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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2002
---------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------------- ------------------
Commission File Number: 0-10956
--------
EMC INSURANCE GROUP INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
------------------------------ ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
------------------------------------- --------
(Address of principal executive office) (Zip Code)
(515) 280-2902
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at October 31, 2002
----- -------------------------------
Common stock, $1.00 par value 11,393,499
----------
Total pages 28
----
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $30,006,515 and $35,502,755) ... $ 28,339,998 $ 33,572,602
Securities available-for-sale, at fair value
(amortized cost $372,750,283 and
$384,410,393) .............................. 396,979,110 390,214,177
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $36,841,170 and $35,962,133) ... 31,455,510 32,505,305
Securities available-for-sale, at fair value
(amortized cost $56,026,658 and $27,325,968) 57,156,389 28,436,008
Equity securities available-for-sale, at fair
value (cost $37,196,341 and $28,686,321) ..... 33,961,095 33,322,767
Other long-term investments, at fair value
(cost $3,629,500 and $0) ..................... 3,629,500 -
Short-term investments, at cost ................ 26,668,157 17,724,458
------------ ------------
Total investments ......................... 578,189,759 535,775,317
Cash ............................................. (289,238) 558,073
Indebtedness of related party .................... 17,443,377 -
Accrued investment income ........................ 7,512,262 8,659,008
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $573,502) ..... 592,252 1,081,024
Income taxes recoverable ......................... 235,035 100,614
Reinsurance receivables .......................... 10,873,749 14,501,336
Deferred policy acquisition costs ................ 26,543,235 21,363,528
Deferred income taxes ............................ 14,369,173 18,328,807
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Prepaid reinsurance premiums ..................... 3,540,913 2,275,231
Securities lending collateral .................... 96,485,845 66,809,518
Other assets ..................................... 1,813,984 1,170,655
------------ ------------
Total assets .......................... $758,251,932 $671,564,697
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
------------ ------------
(Unaudited)
LIABILITIES
Losses and settlement expenses ................... $323,846,952 $314,518,588
Unearned premiums ................................ 124,191,980 99,382,176
Other policyholders' funds ....................... 1,036,038 472,952
Surplus notes payable ............................ 36,000,000 25,000,000
Indebtedness to related party .................... - 2,684,418
Postretirement benefits .......................... 7,438,373 6,967,484
Securities lending ............................... 96,485,845 66,809,518
Other liabilities ................................ 14,891,938 15,271,938
------------ ------------
Total liabilities ......................... 603,891,126 531,107,074
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,392,184
shares in 2002 and 11,329,987 shares in 2001 ... 11,392,184 11,329,987
Additional paid-in capital ....................... 67,165,042 66,013,203
Accumulated other comprehensive income ........... 14,380,153 7,507,672
Retained earnings ................................ 61,423,427 55,606,761
------------ ------------
Total stockholders' equity ................ 154,360,806 140,457,623
------------ ------------
Total liabilities and stockholders' equity $758,251,932 $671,564,697
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
2002 2001 2002 2001
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$74,979,176 $69,138,856 $216,837,256 $192,548,093
Investment income, net ... 7,934,259 7,932,760 24,539,285 23,082,657
Realized investment
(losses) gains ......... (1,340,914) (39,421) (4,441,374) 562,317
Other income ............. 190,584 148,046 567,859 590,002
----------- ----------- ------------ ------------
81,763,105 77,180,241 237,503,026 216,783,069
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 52,335,783 57,796,154 152,102,635 162,802,872
Dividends to policyholders 567,313 471,493 2,319,931 1,060,241
Amortization of deferred
policy acquisition costs 15,685,552 13,932,628 47,175,214 39,864,489
Other underwriting
expenses ............... 6,420,699 5,573,609 18,927,655 15,248,838
Interest expense ......... 484,575 - 1,156,294 -
Other expenses ........... 297,403 173,266 860,891 921,473
----------- ----------- ------------ ------------
75,791,325 77,947,150 222,542,620 219,897,913
----------- ----------- ------------ ------------
Income (loss) before
income tax expense
(benefit) ............ 5,971,780 (766,909) 14,960,406 (3,114,844)
----------- ----------- ------------ ------------
INCOME TAX EXPENSE
(BENEFIT):
Current ................ 617,981 (8,480) 3,765,588 (142,528)
Deferred ............... 1,052,614 (694,901) 259,070 (2,128,076)
----------- ----------- ------------ ------------
1,670,595 (703,381) 4,024,658 (2,270,604)
----------- ----------- ------------ ------------
Net income (loss) ..$ 4,301,185 $ (63,528)$ 10,935,748 $ (844,240)
=========== =========== ============ ============
Net income (loss) per
common share -
basic and diluted ........$ .38 $ (.01)$ .96 $ (.07)
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .45 $ .45
=========== =========== ============ ============
Average number of common
shares outstanding -
basic and diluted ........ 11,391,128 11,316,708 11,369,014 11,308,273
