**UNITED      STATES**

**SECURITIES      AND EXCHANGE COMMISSION**

**WASHINGTON,      D.C. 20549**

**FORM      10-Q**

**Hallmark      Financial Services, Inc.**

| Nevada                                         |   | 87-0447375                         |
|------------------------------------------------|--------|------------------------------------|
| (State                or other jurisdiction of |   | (I.R.S.                Employer    |
| Incorporation                or organization)  |   | Identification                No.) |

| 777                Main Street, Suite 1000, Fort Worth, Texas |   | 76102                     |
|---------------------------------------------------------------|--------|---------------------------|
| (Address                of principal executive offices)       |   | (Zip                Code) |

| Large                accelerated filer  ̈ | Accelerated                filer  ̈    |
|-----------------------------------------------|--------------------------------------------|
| Non-accelerated                filer  ̈   | Smaller                reporting company x |

----

**PART      I**

**FINANCIAL      INFORMATION**

**Item      1.**
**Financial      Statements**

| **INDEX                TO FINANCIAL STATEMENTS**                                                                                                                                                                                                   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                               |   | Page                Number |
|                                                                                                                                                                                                                                               |   |   |
| Consolidated                Balance Sheets at September 30, 2008 (unaudited) and December 31,                2007                                                                                                                                  |   | 3 |
|                                                                                                                                                                                                                                               |   |   |
| Consolidated                Statements of Operations (unaudited) for the three months and nine                months                ended September 30, 2008 and September 30, 2007                                                                |   | 4 |
|                                                                                                                                                                                                                                               |   |   |
| Consolidated                Statements of Stockholders’ Equity and Comprehensive Income (Loss)                (unaudited) for the three months and nine months ended September                30, 2008                and September 30, 2007 |   | 5 |
|                                                                                                                                                                                                                                               |   |   |
| Consolidated                Statements of Cash Flows (unaudited) for the nine months ended September                30, 2008 and September 30, 2007                                                                                                |   | 6 |
|                                                                                                                                                                                                                                               |   |   |
| Notes                to Consolidated Financial Statements (unaudited)                                                                                                                                                                              |   | 7 |

----

**Hallmark      Financial Services, Inc. and Subsidiaries**

**Consolidated      Balance Sheets**

|                                                                                                                                                                |   | **September 30** |    | **December 31** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|---------|----------------------|--------|
|                                                                                                                                                                |   | **2008**              |    | **2007**             |   |
|                                                                                                                                                                |   | (unaudited)           |    |                 |   |
| ASSETS                                                                                                                                                              |   |                  |    |                 |   |   |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Investments:                                                                                                                                                        |   |                  |    |                 |   |   |   |
| Debt                securities, available-for-sale, at fair value                                                                                                   |   | $                     | 180,954 |                 | $      | 248,069 |   |
| Equity                securities, available-for-sale, at fair value                                                                                                 |   |                  | 41,568  |                 |   | 15,166 |   |
| Short-term                investments, available-for-sale, at fair value                                                                                            |   |                  | 112,965 |                 |   | 2,625 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Total                investments                                                                                                                                    |   |                  | 335,487 |                 |   | 265,860 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Cash                and cash equivalents                                                                                                                            |   |                  | 24,191  |                 |   | 145,884 |   |
| Restricted                cash and cash equivalents                                                                                                                 |   |                  | 8,963   |                 |   | 16,043 |   |
| Premiums                receivable                                                                                                                                  |   |                  | 47,052  |                 |   | 46,026 |   |
| Accounts                receivable                                                                                                                                  |   |                  | 5,243   |                 |   | 5,219 |   |
| Receivable                for securities                                                                                                                            |   |                  | -       |                 |   | 27,395 |   |
| Prepaid                reinsurance premiums                                                                                                                         |   |                  | 2,636   |                 |   | 942 |   |
| Reinsurance                recoverable                                                                                                                              |   |                  | 11,525  |                 |   | 4,952 |   |
| Deferred                policy acquisition costs                                                                                                                    |   |                  | 20,149  |                 |   | 19,757 |   |
| Excess                of cost over fair value of net assets acquired                                                                                                |   |                  | 37,738  |                 |   | 30,025 |   |
| Intangible                assets                                                                                                                                    |   |                  | 29,683  |                 |   | 23,781 |   |
| Current                federal income tax recoverable                                                                                                               |   |                  | 1,586   |                 |   | - |   |
| Deferred                federal income taxes                                                                                                                        |   |                  | 4,371   |                 |   | 275 |   |
| Prepaid                expenses                                                                                                                                     |   |                  | 941     |                 |   | 1,240 |   |
| Other                assets                                                                                                                                         |   |                  | 20,115  |                 |   | 19,583 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Total                assets                                                                                                                                         |   | $                     | 549,680 |                 | $      | 606,982 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| LIABILITIES                AND STOCKHOLDERS' EQUITY                                                                                                                 |   |                  |    |                 |   |   |   |
| Liabilities:                                                                                                                                                        |   |                  |    |                 |   |   |   |
| Notes                payable                                                                                                                                        |   | $                     | 61,760  |                 | $      | 60,814 |   |
| Structured                settlements                                                                                                                               |   |                  | -       |                 |   | 10,000 |   |
| Reserves                for unpaid losses and loss adjustment expenses                                                                                              |   |                  | 155,288 |                 |   | 125,338 |   |
| Unearned                premiums                                                                                                                                    |   |                  | 105,293 |                 |   | 102,998 |   |
| Unearned                revenue                                                                                                                                     |   |                  | 2,126   |                 |   | 2,949 |   |
| Accrued                agent profit sharing                                                                                                                         |   |                  | 1,935   |                 |   | 2,844 |   |
| Accrued                ceding commission payable                                                                                                                    |   |                  | 12,193  |                 |   | 12,099 |   |
| Pension                liability                                                                                                                                    |   |                  | 1,017   |                 |   | 1,669 |   |
| Current                federal income tax                                                                                                                           |   |                  | -       |                 |   | 864 |   |
| Payable                for securities                                                                                                                               |   |                  | 5,504   |                 |   | 91,401 |   |
| Accounts                payable and other accrued expenses                                                                                                          |   |                  | 14,439  |                 |   | 16,385 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Total                liabilities                                                                                                                                    |   |                  | 359,555 |                 |   | 427,361 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Commitments                and Contingencies (Note 17)                                                                                                              |   |                  |    |                 |   |   |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Redeemable                minority interest                                                                                                                         |   |                  | 619     |                 |   | - |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Stockholders'                equity:                                                                                                                                |   |                  |    |                 |   |   |   |
| Common                stock, $.18 par value (authorized 33,333,333 shares in 2008 and 2007;                issued 20,816,782 in 2008 and 20,776,080 shares in 2007) |   |                  | 3,747   |                 |   | 3,740 |   |
| Capital                in excess of par value                                                                                                                       |   |                  | 119,649 |                 |   | 118,459 |   |
| Retained                earnings                                                                                                                                    |   |                  | 74,649  |                 |   | 59,343 |   |
| Accumulated                other comprehensive loss                                                                                                                 |   |                  | (8,462  | )                    |   | (1,844 | ) |
| Treasury                stock, at cost (7,828 shares in 2008 and 2007)                                                                                              |   |                  | (77     | )                    |   | (77 | ) |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
| Total                stockholders' equity                                                                                                                           |   |                  | 189,506 |                 |   | 179,621 |   |
|                                                                                                                                                                |   |                  |    |                 |   |   |   |
|                                                                                                                                                                |   | $                     | 549,680 |                 | $      | 606,982 |   |

