gains and losses on securities available for sale and unrealized loss on interest rate swaps.

Preferred Stock

Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference.

Common Stock

The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share. There is currently no Class A Common Stock issued or outstanding.

In the event of any liquidation, dissolution or distribution of the assets of the Company remaining after the payments to the holders of the Preferred Stock of the full preferential amounts to which they may be entitled as provided in the resolution or resolutions creating any series thereof, the remaining assets of the Company shall be divided and distributed among the holders of both classes of common stock, except as may otherwise be provided in any such resolution or resolutions.

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

The table below provides information regarding the Company's preferred and common stock as of March 31, 2016 and December 31, 2015:



	Authorized	Issued	Outstanding
Preferred Stock, $1 par value	500,000	—	—
Class A Common Stock, $1 par value	2,000,000	—	—
Common Stock, $1 par value	3,000,000	2,512,425	2,512,425

NOTE 11 – ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income (loss) ("AOCI") includes certain items that are reported directly within a separate component of shareholders' equity. The following table presents changes in AOCI balances (dollars in thousands):



	Three months ended March 31,
	2016			2015
Gains and Losses on Cash Flow Hedges
Balance at beginning of period	$	(935	)	$	(816	)
Other comprehensive loss for period:
Other comprehensive loss before reclassifications	(102		)	(117		)
Amounts reclassified from accumulated other comprehensive income	—			—
Net current period other comprehensive loss	(102		)	(117		)
Balance at end of period	$	(1,037	)	$	(933	)
Unrealized Gains and Losses on Available-for-Sale Securities
Balance at beginning of period	$	1,460		$	3,588
Other comprehensive income for period:
Other comprehensive income before reclassifications	1,170			459
Amounts reclassified from accumulated other comprehensive income	(12		)	(94		)
Net current period other comprehensive income	1,158			365
Balance at end of period	$	2,618		$	3,953
Total Accumulated Other Comprehensive Income at end of period	$	1,581		$	3,020

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2016 (dollars in thousands):



Details about Accumulated Other Comprehensive Income Components	Amounts Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized Gains and Losses on Available-for-Sale Securities	$	18		Net realized investment gains
	18			Total before tax
	(6		)	Tax (expense) or benefit
	$	12		Net of Tax

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2015 (dollars in thousands):

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)



Details about Accumulated Other Comprehensive Income Components	Amounts Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized Gains and Losses on Available-for-Sale Securities	$	142		Net realized investment gains
	142			Total before tax
	(48		)	Tax (expense) or benefit
	$	94		Net of Tax

NOTE 12 – SEGMENTS

The Company’s property and casualty insurance operations comprise one business segment. The property and casualty insurance segment primarily underwrites home insurance coverage with primary lines of business consisting of dwelling fire and extended coverage, homeowners (including mobile homeowners) and other liability.

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

The Company’s life and accident and health operations comprise the second business segment. The life and accident and health insurance segment consists of two lines of business: traditional life insurance and accident and health insurance.

Total assets by industry segment at March 31, 2016 and at December 31, 2015 are summarized below (dollars in thousands):



	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations

March 31, 2016	$	148,612	$	84,837	$	57,638	$	6,137

December 31, 2015	$	147,841	$	84,435	$	57,067	$	6,339

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

Premium revenues and operating income by business segment for the quarters ended March 31, 2016 and 2015 are summarized below (dollars in thousands):



Three months ended March 31, 2016	Total		P&C Insurance Operations		Life Insurance Operations		Non-Insurance Operations
REVENUE
Net premiums earned	$	15,165	$	13,601	$	1,564	$	—
Net investment income	991		453		521		17
Net realized investment gains (losses)	7		—		7		—
Other income	154		153		1		—
	16,317		14,207		2,093		17
BENEFITS AND EXPENSES
Policyholder benefits paid	9,047		7,862		1,185		—
Amortization of deferred policy acquisition costs	787		696		91		—
Commissions	2,108		2,016		92		—
General and administrative expenses	2,129		1,421		505		203
Taxes, licenses and fees	600		535		65		—
Interest expense	345		—		18		327
	15,016		12,530		1,956		530
Income (Loss) Before Income Taxes	$	1,301	$	1,677	$	137	$	(513	)



Three months ended March 31, 2015	Total		P&C Insurance Operations		Life Insurance Operations			Non-Insurance Operations
REVENUE
Net premiums earned	$	14,706	$	13,122	$	1,584		$	—
Net investment income	1,002		490		493			19
Net realized investment gains	142		31		111			—
Other income	158		157		1			—
	16,008		13,800		2,189			19
BENEFITS AND EXPENSES
Policyholder benefits paid	8,262		6,777		1,485			—
Amortization of deferred policy acquisition costs	899		675		224			—
Commissions	2,055		1,968		87			—
General and administrative expenses	2,031		1,540		337			154
Taxes, licenses and fees	655		544		111			—
Interest expense	320		—		10			310
	14,222		11,504		2,254			464
Income (Loss) Before Income Taxes	$	1,786	$	2,296	$	(65	)	$	(445	)

