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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 JUNE 30, 2003
-------------
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. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] 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 July 31, 2003
----- ----------------------------
Common stock, $1.00 par value 11,462,586
Total pages 34
----
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $23,270,855 and $61,639,037) ... $ 20,745,186 $ 55,033,675
Securities available-for-sale, at fair value
(amortized cost $387,788,519 and
$459,844,928) .............................. 417,953,300 485,855,966
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $33,428,582 and $0) ............ 30,144,246 -
Securities available-for-sale, at fair value
(amortized cost $70,505,300 and $0) ........ 70,955,510 -
Equity securities available-for-sale, at fair
value (cost $34,630,883 and $38,444,030) ..... 38,711,870 34,596,985
Other long-term investments, at cost ........... 3,475,473 3,057,000
Short-term investments, at cost ................ 54,461,720 29,650,230
------------ ------------
Total investments ........................ 636,447,305 608,193,856
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 12,137,066 11,582,136
Prepaid reinsurance premiums ................. 4,642,206 2,442,899
Intangible asset, defined benefit
retirement plan ............................ 1,411,716 1,411,716
Other assets ................................. 3,042,753 1,331,816
Indebtedness of related party ................ 15,351,230 -
Cash ............................................. (4,280,288) (119,097)
Accrued investment income ........................ 8,051,825 9,179,555
Accounts receivable (net of allowance for
uncollectible accounts of $7,297 and $7,297) ... 1,044,702 772,944
Income taxes recoverable ......................... 2,715,969 213,504
Deferred policy acquisition costs ................ 26,690,369 24,926,861
Deferred income taxes ............................ 9,410,324 13,986,172
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 107,255,529 -
------------ ------------
Total assets ............................. $824,862,292 $674,863,948
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
------------ ------------
(Unaudited)
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............... $350,985,734 $331,226,753
Unearned premiums ............................ 125,962,065 115,746,814
Other policyholders' funds ................... 1,353,740 1,035,622
Surplus notes payable ........................ 36,000,000 36,000,000
Indebtedness to related party ................ - 3,304,539
Employee retirement plans .................... 10,970,232 10,014,349
Other liabilities ............................ 21,241,604 19,767,507
Securities lending obligation .................... 107,255,529 -
------------ ------------
Total liabilities ........................ 653,768,904 517,095,584
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,459,977
shares in 2003 and 11,399,050 shares in 2002 ... 11,459,977 11,399,050
Additional paid-in capital ....................... 68,360,742 67,270,591
Accumulated other comprehensive income ........... 22,364,118 14,218,330
Retained earnings ................................ 68,908,551 64,880,393
------------ ------------
Total stockholders' equity ............... 171,093,388 157,768,364
------------ ------------
Total liabilities and stockholders' equity $824,862,292 $674,863,948
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
All balances presented below, with the exception of investment income,
realized investment gains (losses) and income tax (benefit) expense, are the
result of related party transactions with Employers Mutual.
Three months ended Six months ended
June 30, June 30,
----------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ------------ ------------
REVENUES
Premiums earned ..........$81,977,768 $73,348,688 $162,359,666 $141,858,080
Net investment income .... 7,387,056 8,346,315 15,233,980 16,605,026
Realized investment
gains (losses) ......... 586,584 (3,372,379) (1,163,201) (3,100,460)
Other income ............. 264,328 260,163 432,158 377,275
----------- ----------- ------------ ------------
90,215,736 78,582,787 176,862,603 155,739,921
----------- ----------- ------------ ------------
LOSSES AND EXPENSES
Losses and settlement
expenses ............... 62,621,635 51,215,844 112,848,707 99,766,852
Dividends to policyholders 1,226,295 783,385 1,616,529 1,752,618
Amortization of deferred
policy acquisition costs 17,770,488 16,345,669 35,326,862 31,489,662
Other underwriting
expenses ............... 6,350,968 6,073,752 14,386,165 12,506,956
Interest expense ......... 278,100 340,075 764,066 671,719
Other expenses ........... 548,658 305,759 957,206 563,488
----------- ----------- ------------ ------------
88,796,144 75,064,484 165,899,535 146,751,295
----------- ----------- ------------ ------------
Income before income
tax (benefit) expense 1,419,592 3,518,303 10,963,068 8,988,626
----------- ----------- ------------ ------------
INCOME TAX (BENEFIT)
EXPENSE
Current ................ 910,365 2,337,022 2,897,546 3,147,607
Deferred ............... (920,965) (1,763,405) 189,652 (793,544)
----------- ----------- ------------ ------------
(10,600) 573,617 3,087,198 2,354,063
----------- ----------- ------------ ------------
Net income .........$ 1,430,192 $ 2,944,686 $ 7,875,870 $ 6,634,563
=========== =========== ============ ============
Net income per common
share - basic and diluted $ .12 $ .26 $ .69 $ .58
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,442,717 11,374,729 11,423,035 11,357,957
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income ................. $ 1,430,192 $ 2,944,686 $ 7,875,870 $ 6,634,563