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income (loss) .......... $ 4,301,185 $ (63,528)$10,935,748 $ (844,240)
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding
gains arising during the
period, before deferred
income tax expense ..... 8,911,347 2,872,383 6,131,668 3,539,740
Deferred income tax
expense ................ 3,118,971 976,612 2,146,080 1,203,516
----------- ----------- ----------- -----------
5,792,376 1,895,771 3,985,588 2,336,224
----------- ----------- ----------- -----------
Reclassification
adjustment for losses
(gains) included in net
income (loss) before
income tax (benefit)
expense ................ 1,349,804 39,421 4,441,374 (552,108)
Income tax (benefit)
expense ................ (472,431) (13,403) (1,554,481) 187,717
----------- ----------- ----------- -----------
877,373 26,018 2,886,893 (364,391)
----------- ----------- ----------- -----------
Other comprehensive
income ........... 6,669,749 1,921,789 6,872,481 1,971,833
----------- ----------- ----------- -----------
Total comprehensive
income ........... $10,970,934 $ 1,858,261 $17,808,229 $ 1,127,593
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
--------------------------
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................. $ 10,935,748 $ (844,240)
------------ ------------
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Losses and settlement expenses ............ 9,328,364 20,611,071
Unearned premiums ......................... 24,809,804 19,652,702
Other policyholders' funds ................ 563,086 (362,928)
Deferred policy acquisition costs ......... (5,179,707) (6,467,825)
Indebtedness of related party ............. (20,127,795) (4,439,934)
Accrued investment income ................. 1,146,746 263,041
Accrued income taxes:
Current ................................. (134,421) (334,703)
Deferred ................................ 259,069 (2,128,080)
Realized investment losses (gains) ........ 4,441,374 (562,317)
Postretirement benefits ................... 470,889 818,918
Reinsurance receivables ................... 3,627,587 (2,295,656)
Prepaid reinsurance premiums .............. (1,265,682) (1,597,201)
Amortization of deferred income ........... - (39,859)
Other, net ................................ (807,329) 8,546,944
------------ ------------
17,131,985 31,664,173
Cash provided by the property and casualty
insurance subsidiaries' change in
recording the full-term premium amount
on policies billed on an installment
basis (note 2) .......................... - 11,880,803
------------ ------------
Net cash provided by
operating activities ................ $ 28,067,733 $ 42,700,736
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Nine months ended
September 30,
--------------------------
2002 2001
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of fixed maturity securities
held-to-maturity ............................ $ 6,304,505 $ 35,808,699
Purchases of fixed maturity securities
available-for-sale .......................... (162,124,817) (95,881,016)
Disposals of fixed maturity securities
available-for-sale .......................... 142,278,735 26,112,612
Purchases of equity securities
available-for-sale .......................... (31,416,776) (19,489,793)
Disposals of equity securities
available-for-sale .......................... 21,521,555 20,157,569
Purchase of other long-term investments ....... (4,061,808) -
Disposals of other long-term investments ...... 432,308 -
Net purchases of short-term investments ....... (8,943,700) (4,405,377)
------------ ------------
Net cash used in investing activities ....... (36,009,998) (37,697,306)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 1,214,036 357,877
Dividends paid to stockholders ................ (5,119,082) (5,089,054)
Issuance of surplus note (note 5) ............. 11,000,000 -
------------ ------------
Net cash provided by (used in)
financing activities .................... 7,094,954 (4,731,177)
------------ ------------
NET (DECREASE) INCREASE IN CASH ................. (847,311) 272,253
Cash at beginning of year ....................... 558,073 490,226
------------ ------------
Cash at end of quarter .......................... $ (289,238) $ 762,479
============ ============
Income taxes paid ............................... $ 3,900,010 $ 191,684
Interest paid (received) ........................ $ 19,232 $ (79,232)
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(Unaudited)
1. BASIS OF PRESENTATION
The results of operations for the interim periods reported are not
necessarily indicative of the results to be expected for the year. The
information reflects all adjustments (which include only normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
Certain amounts previously reported in prior years' consolidated
financial statements have been reclassified to conform to current year
presentation.
In reading these financial statements, reference should be made to the
Company's 2001 Form 10-K or the 2001 Annual Report to Shareholders for more
detailed footnote information.
2. INSTALLMENT BASIS PREMIUMS
Effective January 1, 2001, the Company began recording the full-term
premium amount due on policies that are billed on an installment basis.
Previously, such amounts were recorded as each installment became due. As a
result, on January 1, 2001 written premiums and unearned premiums increased
$13,884,423, assets increased $11,880,803 and the Company incurred $1,706,181
of commission expense and $297,439 of premium tax expense. These expenses
were offset by a $3,054,573 increase in deferred policy acquisition costs,
resulting in $1,050,953 of non-recurring income that was amortized into
operations on a quarterly basis.
3. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate.