----

**Hallmark      Financial Services, Inc. and Subsidiaries**

**Consolidated      Statements of Operations**

|                                                                |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|---------------------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
|                                                                |   | **September 30**            |   | **September 30**           |   |
|                                                                |   | **2008**                         |   | **2007**                        |   | **2008** |   | **2007** |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |
| Gross                premiums written                               |   | $                                | 59,005 |                            | $      | 62,304 |   | $ | 186,357 |   | $ | 193,539 |   |
| Ceded                premiums written                               |   |                             | (2,493 | )                               |   | (441 | ) |   | (6,503 | ) |   | (8,609 | ) |
| Net                premiums written                                 |   |                             | 56,512 |                            |   | 61,863 |   |   | 179,854 |   |   | 184,930 |   |
| Change                in unearned premiums                          |   |                             | 2,416  |                            |   | (2,100 | ) |   | (1,918 | ) |   | (18,209 | ) |
| Net                premiums earned                                  |   |                             | 58,928 |                            |   | 59,763 |   |   | 177,936 |   |   | 166,721 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Investment                income, net of expenses                   |   |                             | 4,100  |                            |   | 3,774 |   |   | 11,682 |   |   | 9,811 |   |
| Net                realized gains (impairments and realized losses) |   |                             | (2,496 | )                               |   | 418 |   |   | (1,405 | ) |   | 1,299 |   |
| Finance                charges                                      |   |                             | 1,307  |                            |   | 1,206 |   |   | 3,894 |   |   | 3,477 |   |
| Commission                and fees                                  |   |                             | 3,127  |                            |   | 7,280 |   |   | 16,280 |   |   | 23,344 |   |
| Processing                and service fees                          |   |                             | 20     |                            |   | 111 |   |   | 98 |   |   | 586 |   |
| Other                income                                         |   |                             | 3      |                            |   | 4 |   |   | 9 |   |   | 12 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Total                revenues                                       |   |                             | 64,989 |                            |   | 72,556 |   |   | 208,494 |   |   | 205,250 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Losses                and loss adjustment expenses                  |   |                             | 38,981 |                            |   | 36,723 |   |   | 110,514 |   |   | 99,620 |   |
| Other                operating expenses                             |   |                             | 24,041 |                            |   | 24,087 |   |   | 71,114 |   |   | 70,511 |   |
| Interest                expense                                     |   |                             | 1,186  |                            |   | 1,026 |   |   | 3,557 |   |   | 2,608 |   |
| Amortization                of intangible assets                    |   |                             | 620    |                            |   | 573 |   |   | 1,766 |   |   | 1,719 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Total                expenses                                       |   |                             | 64,828 |                            |   | 62,409 |   |   | 186,951 |   |   | 174,458 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Income                before tax and minority interest              |   |                             | 161    |                            |   | 10,147 |   |   | 21,543 |   |   | 30,792 |   |
| Income                tax expense (benefit)                         |   |                             | (485   | )                               |   | 3,345 |   |   | 6,222 |   |   | 10,205 |   |
| Income                before minority interest                      |   |                             | 646    |                            |   | 6,802 |   |   | 15,321 |   |   | 20,587 |   |
| Minority                interest                                    |   |                             | 15     |                            |   | - |   |   | 15 |   |   | - |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Net                income                                           |   | $                                | 631    |                            | $      | 6,802 |   | $ | 15,306 |   | $ | 20,587 |   |
|                                                                |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Common                stockholders net income per share:            |   |                             |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                               |   | $                                | 0.03   |                            | $      | 0.33 |   | $ | 0.74 |   | $ | 0.99 |   |
| Diluted                                                             |   | $                                | 0.03   |                            | $      | 0.33 |   | $ | 0.73 |   | $ | 0.99 |   |

----

**Hallmark      Financial Services, Inc. and Subsidiaries**

**Consolidated      Statement of Stockholders' Equity and Comprehensive Income      (Loss)**

|                                                                         |   | **Three Months Ended** |    | **Nine Months Ended** |   |
|------------------------------------------------------------------------------|--------|----------------------------------|---------|---------------------------------|--------|
|                                                                         |   | **September 30,**           |    | **September 30,**          |   |
|                                                                         |   | **2008**                         |    | **2007**                        |   | **2008** |   | **2007** |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |
| **Common                Stock**                                              |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                beginning of period                                  |   | $                                | 3,747   |                            | $      | 3,740 |   | $ | 3,740 |   | $ | 3,740 |   |
| Issuance                of common stock upon option exercises                |   |                             | -       |                            |   | - |   |   | 7 |   |   | - |   |
| Balance,                end of period                                        |   |                             | 3,747   |                            |   | 3,740 |   |   | 3,747 |   |   | 3,740 |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| **Additional                Paid-In Capital**                                |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                beginning of period                                  |   |                             | 119,369 |                            |   | 118,085 |   |   | 118,459 |   |   | 117,932 |   |
| Accretion                of redeemable minority interest to redemption value |   |                             | (25     | )                               |   | - |   |   | (25 | ) |   | - |   |
| Equity                based compenstion                                      |   |                             | 305     |                            |   | 198 |   |   | 1,078 |   |   | 351 |   |
| Exercise                of stock options                                     |   |                             | -       |                            |   | - |   |   | 137 |   |   | - |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                end of period                                        |   |                             | 119,649 |                            |   | 118,283 |   |   | 119,649 |   |   | 118,283 |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| **Retained                Earnings**                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                beginning of period                                  |   |                             | 74,018  |                            |   | 45,265 |   |   | 59,343 |   |   | 31,480 |   |
| Net                income                                                    |   |                             | 631     |                            |   | 6,802 |   |   | 15,306 |   |   | 20,587 |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                end of period                                        |   |                             | 74,649  |                            |   | 52,067 |   |   | 74,649 |   |   | 52,067 |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| **Accumulated                Other Comprehensive Loss**                      |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                beginning of period                                  |   |                             | (4,756  | )                               |   | (2,746 | ) |   | (1,844 | ) |   | (2,344 | ) |
| Additional                minimun pension liability, net of tax              |   |                             | 10      |                            |   | 33 |   |   | 31 |   |   | 97 |   |
| Unrealized                gains (losses) on securities, net of tax           |   |                             | (3,716  | )                               |   | 1,006 |   |   | (6,649 | ) |   | 540 |   |
| Balance,                end of period                                        |   |                             | (8,462  | )                               |   | (1,707 | ) |   | (8,462 | ) |   | (1,707 | ) |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| **Treasury                Stock**                                            |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                beginning of period                                  |   |                             | (77     | )                               |   | (77 | ) |   | (77 | ) |   | (77 | ) |
| Acquisition                of treasury shares                                |   |                             | -       |                            |   | - |   |   | - |   |   | - |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Balance,                end of period                                        |   |                             | (77     | )                               |   | (77 | ) |   | (77 | ) |   | (77 | ) |
|                                                                         |   |                             |         |                            |   |  |   |   |   |   |   |   |   |
| **Stockholders'                Equity**                                      |   | $                                | 189,506 |                            | $      | 172,306 |   | $ | 189,506 |   | $ | 172,306 |   |
|                                                                         |   |                             |    |                            |   |   |   |   |   |   |   |   |   |
| Net                income                                                    |   | $                                | 631     |                            | $      | 6,802 |   | $ | 15,306 |   | $ | 20,587 |   |
| Additional                minimum pension liablilty, net of tax              |   |                             | 10      |                            |   | 33 |   |   | 31 |   |   | 97 |   |
| Unrealized                gains (losses) on securities, net of tax           |   |                             | (3,716  | )                               |   | 1,006 |   |   | (6,649 | ) |   | 540 |   |
| **Comprehensive                Income (Loss)**                               |   | $                                | (3,075  | )                               | $      | 7,841 |   | $ | 8,688 |   | $ | 21,224 |   |