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding
gains (losses) arising
during the period,
before deferred income
tax expense (benefit) .. 11,807,739 3,776,003 11,368,051 (2,779,679)
Deferred income tax
expense (benefit) ...... 4,132,710 1,321,601 3,978,820 (972,891)
----------- ----------- ----------- -----------
7,675,029 2,454,402 7,389,231 (1,806,788)
----------- ----------- ----------- -----------
Reclassification
adjustment for (gains)
losses included in net
income, before income
tax expense (benefit) .. (585,140) 3,363,489 1,163,934 3,091,570
Income tax expense
(benefit) .............. 204,799 (1,177,222) (407,377) (1,082,050)
----------- ----------- ----------- -----------
(380,341) 2,186,267 756,557 2,009,520
----------- ----------- ----------- -----------
Other comprehensive
income ........... 7,294,688 4,640,669 8,145,788 202,732
----------- ----------- ----------- -----------
Total comprehensive
income ........... $ 8,724,880 $ 7,585,355 $16,021,658 $ 6,837,295
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
--------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 7,875,870 $ 6,634,563
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Balances resulting from related party
transactions with Employers Mutual:
Losses and settlement expenses ........ 19,758,981 6,188,287
Unearned premiums ..................... 10,215,251 10,611,036
Other policyholders' funds ............ 318,118 613,656
Indebtedness to related party ......... (18,655,769) (9,517,805)
Employee retirement plans ............. 955,883 1,016,478
Reinsurance receivables ............... (554,930) 3,070,496
Prepaid reinsurance premiums .......... (2,199,307) (833,095)
Commissions payable ................... (1,347,023) (632,287)
Interest payable ...................... (1,559,266) 671,719
Prepaid assets ........................ (1,556,967) (737,188)
Deferred policy acquisition costs ......... (1,763,508) (2,151,147)
Accrued investment income ................. 1,127,730 (402,216)
Accrued income taxes:
Current ................................. (2,502,465) 557,597
Deferred ................................ 189,652 (793,545)
Realized investment losses ................ 1,163,201 3,100,460
Other, net ................................ (1,528,778) (3,364,778)
------------ ------------
2,060,803 7,397,668
------------ ------------
Net cash provided by
operating activities .............. $ 9,936,673 $ 14,032,231
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Six months ended
June 30,
--------------------------
2003 2002
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 4,159,415 $ 5,474,136
Purchases of fixed maturity securities
available-for-sale .......................... (355,084,966) (114,264,640)
Disposals of fixed maturity securities
available-for-sale .......................... 365,111,374 111,323,992
Purchases of equity securities
available-for-sale .......................... (14,067,053) (25,850,242)
Disposals of equity securities
available-for-sale .......................... 13,709,963 16,038,657
Purchase of other long-term investments ....... (750,000) (2,644,445)
Disposal of other long-term investments ....... 331,527 444,216
Net purchases of short-term investments ....... (24,811,490) (13,764,113)
------------ ------------
Net cash used in investing activities ..... (11,401,230) (23,242,439)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related party
transactions with Employers Mutual:
Issuance of common stock .................. 1,151,078 1,174,941
Issuance of surplus note .................. - 11,000,000
Dividends paid to Employers Mutual ........ (3,164,141) (2,706,041)
Dividends paid to public stockholders ......... (683,571) (704,213)
------------ ------------
Net cash (used) provided by financing
activities .............................. (2,696,634) 8,764,687
------------ ------------
NET DECREASE IN CASH ............................ (4,161,191) (445,521)
Cash at beginning of year ....................... (119,097) 558,073
------------ ------------
Cash at end of quarter .......................... $ (4,280,288) $ 112,552
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2003
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States (GAAP) for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. The results of operations for the interim
periods reported are not necessarily indicative of results to be expected for
the year.
The consolidated balance sheet at December 31, 2002 has been derived from
the audited financial statements at that date but does not include all of the
information and notes required by GAAP for complete financial statements.
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 2002 Form 10-K or the 2002 Annual Report to Shareholders for more
detailed footnote information.
2. STOCK BASED COMPENSATION
Prior to the fourth quarter of 2002, the Company had concluded that it
was not subject to the accounting requirements of Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations, since it receives the current fair value for any common stock
issued under Employers Mutual Casualty Company's (Employers Mutual) stock
option plans. As a result, the Company was recognizing as compensation
expense its pool participation share of the stock option expense recorded by
Employers Mutual for these plans. During the fourth quarter of 2002, the
Company concluded that it is subject to the accounting requirements of APB 25
and, accordingly, should not be recognizing compensation expense from
Employers Mutual's stock option plans since the exercise price of the options
is equal to the fair value of the stock at the date of grant. The results for
the three and six months ended June 30, 2002 reflect (income) expense after
tax of ($22,031) and $99,415, respectively, associated with stock options.