Property
Three months ended and casualty Parent
September 30, 2002 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 58,178,665 $ 16,800,511 $ 74,979,176
Underwriting gain
(loss) ............. 957,755 (987,926) (30,171)
Net investment income 5,634,157 2,276,683 $ 23,419 7,934,259
Realized investment
(losses) gains ..... (1,371,512) 30,598 - (1,340,914)
Other income ......... 190,584 - - 190,584
Interest expense ..... (339,014) (145,561) - (484,575)
Other expense ........ (227,871) - (69,532) (297,403)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 4,844,099 $ 1,173,794 $ (46,113) $ 5,971,780
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2002
Property
Three months ended and casualty Parent
September 30, 2001 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 51,637,788 $ 17,501,068 $ 69,138,856
Underwriting loss .... (6,358,566) (2,276,462) (8,635,028)
Net investment income 5,793,272 2,094,020 $ 45,468 7,932,760
Realized investment
losses ............. (35,210) (4,211) - (39,421)
Other income ......... 136,547 11,499 - 148,046
Other expense ........ (100,587) - (72,679) (173,266)
------------ ------------ ------------ ------------
Loss before income
tax benefit ........ $ (564,544) $ (175,154) $ (27,211) $ (766,909)
============ ============ ============ ============
Property
Nine months ended and casualty Parent
September 30, 2002 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $165,989,988 $ 50,847,268 $216,837,256
Underwriting loss .... (839,626) (2,848,553) (3,688,179)
Net investment income 17,669,191 6,775,603 $ 94,491 24,539,285
Realized investment
(losses) gains ..... (3,427,908) (1,018,779) 5,313 (4,441,374)
Other income ......... 567,859 - - 567,859
Interest expense ..... (1,005,986) (150,308) - (1,156,294)
Other expense ........ (558,528) - (302,363) (860,891)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 12,405,002 $ 2,757,963 $ (202,559) $ 14,960,406
============ ============ ============ ============
Property
Nine months ended and casualty Parent
September 30, 2001 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $150,458,463 $ 42,089,630 $192,548,093
Underwriting loss .... (20,206,176) (6,222,171) (26,428,347)
Net investment income 16,737,370 6,190,239 $ 155,048 23,082,657
Realized investment
gains (losses) ..... 576,633 (14,316) - 562,317
Other income ......... 550,143 39,859 - 590,002
Other expense ........ (536,953) - (384,520) (921,473)
------------ ------------ ------------ ------------
Loss before income
tax benefit ........ $ (2,878,983) $ (6,389) $ (229,472) $ (3,114,844)
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2002
4. INCOME TAXES
The actual income tax expense (benefit) for the three and nine months
ended September 30, 2002 and 2001 differed from the "expected" tax expense
(benefit) for those periods (computed by applying the United States federal
corporate tax rate of 35 percent for 2002 and 34 percent for 2001 to income
(loss) before income tax expense (benefit)) as follows:
Three months ended Nine months ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Computed "expected" tax
expense (benefit) ...... $ 2,090,123 $ (260,749) $ 5,236,142 $(1,059,047)
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (392,798) (361,910) (1,117,967) (1,108,768)
Proration of
tax-exempt interest
and dividends
received deduction 40,605 41,451 123,422 125,021
Other, net ........... (67,335) (122,173) (216,939) (227,810)
----------- ----------- ----------- -----------
Income tax expense
(benefit) ...... $ 1,670,595 $ (703,381) $ 4,024,658 $(2,270,604)
=========== =========== =========== ===========
5. SURPLUS NOTES
On June 27, 2002, EMC Reinsurance Company, a subsidiary of the Company,
issued a surplus note in the amount of $11,000,000 to Employers Mutual
Casualty Company. The surplus note bears an annual interest rate of 5.25
percent and does not have a maturity date. All payments of interest and
principal must be approved in advance by the Iowa Insurance Commissioner and
can only be made out of EMC Reinsurance Company's statutory surplus earnings.
The surplus note is subordinate and junior in right of payment to all
obligations or liabilities of EMC Reinsurance Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2002
6. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets". SFAS
No. 141 requires the purchase method of accounting for all business
combinations initiated after June 30, 2001 and establishes specific criteria
for the recognition of intangible assets separately from goodwill. SFAS No.
142 addresses accounting for intangible assets, eliminates the amortization of
goodwill and provides specific steps for testing the impairment of goodwill.
SFAS No. 142 was effective for fiscal years beginning after December 15, 2001;
however, the amortization provisions apply to goodwill and intangible assets
acquired after June 30, 2001. Other than the requirement to eliminate the
amortization of the Company's carried goodwill, adoption of these statements
did not have an impact on the operating results of the Company.
Goodwill amortization expense amounted to approximately $34,000 and
$101,000 for the three and nine months ended September 30, 2001, respectively
and $135,000 for the twelve months ended December 31, 2001. On an after tax
basis, these amounts totaled approximately $22,000, $67,000 and $87,000,
respectively. Due to the immaterial amounts involved, the Company has not
presented prior year net income or earnings per share information that has
been adjusted to exclude this expense.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which is effective for fiscal
years beginning after December 15, 2001. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of". SFAS No. 144 requires that one accounting model be
used for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions. Adoption of this statement
did not have any effect on the operating results of the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
OVERVIEW
EMC Insurance Group Inc., a 79.6 percent-owned subsidiary of Employers
Mutual Casualty Company (Employers Mutual), is an insurance holding company
with operations in property and casualty insurance and reinsurance. Property
and casualty insurance is the most significant segment, representing 76.6
percent of consolidated premiums earned. For purposes of this discussion, the
term "Company" is used interchangeably to describe EMC Insurance Group Inc.
(Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.