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

The following table presents the Company’s gross and net premiums written for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2016 and 2015, respectively:



	Three months ended March 31,
	2016			2015
Life, accident and health operations premiums written:
Traditional life insurance	$	1,119		$	1,137
Accident and health insurance	418			419
Gross life, accident and health	1,537			1,556
Reinsurance premium ceded	(25		)	(15		)
Net life, accident and health premiums written	$	1,512		$	1,541
Property and Casualty operations premiums written:
Dwelling fire & extended coverage	$	9,192		$	8,728
Homeowners (Including mobile homeowners)	5,712			5,751
Other liability	523			505
Gross property and casualty	15,427			14,984
Reinsurance premium ceded	(1,002		)	(1,491		)
Net property and casualty written	$	14,425		$	13,493
Consolidated gross premiums written	$	16,964		$	16,540
Reinsurance premium ceded	(1,027		)	(1,506		)
Consolidated net premiums written	$	15,937		$	15,034

The following table presents the Company’s gross and net premiums earned for the property and casualty segment and the life and accident and health segment for the three months ended March 31, 2016 and 2015, respectively:



	Three months ended March 31,
	2016			2015
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,173		$	1,178
Accident and health insurance	416			421
Gross life, accident and health	1,589			1,599
Reinsurance premium ceded	(25		)	(15		)
Net life, accident and health premiums earned	$	1,564		$	1,584
Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	$	8,662		$	8,200
Homeowners (Including mobile homeowners)	5,906			5,948
Other liability	493			465
Gross property and casualty	15,061			14,613
Reinsurance premium ceded	(1,460		)	(1,491		)
Net property and casualty earned	$	13,601		$	13,122
Consolidated gross premiums earned	$	16,650		$	16,212
Reinsurance premium ceded	(1,485		)	(1,506		)
Consolidated net premiums earned	$	15,165		$	14,706

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THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2015 AMOUNTS)

NOTE 13 – CONTINGENCIES

The Company and its subsidiaries continue to be named individually as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of the Company's subsidiaries, and other miscellaneous causes of action.

The Company's property & casualty subsidiaries are defending a limited number of matters filed in the aftermath of Hurricane Ike in Texas. These actions include individual lawsuits with allegations of underpayment of hurricane-related claims.

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

NOTE 14 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest during the three months ended March 31, 2016 was $277,000 ($280,000 in 2015). Cash paid for income taxes during the three months ended March 31, 2016 was $150,000 ($500,000 in 2015).

NOTE 15 – SUBSEQUENT EVENTS

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

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REVIEW OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

The National Security Group, Inc.

We have reviewed the condensed consolidated balance sheet of The National Security Group, Inc. as of March 31, 2016, and the related condensed consolidated statements of income, comprehensive income and cash flows for the three-month periods ended March 31, 2016 and 2015, and the related condensed consolidated statement of changes in shareholders’ equity for the three-month period ended March 31, 2016. These condensed consolidated financial statements are the responsibility of the company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion.

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

We have previously audited, in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The National Security Group, Inc. as of December 31, 2015, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 18, 2016, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2015, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.



/s/ Warren Averett, LLC

Birmingham, Alabama
May 13, 2016

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

The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) and its subsidiaries. We are a “smaller reporting company” under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general, the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the three month periods ended March 31, 2016 and 2015.

The National Security Group, Inc. is made up of two segments: the Life segment and the P&C segment. The Company's life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1992.

This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes thereto included in Part 1, Item 1 of this report and with our audited consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2015.

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

The National Security Group operates in the property and casualty and life, accident and supplemental health insurance businesses and markets products primarily through independent agents. The Company operates in ten states with 48.1% of total premium revenue generated in the states of Alabama and Mississippi. Property and casualty insurance is the most significant segment, accounting for 90.5% of gross earned premium revenue in the first three months of 2016. Revenue generated from the life segment accounted for 9.5% of gross insurance premium revenue in the first three months 2016.

National Security Insurance Company (NSIC) is a life, accident and health insurance company founded in 1947. All references to NSIC in the remainder of this management discussion and analysis will refer to the combined life, accident and health insurance operations and will compose the life segment of the Company. NSIC is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.

The property and casualty segment consists of the consolidated operations of two subsidiaries, National Security Fire and Casualty Company and its wholly owned subsidiary, Omega One Insurance Company. Omega One currently has no direct written premium. The Property and Casualty segment has premium in-force in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.