Since these amounts are not material, the financial statements for the three
and six months ended June 30, 2002 have not been restated.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2003
The Company accounts for the stock option plans using the recognition and
measurement principles of the intrinsic value method (APB 25). The following
table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to Employers Mutual's stock option plans:
Three months ended Six months ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported ...... $1,430,192 $2,944,686 $7,875,870 $6,634,563
Add (deduct):
Stock-based compensation
(income) expense reported
in net income, net of
related tax effects ...... - (22,031) - 99,415
Stock-based compensation
expense determined under
fair value method for all
awards, net of related
tax effects .............. (6,346) (4,748) (12,692) (9,496)
---------- ---------- ---------- ----------
Pro forma net income ......... $1,423,846 $2,917,907 $7,863,178 $6,724,482
========== ========== ========== ==========
Net income per share:
Basic and diluted -
As reported .............. $0.12 $0.26 $.69 $.58
Basic and diluted -
Pro forma ................ $0.12 $0.26 $.69 $.59
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2003
Property
Three months ended and casualty Parent
June 30, 2003 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 60,342,141 $ 21,635,627 $ 81,977,768
Underwriting loss .... (5,684,419) (307,199) (5,991,618)
Net investment income 5,187,381 2,193,977 $ 5,698 7,387,056
Realized investment
gains .............. 415,383 171,201 - 586,584
Other income ......... 264,328 - - 264,328
Interest expense ..... (193,125) (84,975) - (278,100)
Other expense ........ (333,238) - (215,420) (548,658)
------------ ------------ ------------ ------------
(Loss) income before
income tax (benefit)
expense ............ $ (343,690) $ 1,973,004 $ (209,722) $ 1,419,592
============ ============ ============ ============
Property
Three months ended and casualty Parent
June 30, 2002 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 55,367,753 $ 17,980,935 $ 73,348,688
Underwriting loss .... (607,379) (462,583) (1,069,962)
Net investment income 6,027,417 2,279,541 $ 39,357 8,346,315
Realized investment
(losses) gains ..... (2,305,356) (1,072,336) 5,313 (3,372,379)
Other income ......... 260,163 - - 260,163
Interest expense ..... (335,328) (4,747) - (340,075)
Other expense ........ (179,429) - (126,330) (305,759)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 2,860,088 $ 739,875 $ (81,660) $ 3,518,303
============ ============ ============ ============
Property
Six months ended and casualty Parent
June 30, 2003 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $119,547,945 $ 42,811,721 $162,359,666
Underwriting loss .... (1,214,328) (604,269) (1,818,597)
Net investment income 10,738,318 4,439,732 $ 55,930 15,233,980
Realized investment
losses ............. (943,531) (219,670) - (1,163,201)
Other income ......... 432,158 - - 432,158
Interest expense ..... (533,112) (230,954) - (764,066)
Other expense ........ (610,422) - (346,784) (957,206)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 7,869,083 $ 3,384,839 $ (290,854) $ 10,963,068
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2003
Property
Six months ended and casualty Parent
June 30, 2002 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $107,811,323 $ 34,046,757 $141,858,080
Underwriting loss .... (1,797,381) (1,860,627) (3,658,008)
Net investment income 12,035,034 4,498,920 $ 71,072 16,605,026
Realized investment
(losses) gains ..... (2,056,396) (1,049,377) 5,313 (3,100,460)
Other income ......... 377,275 - - 377,275
Interest expense ..... (666,972) (4,747) - (671,719)
Other expense ........ (330,657) - (232,831) (563,488)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 7,560,903 $ 1,584,169 $ (156,446) $ 8,988,626
============ ============ ============ ============
4. INCOME TAXES
The actual income tax (benefit) expense for the three and six months
ended June 30, 2003 and 2002 differed from the "expected" tax expense for
those periods (computed by applying the United States federal corporate tax
rate of 35 percent to income before income tax expense (benefit)) as follows:
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Computed "expected" tax
expense ................ $ 496,857 $ 1,231,406 $ 3,837,074 $ 3,146,019
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (480,265) (360,715) (885,541) (725,169)
Proration of
tax-exempt interest
and dividends
received deduction 43,635 41,677 83,909 82,817
Other, net ........... (70,827) (338,751) 51,756 (149,604)
----------- ----------- ----------- -----------
Income tax
(benefit)
expense ........ $ (10,600) $ 573,617 $ 3,087,198 $ 2,354,063
=========== =========== =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2003
5. NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement is generally
effective for contracts entered into or modified after June 30, 2003.
Currently, the Company's investment strategy does not include investments in
derivative instruments or hedging activities. Therefore, adoption of this
statement will not have any effect on the operating results of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS 150 establishes standards for how an issuer measures certain financial
instruments with characteristics of both liabilities and equity and it
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). This Statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. 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., an 80.7 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 73.6
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, nor 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 investment
and income tax activities of the reinsurance subsidiary are not subject to the
quota share agreement.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been
included. The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year.
CONSOLIDATED RESULTS OF OPERATIONS
Net income for the three months and six months ended June 30, 2003 and
2002 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
REVENUES
Premiums earned ..................... $ 81,978 $ 73,349 $162,360 $141,858
Net investment income ............... 7,387 8,346 15,234 16,605
Realized investment gains (losses) .. 587 (3,372) (1,163) (3,100)
Other income ........................ 264 260 432 377
-------- -------- -------- --------
90,216 78,583 176,863 155,740
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ...... 62,622 51,216 112,849 99,767
Acquisition and other expenses ...... 25,348 23,202 51,330 45,749
Interest expense .................... 278 340 764 672
Other expense ....................... 549 306 957 563
-------- -------- -------- --------
88,797 75,064 165,900 146,751
-------- -------- -------- --------
Income before income tax (benefit)
expense ........................... 1,419 3,519 10,963 8,989
Income tax (benefit) expense ........ (11) 574 3,087 2,354
-------- -------- -------- --------
Net income .......................... $ 1,430 $ 2,945 $ 7,876 $ 6,635
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 59,145 $ 52,796 $108,686 $102,498
Increase (decrease) in provision
for insured events of prior
years ......................... 3,477 (1,580) 4,163 (2,731)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 62,622 $ 51,216 $112,849 $ 99,767
======== ======== ======== ========
Catastrophe and storm losses ........ $ 10,341 $ 3,936 $ 11,428 $ 4,819
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Net income declined for the three months but improved for the six months
ended June 30, 2003 compared to the same periods in 2002. The decline in net
income for the second quarter of 2003 is attributed to the property and
casualty insurance segment, which experienced a high level of storm losses and
a significant amount of adverse development on prior years' reserves. Despite
the decline in second quarter results, net income improved for the six months
ended June 30, 2003 due to fundamental improvements in pricing, prudent risk
selection and careful claims management. The initiatives implemented in
recent years to improve profitability have been successful and this trend is
expected to continue during the remainder of 2003.
