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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 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
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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 October 31, 2003
----- -------------------------------
Common stock, $1.00 par value 11,494,418
Total pages 33
----
PART I. FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $21,753,439 and $61,639,037) ... $ 19,591,405 $ 55,033,675
Securities available-for-sale, at fair value
(amortized cost $384,384,236 and
$459,844,928) .............................. 410,137,457 485,855,966
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $33,465,539 and $0) ............ 30,647,575 -
Securities available-for-sale, at fair value
(amortized cost $95,304,043 and $0) ........ 95,523,795 -
Equity securities available-for-sale, at fair
value (cost $39,363,953 and $38,444,030) ..... 44,283,952 34,596,985
Other long-term investments, at cost ........... 3,737,307 3,057,000
Short-term investments, at cost ................ 41,628,042 29,650,230
------------ ------------
Total investments ........................ 645,549,533 608,193,856
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 14,971,636 11,582,136
Prepaid reinsurance premiums ................. 5,421,803 2,442,899
Intangible asset, defined benefit
retirement plan ............................ 1,411,716 1,411,716
Other assets ................................. 2,773,391 1,331,816
Indebtedness of related party ................ 17,894,094 -
Cash ............................................. 470,899 (119,097)
Accrued investment income ........................ 7,047,430 9,179,555
Accounts receivable (net of allowance for
uncollectible accounts of $7,297 and $7,297) ... 655,332 772,944
Income taxes recoverable ......................... - 213,504
Deferred policy acquisition costs ................ 29,056,226 24,926,861
Deferred income taxes ............................ 11,318,163 13,986,172
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 131,944,998 -
------------ ------------
Total assets ............................. $869,456,807 $674,863,948
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
------------ ------------
(Unaudited)
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............... $357,126,346 $331,226,753
Unearned premiums ............................ 137,495,558 115,746,814
Other policyholders' funds ................... 1,620,877 1,035,622
Surplus notes payable ........................ 36,000,000 36,000,000
Indebtedness to related party ................ - 3,304,539
Employee retirement plans .................... 11,448,173 10,014,349
Other liabilities ............................ 19,556,391 19,767,507
Income taxes payable ............................. 401,528 -
Securities lending obligation .................... 131,944,998 -
------------ ------------
Total liabilities ........................ 695,593,871 517,095,584
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,494,418
shares in 2003 and 11,399,050 shares in 2002 ... 11,494,418 11,399,050
Additional paid-in capital ....................... 68,981,930 67,270,591
Accumulated other comprehensive income ........... 19,892,166 14,218,330
Retained earnings ................................ 73,494,422 64,880,393
------------ ------------
Total stockholders' equity ............... 173,862,936 157,768,364
------------ ------------
Total liabilities and stockholders' equity $869,456,807 $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 net investment income,
realized investment gains (losses) and income tax expense (benefit), are the
result of related party transactions with Employers Mutual.
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ------------ ------------
REVENUES
Premiums earned .........$84,210,207 $74,979,176 $246,569,873 $216,837,256
Net investment income ... 7,013,882 7,934,259 22,247,862 24,539,285
Realized investment
gains (losses) ........ 1,174,178 (1,340,914) 10,977 (4,441,374)
Other income ............ 195,993 190,584 628,151 567,859
----------- ----------- ------------ ------------
92,594,260 81,763,105 269,456,863 237,503,026
----------- ----------- ------------ ------------
LOSSES AND EXPENSES
Losses and settlement
expenses .............. 56,508,783 52,335,783 169,357,490 152,102,635
Dividends to
policyholders ......... 912,633 567,313 2,529,162 2,319,931
Amortization of deferred
policy acquisition
costs ................. 17,503,086 15,685,552 52,829,948 47,175,214
Other underwriting
expenses .............. 8,132,401 6,420,699 22,518,566 18,927,655
Interest expense ........ 278,100 484,575 1,042,166 1,156,294
Other expenses .......... 336,443 297,403 1,293,649 860,891
----------- ----------- ------------ ------------
83,671,446 75,791,325 249,570,981 222,542,620
----------- ----------- ------------ ------------
Income before income
tax expense (benefit) 8,922,814 5,971,780 19,885,882 14,960,406
----------- ----------- ------------ ------------
INCOME TAX EXPENSE
(BENEFIT)
Current ............... 3,117,497 617,981 6,015,043 3,765,588
Deferred .............. (576,787) 1,052,614 (387,135) 259,070
----------- ----------- ------------ ------------
2,540,710 1,670,595 5,627,908 4,024,658
----------- ----------- ------------ ------------
Net income ........$ 6,382,104 $ 4,301,185 $ 14,257,974 $ 10,935,748
=========== =========== ============ ============
Net income per common
share - basic and diluted $ .56 $ .38 $ 1.25 $ .96
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .45 $ .45
=========== =========== ============ ============
Average number of common
shares outstanding -
basic and diluted ....... 11,471,458 11,391,128 11,439,176 11,369,014
=========== =========== ============ ============
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,
----------------------- -----------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income ................. $ 6,382,104 $ 4,301,185 $14,257,974 $10,935,748