All of the insurance subsidiaries are Alabama domiciled insurance companies; therefore, the Alabama Department of Insurance is the primary insurance regulator. However, each subsidiary is subject to regulation by the respective insurance regulators of each state in which it is licensed to transact business. Insurance rates charged by each of the insurance subsidiaries are typically reviewed and approved by each insurance department for the respective state in which the rates will apply.

All of our insurance companies have been assigned ratings by A.M. Best Co (Best). On February 10, 2016, Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The outlook for all of these ratings is stable. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a stable outlook. The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On November 23, 2015, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.

The two primary segments in which we report insurance operations are the personal lines property and casualty segment (NSFC) and the life, accident and health insurance segment (NSIC). Due to Omega currently producing no direct written premium and the fact that Omega is a wholly owned subsidiary of NSFC authorized to underwrite similar lines of business, all references to NSFC in the remainder of this management discussion and analysis will include

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the insurance operations of both NSFC and Omega. Our income is principally derived from net underwriting profits and investment income. Net underwriting profit is principally derived from earned premiums received less claims paid, sales commissions to agents, costs of underwriting and insurance taxes and fees. Investment income includes interest and dividend income and gains and losses on investment holdings.

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

Consolidated Results of Operations:

For the three months ended March 31, 2016, net income for the Company totaled $941,000 or $0.37 per share, compared to net income of $1,308,000, $0.52 per share, for the three months ended March 31, 2015. Net income declined $367,000 due to an increase in frequency of storm related losses in our P&C segment. We incurred losses from severe thunderstorms, hail and isolated tornadoes totaling $2,882,000 in the first quarter of 2016 compared to $1,304,000 in the first quarter of 2015, an increase of $1,578,000. Partially offsetting the increase in P&C segment storm losses was a decline in fire losses of $291,000 and a $459,000 increase in net insurance premiums earned.

Pretax income from operations in the first quarter of 2016 totaled $1,294,000 compared to $1,644,000 in the first quarter of 2015. Pretax income from operations declined only $350,000 in the first three months of 2016 compared to the same period in 2015 despite the quarterly increase in storm related claims.

Financial results for the three months ended March 31, 2016 and 2015 were as follows:



Unaudited Consolidated Financial Summary	Three months ended March 31,
(dollars in thousands)	2016			2015
Gross premiums written	$	16,964		$	16,540
Net premiums written	$	15,937		$	15,034

Net premiums earned	$	15,165		$	14,706
Net investment income	991			1,002
Net realized investment gains	7			142
Other income	154			158
Total Revenues	16,317			16,008
Policyholder benefits and settlement expenses	9,047			8,262
Amortization of deferred policy acquisition costs	787			899
Commissions	2,108			2,055
General and administrative expenses	2,129			2,031
Taxes, licenses and fees	600			655
Interest expense	345			320
Total Benefits, Losses and Expenses	15,016			14,222
Income Before Income Taxes	1,301			1,786
Income tax expense	360			478
Net Income	$	941		$	1,308
Income Per Common Share	$	0.37		$	0.52
Reconciliation of Net Income to non-GAAP Measurement
Net income	$	941		$	1,308
Income tax expense	360			478
Realized investment gains, net	(7		)	(142		)
Pretax Income From Operations	$	1,294		$	1,644

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Premium Revenue:

For the quarter ended March 31, 2016, net premiums earned totaled $15,165,000 compared to $14,706,000 in the first quarter of 2015; an increase of 3.1%. The primary reason for the increase was a moderate decline in catastrophe reinsurance ceded premium coupled with a 2.6% increases in direct written premium. The P&C segment was the primary contributor to the increase with gross earned premium revenue up 3.1% in the first quarter of 2016 compared to last year.

Net Income:

For the three months ended March 31, 2016, the Company had net income of $941,000, $0.37 per share, compared to net income of $1,308,000, $0.52 per share, for the same period in 2015, a decrease of $367,000. As discussed above, an increase in storm losses was the primary factor contributing to the decline in net income.

Pretax income from operations:

For the quarter ended March 31, 2016, pretax income from operations was $1,294,000 compared to $1,644,000 for the quarter ended March 31, 2015, a decrease of $350,000. Losses from storm related catastrophe events totaled $1,447,000 in the first quarter of 2016 compared to only $511,000 last year. In addition, non-cat wind and hail losses totaled $1,435,000 in the first quarter of 2016 compared to $793,000 in 2015. The single largest catastrophe event was a February severe thunderstorm event that heavily impacted Louisiana along with several other Gulf coast states and generated $998,000 in storm losses. In total, catastrophe losses increased policyholder benefits and settlement expenses by $1,447,000 in the first three months of 2016. The P&C segment ended the first quarter of 2016 with a combined ratio of 92.1% with catastrophe losses contributing 10.6 percentage points to the combined ratio. In comparison, first quarter 2015 cat events added only $511,000 to prior year policyholder benefits and settlement expenses. The P&C segment ended the first quarter of 2015 with a combined ratio of 87.7% with catastrophe losses contributing 3.9 percentage points to the combined ratio. Offsetting the negative impact of the cat events was a $227,000 decrease in catastrophe reinsurance cost coupled with a 3.1% increase in P&C segment gross earned premiums.