Employers Mutual and all of its subsidiaries (including the Company) and an
affiliate are referred to as the "EMC Insurance Companies."
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. The aggregate
participation of the Company's property and casualty insurance subsidiaries is
23.5 percent. Operations of the pool give rise to inter-company balances with
Employers Mutual, which are settled on a quarterly basis. The investment and
income tax activities of the pool participants are not subject to the pooling
agreement.
The purpose of the pooling agreement is to spread the risk of an exposure
insured by any of the pool participants among all the companies. The pooling
agreement produces a more uniform and stable underwriting result from year to
year for all companies in the pool than might be experienced individually. In
addition, each company benefits from the capacity of the entire pool, rather
than being limited to policy exposures of a size commensurate with its own
assets, and from the wide range of policy forms, lines of insurance written,
rate filings and commission plans offered by each of the companies. A single
set of reinsurance treaties is maintained for the protection of all companies
in the pool.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related losses
and settlement expenses of this business, subject to a maximum loss of
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, or any "involuntary" facility or
pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to inter-company balances
with Employers Mutual, which are settled on a quarterly basis.
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The results of operations for the interim periods reported are not
necessarily indicative of the results to be expected for the year. The
information reflects all adjustments that are, in the opinion of management,
necessary for a fair statement of the results for the interim periods.
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and nine months ended September
30, 2002 and 2001 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 74,979 $ 69,139 $216,837 $192,548
Losses and settlement expenses ...... 52,336 57,796 152,103 162,803
Acquisition and other expenses ...... 22,673 19,978 68,422 56,174
-------- -------- -------- --------
Underwriting loss ................... (30) (8,635) (3,688) (26,429)
Net investment income ............... 7,934 7,933 24,539 23,083
Interest expense .................... (484) - (1,156) -
Other expense ....................... (107) (25) (293) (331)
-------- -------- -------- --------
Operating income (loss) before
income tax expense (benefit) ...... 7,313 (727) 19,402 (3,677)
Realized investment (losses) gains .. (1,341) (40) (4,441) 562
-------- -------- -------- --------
Income (loss) before income tax
expense (benefit) ................. 5,972 (767) 14,961 (3,115)
Income tax expense (benefit) ........ 1,671 (703) 4,025 (2,271)
-------- -------- -------- --------
Net income (loss) ................... $ 4,301 $ (64) $ 10,936 $ (844)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 50,352 $ 57,669 $152,850 $163,043
Increase (decrease) in provision
for insured events of prior
years ......................... 1,984 127 (747) (240)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 52,336 $ 57,796 $152,103 $162,803
======== ======== ======== ========
Catastrophe and storm losses ........ $ 1,125 $ 6,788 $ 5,944 $ 19,373
======== ======== ======== ========
Operating results before income taxes improved substantially for both the
three months and nine months ended September 30, 2002 compared to the same
periods in 2001. Increased rate adequacy and focused underwriting initiatives
have sparked a fundamental improvement in the underlying book of business.
This, coupled with a significant decline in catastrophe and storm losses from
the unusually high levels experienced in 2001, produced a substantial
improvement in operating results. Results for the first nine months of 2002
reflect a company-wide effort to improve profitability, and because of the
Company's conservative reserving practices this improvement has not been
dampened by the need to make up for prior year reserve deficiencies.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premium rate increases continued to grow progressively larger during the
first nine months of 2002. Based on current projections, premium rates for
most lines of business will approach adequate levels by year-end for the first
time in nearly a decade. While management expects to implement additional
rate increases in 2003, those increases will likely be smaller and will be
focused on specific territories and lines of business. The improvement that
has been achieved in premium rate adequacy over the last three years will have
a positive impact on future operating results, but the unpredictable nature of
catastrophe and storm losses will remain. Underwriting profitability is
considered to be the Company's number one priority, especially in light of the
declining stock markets and the low interest rate environment. Existing
accounts and agencies are being evaluated to ensure that business with a
reasonable expectation of profitability is retained. In addition, new business
is generally being limited to that which fits within the Company's core
competencies and can be priced adequately.
Effective January 1, 2001, the Company began recording the full-term
written premium and related commission expense at the inception of insurance
policies that are billed on an installment basis. Previously, such amounts
were recorded as each installment became due. As a result, written premiums
and unearned premiums increased $13,884,000, invested assets increased
$11,881,000 and the Company incurred $1,706,000 of commission expense and
$297,000 of premium tax expense. These expenses were offset by a $3,054,000
increase in deferred policy acquisition costs, resulting in $1,051,000 of non-
recurring income that was amortized into operations on a quarterly basis
during 2001.
Premiums earned increased 8.4 percent for the three months and 12.6
percent for the nine months ended September 30, 2002 from the same periods in
2001. These increases primarily reflect rate increases that were implemented
during the last two years; however, the increase for the three months ended
September 30, 2002 was limited by a large amount of reinstatement premium that
was recognized by the reinsurance subsidiary in the third quarter of 2001 in
connection with the World Trade Center catastrophe. Despite rising premium
rates, retention levels have remained fairly constant, evidence of the
movement of the insurance industry towards more adequate rate levels. The
Company continues to be selective in the insurance risks that it accepts and
has been able to price both new and renewal business at more adequate levels.