Premiums earned increased 11.8 percent for the three months and 14.5
percent for the six months ended June 30, 2003 from the same periods in 2002.
These increases are primarily due to rate increases that were implemented
during the last two years in the property and casualty insurance business and
growth and improved pricing in the assumed reinsurance business. The Company
continued to implement rate increases in the property and casualty insurance
business during the first six months of 2003 and additional rate increases are
anticipated for the remainder of 2003. These rate increases will be targeted
to specific territories and lines of business and generally will be smaller
than the rate increases implemented during the past several months. Policy
counts have declined slightly as the Company continues to concentrate on rate
adequacy and is non-renewing under-priced or under-performing accounts.
Net investment income decreased 11.5 percent for the three months and 8.3
percent for the six months ended June 30, 2003 from the same periods in 2002.
These decreases are primarily attributable to the lingering low interest rate
environment. Proceeds from called and maturing securities are being
reinvested at the current lower interest rates, resulting in a lower rate of
return.
The Company reported a net realized investment gain of $587,000 for the
three months ended June 30, 2003, but posted a net realized investment loss of
$1,163,000 for the six months ended June 30, 2003. Included in the losses of
2003 is $1,567,000 of impairment losses recognized on the Company's equity
portfolio during the first quarter and $2,689,000 of net losses recognized by
the Company's equity managers during the first quarter as they rebalanced the
Company's portfolios to enhance future returns. The Company also recognized
$4,342,000 of losses during the first quarter from the sale of its American
Airlines and United Airlines bonds. At December 31, 2002, these bonds were
collateralized by aircraft with an appraised value sufficient to recover the
Company's investment; however, during the first quarter of 2003 the value of
this collateral declined below the Company's investment as a result of the war
with Iraq, a significant decline in air travel, and the prospects of a
bankruptcy filing by American Airlines and a liquidation of United Airlines.
These losses were largely offset by gains recognized on the sale of certain
bond and equity investments during the first and second quarters of 2003. The
Company did not recognize any investment impairment losses in the second
quarter of 2003. The realized investment losses reported in the second
quarter of 2002 reflect a $3,821,000 impairment write down of the Company's
investment in MCI Communications Corporation corporate bonds.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Losses and settlement expenses increased 22.3 percent for the three
months and 13.1 percent for the six months ended June 30, 2003 from the same
periods in 2002. These increases are largely attributed to a significant
increase in storm activity and a strengthening of loss and settlement expense
reserves in the property and casualty insurance segment during the second
quarter. Despite the increase in loss experience reported in the second
quarter, the quality of the Company's underlying book of business has improved
over the last several years due to the implementation of more stringent
underwriting standards and changes in agent compensation.
Acquisition and other expenses increased 9.2 percent for the three months
and 12.2 percent for the six months ended June 30, 2003 compared to the same
periods in 2002. These increases are primarily attributed to an increase in
commission expense, which reflects the growth in premium volume experienced
during the first six months of 2003 as well as commission expense associated
with increased participation in the MRB reinsurance pool by Employers Mutual,
which is assumed by the Company's reinsurance subsidiary. Higher contingent
commission expense from the property and casualty insurance segment during
2003, in the form of agents' profit share expenses, was offset by a sharp
decline in contingent commission expense in the reinsurance subsidiary during
the second quarter of 2003. Increased employee benefits costs and a decline
in the amount of acquisition expenses deferred during each of the first two
quarters of 2003 also contributed to the increase in acquisition and other
expenses.
The Company incurred $278,000 and $764,000 of interest expense on surplus
notes during the three months and six months ended June 30, 2003 compared to
$340,000 and $672,000 for the same periods in 2002. The decline in interest
expense for the second quarter of 2003 is attributed to the fact that the
surplus notes were refinanced with Employers Mutual effective April 1, 2003 at
a rate of 3.09 percent. Previously, $25,000,000 of the surplus notes carried
an interest rate of 5.38 percent and $11,000,000 of the surplus notes carried
an interest rate of 5.25 percent. The increase in interest expense for the
six months ended June 30, 2003 reflects the fact that $11,000,000 of the
surplus notes were issued on June 27, 2002 and therefore only incurred four
days of interest expense at June 30, 2002. The interest expense incurred on
these surplus notes did not have a material impact on the Company's results of
operations as the proceeds of the surplus notes were invested and earned a
similar amount of interest income.