Balance Sheet highlights at March 31, 2016 compared to December 31, 2015



Selected Balance Sheet Highlights	March 31, 2016		December 31, 2015
(dollars in thousands)	(UNAUDITED)
Invested Assets	$	116,127	$	112,557
Cash	$	4,163	$	6,763
Total Assets	$	148,612	$	147,841
Policy Liabilities	$	76,416	$	77,043
Total Debt	$	17,959	$	17,957
Accumulated Other Comprehensive Income	$	1,581	$	525
Shareholders' Equity	$	46,767	$	44,883
Book Value Per Share	$	18.61	$	17.87

Invested Assets:

Invested assets as of March 31, 2016 were $116,127,000 up $3,570,000, or 3.2%, compared to December 31, 2015. The increase in invested assets was primarily driven by $1,987,000 in new investments with the remainder of the increase consisting of increases in market value of primarily fixed income investments.

Cash:

The Company, primarily through its insurance subsidiaries, had $4,163,000 in cash and cash equivalents at March 31, 2016, compared to $6,763,000 at December 31, 2015. The decrease in cash was primarily due to an increase in investment in fixed income securities.

Total Assets:

Total assets as of March 31, 2016 were $148,612,000 compared to $147,841,000 at December 31, 2015. The increase in total assets was primarily due to increase in market values of stock and bond values in subsidiary investment portfolios.

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Policy Liabilities:

Policy liabilities were $76,416,000 at March 31, 2016 compared to $77,043,000 at December 31, 2015; a decrease of $627,000. The decrease in policy liabilities was primarily due to a reduction in outstanding claims in the P&C segment.

Debt Outstanding:

Total debt was virtually unchanged at March 31, 2016 at $17,959,000 compared to $17,957,000 at December 31, 2015.

Shareholders' Equity:

Shareholders' equity as of March 31, 2016 was $46,767,000 up $1,884,000 compared to December 31, 2015 Shareholders' equity of $44,883,000. Book value per share was $18.61 at March 31, 2016, compared to $17.87 per share at December 31, 2015, an increase of $0.74. The primary factors contributing to the increase in Shareholders' equity were net income of $941,000 coupled with an increase in accumulated other comprehensive income of $1,056,000. The increase in accumulated other comprehensive income was driven by increases in market values of available for sale investment securities primarily in our fixed income portfolio. Partially offsetting the increase in Shareholders' equity was dividends paid of $113,000.

Three Months Ended March 31, 2016 compared to Three Months Ended March 31, 2015

Premium revenue:

The table below provides earned premium revenue by segment for the three months ended March 31, 2016 and 2015:



	Three months ended March 31,						Percent
(dollars in thousands)	2016			2015			increase (decrease)
Life, accident and health operations premiums earned:
Traditional life insurance	$	1,173		$	1,178		(0.4	)%
Accident and health insurance	416			421			(1.2	)%
Gross life, accident and health	1,589			1,599			(0.6	)%
Reinsurance premium ceded	(25		)	(15		)	66.7	%
Net life, accident and health premiums earned	$	1,564		$	1,584		(1.3	)%

Property and Casualty operations premiums earned:
Dwelling fire & extended coverage	8,662			8,200			5.6	%
Homeowners (Including mobile homeowners)	5,906			5,948			(0.7	)%
Other liability	493			465			6.0	%
Gross property and casualty	15,061			14,613			3.1	%
Reinsurance premium ceded	(1,460		)	(1,491		)	(2.1	)%
Net property and casualty premiums earned	$	13,601		$	13,122		3.7	%

Consolidated gross premiums earned	$	16,650		$	16,212		2.7	%
Reinsurance premium ceded	(1,485		)	(1,506		)	(1.4	)%
Consolidated net premiums earned	$	15,165		$	14,706		3.1	%

Consolidated net premium earned was up 3.1% for the quarter ended March 31, 2016, at $15,165,000 compared to $14,706,000 for the quarter ended March 31, 2016. The growth in net premium earned was due to a 3.7% increase in net premium earned in the P&C segment which was driven by increases in direct premium. A 2.1% reduction in catastrophe reinsurance cost also contributed to the increase in net premium earned in the P&C segment. The reduction in catastrophe reinsurance cost was due to a catastrophe reinsurance rate reduction in our 2016 calendar year contract renewal.