----

**Hallmark      Financial Services, Inc. and Subsidiaries**

**Consolidated      Statement of Cash Flows**

|                                                                                                                                                       |   | **Nine Months Ended** |     |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|----------|
|                                                                                                                                                       |   | **September 30**           |     |
|                                                                                                                                                       |   | **2008**                        |     | **2007** |   |
| Cash                flows from operating activities:                                                                                                       |   |                            |     |   |   |   |   |
| Net                income                                                                                                                                  |   | $                               | 15,306   |   | $ | 20,587 |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Adjustments                to reconcile net income to cash provided by operating                activites:                                                 |   |                            |     |   |   |   |   |
| Depreciation                and amortization expense                                                                                                       |   |                            | 2,311    |   |   | 2,344 |   |
| Minority                interest                                                                                                                           |   |                            | 15       |   |   | - |   |
| Amortization                of discount on structured settlement                                                                                           |   |                            | -        |   |   | 310 |   |
| Deferred                federal income tax benefit                                                                                                         |   |                            | (1,849   | ) |   | (1,170 | ) |
| Realized                (gain) loss on investments and impairment losses                                                                                   |   |                            | 1,405    |   |   | (1,299 | ) |
| Change                in prepaid reinsurance premiums                                                                                                      |   |                            | (1,694   | ) |   | 137 |   |
| Change                in prepaid commissions                                                                                                               |   |                            | -        |   |   | 487 |   |
| Change                in premiums receivable                                                                                                               |   |                            | (1,026   | ) |   | (8,492 | ) |
| Change                in accounts receivable                                                                                                               |   |                            | (24      | ) |   | 1,604 |   |
| Change                in deferred policy acquisition costs                                                                                                 |   |                            | (392     | ) |   | (3,631 | ) |
| Change                in unpaid losses and loss adjustment expenses                                                                                        |   |                            | 29,950   |   |   | 38,572 |   |
| Change                in unearned premiums                                                                                                                 |   |                            | 2,295    |   |   | 16,759 |   |
| Change                in unearned revenue                                                                                                                  |   |                            | (823     | ) |   | (2,378 | ) |
| Change                in accrued agent profit sharing                                                                                                      |   |                            | (909     | ) |   | 206 |   |
| Change                in reinsurance recoverable                                                                                                           |   |                            | (6,573   | ) |   | 149 |   |
| Change                in reinsurance payable                                                                                                               |   |                            | -        |   |   | (1,060 | ) |
| Change                in current federal income tax payable                                                                                                |   |                            | (2,451   | ) |   | (1,678 | ) |
| Change                in accrued ceding commission payable                                                                                                 |   |                            | 94       |   |   | 3,096 |   |
| Change                in all other liabilities                                                                                                             |   |                            | (2,599   | ) |   | 3,059 |   |
| Change                in all other assets                                                                                                                  |   |                            | 4,122    |   |   | (5,835 | ) |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Net                cash provided by operating activities                                                                                                   |   |                            | 37,158   |   |   | 61,767 |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Cash                flows from investing activities:                                                                                                       |   |                            |     |   |   |   |   |
| Purchases                of property and equipment                                                                                                         |   |                            | (477     | ) |   | (367 | ) |
| Acquisition                of subsidiaries, net of cash acquired                                                                                           |   |                            | (14,799  | ) |   | - |   |
| Change                in restricted cash                                                                                                                   |   |                            | 7,080    |   |   | 12,244 |   |
| Purchases                of debt and equity securities                                                                                                     |   |                            | (258,465 | ) |   | (187,256 | ) |
| Maturities                and redemptions of investment securities                                                                                         |   |                            | 227,061  |   |   | 115,288 |   |
| Net                purchases of short-term investments                                                                                                     |   |                            | (110,340 | ) |   | (30,713 | ) |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Net                cash (used in) investing activities                                                                                                     |   |                            | (149,940 | ) |   | (90,804 | ) |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Cash                flows from financing activities:                                                                                                       |   |                            |     |   |   |   |   |
| Proceeds                from exercise of employee stock options                                                                                            |   |                            | 143      |   |   | - |   |
| Net                borrowings (repayment) of notes payable                                                                                                 |   |                            | 946      |   |   | (856 | ) |
| Payment                of structured settlement                                                                                                            |   |                            | (10,000  | ) |   | (15,000 | ) |
| Proceeds                from issuance of trust preferred securities                                                                                        |   |                            | -        |   |   | 25,774 |   |
| Debt                issuance costs                                                                                                                         |   |                            | -        |   |   | (674 | ) |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Net                cash (used in) provided by financing activities                                                                                         |   |                            | (8,911   | ) |   | 9,244 |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Decrease                in cash and cash equivalents                                                                                                       |   |                            | (121,693 | ) |   | (19,793 | ) |
| Cash                and cash equivalents at beginning of period                                                                                            |   |                            | 145,884  |   |   | 81,474 |   |
| Cash                and cash equivalents at end of period                                                                                                  |   | $                               | 24,191   |   | $ | 61,681 |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Supplemental                Cash Flow Information:                                                                                                         |   |                            |     |   |   |   |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Interest                paid                                                                                                                               |   | $                               | 3,576    |   | $ | 2,184 |   |
| Taxes                paid                                                                                                                                  |   | $                               | 10,521   |   | $ | 13,053 |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Supplemental                schedule of non-cash investing activities:                                                                                     |   |                            |     |   |   |   |   |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Change                in receivable for securities related to investment disposals that                settled                after the balance sheet date |   | $                               | 27,395   |   | $ | (14 | ) |
|                                                                                                                                                       |   |                            |     |   |   |   |   |
| Change                in payable for securities related to investment purchases that settled                after the balance sheet date                   |   | $                               | (85,897  | ) | $ | 8,878 |   |

----

**Hallmark      Financial Services, Inc. and Subsidiaries**

**Notes      to Consolidated Financial Statements (Unaudited)**

**1.      General**

**2.      Basis of Presentation**

----

***Redeemable***
** **
***minority      interest***

***Reclassification***

***Immaterial      Correction of an Error***

----

|                                                     |   | For the Three Months Ended |   |
|----------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                     |   | September 30,                             |   | December 31, |   | March 31, |   | June 30, |   |
|                                                     |   | 2007                                           |   | 2007 |   | 2008 |   | 2008 |   |
| As                previously reported:                   |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Ceded                premiums written                    |   | $                                              | (779   | ) | $ | (2,382 | ) | $ | (2,332 | ) | $ | (2,327 | ) |
| Net                premiums written                      |   |                                           | 61,525 |   |   | 53,551 |   |   | 61,905 |   |   | 60,788 |   |
| Net                premiums earned                       |   |                                           | 59,425 |   |   | 58,920 |   |   | 58,916 |   |   | 59,443 |   |
| Total                revenues                            |   |                                           | 72,218 |   |   | 69,586 |   |   | 71,193 |   |   | 71,663 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Income                before tax                         |   |                                           | 9,809  |   |   | 10,647 |   |   | 10,466 |   |   | 10,267 |   |
| Income                tax expense                        |   |                                           | 3,227  |   |   | 3,585 |   |   | 3,414 |   |   | 3,066 |   |
| Net                income                                |   | $                                              | 6,582  |   | $ | 7,062 |   | $ | 7,052 |   | $ | 7,201 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Common                stockholders net income per share: |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                    |   | $                                              | 0.32   |   | $ | 0.34 |   | $ | 0.34 |   | $ | 0.35 |   |
| Diluted                                                  |   | $                                              | 0.32   |   | $ | 0.34 |   | $ | 0.34 |   | $ | 0.34 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Adjustments:                                             |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Ceded                premiums written                    |   | $                                              | 338    |   | $ | 330 |   | $ | 328 |   | $ | 321 |   |
| Income                tax expense                        |   |                                           | 118    |   |   | 116 |   |   | 115 |   |   | 112 |   |
| Net                income impact                         |   | $                                              | 220    |   | $ | 214 |   | $ | 213 |   | $ | 209 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| As                revised:                               |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Ceded                premiums written                    |   | $                                              | (441   | ) | $ | (2,052 | ) | $ | (2,004 | ) | $ | (2,006 | ) |
| Net                premiums written                      |   |                                           | 61,863 |   |   | 53,881 |   |   | 62,233 |   |   | 61,109 |   |
| Net                premiums earned                       |   |                                           | 59,763 |   |   | 59,250 |   |   | 59,244 |   |   | 59,764 |   |
| Total                revenues                            |   |                                           | 72,556 |   |   | 69,916 |   |   | 71,521 |   |   | 71,984 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Income                before tax                         |   |                                           | 10,147 |   |   | 10,977 |   |   | 10,794 |   |   | 10,588 |   |
| Income                tax expense                        |   |                                           | 3,345  |   |   | 3,701 |   |   | 3,529 |   |   | 3,178 |   |
| Net                income                                |   | $                                              | 6,802  |   | $ | 7,276 |   | $ | 7,265 |   | $ | 7,410 |   |
|                                                     |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Common                stockholders net income per share: |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                    |   | $                                              | 0.33   |   | $ | 0.35 |   | $ | 0.35 |   | $ | 0.36 |   |
| Diluted                                                  |   | $                                              | 0.33   |   | $ | 0.35 |   | $ | 0.35 |   | $ | 0.35 |   |