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding
(losses) gains arising
during the period,
before deferred income
tax (benefit) expense .. (2,628,828) 8,911,347 8,739,223 6,131,668
Deferred income tax
(benefit) expense ...... (920,092) 3,118,971 3,058,728 2,146,080
----------- ----------- ----------- -----------
(1,708,736) 5,792,376 5,680,495 3,985,588
----------- ----------- ----------- -----------
Reclassification
adjustment for (gains)
losses included in net
income, before income
tax expense (benefit) .. (1,174,178) 1,349,804 (10,244) 4,441,374
Income tax expense
(benefit) .............. 410,962 (472,431) 3,585 (1,554,481)
----------- ----------- ----------- -----------
(763,216) 877,373 (6,659) 2,886,893
----------- ----------- ----------- -----------
Other comprehensive
(loss) income .... (2,471,952) 6,669,749 5,673,836 6,872,481
----------- ----------- ----------- -----------
Total comprehensive
income ........... $ 3,910,152 $10,970,934 $19,931,810 $17,808,229
=========== =========== =========== ===========
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,
--------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 14,257,974 $ 10,935,748
------------ ------------
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 ........ 25,899,593 9,328,364
Unearned premiums ..................... 21,748,744 24,809,804
Other policyholders' funds ............ 585,255 563,086
Indebtedness to related party ......... (21,198,633) (20,127,795)
Employee retirement plans ............. 1,433,824 1,524,284
Reinsurance receivables ............... (3,389,500) 3,627,587
Prepaid reinsurance premiums .......... (2,978,904) (1,265,682)
Commissions payable ................... 569,978 73,705
Interest payable ...................... (1,281,166) 1,152,528
Prepaid assets ........................ (1,070,154) (466,790)
Deferred policy acquisition costs ......... (4,129,365) (5,179,707)
Accrued investment income ................. 2,132,125 1,146,746
Accrued income taxes:
Current ................................. 615,032 (134,421)
Deferred ................................ (387,135) 259,069
Realized investment (gains) losses......... (10,977) 4,441,374
Other, net ................................ (421,683) (2,620,167)
------------ ------------
18,117,034 17,131,985
------------ ------------
Net cash provided by
operating activities .............. $ 32,375,008 $ 28,067,733
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Nine months ended
September 30,
--------------------------
2003 2002
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 4,815,628 $ 6,304,505
Purchases of fixed maturity securities
available-for-sale .......................... (540,980,844) (162,124,817)
Disposals of fixed maturity securities
available-for-sale .......................... 525,372,420 142,278,735
Purchases of equity securities
available-for-sale .......................... (27,898,895) (31,416,776)
Disposals of equity securities
available-for-sale .......................... 23,402,039 21,521,555
Purchase of other long-term investments ....... (1,121,380) (4,061,808)
Disposal of other long-term investments ....... 441,072 432,308
Net purchases of short-term investments ....... (11,977,814) (8,943,700)
------------ ------------
Net cash used in investing activities ..... (27,947,774) (36,009,998)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related party
transactions with Employers Mutual:
Issuance of common stock .................. 1,806,707 1,214,036
Issuance of surplus note .................. - 11,000,000
Dividends paid to Employers Mutual ........ (4,626,962) (4,062,927)
Dividends paid to public stockholders ......... (1,016,983) (1,056,155)
------------ ------------
Net cash (used) provided by financing
activities .............................. (3,837,238) 7,094,954
------------ ------------
NET INCREASE (DECREASE) IN CASH ................. 589,996 (847,311)
Cash at beginning of year ....................... (119,097) 558,073
------------ ------------
Cash at end of quarter .......................... $ 470,899 $ (289,238)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 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 nine months ended September 30, 2002 reflect (income)
expense after tax of ($92,624) and $6,791, respectively, associated with
stock options. Since these amounts are not material, the financial
statements for the three and nine months ended September 30, 2002 have not
been restated.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 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 Nine months ended
September 30, September 30,
---------------------- ------------------------
2003 2002 2003 2002
---------- ---------- ----------- -----------
Net income, as reported ....$6,382,104 $4,301,185 $14,257,974 $10,935,748
Add (deduct):
Stock-based compensation
(income) expense
reported in net income,
net of related tax
effects ................ - (92,624) - 6,791
Stock-based compensation
expense determined under
fair value method for
all awards, net of
related tax effects .... (6,346) (4,748) (19,038) (14,244)
---------- ---------- ----------- -----------
Pro forma net income .......$6,375,758 $4,203,813 $14,238,936 $10,928,295
========== ========== =========== ===========
Net income per share:
Basic and diluted -
As reported ............ $0.56 $0.38 $1.25 $.96
Basic and diluted -
Pro forma .............. $0.56 $0.37 $1.24 $.96
3. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2003
Property
Three months ended and casualty Parent
September 30, 2003 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ......$ 61,322,190 $ 22,888,017 $ 84,210,207
Underwriting (loss)
gain ............... (4,731,712) 5,885,016 1,153,304
Net investment income
(loss) ............. 4,880,947 2,168,690 $ (35,755) 7,013,882
Realized investment
gains .............. 1,058,176 116,002 - 1,174,178
Other income ......... 195,993 - - 195,993
Interest expense ..... (193,125) (84,975) - (278,100)
Other expense ........ (201,223) - (135,220) (336,443)