The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. With our 2016 catastrophe contract placement, our catastrophe retention remained unchanged from last year at $4 million and, also unchanged from last year, we maintain catastrophe reinsurance covering incurred claims of a single catastrophe event up to $72.5 million. Our catastrophe reinsurance has a reinstatement provision for one event and covers the cost of a second event up to the same $72.5 million upper limit. In our reinsurance structure, management attempts to limit the impact on pretax earnings of a single modeled 100 year cat event to no more than $4 million. It

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is noted, however, that hurricane models are subject to significant risk and are only a tool to estimate the impact of catastrophe events. The Company also has risk associated with multiple smaller catastrophe events that individually may not exceed our $4 million retention and would not be covered under our catastrophe reinsurance contract.

Under the catastrophe reinsurance program in 2016, the Company retains the first $4,000,000 in losses from each event. Reinsurance coverage is maintained in three layers as follows:



Layer	Reinsurers' Limits of Liability
First Layer	100% of $13,500,000 in excess of $4,000,000 retention
Second Layer	100% of $25,000,000 in excess of $17,500,000
Third Layer	100% of $30,000,000 in excess of $42,500,000

Investment income:

For the three months ended March 31, 2016, net investment income was $991,000 compared to $1,002,000 for the same period in 2015; a moderate decrease of $11,000.

Realized investment gains and losses:

For the three months ended March 31, 2016, the Company had net realized capital gains totaling $7,000 compared to $142,000 for the same period in 2015. The $135,000 change was primarily associated with a $104,000 decrease in realized investment gains in the P&C segment compared to the same period in 2015. The realization of capital gains in the investment portfolio is influenced by both market conditions and liquidity requirements and therefore can vary significantly from quarter to quarter and year to year. Other activities, such as tax planning strategies, may also lead to significant variation in realized capital gains from year to year.

Other income:

Other income was comparable at $154,000 for the three months ended March 31, 2016, compared to $158,000 for the same period in 2015; a decrease of $4,000. Other income consists primarily of fees related to the issuance of our property insurance policies as well as other miscellaneous income.

Policyholder benefits:

Policyholder claims were $9,047,000 for the three months ended March 31, 2016, compared to $8,262,000 for the three months ended March 31, 2015; an increase of $785,000 or 9.5%. Claims as a percentage of premium earned was 59.7% in the first quarter of 2016 compared to 56.2% in the first quarter of 2015. An active spring storm season in the first quarter of 2016 lead to higher windstorm related claims which negatively impacted underwriting results in the current year.

The table below provides a recap of P&C segment gross reported losses and LAE by catastrophe event and non-catastrophe wind and hail losses and LAE for the three months ended March 31, 2016 and 2015 (dollars in thousands):



For the three months ended March 31, 2016				For the three months ended March 31, 2015
Cat event	Reported Losses & LAE		Claim Count	Cat event	Reported Losses & LAE		Claim Count
Cat 16 (Feb 22-24)	998		233	Cat 70 (Mar 25-26)	372		69
Cat 17 (Mar 5-11)	279		92
Misc cats less than $100k	170		60	Misc cats less than $100k	139		60
Total Cat losses	$	1,447	385	Total Cat losses	$	511	129

Non-cat wind & hail	$	1,435	486	Non-cat wind & hail	$	793	291

Non-catastrophe wind and hail claims reported in the first quarter of 2016 totaled $1,435,000 compared to non-catastrophe wind and hail claims reported in the first quarter of 2015 totaling $793,000; an increase of $642,000 or 81.0%. During the first three months of 2016, the P&C segment had 486 non-cat wind and hail claims reported (an average of $3,000 per claim) compared to 291 claims reported during the first three months of 2015 (an average of $3,000 per claim). Non-cat wind and hail claims reported during the first quarter of 2016 accounted for 18.3% of total P&C segment incurred losses and LAE in the current year. Non-cat wind and hail claims reported during the first quarter of 2015 accounted for 11.7% of total P&C segment incurred losses and LAE in 2015.

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During the first three months of 2016, the P&C segment was impacted by six catastrophe events totaling $1,447,000 from 385 claims compared to reported losses and LAE from four cat events totaling $511,000 from 129 claims in the first three months of 2015. The primary source of the significant increase in losses from cat events in the first quarter of 2016 was Cat 16. This cat event accounted for 69.0% of all losses reported from cat events during the first three months in 2016. Claims reported from first quarter 2016 cat events contributed 10.6 percentage points to the first quarter 2016 P&C segment loss ratio. In comparison, claims reported during the first quarter of 2015 from cat events contributed 3.9 percentage points to the first quarter 2015 P&C segment loss ratio.