----

|                                                     |   | For the Nine |    | For the Year |   | For the Six   |   |
|----------------------------------------------------------|--------|------------------------|---------|------------------------|--------|-------------------------|--------|
|                                                     |   | Months Ended      |    | Ended                  |   | Months Ended       |   |
|                                                     |   | September 30,     |    | December 31,      |   | June                30, |   |
|                                                     |   | 2007                   |    | 2007                   |   | 2008                    |   |
| As                previously reported:                   |   |                   |    |                   |   |                    |   |   |   |   |
| Ceded                premiums written                    |   | $                      | (8,947  | )                      | $      | (11,329                 | )      | $ | (4,659 | ) |
| Net                premiums written                      |   |                   | 184,592 |                   |   | 238,143                 |   |   | 122,693 |   |
| Net                premiums earned                       |   |                   | 166,383 |                   |   | 225,303                 |   |   | 118,359 |   |
| Total                revenues                            |   |                   | 204,912 |                   |   | 274,498                 |   |   | 142,856 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| Income                before tax                         |   |                   | 30,454  |                   |   | 41,101                  |   |   | 20,733 |   |
| Income                tax expense                        |   |                   | 10,087  |                   |   | 13,672                  |   |   | 6,480 |   |
| Net                income                                |   | $                      | 20,367  |                   | $      | 27,429                  |   | $ | 14,253 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| Common                stockholders net income per share: |   |                   |    |                   |   |                    |   |   |   |   |
| Basic                                                    |   | $                      | 0.98    |                   | $      | 1.32                    |   | $ | 0.69 |   |
| Diluted                                                  |   | $                      | 0.98    |                   | $      | 1.32                    |   | $ | 0.68 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| Adjustments:                                             |   |                   |    |                   |   |                    |   |   |   |   |
| Ceded                premiums written                    |   | $                      | 338     |                   | $      | 668                     |   | $ | 649 |   |
| Income                tax expense                        |   |                   | 118     |                   |   | 234                     |   |   | 227 |   |
| Net                income impact                         |   | $                      | 220     |                   | $      | 434                     |   | $ | 422 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| As                revised:                               |   |                   |    |                   |   |                    |   |   |   |   |
| Ceded                premiums written                    |   | $                      | (8,609  | )                      | $      | (10,661                 | )      | $ | (4,010 | ) |
| Net                premiums written                      |   |                   | 184,930 |                   |   | 238,811                 |   |   | 123,342 |   |
| Net                premiums earned                       |   |                   | 166,721 |                   |   | 225,971                 |   |   | 119,008 |   |
| Total                revenues                            |   |                   | 205,250 |                   |   | 275,166                 |   |   | 143,505 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| Income                before tax                         |   |                   | 30,792  |                   |   | 41,769                  |   |   | 21,382 |   |
| Income                tax expense                        |   |                   | 10,205  |                   |   | 13,906                  |   |   | 6,707 |   |
| Net                income                                |   | $                      | 20,587  |                   | $      | 27,863                  |   | $ | 14,675 |   |
|                                                     |   |                   |    |                   |   |                    |   |   |   |   |
| Common                stockholders net income per share: |   |                   |    |                   |   |                    |   |   |   |   |
| Basic                                                    |   | $                      | 0.99    |                   | $      | 1.34                    |   | $ | 0.71 |   |
| Diluted                                                  |   | $                      | 0.99    |                   | $      | 1.34                    |   | $ | 0.70 |   |

|                                              |   | As previously |    |       |   |            |   |
|---------------------------------------------------|--------|--------------------|---------|------------|--------|-----------------|--------|
|                                              |   | reported           |    | Adjustment |   | As revised |   |
| Balances                as of December 31, 2007   |   |               |    |       |   |            |   |   |   |   |
| Prepaid                reinsurance premiums       |   | $                  | 274     |       | $      | 668             |   | $ | 942 |   |
| Total                assets                       |   |               | 606,314 |       |   | 668             |   |   | 606,982 |   |
| Current                federal income tax payable |   |               | 630     |       |   | 234             |   |   | 864 |   |
| Total                liabilities                  |   |               | 427,127 |       |   | 234             |   |   | 427,361 |   |
| Retained                earnings                  |   |               | 58,909  |       |   | 434             |   |   | 59,343 |   |
| Total                stockholders' equity         |   |               | 179,187 |       |   | 434             |   |   | 179,621 |   |

----

|                                                        |   | For the Nine |   | For the Year |   | For the Three |   | For the Six |   |
|-------------------------------------------------------------|--------|------------------------|--------|------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                        |   | Months Ended      |   | Ended                  |   | Months Ended       |   | Months Ended     |   |
|                                                        |   | September 30,     |   | December 31,      |   | March 31,     |   | June 30,         |   |
|                                                        |   | 2007                   |   | 2007                   |   | 2008                    |   | 2008                  |   |
| As                previously reported:                      |   |                   |   |                   |   |                    |   |                  |   |   |   |   |   |
| Net                income                                   |   | $                      | 20,367 |                   | $      | 27,429                  |   | $                     | 7,052  |   | $ | 14,253 |   |
| Change                in prepaid reinsurance premiums       |   |                   | 475    |                   |   | 1,355                   |   |                  | (1,923 | ) |   | (408 | ) |
| Change                in current federal income tax payable |   |                   | (1,796 | )                      |   | (1,502                  | )      |                  | 2,788  |   |   | (1,354 | ) |
| Net                cash provided by operating activities    |   |                   | 61,767 |                   |   | 80,337                  |   |                  | 12,388 |   |   | 29,749 |   |
|                                                        |   |                   |   |                   |   |                    |   |                  |   |   |   |   |   |
| Adjustments:                                                |   |                   |   |                   |   |                    |   |                  |   |   |   |   |   |
| Net                income                                   |   | $                      | 220    |                   | $      | 434                     |   | $                     | 213    |   | $ | 422 |   |
| Change                in prepaid reinsurance premiums       |   |                   | (338   | )                      |   | (668                    | )      |                  | (328   | ) |   | (649 | ) |
| Change                in current federal income tax payable |   |                   | 118    |                   |   | 234                     |   |                  | 115    |   |   | 227 |   |
| Net                cash provided by operating activities    |   |                   | -      |                   |   | -                       |   |                  | -      |   |   | - |   |
|                                                        |   |                   |   |                   |   |                    |   |                  |   |   |   |   |   |
| As                revised:                                  |   |                   |   |                   |   |                    |   |                  |   |   |   |   |   |
| Net                income                                   |   | $                      | 20,587 |                   | $      | 27,863                  |   | $                     | 7,265  |   | $ | 14,675 |   |
| Change                in prepaid reinsurance premiums       |   |                   | 137    |                   |   | 687                     |   |                  | (2,251 | ) |   | (1,057 | ) |
| Change                in current federal income tax payable |   |                   | (1,678 | )                      |   | (1,268                  | )      |                  | 2,903  |   |   | (1,127 | ) |
| Net                cash provided by operating activities    |   |                   | 61,767 |                   |   | 80,337                  |   |                  | 12,388 |   |   | 29,749 |   |

***Use      of Estimates in the Preparation of the Financial      Statements***

***Recently      Issued Accounting Standards***

----

----

**3.      Business Combinations**

| Tradename                            |   | $ | 757   |   |   | 15                years |   |
|--------------------------------------|--------|---|-------|--------|--------|-------------------------|--------|
| Non-compete                agreement |   | $ | 526   |   |   | 6                years  |   |
| Agency                relationships  |   | $ | 6,385 |   |   | 15                years |   |

**4.      Supplemental Cash Flow Information**

----

| Fair                value of tangible assets excluding cash and cash                equivalents |   | $      | (3     | )      |
|-------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Fair                value of intangible assets acquired                                         |   |   | 15,381 |   |
| Redeemable                minority interest assumed                                             |   |   | (579   | )      |
| Cash                and cash equivalents used in acquisitions,                                  |   |   |   |   |
| net                of $201 thousand cash and cash equivalents acquired                          |   | $      | 14,799 |   |

**5.      Fair Value**

|   | · | Level                1: quoted prices in active markets for identical assets; |
|--------|--------|-------------------------------------------------------------------------------|

|   | · | Level                2: inputs to the valuation methodology include quoted prices for                similar                assets and liabilities in active markets, inputs of identical assets                for                less active markets, and inputs that are observable for the asset                or                liability, either directly or indirectly, for substantially the full                term                of the instrument; and |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Level                3: inputs to the valuation methodology that are unobservable for                the asset                or liability. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|

----

        The      following table presents for each of the fair value hierarchy levels, our assets      that are measured at fair value on a recurring basis at September 30, 2008      (in      thousands).

|                                  |   | Quoted Prices in   |   | Other          |   |           |   |   |   |
|---------------------------------------|--------|------------------------------|--------|----------------|--------|----------------|--------|--------|--------|
|                                  |   | Active Markets for |   | Observable     |   | Unobservable   |   |   |   |
|                                  |   | Identical Assets        |   | Inputs         |   | Inputs         |   |   |   |
|                                  |   | (Level 1)               |   | (Level 2) |   | (Level 3) |   | Total  |   |
|                                  |   |                         |   |           |   |           |   |   |   |
| Debt                securities        |   | $                            | -      |           | $      | 180,954        |   | $      | -      |   | $ | 180,954 |   |
| Equity                securities      |   |                         | 41,568 |           |   | -              |   |   | -      |   |   | 41,568 |   |
| Short-term                investments |   |                         | 335    |           |   | 112,630        |   |   | -      |   |   | 112,965 |   |
| Total                                 |   | $                            | 41,903 |           | $      | 293,584        |   | $      | -      |   | $ | 335,487 |   |

| Beginning                balance as of January 1, 2008                         |   | $      | 4,000  |   |
|--------------------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                           |   |   |   |   |
| Purchases,                issuances, sales and settlements                     |   |   | (4,000 | )      |
| Total                realized/unrealized gains/(losses) included in net income |   |   | -      |   |
| Net                gains/(losses) included on other comprehensive income       |   |   | -      |   |
| Transfers                in and/or out of Level 3                              |   |   | -      |   |
|                                                                           |   |   |   |   |
| Ending                balance as of September 30, 2008                         |   | $      | -      |   |