Income tax expense declined for the three months but increased for the
six months ended June 30, 2003 from the same periods in 2002. These
fluctuations primarily reflect the changes in pre-tax income for these
periods. Effective April 1, 2003, the Company was included in Employers
Mutual's consolidated tax return due to the fact that Employers Mutual
attained 80 percent ownership of the Company at the end of March. The Company
will file a short-period tax return for the period January 1, 2003 through
March 31, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Prior to the fourth quarter of 2002, the Company had concluded that it
was not subject to the accounting requirements of Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations, since it receives the current fair value for any common stock
issued under Employers Mutual's stock option plans. As a result, the Company
was recognizing as compensation expense its pool participation share of the
stock option expense recorded by Employers Mutual for these plans. During the
fourth quarter of 2002, the Company concluded that it is subject to the
accounting requirements of APB 25 and, accordingly, should not be recognizing
compensation expense from Employers Mutual's stock option plans since the
exercise price of the options is equal to the fair value of the stock at the
date of grant. The results for the three and six months ended June 30, 2002
reflect (income) expense after tax of ($22,000) and $99,000, respectively,
associated with stock options. Since these amounts are not material, the
financial statements for the three and six months ended June 30, 2002 have not
been restated.
SEGMENT RESULTS
Property and Casualty Insurance
(Loss) income before income tax (benefit) expense for the three months
and six months ended June 30, 2003 and 2002 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Premiums earned ..................... $ 60,342 $ 55,368 $119,548 $107,811
Losses and settlement expenses ...... 45,638 38,871 80,927 75,090
Acquisition and other expenses ...... 20,388 17,103 39,835 34,518
-------- -------- -------- -------
Underwriting loss ................... (5,684) (606) (1,214) (1,797)
Net investment income ............... 5,187 6,027 10,738 12,035
Realized gains (losses) ............. 416 (2,305) (943) (2,056)
Other income ........................ 264 260 432 377
Interest expense .................... 193 335 533 667
Other expense ....................... 334 181 611 331
-------- -------- -------- --------
(Loss) income before income tax
(benefit) expense ................. $ (344)$ 2,860 $ 7,869 $ 7,561
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 41,287 $ 40,075 $ 77,950 $ 78,778
Increase (decrease) in provision
for insured events of prior
years ......................... 4,351 (1,204) 2,977 (3,688)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 45,638 $ 38,871 $ 80,927 $ 75,090
======== ======== ======== ========
Catastrophe and storm losses ........ $ 9,090 $ 3,513 $ 10,003 $ 4,172
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premiums earned increased 9.0 percent for the three months and 10.9
percent for the six months ended June 30, 2003 from the same periods in 2002.
These increases are primarily attributable to rate increases that were
implemented during the last two years. The rate level increases implemented
during 2002 were broad based in nature. As a result of these increases and
those implemented during the prior two years, the Company's premium rate
levels for most lines of business were considered to be at, or near, adequate
levels at December 31, 2002. Accordingly, moderate and more targeted rate
increases have been implemented during the first six months of 2003, and
similar actions are anticipated for the remainder of the year. This fine
tuning of the Company's rate structure is being directed toward specific
territories and lines of business where additional rate increases are
warranted. Due to the timing of policy renewals and the earning of premiums
ratably over the terms of the underlying policies, a time delay exists for
implemented rate increases to have a noticeable impact on premiums earned.
Premiums earned in 2003 will reflect this delay and, therefore, are expected
to continue to show strong growth as the rate increases obtained in 2002
become earned.
Losses and settlement expenses increased 17.4 percent for the three
months and 7.8 percent for the six months ended June 30, 2003 as compared to
the same periods in 2002. The large increase for the second quarter of 2003
is attributed to a significant increase in storm losses and adverse
development on prior years' reserves. Storm losses for the first six months
of 2003 are comparable in amount to those experienced during the storm-plagued
first six months of 2001; however, the impact of these losses was not as
severe because premium rates are much more adequate now than they were in
2001. The adverse development on prior years' reserves is primarily related
to a strengthening of loss reserves in the workers' compensation line of
business and a general strengthening of settlement expense reserves. These
reserve increases were implemented in response to recently completed actuarial
projections. The Company monitors claims activity and performs actuarial
analyses and projections of loss and settlement expense reserves on a regular
basis. As necessary, reserves are strengthened in accordance with established
practices that attempt to maintain consistently adequate levels of reserves.
Loss frequency continued its downward trend in the second quarter of 2003
while loss severity continued to increase.
Acquisition and other expenses increased 19.2 percent for the three
months and 15.4 percent for the six months ended June 30, 2003 as compared to
the same periods in 2002. These increases are primarily related to the growth
in premium income noted above, but also reflect an increase in contingent
commission expense, a decline in the amount of acquisition expenses deferred
during each of the first two quarters of 2003 and higher employee benefit
costs. Policyholder dividends increased significantly during the second
quarter of 2003 but remained below the 2002 amount for the first six months of
the year. Policyholder dividends are expected to continue to increase due to
the improving profitability of the underlying insurance policies.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Underwriting results for the property and casualty insurance segment
declined sharply in the second quarter of 2003, but improved for the first
half of 2003 in comparison to the same periods in 2002. The results for the
second quarter of 2003 were negatively impacted by a combination of high storm
losses and adverse development on prior years' reserves, but the quality of
the underlying book of business has improved as a result of improved premium
rate adequacy and more stringent underwriting standards. The implemented rate
increases of the last two years have pushed premium rate levels for most lines
of business to adequate, or near adequate, levels. Results for the second
half of 2003 will benefit from the current rate levels, but the unpredictable
nature of catastrophe and storm losses will remain. Underwriting for
profitability is always stressed, but has become even more critical in light
of the current low interest rate environment and the protracted decline in the
equity markets. New and renewal business is being closely scrutinized to
ensure that there is potential for an underwriting profit.