While overall policyholder benefit payments were up in the property and casualty segment due to a higher frequency of wind related losses, fire losses reported in the first quarter of 2016 were down $291,000 or 6.7% compared to fire losses reported during the first quarter of 2015. The P&C segment had 129 fire losses reported in the first three months of 2016 totaling $4,031,000 compared to 166 claims reported in the first three months of 2015 totaling $4,322,000. The average cost per claim was $31,200 for fire losses reported in the first quarter of 2016 compared to $26,000 for fire losses reported in the first quarter of 2015. Many factors can impact the frequency and severity of fire losses, but the primary factor we observe is the duration of cold weather in our coverage areas. The first quarter of 2016 was unseasonably warm over much of our coverage area contributing to the decline in fire losses but also contributing to the increased frequency of windstorm related losses.

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

For the three months ended March 31, 2016, policy acquisition costs were $2,895,000 compared to $2,954,000 for the same period in 2015; a decrease of $59,000. Policy acquisition costs consist of amortization of previously capitalized distribution costs and current commission payments to agents. As a percentage of premium revenue, policy acquisition costs were 19.1% in the first quarter of 2016 compared to 20.1% for the same period in 2015.

General Expenses:

General and administrative expenses totaled $2,129,000 in the first quarter of 2016 compared to $2,031,000 in the first quarter of 2015; a 4.8% increase. The timing of an employee stock ownership plan contribution was the primary factor contributing to the $98,000 increase in general expenses.

Taxes, licenses and fees:

Insurance taxes, licenses and fees were $600,000 for the three months ended March 31, 2016, compared to $655,000 for the same period in 2015. As a percentage of net premiums earned, insurance taxes, licenses and fees were relatively unchanged at 4.0% for the three months ended March 31, 2016 compared to 4.5% for the three months ended March 31, 2015.

Interest expense:

Interest expense for the first quarter of 2016 was $345,000 compared to $320,000 for the same period in 2015. Interest expenses associated with a revolving line of credit was the primary factor contributing to the $25,000 increase.

Income taxes:

For the three month period ended March 31, 2016, the Company had pretax income of $1,301,000 compared to $1,786,000 for the same period in 2015. The $360,000 tax expense for the first quarter 2016 consisted of current tax expense of $221,000 and deferred tax expense $139,000 . Tax expense for the first quarter of 2015 consisted of current tax expense of $471,000 and deferred tax expense of $7,000. The effective tax rate for the three month period ended March 31, 2016 and 2015 was 27.7% and 26.7%, respectively.

Net income:

The Company ended the first quarter of 2016 with net income of $941,000 compared to net income of $1,308,000 for the same period in 2015. As discussed in detail above, the primary reason for the decline in first quarter 2016 earnings compared to first quarter 2015 was an increase in storm related losses.

Liquidity and capital resources:

Due to regulatory restrictions, the majority of the Company's cash is required to be invested in investment-grade securities to provide protection for policyholders. The liabilities of the property and casualty insurance subsidiaries are of various terms, and therefore, those subsidiaries invest in securities with various effective maturities spread over periods usually not exceeding five years. The liabilities of the life insurance subsidiary are typically of a longer duration, and therefore, a higher percentage of securities in the life insurance subsidiary are invested for periods exceeding 10 years.

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The liquidity requirements for the Company are primarily met by funds generated from operations of the life insurance and property/casualty insurance subsidiaries. All operations and virtually all investments are maintained by the insurance subsidiaries. Premium and investment income as well as maturities and sales of invested assets provide the primary sources of cash for both the life and property/casualty businesses, while applications of cash are applied by both businesses to the payment of policy benefits, the cost of acquiring new business (principally commissions), operating expenses, purchases of new investments, and in the case of life insurance, policy loans.

Virtually all invested assets of the Company are held in the insurance subsidiaries. As of March 31, 2016, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows (dollars in thousands):



Maturity	Available- for-Sale		Held-to-Maturity		Total		Percentage of Total
Maturity in less than 1 year	$	2,038	$	—	$	2,038	2.12	%
Maturity in 1-5 years	15,799		66		15,865		16.46	%
Maturity in 5-10 years	34,131		99		34,230		35.52	%
Maturity after 10 years	42,022		2,205		44,227		45.90	%
	$	93,990	$	2,370	$	96,360	100.00	%

It should be noted that the above table represents maturities based on stated/contractual maturity. Due to call and prepayment features inherent in some debt securities and principal pay-downs on mortgage backed securities, actual repayment, or effective maturities, will differ from stated maturities. The Company routinely evaluates the impact of changing interest rates on the projected maturities of bonds in the portfolio and actively manages the portfolio in order to minimize the impact of interest rate risk. However, due to other factors, both regulatory and those associated with good investment management practices associated with asset/liability matching, we do have exposure to changes in market values of securities due to changes in interest rates. Currently, a 100 basis point immediate increase in interest rates would generate approximately a $4,520,000, or 4.7%, decline in the market value of fixed income investments. Alternatively, a 100 basis point decrease in interest rates will generate approximately $4,569,000, or 4.8%, in increases in market value of fixed income investments. Management has attempted, to the extent possible, to reduce risk in a rising rate environment. However, due to asset liability matching requirements, particularly in the life subsidiary portfolio, interest rate risk can not be eliminated.