----

**6.      Investments**

|                                     |   | As of September 30, 2008 |    |
|------------------------------------------|--------|----------------------------------------------|---------|
|                                     |   | Less than 12 months           |    | 12 months or longer |   | Total |   |
|                                     |   |                                         |    | Unrealized |   |   |   | Unrealized |   |   |   | Unrealized |   |
|                                     |   | Fair Value                              |    | Losses |   | Fair Value |   | Losses |   | Fair Value |   | Losses |   |
|                                     |   |                                         |    |   |   |   |   |   |   |   |   |   |   |
| Corporate                debt securities |   | $                                            | 25,169  |   | $ | (1,063 | ) | $ | 16,860 |   | $ | (2,778 | ) | $ | 42,029 |   | $ | (3,841 | ) |
| Municipal                bonds           |   |                                         | 79,655  |   |   | (3,216 | ) |   | 7,488 |   |   | (232 | ) |   | 87,143 |   |   | (3,448 | ) |
| Equity                securities         |   |                                         | 29,181  |   |   | (3,976 | ) |   | - |   |   | - |   |   | 29,181 |   |   | (3,976 | ) |
| Short                term securities     |   |                                         | 354     |   |   | - |   |   | - |   |   | - |   |   | 354 |   |   | - |   |
| Total                                    |   | $                                            | 134,359 |   | $ | (8,255 | ) | $ | 24,348 |   | $ | (3,010 | ) | $ | 158,707 |   | $ | (11,265 | ) |

|                                     |   | As of December 31, 2007 |   |
|------------------------------------------|--------|---------------------------------------------|--------|
|                                     |   | Less than 12 months          |   | 12 months or longer |   | Total |   |
|                                     |   |                                        |   | Unrealized |   |   |   | Unrealized |   |   |   | Unrealized |   |
|                                     |   | Fair Value                             |   | Losses |   | Fair Value |   | Losses |   | Fair Value |   | Losses |   |
|                                     |   |                                        |   |   |   |   |   |   |   |   |   |   |   |
| Corporate                debt securities |   | $                                           | 19,021 |   | $ | (840 | ) | $ | 18,329 |   | $ | (896 | ) | $ | 37,350 |   | $ | (1,736 | ) |
| Municipal                bonds           |   |                                        | 24,392 |   |   | (122 | ) |   | 7,780 |   |   | (130 | ) |   | 32,172 |   |   | (252 | ) |
| Equity                securities         |   |                                        | 6,954  |   |   | (318 | ) |   | - |   |   | - |   |   | 6,954 |   |   | (318 | ) |
| Short                term securities     |   |                                        | 352    |   |   | (1 | ) |   | - |   |   | - |   |   | 352 |   |   | (1 | ) |
| Total                                    |   | $                                           | 50,719 |   | $ | (1,281 | ) | $ | 26,109 |   | $ | (1,026 | ) | $ | 76,828 |   | $ | (2,307 | ) |

----

**7.      Pledged Investments**

**8.      Share-Based Payment Arrangements**

----

|                                             |   |           |      | Average  |   | Contractual |   | Intrinsic |   |
|--------------------------------------------------|--------|----------------|-----------|----------|--------|-------------|--------|-----------|--------|
|                                             |   | Number of |      | Exercise |   | Term        |   | Value     |   |
|                                             |   | Shares         |      | Price    |   | (Years)     |   | ($000)    |   |
|                                             |   |           |      |     |   |        |   |      |   |
| Outstanding                at January 1, 2008    |   |           | 848,000   |     | $      | 10.41       |   |      |   |   |   |   |   |
| Granted                                          |   |           | 270,000   |     | $      | 11.46       |   |      |   |   |   |   |   |
| Exercised                                        |   |           | (40,702   | )        | $      | 3.54        |   |      |   |   |   |   |   |
| Forfeited                or expired              |   |           | -         |     | $      | -           |   |      |   |   |   |   |   |
| Outstanding                at September 30, 2008 |   |           | 1,077,298 |     | $      | 10.93       |   |      | 8.0    |   | $ | 682 |   |
| Exercisable                at September 30, 2008 |   |           | 263,549   |     | $      | 8.19        |   |      | 5.5    |   | $ | 614 |   |

|                                                                           |   | Three Months Ended |   | Nine Months Ended |   |
|--------------------------------------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                                                           |   | September 30,           |   | September 30,          |   |
|                                                                           |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
|                                                                           |   |                         |   |                        |   |   |   |   |   |
| Intrinsic                value of options exercised                            |   | $                            | -      |                        | $      | - |   | $ | 337 |   | $ | - |   |
|                                                                           |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Cost                of share-based payments (non-cash)                         |   | $                            | 305    |                        | $      | 198 |   | $ | 1,078 |   | $ | 351 |   |
|                                                                           |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Income                tax benefit of share-based payments recognized in income |   | $                            | 107    |                        | $      | 69 |   | $ | 377 |   | $ | 123 |   |

----

|                                           |   | Three Months Ended |   | Nine Months Ended |   |
|------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                           |   | September 30,           |   | September 30,          |   |
|                                           |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
|                                           |   |                         |   |                        |   |   |   |   |   |
| Grant                date fair value per share |   |                         | n/a    |                        | $      | 4.14 |   | $ | 4.74 |   | $ | 4.04 |   |
|                                           |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Expected                term (in years)        |   |                         | n/a    |                        |   | 6.5 |   |   | 6.4 |   |   | 6.4 |   |
| Expected                volatility             |   |                         | n/a    |                        |   | 19.0 | % |   | 35.0 | % |   | 19.4 | % |
| Risk                free interest rate         |   |                         | n/a    |                        |   | 4.8 | % |   | 3.4 | % |   | 4.5 | % |

**9.      Segment Information**

|                                                            |   | Three Months Ended |   | Nine Months Ended |   |
|-----------------------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                                            |   | September 30,           |   | September  30,    |   |
|                                                            |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
| Revenues:                                                       |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Standard                Commercial Segment                      |   | $                            | 20,280 |                        | $      | 23,718 |   | $ | 64,617 |   | $ | 65,488 |   |
| Specialty                Commercial Segment                     |   |                         | 30,245 |                        |   | 32,910 |   |   | 94,617 |   |   | 93,986 |   |
| Personal                Segment                                 |   |                         | 16,053 |                        |   | 15,185 |   |   | 48,277 |   |   | 43,654 |   |
| Corporate                                                       |   |                         | (1,589 | )                           |   | 743 |   |   | 983 |   |   | 2,122 |   |
| Consolidated                                                    |   | $                            | 64,989 |                        | $      | 72,556 |   | $ | 208,494 |   | $ | 205,250 |   |
|                                                            |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Pre-tax                income (loss), net of minority interest: |   |                         |   |                        |   |   |   |   |   |   |   |   |   |
| Standard                Commercial Segment                      |   | $                            | 887    |                        | $      | 3,702 |   | $ | 9,104 |   | $ | 9,125 |   |
| Specialty                Commercial Segment                     |   |                         | 745    |                        |   | 6,500 |   |   | 12,601 |   |   | 20,627 |   |
| Personal                Segment                                 |   |                         | 2,544  |                        |   | 1,854 |   |   | 7,047 |   |   | 6,148 |   |
| Corporate                                                       |   |                         | (4,030 | )                           |   | (1,909 | ) |   | (7,224 | ) |   | (5,108 | ) |
| Consolidated                                                    |   | $                            | 146    |                        | $      | 10,147 |   | $ | 21,528 |   | $ | 30,792 |   |

----

|                                        |   | September 30, |    | December 31, |   |
|---------------------------------------------|--------|--------------------|---------|-------------------|--------|
|                                        |   | 2008               |    | 2007              |   |
| Assets                                      |   |               |    |              |   |   |   |
|                                        |   |               |    |              |   |   |   |
| Standard                Commercial Segment  |   | $                  | 157,105 |              | $      | 211,761 |   |
| Specialty                Commercial Segment |   |               | 219,124 |              |   | 229,473 |   |
| Personal                Segment             |   |               | 78,143  |              |   | 100,986 |   |
| Corporate                                   |   |               | 95,308  |              |   | 64,762 |   |
|                                        |   | $                  | 549,680 |              | $      | 606,982 |   |