Losses and settlement expenses decreased 9.4 percent for the three months
and 6.6 percent for the nine months ended September 30, 2002 from the same
periods in 2001, primarily due to a significant decline in catastrophe and
storm losses from the unusually large amount experienced during 2001. Other
factors contributing to the decline in losses and settlement expenses include
the implementation of more stringent underwriting standards and a decline in
large losses. Adverse development on prior years' reserves during the third
quarter of 2002 offset much of the favorable development that had been
recognized through the first six months of 2002.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Acquisition and other expenses increased 13.5 percent for the three
months and 21.8 percent for the nine months ended September 30, 2002 from the
same periods in 2001. The increase for the nine months ended September 2002
is primarily attributed to increases in both commission and contingent
commission expenses, reflecting the large increase in premium volume as well
as the significant improvement in underwriting results. The increase for the
three months ended September 30, 2002 reflects substantial growth in
commission expense, but little impact from contingent commissions and
policyholder dividends. Other influences impacting acquisition and other
expenses for 2002 include the discontinuation of an assigned risk program
during 2001 that produced commission income and an increase in employee
benefit costs. Acquisition and other expenses for the first nine months of
2001 include approximately $101,000 of goodwill amortization expense. In
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets", which became effective January 1, 2002, the
Company's carried goodwill is no longer subject to amortization and must
instead be tested for impairment on a periodic basis.
Net investment income was flat for the three months and increased 6.3
percent for the nine months ended September 30, 2002 from the same periods in
2001. The Company has experienced a significant increase in fixed maturity
security investments in 2002 due to the issuance of $25,000,000 of surplus
notes in December 2001 and another $11,000,000 in June 2002; however, this
increase in invested assets has not produced a significant increase in
investment income due to the declining interest rate environment. In
addition, the Company experienced a significant amount of call activity on its
portfolio of fixed maturity securities during 2001 due to the large decline in
interest rates. Proceeds from this call activity, and from maturing
securities, were reinvested at lower current interest rates, resulting in less
investment income for 2002.
The Company currently has $36,000,000 of surplus notes issued to
Employers Mutual. These surplus notes were issued in response to statutory
capital adequacy concerns raised by certain rating agencies because the
statutory surplus position of the Company's insurance and reinsurance
subsidiaries had declined over the last three years due to unfavorable
operating results and the payment of dividends to the parent company. It
should be noted that surplus notes are considered to be a component of surplus
for statutory reporting purposes because the notes have no maturity date and
all payments of interest and principal must be approved in advance by the
insurance commissioner of the state of domicile of the issuing insurance
company; however, under generally accepted accounting principals, surplus
notes are considered to be debt and are reported as a liability in the
Company's financial statements.
The Company incurred $1,156,000 of interest expense on these surplus
notes during the first nine months of 2002. This interest expense did not
have a material impact on operating results as the proceeds of the surplus
notes were invested in government agencies and corporate bonds and earned a
similar amount of interest income.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The realized investment losses for the nine months ended September 30,
2002 primarily reflect an "other than temporary" security impairment write
down of the Company's investment in MCI Communications Corporation corporate
bonds totaling $3,821,000 in the second quarter. MCI Communications
Corporation is owned by WorldCom Inc., whose corporate bonds were downgraded
to junk status in May when it reported the detection of accounting
irregularities. The MCI bonds are supported by the assets of MCI; however,
the magnitude of the WorldCom collapse has cast doubt on the prospect of
collecting the entire amount of principal and interest payments due the
Company. As a result, the Company determined that the decline in the market
value of the MCI bonds was "other than temporary." The realized investment
losses for the three months ended September 30, 2002 were generated from
rebalancing activities in the Company's equity portfolio.
The Company reported income tax expense for both the three months and
nine months ended September 30, 2002, as compared to an income tax benefit for
the same periods in 2001. This change in tax status primarily reflects the
substantial improvement in pre-tax operating results experienced in 2002.
At the time of this writing the United States Congress is working on a
terrorism insurance bill, but no definitive legislation has been proposed.
Meanwhile, exclusions for terrorist activities on the Company's primary
reinsurance coverage have left the Company exposed to terrorism losses on its
direct business. To address this exposure, the Company has implemented
limitations of coverage where allowed, attempted to recognize and minimize
terrorism exposures, and obtained limited stand-alone reinsurance coverage for
terrorism losses. However, due to its very nature, losses from terrorism
cannot be underwritten with any degree of confidence.
Losses from asbestos and mold related claims continue to hamper the
insurance industry as a whole. Employers Mutual has taken steps to more fully
understand and limit these risks. In the case of asbestos, Employers Mutual
has appointed a task force to study the company's exposure to additional
asbestos claims. In the case of mold, the EMC Insurance Companies are using
exclusionary endorsements and sub-limits to control mold losses. In addition,
an improved understanding of these types of claims has resulted in prompt
attention to water damage losses. As a result, management does not consider
the Company to have a significant exposure to mold related losses.