At March 31, 2016, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $46,767,000, up $1,884,000 compared to $44,883,000 at December 31, 2015. Components of the change in equity were net income of $941,000, increase in accumulated unrealized gains on investments of $1,158,000, a net unrealized loss of $102,000 related to interest rate swaps and cash dividends paid totaling $113,000.

As discussed above, changing interest rates can have a significant impact on the market value of fixed income securities. Fixed income securities classified as available-for-sale increase the liquidity resources of the Company as they can be sold at any time to pay claims or meet other Company obligations. However, these securities are required to be carried at market value with net of tax accumulated unrealized gains and losses directly impacting shareholder's equity.

While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 8.6% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.

The Company, primarily through its insurance subsidiaries, had $4,163,000 in cash and cash equivalents at March 31, 2016, compared to $7,108,000 at March 31, 2015. Cash used by operating activities decreased cash by $523,000 during the quarter ended March 31, 2016. The decrease in cash was primarily due to an increase in investments and negative cash flow from operations for the quarter primarily due to an increase in P&C segment claims. For the quarter ended March 31, 2015, cash provided by operating activities totaled $2,933,000. Operating cash flow generated in the property and casualty segment was the primary contributor to cash provided by operating activities in the prior year.

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Net cash used in investing activities totaled $1,987,000 for the period ended March 31, 2016, compared to $1,666,000 for the same period last year. The investment of cash held at December 31, 2015 and reinvestment of maturities of fixed income securities were the primary cash related investment activities during the three months ended March 31, 2016. For the period ended March 31, 2015, the investment of positive cash flow from operations was the primary contributor to cash used in investing activities of $1,666,000.

Net cash used in financing activities totaled $90,000 for the period ended March 31, 2016, compared to $585,000 for the same period last year. During the quarter ended March 31, 2015, the Company repaid a $500,000 long-term note. As of March 31, 2016, a total of $5,143,000 remained outstanding on the note associated with the Mobile Attic settlement with the next installment due in November of 2016. This installment is $857,000 and is included in short-term notes payable. The Company maintains a $1,000,000 operating line of credit which matures in September 2017, as well as a $700,000 line of credit which was renewed in February of 2016. Between the two lines of credit, $1,000,000 was available at March 31, 2016.

The Company had a total of $17,102,000 of long-term debt outstanding as of March 31, 2016, compared to $17,100,000 at December 31, 2015, which includes $12,372,000 in trust preferred securities issued by the Company in addition to the installment note. Current year and prior year amounts were reduced by the unamortized portion of the placement fees associated with the issuance of the trust preferred securities, $256,000 and $258,000, respectively.

The ability of the Company to meet its commitments for timely payment of claims and other expenses depends, in addition to current cash flow, on the liquidity of its investments. The Company has relatively little exposure to below investment grade fixed income investments, which might be especially subject to liquidity problems due to thinly traded markets.

The Company's liquidity requirements are primarily met by funds provided from operations of the insurance subsidiaries. The Company receives funds from its subsidiaries through payment of dividends, management fees, reimbursements for federal income taxes and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used to pay stockholder dividends, principal and interest on debt, corporate administrative expenses, federal income taxes, and for funding investments in the subsidiaries. The Company maintains minimal liquidity in order to maximize liquidity within the insurance subsidiaries in order to support ongoing insurance operations. The Company has no separate source of revenue other than dividends and fees from the insurance subsidiaries. Also, dividends from the insurance subsidiaries are subject to regulatory restrictions and, therefore, are limited depending on capital levels and earnings of the subsidiaries.

Our P&C segment is the primary source of dividends to the holding company. Due to a combination of growth opportunities and continued risk of capital exposure to weather related events, management is maintaining a conservative stance with regard to paying of dividends to the holding company. While we have made significant progress over the past three years, strengthening capital levels in the insurance subsidiaries and reduction of debt remains a priority.

Dividends paid from the insurance subsidiaries are subject to regulatory restrictions and prior approval of the Alabama Department of Insurance. As disclosed in Note 12 to the audited Consolidated Financial Statements included in our 2015 Annual Report on Form 10-K, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company during 2016 is statutorily limited to $1,510,000 in the life insurance subsidiary and $3,445,000 in the property/casualty insurance subsidiary. Dividends are limited to the greater of net income (operating income for life subsidiary) or 10% of statutory capital, and regulators consider dividends paid within the preceding twelve months when calculating the available dividend capacity. Therefore, all of the above referenced dividend capacity will not be available for consideration of payment until dividends paid in the preceding twelve months have been considered on a rolling basis. The Company also has to continuously evaluate other factors such as subsidiary operating performance, subsidiary capital requirements and potential impact by rating agencies in making decisions on how much capital can be released from insurance subsidiaries for payment of dividends to NSG. These factors are considered along with the goal of growing year over year statutory surplus in the subsidiaries, and these considerations along with previous adverse impacts on regulatory surplus, will likely lead to dividend payments to NSG substantially below the above referenced regulatory maximums. The Company received no dividends from its subsidiaries during the three months ended March 31, 2016.