**10.      Reinsurance**

|                                  |   | Three Months Ended |   | Nine Months Ended |   |
|---------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                  |   | September 30,           |   | September 30,          |   |
|                                  |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
|                                  |   |                         |   |                        |   |   |   |   |   |
| Ceded                earned premiums  |   | $                            | 2,153  |                        | $      | 2,035 |   | $ | 6,126 |   | $ | 10,059 |   |
| Reinsurance                recoveries |   | $                            | 8,211  |                        | $      | 537 |   | $ | 9,474 |   | $ | 3,973 |   |

|   | · | Property                catastrophe.                Our property catastrophe reinsurance reduces the financial impact                a                catastrophe could have on our commercial property insurance lines.                Catastrophes might include multiple claims and policyholders. Catastrophes                include hurricanes, windstorms, earthquakes, hailstorms, explosions,                severe winter weather and fires. Our property catastrophe reinsurance                is                excess-of-loss reinsurance, which provides us reinsurance coverage                for                losses in excess of an agreed-upon amount. We utilize catastrophe                models                to assist in determining appropriate retention and limits to purchase.                The                terms of our property catastrophe reinsurance, effective July 1,                2008,                are: |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

|   | o | We                retain the first $3.0 million of property catastrophe losses;                and |
|--------|---|----------------------------------------------------------------------------------------------------|

|   | o | Our                reinsurers reimburse us 100% for each $1.00 of loss in excess of                our $3.0                million retention up to $10.0 million for each catastrophic occurrence,                subject to an aggregate limit of $14 million. As a result of hurricane                losses we have ceded to our reinsurers losses of approximately $7.0                million and have approximately $7.0 million of coverage remaining                under                this layer of catastrophe reinsurance at September 30,                2008. |
|--------|---|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | Our                reinsurers reimburse us 100% for each $1.00 of loss in excess of                $10.0                million up to $35.0 million for each catastrophic occurrence subject                to an                aggregate limit of $50.0 million. |
|--------|---|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Commercial                property.                Our commercial property reinsurance is excess-of-loss coverage intended                to                reduce the financial impact a single-event or catastrophic loss may                have                on our results. The terms of our commercial property reinsurance,                effective July 1, 2008, are: |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | We                retain the first $1.0 million of loss for each commercial property                risk; |
|--------|---|-----------------------------------------------------------------------------------------------------------|

|   | o | Our                reinsurers reimburse us for the next $5.0 million for each commercial                property risk; and |
|--------|---|----------------------------------------------------------------------------------------------------------------------------|

|   | o | Individual                risk facultative reinsurance is purchased on any commercial property                with                limits above $5.0 million. |
|--------|---|--------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Commercial                casualty.                Our commercial casualty reinsurance is excess-of-loss coverage intended                to                reduce the financial impact a single-event loss may have on our results.                The terms of our commercial casualty reinsurance, effective July                1, 2008,                are: |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | We                retain the first $1.0 million of any commercial liability risk: and |
|--------|---|---------------------------------------------------------------------------------------|

|   | o | Our                reinsurers reimburse us for the next $5.0 million for each commercial                liability risk. |
|--------|---|-------------------------------------------------------------------------------------------------------------------------|

|   | · | Aviation.                We purchase reinsurance specific to the aviation risks underwritten                by our                Aerospace Operating Unit. This reinsurance provides aircraft hull                and                liability coverage and airport liability coverage on a per occurrence                basis on the following terms: |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | We                retain the first $350,000 of each aircraft hull or liability loss                or                airport liability loss; |
|--------|---|----------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | Our                reinsurers reimburse us for the next $2.15 million of each aircraft                hull                loss and for the next $650,000 of each aircraft or airport liability                loss;                and |
|--------|---|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | o | Risks                with liability limits greater than $1.0 million are placed in a quota                share treaty where we retain 20% of incurred losses. |
|--------|---|----------------------------------------------------------------------------------------------------------------------------------------------------------------|

**11.      Notes Payable **

----

** **

**12.      Structured Settlements **

**13.      Credit Facilities**

----

**14.      Deferred Policy Acquisition Costs**

|      |   | Three Months Ended |    | Nine Months Ended |   |
|-----------|--------|------------------------------|---------|-----------------------------|--------|
|      |   | September 30,           |    | September 30,          |   |
|      |   | 2008                         |    | 2007                        |   | 2008 |   | 2007 |   |
|      |   |                         |    |                        |   |   |   |   |   |
| Deferred  |   | $                            | (13,700 | )                           | $      | (12,197 | ) | $ | (41,718 | ) | $ | (37,163 | ) |
| Amortized |   |                         | 14,204  |                        |   | 11,635 |   |   | 41,326 |   |   | 33,532 |   |
|      |   |                         |    |                        |   |   |   |   |   |   |   |   |   |
| Net       |   | $                            | 504     |                        | $      | (562 | ) | $ | (392 | ) | $ | (3,631 | ) |

**15.      Earnings per Share**

|                                                       |   | Three Months Ended |   | Nine Months Ended |   |
|------------------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                                       |   | September 30,           |   | September 30,          |   |
|                                                       |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
|                                                       |   |                         |   |                        |   |   |   |   |   |
| Weighted                average shares - basic             |   |                         | 20,809 |                        |   | 20,768 |   |   | 20,799 |   |   | 20,768 |   |
| Effect                of dilutive securities               |   |                         | 62     |                        |   | - |   |   | 82 |   |   | - |   |
| Weighted                average shares - assuming dilution |   |                         | 20,871 |                        |   | 20,768 |   |   | 20,881 |   |   | 20,768 |   |

**16.      Net Periodic Pension Cost**

|                                           |   | Three Months Ended |   | Nine Months Ended |   |
|------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                           |   | September 30,           |   | September 30,          |   |
|                                           |   | 2008                         |   | 2007                        |   | 2008 |   | 2007 |   |
| Interest                cost                   |   | $                            | 167    |                        | $      | 180 |   | $ | 501 |   | $ | 540 |   |
| Amortization                of net (gain) loss |   |                         | 16     |                        |   | 50 |   |   | 48 |   |   | 150 |   |
| Expected                return on plan assets  |   |                         | (167   | )                           |   | (161 | ) |   | (502 | ) |   | (482 | ) |
| Net                periodic pension cost       |   | $                            | 16     |                        | $      | 69 |   | $ | 47 |   | $ | 208 |   |

----

**17.      Contingencies**

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

*The      following discussion should be read together with our consolidated financial      statements and the notes thereto. This discussion contains forward-looking      statements. Please see “Risks Associated with Forward-Looking Statements in this      Form 10-Q” for a discussion of some of the uncertainties, risks and assumptions      associated with these statements.*

**Introduction**

|   | · | ***Standard                Commercial Segment.***                Our Standard Commercial Segment includes the standard lines commercial                property/casualty insurance products and services handled by our                HGA                Operating Unit which is comprised of our American Hallmark Insurance                Services, Inc. and Effective Claims Management, Inc. subsidiaries. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | ***Specialty                Commercial Segment.***                Our Specialty Commercial Segment includes the excess and surplus                lines                commercial property/casualty insurance products and services handled                by                our TGA Operating Unit, the general aviation insurance products and                services handled by our Aerospace Operating Unit, and the excess                commercial automobile and commercial umbrella insurance products                handled                by our Heath XS Operating Unit. Our TGA Operating Unit is comprised                of our                TGA Insurance Managers, Inc., Pan American Acceptance Corporation                (“PAAC”)                and TGA Special Risk, Inc. subsidiaries. Our Aerospace Operating                Unit is                comprised of our Aerospace Insurance Managers, Inc., Aerospace Special                Risk, Inc. and Aerospace Claims Management Group, Inc. subsidiaries.                Our                Heath XS Operating Unit is compromised of our Heath XS, LLC and                Hardscrabble Data Solutions, LLC subsidiaries (collectively, the“Heath                Group”.) |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

|   | · | ***Personal                Segment.***                Our Personal Segment includes the non-standard personal automobile                insurance products and services handled by our Phoenix Operating                Unit                which is comprised solely of American Hallmark General Agency, Inc.,                which                does business as Hallmark Insurance                Company. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | ***American                Hallmark Insurance Company of Texas**** ****(“AHIC”)***** **presently                retains all of the risks on the commercial property/casualty policies                marketed by our HGA Operating Unit, retains a portion of the risks                on the                non-standard personal automobile policies marketed by our Phoenix                Operating Unit, assumes a portion of the risks on the commercial                property/casualty policies marketed by our TGA Operating Unit and                assumes                a portion of the risks on the aviation property/casualty products                marketed                by our Aerospace Operating Unit. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | ***Hallmark                Specialty Insurance Company (“HSIC”)***presently                assumes a portion of the risks on the commercial property/casualty                policies marketed by our TGA Operating                Unit. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | ***Hallmark                Insurance Company (“HIC”) (formerly known as Phoenix Indemnity Insurance                Company)***                presently assumes a portion of the risks on the non-standard personal                automobile policies marketed by our Phoenix Operating Unit and assumes                a                portion of the risks on the aviation property/casualty products marketed                by our Aerospace Operating Unit. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Results      of Operations**