Reinsurance
Income before income tax expense for the three months and six months
ended June 30, 2003 and 2002 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Premiums earned ..................... $ 21,636 $ 17,981 $ 42,812 $ 34,047
Losses and settlement expenses ...... 16,984 12,345 31,922 24,677
Acquisition and other expenses ...... 4,960 6,099 11,495 11,231
-------- -------- -------- --------
Underwriting loss ................... (308) (463) (605) (1,861)
Net investment income ............... 2,195 2,280 4,441 4,499
Realized gains (losses) ............. 171 (1,072) (220) (1,049)
Interest expense .................... 85 5 231 5
-------- -------- -------- --------
Income before income tax expense .... $ 1,973 $ 740 $ 3,385 $ 1,584
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 17,858 $ 12,721 $ 30,736 $ 17,033
(Decrease) increase in
provision for insured events
of prior years ................ (874) (376) 1,186 957
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 16,984 $ 12,345 $ 31,922 $ 24,677
======== ======== ======== ========
Catastrophe losses .................. $ 1,251 $ 423 $ 1,425 $ 647
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premium income increased 20.3 percent for the three months and 25.7
percent for the six months ended June 30, 2003 from the same periods in 2002.
Approximately half of this growth is attributed to increased participation in
the MRB reinsurance pool. Employers Mutual's participation in this pool has
increased from 16.7 percent (one-sixth share) in 2001 to 20 percent (one-fifth
share) in 2002 to 25 percent (one-fourth share) in 2003. Also contributing to
the increase in premium income are rate increases implemented during the
January 2003 renewal season, an increase in the estimate of earned but not
reported premiums and continued growth in a marine syndicate account. Premium
rate increases on excess of loss contracts continued to moderate in the second
quarter of 2003 due to the influx of new capital into the reinsurance
marketplace; however, contracts with poor loss experience continued to receive
exceptionally large rate increases. The rate increases of 2002 and 2003 have
been realized in conjunction with moderate declines in the related exposure
base due to increased retention levels and coverage exclusions for terrorist
activities. In addition, both excess of loss and pro-rata contracts are
benefiting from improved industry-wide rate levels at the primary company
level.
Losses and settlement expenses increased 37.6 percent for the three
months and 29.4 percent for the six months ended June 30, 2003 from the same
periods in 2002. These increases reflect the increase in the exposure base on
the MRB reinsurance pool and the marine syndicate account noted above. In
addition, the results of the second quarter of 2003 were adversely affected by
significant catastrophe losses. Storms that rolled through the Midwest during
the month of May resulted in the reinsurance subsidiary recognizing $1,250,000
of storm losses. The Company experienced favorable development on prior
years' reserves during the second quarter of both 2003 and 2002, but reported
adverse development for the first six months of both years. The majority of
the adverse development reported for the first six months of 2003 came from
ocean marine business; however, this development was offset by additional
premium income. The adverse development reported for the first six months of
2002 was primarily attributed to the MRB reinsurance pool.
Acquisition and other expenses decreased 18.7 percent for the three
months and increased 2.4 percent for the six months ended June 30, 2003 from
the same periods in 2002. The decrease for the three months is attributed to
a sharp decline in contingent commission expense. While this decrease is
attributed to several sources, including a decline of approximately $500,000
associated with the MRB pool and a marine syndicate account and a decline of
approximately $400,000 associated with the commutation of a retrocession
contract related to the World Trade Center catastrophe, it also reflects a
trend toward a reduction in the number of contracts with contingent commission
provisions. The increase for the six months ended June 30, 2003, though
largely offset by the decline in contingent commission expense for the second
quarter, is primarily attributed to the growth in premium volume during 2003.
Commission expense for the first six months of 2003 and 2002 includes $782,000
and $379,000, respectively, of commissions incurred in connection with the
increased participation in the MRB reinsurance pool noted above. To a lesser
extent, the increase in acquisition and other expenses was limited during the
first half of 2003 by a higher amount of deferred acquisition costs when
compared to the same period in 2002.
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 first six months of 2003 is primarily attributed to a significant
decline in contingent commission expense in the second quarter. Although
second quarter results were negatively impacted by catastrophe losses
associated with Midwest storms, premium rates on most reinsurance contracts
are now considered to be near adequate levels, which will benefit the results
for the remainder of the year. In addition to pricing its reinsurance
premiums at 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
The parent company reported a loss before income taxes of $210,000 and
$291,000 for the three months and six months ended June 30, 2003 compared to a
loss of $81,000 and $156,000 for the same periods in 2002. The amounts
reported for 2003 reflect an increase in operating expenses and a decline in
investment income.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of its 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. At June 30, 2003, approximately 29 percent of the Company's fixed
maturity securities were in U.S. government or U.S. government agency issued
securities. A variety of maturities are maintained in the Company's portfolio
to assure adequate liquidity. The maturity structure of the fixed maturity
investments is also established by the relative attractiveness of yields on
short, intermediate and long-term securities. The Company does not invest in
any high-yield debt investments (commonly referred to as junk bonds.)
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 unrealized holding gains, net of deferred taxes, on fixed
maturity securities available-for-sale of $19,900,000 at June 30, 2003 and
$16,907,000 at December 31, 2002. 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 its portfolio as changing
conditions warrant.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
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. This program was temporarily suspended at December 31, 2002 to
eliminate financial ratio concerns expressed by certain regulatory
authorities.