Employers Mutual is currently analyzing the assumptions that will be
utilized in the preparation of the year-end valuation reports for its pension
and postretirement benefit plans. The assumptions utilized in these valuation
reports will likely change, some significantly, due to the current interest
rate environment and the continued escalation in the price of prescription
drugs. The changes in these assumptions are expected to result in a large
increase in both the year-end liabilities for these plans and the associated
expense of these plans for 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and nine months ended September
30, 2002 and 2001 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 58,179 $ 51,638 $165,990 $150,458
Losses and settlement expenses ...... 39,601 42,972 114,691 126,593
Acquisition and other expenses ...... 17,620 15,025 52,138 44,072
-------- -------- -------- --------
Underwriting profit (loss) .......... 958 (6,359) (839) (20,207)
Net investment income ............... 5,634 5,794 17,669 16,738
Interest expense .................... (339) - (1,006) -
Other (expense) income .............. (38) 35 9 13
-------- -------- -------- --------
Operating income (loss) before
income taxes ...................... $ 6,215 $ (530) $ 15,833 $ (3,456)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 38,671 $ 42,532 $117,449 $130,873
Increase (decrease) in provision
for insured events of prior
years ......................... 930 440 (2,758) (4,280)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 39,601 $ 42,972 $114,691 $126,593
======== ======== ======== ========
Catastrophe and storm losses ........ $ 1,481 $ 3,808 $ 5,653 $ 14,812
======== ======== ======== ========
Premiums earned increased 12.7 percent for the three months and 10.3
percent for the nine months ended September 30, 2002 from the same periods in
2001. These increases are primarily attributable to rate increases that were
implemented during the last two years. Premium rate increases continued to
grow progressively larger during the first nine months of 2002 and management
expects to implement additional rate increases in the fourth quarter; however,
rate increases are expected to level off in 2003. Based on current
projections, premium rates for most lines of business will approach adequate
levels by year-end. As a result, future premium rate increases will likely be
focused on specific territories and lines of business. It should be noted
that it takes a considerable amount of time for implemented rate increases to
have a noticeable impact on underwriting results due to the timing of policy
renewals and the fact that premiums are earned ratably over the terms of the
underlying policies.
Losses and settlement expenses decreased 7.8 percent for the three months
and 9.4 percent for the nine months ended September 30, 2002 from the same
periods in 2001. The primary factor contributing to this improvement was a
significant decline in catastrophe and storm losses from the unusually large
amount experienced during the storm plagued first nine months of 2001. Other
factors contributing to this improvement include more stringent underwriting
standards and a decline in large losses. Loss frequency declined during the
first nine months of 2002, continuing a trend that began in 2000, but the
benefit to operating results was partially offset by an increase in loss
severity.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Acquisition and other expenses increased 17.3 percent for the three
months and 18.3 percent for the nine months ended September 30, 2002 from the
same periods in 2001. These increases are primarily related to the growth in
premium income noted above, but also reflect an increase in policyholder
dividends, the discontinuation of an assigned risk program during 2001 that
produced commission income and higher employee benefit costs.
Underwriting results for the three months and nine months ended September
30, 2002 improved substantially in comparison to the same periods in 2001.
This improvement reflects an increase in overall premium rate adequacy and the
implementation of more stringent underwriting standards, as well as a
significant decline in catastrophe and storm losses from the unusually large
amount experienced in 2001. The improvements that have been achieved in
premium rate adequacy will continue to have an increasingly positive impact on
future operating results, but the unpredictable nature of catastrophe and
storm losses will remain. Underwriting for profitability is always stressed,
but has become even more critical due to the declining stock markets and the
low interest rate environment. Both new and renewal business is being closely
scrutinized to ensure that there is potential for an underwriting profit.
Reinsurance
Operating results for the three months and nine months ended September
30, 2002 and 2001 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 16,800 $ 17,501 $ 50,847 $ 42,090
Losses and settlement expenses ...... 12,735 14,824 37,412 36,210
Acquisition and other expenses ...... 5,053 4,953 16,284 12,102
-------- -------- -------- --------
Underwriting loss ................... (988) (2,276) (2,849) (6,222)
Net investment income ............... 2,277 2,093 6,776 6,190
Interest expense .................... (145) - (150) -
Other income ........................ - 12 - 40
-------- -------- -------- --------
Operating income (loss) before
income taxes ...................... $ 1,144 $ (171) $ 3,777 $ 8
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 11,681 $ 15,137 $ 35,401 $ 32,170
Increase (decrease) in
provision for insured events
of prior years ................ 1,054 (313) 2,011 4,040
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 12,735 $ 14,824 $ 37,412 $ 36,210
======== ======== ======== ========
Catastrophe losses .................. $ (356)$ 2,980 $ 291 $ 4,561
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premiums earned decreased 4.0 percent for the three months and increased
20.8 percent for the nine months ended September 30, 2002 from the same
periods in 2001. The decrease for the three months ended September 30, 2002
is attributed to reinstatement premiums of approximately $2,001,000 that were
recognized in the third quarter of 2001 in connection with the World Trade
Center catastrophe, and a reduction of approximately $500,000 in the estimate
of earned but not reported premiums during the third quarter of 2002 due to
the loss of a block of business. The large increase for the nine months ended
September 30, 2002 is attributed to rate increases implemented during the
January 2002 renewal season, increased participation in a reinsurance pool and
growth in a marine syndicate account. Sizable rate increases were placed on
excess of loss contracts during the January 2002 renewal season and both
excess of loss and pro-rata contracts have benefited from industry-wide rate
increases being implemented at the primary company level. These rate
increases have been realized in conjunction with a moderate decline in the
related exposure base due to increased retention levels on many contracts and
coverage exclusions for terrorist activities on most contracts. Premium
income for the nine months ended September 30, 2002 also reflects a reduction
of approximately $550,000 in the estimated amount of assumed reinstatement
premiums to be received on the World Trade Center catastrophe.