The Company’s subsidiaries require cash in order to fund policy acquisition costs, claims, other policy benefits, interest expense, general expenses, and dividends to the Company. Premium and investment income, as well as maturities, calls, and sales of invested assets, provide the primary sources of cash for both subsidiaries. A significant portion of

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the Company’s investment portfolio, which is held by the insurance subsidiaries, consists of readily marketable securities, which can be sold for cash.

The Company continues to monitor liquidity and subsidiary capital closely. Improved underwriting results stemming from the discontinuation of unprofitable lines of business and streamlining of products offered combined with enhancements to the Company's rate development process and improvements in the Company's catastrophe reinsurance structure have reduced the pressure on subsidiary capital levels. However, due to modest levels of growth in premium revenue, it is still necessary to remain cautious and protect subsidiary capital.

Except as discussed above, the Company is unaware of any known trends, events, or uncertainties reasonably likely to have a material effect on its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under smaller reporting company rules we are not required to disclose information required under Item 3. However, in order to provide information to our investors, we have elected to provide information related to market risk.

The Company's primary objectives in managing its investment portfolio are to maximize investment income and total investment returns while minimizing overall credit risk. Investment strategies are developed based on many factors including changes in interest rates, overall market conditions, underwriting results, regulatory requirements and tax position. Investment decisions are made by management and reviewed by the Board of Directors. Market risk represents the potential for loss due to adverse changes in fair value of securities. The three potential risks related to the Company's fixed maturity portfolio are interest rate risk, prepayment risk and default risk. The primary risk related to the Company's equity portfolio is equity price risk.

Since the Company's assets and liabilities are largely monetary in nature, the Company's financial position and earnings are subject to risks resulting from changes in interest rates at varying maturities, changes in spreads over U.S. Treasuries on new investment opportunities and changes in the yield curve and equity pricing risks.

The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $5.1 million. Our portfolio has historically been highly correlated to the S&P 500 with regard to market risk. Based on an evaluation of the historical risk measure of our portfolio relative to the S&P 500, if the market value of the S&P 500 Index decreased 10% from its March 31, 2016 value, the fair value of the Company's common stock investments would decrease by approximately $510,000.

Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note 4 in the condensed consolidated financial statements present additional disclosures concerning fair values of Financial Assets and Financial Liabilities and are incorporated by reference herein.

The Company limits the extent of its market risk by purchasing securities that are backed by entities considered to be financially stable, the majority of the assets are issued by U.S. government sponsored entities or corporate entities with debt considered to be "investment grade". Also, the majority of all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higher-risk mortgage backed bonds. To reduce the risk of losing principal should prepayments exceed expectations, the Company generally does not purchase mortgage backed securities at significant premiums over par value.

The Company's investment approach in the equity markets is based primarily on a fundamental analysis of value. This approach requires the investment committee to invest in well managed, primarily dividend paying companies, which have a low debt to capital ratio, above average return on capital for a sustained period of time, and low volatility rating (beta) relative to the market. The dividends provide a steady cash flow to help pay current claim liabilities, and it has been the Company's experience that by following this investment strategy, long term investment results have been superior to those offered by bonds, while keeping the risk of loss of capital to a minimum relative to the overall equity market.

As for shifts in investment allocations, the Company has used improved cash flows from insurance operations to increase allocations to corporate and US Government bonds.

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Item 4. Controls and Procedures

Our management carried out an evaluation, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2016. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13A-15(d) under the Exchange Act that occurred during the three month period ended March 31, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

Please refer to Note 13 to the condensed consolidated financial statements included herein, and the 2015

Annual Report filed on Form 10-K.

Item 1A. Risk Factors

There has been no material change in risk factors previously disclosed under Item 1A. of the Company’s

Annual Report for 2015 on Form 10-K.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

a. Exhibits



31.1	Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

b. Reports on Form 8-K during the quarter ended March 31, 2016:



Date of Report	Date Filed	Description
January 22, 2016	January 25, 2016	Press release, dated January 25, 2016, issued by The National Security Group, Inc.
February 26, 2016	February 26, 2016	Press release, dated February 26, 2016, issued by The National Security Group, Inc.

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SIGNATURE

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

The National Security Group, Inc.



/s/ Brian R. McLeod		/s/ William L. Brunson, Jr.
Brian R. McLeod		William L. Brunson, Jr.
Chief Financial Officer and Treasurer		President, Chief Executive Officer and Director

Date: May 13, 2016