The Company invested a net $418,000 in the first half of 2003 and
$3,057,000 in 2002 into minor ownership interests in limited partnerships and
limited liability companies. The Company does not hold any other non-traded
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 $9,937,000
during the first half of 2003 compared to $14,032,000 for the same period in
2002.
Employers Mutual reinvested 50 percent of its dividends in additional
shares of the Company's common stock during the first quarter of 2003. As a
result of this dividend reinvestment, the Company became an 80 percent owned
subsidiary of Employers Mutual at the end of March. In order to build and
maintain a sufficient cushion above the 80 percent ownership threshold,
Employers Mutual increased it dividend reinvestment percentage to 75 percent
in the second quarter and announced two separate 30,000-share open market
stock purchase programs. Employers Mutual has notified the Company that it
will be reducing its dividend reinvestment percentage to 25 percent in the
third quarter of 2003. During 2002, Employers Mutual was reinvesting 25
percent of its dividends in additional shares of the Company's common stock.
As a result of becoming an 80 percent owned subsidiary of Employers
Mutual, the Company was included in Employers Mutual's consolidated tax return
effective April 1, 2003. The Company will file a short-period tax return for
the period January 1, 2003 through March 31, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Investment Impairments and Considerations
As of June 30, 2003, the Company has had one fixed maturity security
series, MCI Communications Corporation, and nine common stock issues that have
been determined to be "other than temporarily" impaired. MCI Communications
Corporation is owned by WorldCom Inc. (currently known as MCI), whose
corporate bonds were downgraded to junk status in May 2002 when it reported
the detection of accounting irregularities. The MCI Communications
Corporation bonds are supported by the assets of MCI Communications
Corporation; however, the magnitude of the WorldCom collapse cast doubt on the
prospect of collecting the entire amount of principal and interest payments
due the Company. As a result, on June 30, 2002 the Company recognized
$3,821,000 of realized loss when the carrying value of this investment was
reduced from an aggregate book value of $5,604,000 to the then current fair
value of $1,783,000. As of June 30, 2003, the fair value of the MCI
Communications Corporation bonds has partially recovered, resulting in
pre-tax unrealized gains of $1,035,000 recognized during 2002 and $1,559,000
recognized during the first half of 2003. During the first quarter of 2003,
the Company determined nine common stock issues were "other than temporarily"
impaired and recognized a realized loss of $1,567,000 when the carrying value
of these securities was reduced from an aggregate cost basis of $4,409,000 to
the then current fair value of $2,842,000. Four of these common stock issues
were sold during the second quarter of 2003, producing pre-tax realized gains
of $205,000. As of June 30,2003, the fair value of the remaining five common
stock issues partially recovered, resulting in a pre-tax unrealized gain of
$223,000. The factors surrounding these "other than temporary" impairments
did not have any impact on the carrying value of any other investments held
by the Company.
At June 30, 2003, the Company had unrealized losses on held-to-maturity
and available-for-sale securities as presented in the table below. The
estimated fair value is based on quoted market prices, where available, or on
values obtained from independent pricing services. None of these securities
are considered to be in concentrations by either security type or industry.
The Company uses several factors to determine whether the carrying value of an
individual security has been impaired. Such factors include, but are not
limited to, the security's value and performance in the context of the overall
market, key corporate events and collateralization of fixed maturity
securities. Based on these factors, and the Company's ability and intent to
hold these securities until maturity, it was determined that the carrying
value of these securities was not impaired at June 30, 2003. Risks and
uncertainties inherent in the methodology utilized in this evaluation process
include interest rate risk, equity price risk and the overall performance of
the economy, all of which have the potential to adversely affect the value of
the Company's investments. Should a determination be made at some point in
the future that these unrealized losses are "other than temporary", the
Company's earnings would be reduced by approximately $787,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Gross
unrealized
losses
----------
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities and obligations of U.S.
government corporations and agencies .............$ -
Mortgage-backed securities ......................... -
----------
Total securities held-to-maturity .............. -
----------
Securities available-for-sale:
Fixed maturity securities:
U.S. treasury securities and obligations of U.S.
government corporations and agencies ............. -
Obligations of states and political subdivisions ... 108,673
Mortgage-backed securities ......................... -
Debt securities issued by foreign governments ...... -
Public utilities ................................... -
Corporate securities ............................... 317,599
----------
Total fixed maturity securities ................ 426,272
----------
Equity securities:
Common stocks ...................................... 784,888
Non-redeemable preferred stocks .................... -
----------
Total equity securities ........................ 784,888
----------
Total securities available-for-sale ............ 1,211,160
----------
Total all securities ...........................$1,211,160
==========
Following is a schedule of the length of time the securities presented in
the above table have continuously been in an unrealized loss position.