Losses and settlement expenses decreased 14.1 percent for the three
months and increased 3.3 percent for the nine months ended September 30, 2002
from the same periods in 2001. The decrease for the three months and the
relatively small increase for the nine months ended September 30, 2002 is
primarily the result of a significant decline in catastrophe losses from the
elevated levels experienced in 2001, which included Midwest wind and hail
storms, flood losses from tropical storm Allison and losses associated with
the terrorist attack on the World Trade Center. The reinsurance subsidiary
has experienced a substantial amount of adverse development on prior year
reserves during the last two years. The majority of this development has come
from a reinsurance pool in which the reinsurance subsidiary participates, and
is largely attributed to a high level of construction defect claims on an
account that was discontinued on December 31, 1999.
Acquisition and other expenses increased 2.0 percent for the three months
and 34.6 percent for the nine months ended September 30, 2002 from the same
periods in 2001. The increase for the nine months ended September 30, 2002
primarily reflects increases in both commission and contingent commission
expenses associated with the significant increase in premium volume and good
loss experience on certain reinsurance contracts. The increase for the three
months ended September 30, 2002 also reflects a substantial increase in
commission expense; however, this increase was largely offset by a decline in
contingent commission expense and an increase in the amount of acquisition
expenses deferred as a result of the large increase in unearned premiums.
Commission expense for first nine months of 2002 also includes approximately
$379,000 of expense incurred in connection with the increased participation in
the reinsurance pool noted above.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The improvement in the underwriting results of the reinsurance segment
for the three and nine months ended September 30, 2002 is primarily attributed
to improved rate adequacy, lower catastrophe losses, a decline in the amount
of adverse development experienced on prior years' reserves and a decline in
casualty losses. Although the reinsurance subsidiary was able to implement
significant rate increases in 2002, the methodology utilized to establish loss
and settlement expense reserves has limited the impact of these rate increases
on the underwriting results of 2002. For a significant portion of the
reinsurance book of business, loss and settlement expense reserves for the
latest policy year are established by a formula-based process that produces a
break-even result. This procedure is utilized until sufficient data is
available to more formally project anticipated losses and settlement expenses.
Reported reinsurance results are analyzed throughout the year and
modifications are made to the formula-based reserves when appropriate. It is
anticipated that the rate increases implemented during 2002 will mitigate the
need to establish loss and settlement reserves in excess of the formula-based
amounts, as has been required during the last several years. Such adjustments
to the formula-based reserves totaled $3,400,000 in the first nine months of
2001 and $6,400,000 for the year ended December 31, 2001. In addition to
pricing its reinsurance premiums at more adequate rates, Employers Mutual
continues to work toward improving profitability on the assumed book of
business by accepting larger shares of coverage on desirable programs,
utilizing relationships with reinsurance intermediaries and monitoring
exposures.
Parent Company
Operating loss before income taxes totaled $46,000 and $208,000 for the
three months and nine months ended September 30, 2002 compared to losses of
$26,000 and $229,000 for the same periods in 2001. The operating results of
the Company were positively impacted by a decline in operating expenses for
both the three months and nine months ended September 30, 2002 over the same
periods in 2001. However, this improvement was offset by a decline in
interest income, the Company's primary source of revenue.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of the investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to meet claims and expenses. The remainder of the investment portfolio,
excluding investments in equity securities, is invested in securities with
maturities that approximate the anticipated liabilities of the insurance
issued.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
Despite this intent, the Company has historically classified a portion of its
fixed maturity investments as available-for-sale securities to provide
flexibility in the management of the portfolio. Since the third quarter of
1999, all newly acquired fixed maturity investments have been classified as
available-for-sale securities to provide increased management flexibility.
The Company had an unrealized holding gain on fixed maturity securities
available-for-sale of $16,483,000 at September 30, 2002 compared to $4,494,000
at December 31, 2001. The fluctuation in the market value of these
investments is primarily due to changes in the interest rate environment
during this time period. Since the Company does not actively trade in the
bond market, such fluctuations in the fair value of these investments are not
expected to have a material impact on the operations of the Company, as forced
liquidations of investments are not anticipated. The Company closely monitors
the bond market and makes appropriate adjustments in investment policy as
changing conditions warrant.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of investment
income that supplements underwriting results and contributes to net earnings.
As these investments mature, or are called, the proceeds will be reinvested at
current rates, which may be higher or lower than those now being earned;
therefore, more or less investment income may be available to contribute to
net earnings depending on the interest rate level.