**Management      Overview. **

----

----

**Third      Quarter 2008 as Compared to Third Quarter 2007**

**Hallmark      Financial Services, Inc.**

**Consolidated      Segment Data**

|                                                           |   | **Three Months Ended September 30, 2008** |   |
|----------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|
|                                                           |   | **Standard**                                                       |   | **Specialty** |   |   |   |   |   |   |   |
|                                                           |   | **Commercial**                                                     |   | **Commercial** |   | **Personal** |   |   |   |   |   |
|                                                           |   | **Segment**                                                        |   | **Segment** |   | **Segment** |   | **Corporate** |   | **Consolidated** |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |
| Produced                premium (1)                            |   | $                                                                  | 18,957 |   | $ | 36,295 |   | $ | 14,763 |   | $ | - |   | $ | 70,015 |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                premiums written                          |   |                                                               | 18,954 |   |   | 25,288 |   |   | 14,763 |   |   | - |   |   | 59,005 |   |
| Ceded                premiums written                          |   |                                                               | (1,274 | ) |   | (1,219 | ) |   | - |   |   | - |   |   | (2,493 | ) |
| Net                premiums written                            |   |                                                               | 17,680 |   |   | 24,069 |   |   | 14,763 |   |   | - |   |   | 56,512 |   |
| Change                in unearned premiums                     |   |                                                               | 1,784  |   |   | 650 |   |   | (18 | ) |   | - |   |   | 2,416 |   |
| Net                premiums earned                             |   |                                                               | 19,464 |   |   | 24,719 |   |   | 14,745 |   |   | - |   |   | 58,928 |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                revenues                                  |   |                                                               | 20,280 |   |   | 30,245 |   |   | 16,053 |   |   | (1,589 | ) |   | 64,989 |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                and loss adjustment expenses             |   |                                                               | 13,239 |   |   | 16,287 |   |   | 9,455 |   |   | - |   |   | 38,981 |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Pre-tax                income (loss), net of minority interest |   |                                                               | 887    |   |   | 745 |   |   | 2,544 |   |   | (4,030 | ) |   | 146 |   |
|                                                           |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                loss ratio (2)                              |   |                                                               | 68.0   | % |   | 65.9 | % |   | 64.1 | % |   |   |   |   | 66.2 | % |
| Net                expense ratio (2)                           |   |                                                               | 27.4   | % |   | 31.1 | % |   | 22.6 | % |   |   |   |   | 28.8 | % |
| Net                combined ratio (2)                          |   |                                                               | 95.4   | % |   | 97.0 | % |   | 86.7 | % |   |   |   |   | 95.0 | % |

|                                               |   | **Three Months Ended September 30, 2007** |   |
|----------------------------------------------------|--------|--------------------------------------------------------------------|--------|
|                                               |   | **Standard**                                                       |   | **Specialty** |   |   |   |   |   |   |   |
|                                               |   | **Commercial**                                                     |   | **Commercial** |   | **Personal** |   |   |   |   |   |
|                                               |   | **Segment**                                                        |   | **Segment** |   | **Segment** |   | **Corporate** |   | **Consolidated** |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |
| Produced                premium (1)                |   | $                                                                  | 21,945 |   | $ | 37,919 |   | $ | 14,854 |   | $ | - |   | $ | 74,718 |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                premiums written              |   |                                                               | 21,918 |   |   | 25,531 |   |   | 14,855 |   |   | - |   |   | 62,304 |   |
| Ceded                premiums written              |   |                                                               | 386    |   |   | (827 | ) |   | - |   |   | - |   |   | (441 | ) |
| Net                premiums written                |   |                                                               | 22,304 |   |   | 24,704 |   |   | 14,855 |   |   | - |   |   | 61,863 |   |
| Change                in unearned premiums         |   |                                                               | (311   | ) |   | (870 | ) |   | (919 | ) |   | - |   |   | (2,100 | ) |
| Net                premiums earned                 |   |                                                               | 21,993 |   |   | 23,834 |   |   | 13,936 |   |   | - |   |   | 59,763 |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                revenues                      |   |                                                               | 23,718 |   |   | 32,910 |   |   | 15,185 |   |   | 743 |   |   | 72,556 |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                and loss adjustment expenses |   |                                                               | 13,513 |   |   | 13,682 |   |   | 9,532 |   |   | (4 | ) |   | 36,723 |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Pre-tax                income (loss)               |   |                                                               | 3,702  |   |   | 6,500 |   |   | 1,854 |   |   | (1,909 | ) |   | 10,147 |   |
|                                               |   |                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                loss ratio (2)                  |   |                                                               | 61.4   | % |   | 57.4 | % |   | 68.4 | % |   |   |   |   | 61.4 | % |
| Net                expense ratio (2)               |   |                                                               | 27.1   | % |   | 30.6 | % |   | 22.9 | % |   |   |   |   | 27.5 | % |
| Net                combined ratio (2)              |   |                                                               | 88.5   | % |   | 88.0 | % |   | 91.3 | % |   |   |   |   | 88.9 | % |

| (1) | Produced                premium is a non-GAAP measurement that management uses to track total                controlled premium produced by our operations. We believe this is                a useful                tool                for users of our financial statements to measure our premium production                whether retained by our insurance company subsidiaries or retained                by                third party insurance carriers where we receive commission                revenue. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | The                net loss ratio is calculated as incurred losses and loss adjustment                expenses divided by net premiums earned, each determined in accordance                with GAAP. The net expense ratio is calculated as underwriting expenses                of                our insurance company subsidiaries (which include provisional ceding                commissions, direct agent commissions, premium taxes and assessments,                professional fees, other general underwriting expenses and allocated                overhead expenses) and offset by agency fee income, divided by net                premiums earned, each determined in accordance with GAAP. Net combined                ratio is calculated as the sum of the net loss ratio and the net                expense                ratio. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

***Standard      Commercial Segment***

***Specialty      Commercial Segment***

----

***Personal      Segment***

----

***Corporate***

----

**Nine      Months Ended September 30, 2008 as Compared to Nine Months Ended September      30,      2007**

**Hallmark      Financial Services, Inc.**

**Consolidated      Segment Data**

|                                                           |   | **Nine                Months Ended September 30, 2008** |   |
|----------------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                           |   | **Standard**                                            |   | **Specialty** |   |   |   |   |   |   |   |
|                                                           |   | **Commercial**                                          |   | **Commercial** |   | **Personal** |   |   |   |   |   |
|                                                           |   | **Segment**                                             |   | **Segment** |   | **Segment** |   | **Corporate** |   | **Consolidated** |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |
| Produced                premium (1)                            |   | $                                                       | 62,330 |   | $ | 104,302 |   | $  | 46,643 |   | $ | - |   | $ | 213,275 |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                premiums written                          |   |                                                    | 62,327 |   |   | 77,387 |   |   | 46,643 |   |   | - |   |   | 186,357 |   |
| Ceded                premiums written                          |   |                                                    | (3,667 | ) |   | (2,836 | ) |   | - |   |   | - |   |   | (6,503 | ) |
| Net                premiums written                            |   |                                                    | 58,660 |   |   | 74,551 |   |   | 46,643 |   |   | - |   |   | 179,854 |   |
| Change                in unearned premiums                     |   |                                                    | 2,224  |   |   | (1,900 | ) |   | (2,242 | ) |   | - |   |   | (1,918 | ) |
| Net                premiums earned                             |   |                                                    | 60,884 |   |   | 72,651 |   |   | 44,401 |   |   | - |   |   | 177,936 |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                revenues                                  |   |                                                    | 64,617 |   |   | 94,617 |   |   | 48,277 |   |   | 983 |   |   | 208,494 |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                and loss adjustment expenses             |   |                                                    | 36,218 |   |   | 45,266 |   |   | 29,030 |   |   | - |   |   | 110,514 |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Pre-tax                income (loss), net of minority interest |   |                                                    | 9,104  |   |   | 12,601 |   |   | 7,047 |   |   | (7,224 | ) |   | 21,528 |   |
|                                                           |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                loss ratio (2)                              |   |                                                    | 59.5   | %   |   | 62.3 | %   |   | 65.4 | %   |   |   |   |   | 62.1 | % |
| Net                expense ratio (2)                           |   |                                                    | 27.2   | % |   | 30.7 | % |   | 22.2 | % |   |   |   |   | 28.9 | % |
| Net                combined ratio (2)                          |   |                                                    | 86.7   | % |   | 93.0 | % |   | 87.6 | % |   |   |   |   | 91.0 | % |