Gross
Book Fair unrealized
value value loss
----------- ----------- -----------
Fixed maturity securities
available-for-sale:
Three months or less ...............$13,089,095 $12,980,422 $ 108,673
Over three months to six months .... - - -
Over six months to nine months ..... 1,000,000 960,000 40,000
Over nine months to twelve months .. - - -
Over twelve months ................. 8,853,952 8,576,353 277,599
----------- ----------- -----------
$22,943,047 $22,516,775 $ 426,272
=========== =========== ===========
Equity securities:
Three months or less ...............$ 4,144,303 $ 3,946,363 $ 197,940
Over three months to six months .... 1,091,356 983,157 108,199
Over six months to nine months ..... 192,007 165,440 26,567
Over nine months to twelve months .. 1,161,487 983,253 178,234
Over twelve months ................. 1,701,033 1,427,085 273,948
----------- ----------- -----------
$ 8,290,186 $ 7,505,298 $ 784,888
=========== =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Following is a schedule of gross realized losses recognized in 2003 along
with the associated book values and sales prices aged according to the length
of time the underlying securities were in an unrealized loss position. This
schedule does not include realized losses stemming from corporate actions such
as calls, pay-downs, redemptions, etc. The Company's equity portfolio is
managed on a "tax-aware" basis, which generally results in sales of securities
at a loss to offset sales of securities at a gain, thus minimizing the
Company's income tax expense. Fixed maturity securities are generally held
until maturity.
Gross
Book Sales realized
value price loss
----------- ----------- -----------
Fixed maturity securities
available-for-sale:
Three months or less ...............$ 186,263 $ 182,538 $ 3,725
Over three months to six months .... - - -
Over six months to nine months ..... - - -
Over nine months to twelve months .. - - -
Over twelve months ................. 11,271,963 6,712,404 4,559,559
----------- ----------- -----------
$11,458,226 $ 6,894,942 $ 4,563,284
=========== =========== ===========
Equity securities:
Three months or less ...............$ 3,000,649 $ 2,501,203 $ 499,446
Over three months to six months .... 2,459,980 1,978,160 481,820
Over six months to nine months ..... 4,792,049 3,164,333 1,627,716
Over nine months to twelve months .. 1,626,288 1,186,137 440,151
Over twelve months ................. 215,933 90,701 125,232
----------- ----------- -----------
$12,094,899 $ 8,920,534 $ 3,174,365
=========== =========== ===========
NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement is generally
effective for contracts entered into or modified after June 30, 2003.
Currently, the Company's investment strategy does not include investments in
derivative instruments or hedging activities. Therefore, adoption of this
statement will not have any effect on the operating results of the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS 150 establishes standards for how an issuer measures certain financial
instruments with characteristics of both liabilities and equity and it
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). This Statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. 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, CONTINUED
----------------------------------------------
(Unaudited)
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; rate competition; 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, CONTINUED
- ------- ---------------------------------------------------------------------
(Unaudited)
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 increased noticeably during 2002 and remain
present at June 30, 2003. As it relates to equity price risk, the recent bear
market resulted in a decline in the value of the Company's equity investments.
During the second quarter of 2003 the market appeared to show signs of
recovery, but much uncertainty remains. While credit quality risk was high in
2002, as evidenced by the decline in the values of several bond investments
stemming from the many high-profile bankruptcies and other downgrade
activities during this period, this risk appears to have substantially
declined during the first half of 2003. Prepayment risk increased, primarily
for the mortgage-backed securities, as the decline in interest rates during
2002 accelerated the payment of higher-interest rate mortgages through
refinancing activity. And finally, to a lesser extent, interest rate risk has
increased due to interest rates bottoming-out during this period. As of June
30, 2003 it appears interest rates may be poised for a rise, and refinancing
activity may be slowing. Future interest rate increases will result in a
decline in the value 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. DISCLOSURE CONTROLS AND PROCEDURES
- ------- ----------------------------------
As of the end of the period covered by this report, the Company's
management conducted an evaluation, under the supervision and with the
participation of the principal executive officer and principal financial
officer, of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act")). Based on that evaluation, the principal executive officer
and principal financial officer concluded that the Company's disclosure
controls and procedures are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.
There was no change in the Company's internal control over financial reporting
during the Company's most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ----------------------------------------------------
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 20, 2003
(b) The following seven persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter III Elwin H. Creese
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
----------------------- ---------- --------
George C. Carpenter III 11,052,314 21,432
Elwin H. Creese 11,052,354 21,392
David J. Fisher 11,052,928 20,818
Bruce G. Kelley 11,017,103 56,643
George W. Kochheiser 11,052,533 21,213
Raymond A. Michel 11,052,308 21,438
Fredrick A. Schiek 11,016,992 56,754
2. Proposal to ratify the appointment of Ernst & Young LLP as
the independent auditors of the Company:
For 11,057,673 Against 10,797 Withheld 5,276
---------- ------ -----
The total number of qualified shares voted by proxy
was: 11,073,746
(d) None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibit 31.1 Certification of the President and Chief Executive
Officer as required by Section 302 of the Sarbanes-
Oxley Act of 2002.
Exhibit 31.2 Certification of the Vice President and Chief Financial
Officer as required by Section 302 of the Sarbanes-
Oxley Act of 2002.
Exhibit 32.1 Certification of the 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 32.2 Certification of the 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
- ------- -------------------------------------------
(b) An 8-K was filed on April 9, 2003 announcing that Employers Mutual
Casualty Company would purchase up to 30,000 additional shares of
the Company's common stock on the open market during the second
quarter of 2003 in order to maintain the 80 percent ownership
threshold that it recently obtained.
An 8-K was filed on May 1, 2003 announcing the Company's financial
results for the first quarter of 2003 and Employers Mutual's second
30,000-share open-market stock purchase program to maintain the 80
percent ownership threshold of the Company.
An 8-K was filed on May 20, 2003 announcing the Company's declaration
of a quarterly dividend of fifteen cents per share of common stock
payable June 9, 2003 to shareholders of record as of June 2, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
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: August 14, 2003