The Company participates in a securities lending program whereby certain
fixed maturity securities from the investment portfolio are loaned to other
institutions for short periods of time. The Company receives a fee for each
security loaned out under this program and requires initial collateral,
primarily cash, equal to 102 percent of the market value of the loaned
securities.
The major ongoing sources of the Company's liquidity are insurance
premium income, investment income and cash provided from maturing or
liquidated investments. The principal outflows of cash are payments of
claims, commissions, premium taxes, operating expenses, income taxes,
dividends, interest and principal payments on debt, and investment purchases.
The Company generated positive cash flows from operations of $28,067,733
during the first nine months of 2002 compared to $42,700,736 for the same
period in 2001. The amount for 2001 includes $11,880,803 received from
Employers Mutual in connection with a change in the recording of written
premiums and commissions on policies billed on an installment basis.
Employers Mutual reinvested 25 percent of its dividends in additional
shares of the Company's common stock during the first nine months of 2002.
Prior to 2002, Employers Mutual was reinvesting 100 percent of its dividends
in additional shares of the Company's common stock. Employers Mutual has
indicated that it will increase its dividend reinvestment percentage to 50
percent in the first quarter of 2003. In addition, Employers Mutual may elect
to fulfill its obligations under its incentive stock option plans by
purchasing the Company's common stock on the open market, rather than
requesting the Company to issue new shares. The combination of these two
actions is expected to result in Employers Mutual achieving an 80 percent
ownership of the Company by March 31, 2003. At that time, Employers Mutual
will likely discontinue its participation in the Company's dividend
reinvestment plan. Under this timeline, the Company will be included in a
consolidated tax return with Employers Mutual and its subsidiaries effective
April 1, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations", and
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and establishes specific criteria for the recognition of
intangible assets separately from goodwill. SFAS No. 142 addresses accounting
for intangible assets, eliminates the amortization of goodwill and provides
specific steps for testing the impairment of goodwill. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001; however, the
amortization provisions apply to goodwill and intangible assets acquired after
June 30, 2001. Other than the requirement to eliminate the future
amortization of the Company's carried goodwill, which has amounted to $135,000
per year, adoption of these statements did not have an impact on the operating
results of the Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which is effective for fiscal
years beginning after December 15, 2001. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of". SFAS No. 144 requires that one accounting model be
used for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions. Adoption of this statement
did not have any effect on the operating results of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained in this
report is based on management's current expectations and actual results of the
Company may differ materially from such expectations. The risks and
uncertainties that may affect the actual results of the Company include but
are not limited to the following: catastrophic events and the occurrence of
significant severe weather conditions; state and federal legislation and
regulations; changes in the demand for, pricing of, or supply of insurance or
reinsurance; changes in interest rates and the performance of financial
markets; the adequacy of loss and settlement expense reserves, including
asbestos and environmental claims; terrorist activities and federal solutions
to make available insurance coverage for acts of terrorism; timely collection
of amounts due under ceded reinsurance contracts; rating agency actions; and
other risks and uncertainties inherent in the Company's business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
(Unaudited)
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective board of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Two categories of influences on market risk exist as it relates to
financial instruments. First are systematic aspects, which relate to the
investing environment and are out of the control of the investment manager.
Second are non-systematic aspects, which relate to the construction of the
investment portfolio through investment policies and decisions, and are under
the direct control of the investment manager. Due to systematic changes,
several components of market risk have increased noticeably during the first
nine months of 2002. As it relates to equity price risk, the poor performance
of the markets during 2002 has resulted in declines in the values of the
Company's equity investments. Credit quality risk has risen resulting in
declines in the values of several bond investments stemming from the many
high-profile bankruptcies and other downgrade activities during 2002.
Prepayment risk has increased, primarily for the mortgage-backed securities,
as declines in interest rates during 2002 have accelerated the payment of
higher-interest rate mortgages through re-financing activity. And finally, to
a lesser extent interest rate risk has increased due to interest rates
bottoming-out during 2002. Future interest rate increases will result in
declines in the values of fixed maturity securities from their current values.
Throughout all these systematic changes, the Company continues its commitment
to controlling non-systematic risk through sound investment policies and
diversification.
ITEM 4. CONTROLS AND PROCEDURES
- ------- -----------------------
Within the 90 days prior to the filing date of this report, the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are functioning effectively to provide reasonable
assurance that the Company can meet its disclosure obligations. Since the
date of the most recent evaluation of the Company's internal controls by the
Chief Executive Officer and Chief Financial Officer there have been no
significant changes in the Company's internal controls or in other factors
that could significantly affect these controls.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibit 99.1. Certification of President and Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Exhibit 99.2. Certification of Vice President and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) No Form 8-K was filed by the registrant during the
quarter ended September 30, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: November 13, 2002
CERTIFICATIONS
I, Bruce G. Kelley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of EMC Insurance
Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 13, 2002
-----------------
/s/ Bruce G. Kelley
-------------------------
Bruce G. Kelley
President & Chief Executive Officer
CERTIFICATIONS
I, Mark Reese, certify that:
1. I have reviewed this quarterly report on Form 10-Q of EMC Insurance
Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 13, 2002
-----------------
/s/ Mark Reese
-------------------------
Mark Reese
Vice President and
Chief Financial Officer