|                                               |   | **Nine                Months Ended September 30, 2007** |   |
|----------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                               |   | **Standard**                                            |   | **Specialty** |   |   |   |   |   |   |   |
|                                               |   | **Commercial**                                          |   | **Commercial** |   | **Personal** |   |   |   |   |   |
|                                               |   | **Segment**                                             |   | **Segment** |   | **Segment** |   | **Corporate** |   | **Consolidated** |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |
| Produced                premium (1)                |   | $                                                       | 70,246 |   | $ | 118,232 |   | $ | 43,228 |   | $ | - |   | $ | 231,706 |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross                premiums written              |   |                                                    | 70,139 |   |   | 80,172 |   |   | 43,228 |   |   | - |   |   | 193,539 |   |
| Ceded                premiums written              |   |                                                    | (5,053 | ) |   | (3,556 | ) |   | - |   |   | - |   |   | (8,609 | ) |
| Net                premiums written                |   |                                                    | 65,086 |   |   | 76,616 |   |   | 43,228 |   |   | - |   |   | 184,930 |   |
| Change                in unearned premiums         |   |                                                    | (2,966 | ) |   | (12,100 | ) |   | (3,143 | ) |   | - |   |   | (18,209 | ) |
| Net                premiums earned                 |   |                                                    | 62,120 |   |   | 64,516 |   |   | 40,085 |   |   | - |   |   | 166,721 |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                revenues                      |   |                                                    | 65,488 |   |   | 93,986 |   |   | 43,654 |   |   | 2,122 |   |   | 205,250 |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                and loss adjustment expenses |   |                                                    | 37,621 |   |   | 35,398 |   |   | 26,612 |   |   | (11 | ) |   | 99,620 |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Pre-tax                income (loss)               |   |                                                    | 9,125  |   |   | 20,627 |   |   | 6,148 |   |   | (5,108 | ) |   | 30,792 |   |
|                                               |   |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                loss ratio (2)                  |   |                                                    | 60.6   | %   |   | 54.9 | %   |   | 66.4 | %   |   |   |   |   | 59.8 | % |
| Net                expense ratio (2)               |   |                                                    | 27.3   | % |   | 31.4 | % |   | 23.1 | % |   |   |   |   | 27.9 | % |
| Net                combined ratio (2)              |   |                                                    | 87.9   | % |   | 86.3 | % |   | 89.5 | % |   |   |   |   | 87.7 | % |

----

***Standard      Commercial Segment***

***Specialty      Commercial Segment***

----

***Personal      Segment***

----

***Corporate***

**Financial      Condition and Liquidity**

***Sources      and Uses of Funds***

----

***Comparison      of September 30, 2008 to December 31, 2007***

----

***Comparison      of Nine Months Ended September 30, 2008 and September 30,      2007***

***Credit      Facilities***

** **

----

***Trust      Preferred Securities***

On      June      21, 2005, an unconsolidated trust subsidiary completed a private placement      of      $30.0 million of 30-year floating rate trust preferred securities.      Simultaneously, we borrowed $30.9 million from the trust subsidiary and      contributed $30.0 million to one of our insurance company subsidiaries in order      to increase policyholder surplus. The note bears an initial interest rate of      7.725% until June 15, 2015, at which time interest will adjust quarterly to      the      three-month LIBOR rate plus 3.25 percentage points. As of September 30, 2008,      the note balance was $30.9 million. Under the terms of the note, we pay interest      only each quarter and the principal of the note at maturity.

***Structured      Settlements***

**Item      3. Quantitative and Qualitative Disclosures About Market      Risk.**

**Item      4T. Controls and Procedures.**

----

**Risks      Associated with Forward-Looking Statements Included in this Form      10-Q**

----

**PART      II**

**OTHER      INFORMATION**

**Item      1.**
**Legal      Proceedings.**

**Item      1A.**
**Risk      Factors. **

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

**Item      3.**
**Defaults      Upon Senior Securities.**

**Item      4.**
**Submission      of Matters to a Vote of Security Holders.**

**Item      5.**
**Other      Information.**

**Item      6. **
**Exhibits.**

| ExhibitNumber |   |  Description                                                                                                                                                                                                                                                                                                                                |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                                                                                                                                                                                                                             |
| 3(a)          |   | Restated                Articles of Incorporation of the registrant, as amended (incorporated                by                reference to Exhibit 3.1 to the registrant’s Registration Statement on                Form S-1 [Registration No. 333-136414] filed September 8,                2006).                                       |
|          |   |                                                                                                                                                                                                                                                                                                                                             |
| 3(b)          |   | Amended                and Restated By-Laws of the registrant (incorporated by reference                to                Exhibit 3.1 to the registrant’s Current Report on Form 8-K filed October                1, 2007).                                                                                                                |
|          |   |                                                                                                                                                                                                                                                                                                                                             |
| 4(a)          |   | Specimen                certificate for Common Stock, $0.18 par value per share, of the registrant                (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the                registrant’s Registration Statement on Form S-1 [Registration No.                333-136414] filed September 8,                2006). |

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| ExhibitNumber |   |  Description |
|---------------|--------|-------------------|

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4(b)   |   | Indenture                dated as of June 21, 2005, between Hallmark Financial Services, Inc.                and                JPMorgan Chase Bank, National Association (incorporated by reference                to                Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed June 27,                2005).                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(c)   |   | Amended                and Restated Declaration of Trust of Hallmark Statutory Trust I dated                as                of June 21, 2005, among Hallmark Financial Services, Inc., as sponsor,                Chase Bank USA, National Association, as Delaware trustee, and JPMorgan                Chase Bank, National Association, as institutional trustee, and Mark                Schwarz and Mark Morrison, as administrators (incorporated by reference                to                Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed June 27,                2005).                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(d)   |   | Form                of Junior Subordinated Debt Security Due 2035 (incorporated by reference                to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed June                27, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(e)   |   | Form                of Capital Security Certificate (incorporated by reference to Exhibit                4.2                to the registrant’s Current Report on Form 8-K filed June 27,                2005).                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(f)   |   | First                Restated Credit Agreement dated January 27, 2006, between Hallmark                Financial Services, Inc. and The Frost National Bank (incorporated                by                reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K                filed February 2, 2006).                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(g)   |   | Form                of Registration Rights Agreement dated January 27, 2006, between                Hallmark                Financial Services, Inc. and Newcastle Special Opportunity Fund I,                L.P.                and Newcastle Special Opportunity Fund II, L.P. (incorporated by                reference                to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed                February 2, 2006).                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(h)   |   | Indenture                dated as of August 23, 2007, between Hallmark Financial Services,                Inc. and                The Bank of New York Trust Company, National Association (incorporated                by                reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K                filed August 24, 2007).                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(i)   |   | Amended                and Restated Declaration of Trust of Hallmark Statutory Trust II                dated as                of August 23, 2007, among Hallmark Financial Services, Inc., as sponsor,                The Bank of New York (Delaware), as Delaware trustee, and The Bank                of New                York Trust Company, National Association, as institutional trustee,                and                Mark Schwarz and Mark Morrison, as administrators (incorporated by                reference to Exhibit 4.2 to the registrant’s Current Report on Form 8-K                filed August 24, 2007). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(j)   |   | Form                of Junior Subordinated Debt Security Due 2037 (incorporated by reference                to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed August                24, 2007).                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(k)   |   | Form                of Capital Security Certificate (incorporated by reference to Exhibit                4.2                to the registrant’s Current Report on Form 8-K filed August 24,                2007).                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31(a)  |   | Certification                of principal executive officer required by Rule 13a-14(a) or Rule                15d-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31(b)  |   | Certification                of principal financial officer required by Rule 13a-14(a) or Rule                15d-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32(a)  |   | Certification                of principal executive officer Pursuant to 18 U.S.C.                1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32(b)  |   | Certification                of principal financial officer Pursuant to 18 U.S.C.                1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

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|                                     |   | HALLMARK                  FINANCIAL SERVICES, INC.                                                                      |
|------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------|
|                                     |   | (Registrant)                                                                                                            |
|                                     |   |                                                                                                                    |
| Date:                  November 12, 2008 |   | /s/                  Mark J. Morrison                                                                                   |
|                                     |   | Mark                  J. Morrison, Chief Executive Officer and President (Principal                  Executive Officer) |
|                                     |   |                                                                                                                    |
| Date:                  November 12, 2008 |   | /s/                  Jeffrey R. Passmore                                                                                |
|                                     |   | Jeffrey                  R. Passmore, Chief Accounting Officer and Senior Vice                  President               |
|                                     |   | (Principal                  Financial Officer)                                                                          |

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