------------ ------------ ------------ ------------
Income (loss) before
income tax (benefit)
expense ............$ 1,009,056 $ 8,084,733 $ (170,975) $ 8,922,814
============ ============ ============ ============
Property
Three months ended and casualty Parent
September 20, 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
============ ============ ============ ============
Property
Nine months ended and casualty Parent
September 30, 2003 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ..... $180,870,135 $ 65,699,738 $246,569,873
Underwriting (loss)
gain .............. (5,946,040) 5,280,747 (665,293)
Net investment income 15,619,265 6,608,422 $ 20,175 22,247,862
Realized investment
gains (losses) .... 114,645 (103,668) - 10,977
Other income ........ 628,151 - - 628,151
Interest expense .... (726,237) (315,929) - (1,042,166)
Other expense ....... (811,645) - (482,004) (1,293,649)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) ......... $ 8,878,139 $ 11,469,572 $ (461,829) $ 19,885,882
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2003
Property
Nine months ended and casualty Parent
September 20, 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
============ ============ ============ ============
4. INCOME TAXES
The actual income tax expense for the three and nine months ended
September 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) as follows:
Three months ended Nine months ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Computed "expected" tax
expense ............... $ 3,122,985 $ 2,090,123 $ 6,960,059 $ 5,236,142
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............ (423,739) (392,798) (1,309,280) (1,117,967)
Proration of
tax-exempt interest
and dividends
received deduction 42,140 40,605 126,049 123,422
Other, net .......... (200,676) (67,335) (148,920) (216,939)
----------- ----------- ----------- -----------
Income tax
expense ....... $ 2,540,710 $ 1,670,595 $ 5,627,908 $ 4,024,658
=========== =========== =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
September 30, 2003
5. CONTINGENT LIABILITIES
The Company and Employers Mutual and its other subsidiaries are parties
to numerous lawsuits arising in the normal course of the insurance business.
The Company believes that the resolution of these lawsuits will not have a
material adverse effect on its financial condition or its results of
operations. The companies involved have reserves which are believed adequate
to cover any potential liabilities arising out of all such pending or
threatened proceedings.
The members of the pooling agreement have purchased annuities from
various companies to fund future payments that are fixed pursuant to specific
claim settlement provisions. The Company, under the current terms of the
pooling agreement, is contingently liable for 23.5 percent of these
annuities. The Company believes the contingent liability to various claimants
in the event that the issuing company would be unable to fulfill its
obligations would not have a material adverse effect on its financial
condition or its results of operations.
6. 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 did 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 80.6 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 73.4
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 $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been
included. The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year.
CONSOLIDATED RESULTS OF OPERATIONS
Net income for the three months and nine months ended September 30, 2003
and 2002 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
REVENUES
Premiums earned ..................... $ 84,210 $ 74,979 $246,570 $216,837
Net investment income ............... 7,014 7,934 22,248 24,539
Realized investment gains (losses) .. 1,174 (1,341) 11 (4,441)
Other income ........................ 196 191 628 568
-------- -------- -------- --------
92,594 81,763 269,457 237,503
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ...... 56,508 52,336 169,357 152,103
Acquisition and other expenses ...... 26,548 22,673 77,878 68,422
Interest expense .................... 278 484 1,042 1,156
Other expense ....................... 337 298 1,294 861
-------- -------- -------- --------
83,671 75,791 249,571 222,542
-------- -------- -------- --------
Income before income tax expense .... 8,923 5,972 19,886 14,961
Income tax expense .................. 2,541 1,671 5,628 4,025
-------- -------- -------- --------
Net income .......................... $ 6,382 $ 4,301 $ 14,258 $ 10,936
======= ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 57,945 $ 50,352 $166,631 $152,850
(Decrease) increase in provision
for insured events of prior
years ......................... (1,437) 1,984 2,726 (747)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 56,508 $ 52,336 $169,357 $152,103
======== ======== ======== ========
Catastrophe and storm losses ........ $ 8,703 $ 1,125 $ 20,131 $ 5,944
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Net income improved for both the three months and nine months ended
September 30, 2003 compared to the same periods in 2002. These improvements
were largely driven by unusually good loss experience in the reinsurance
segment, which benefited from a significant decline in reported losses and
favorable development on prior year reserves during the third quarter. This
improvement in the operating results of the reinsurance segment more than
offset a continued high level of storm losses and some necessary reserve
strengthening that occurred in the property and casualty insurance segment
during the second and third quarters. As a result of the high level of storm
losses experienced during the third quarter, storm losses for the first nine
months of 2003 are greater than those experienced during the storm-plagued
first nine months of 2001; however, the impact of these losses is not as
severe because premium rate levels are much more adequate now than they were
in 2001.
Premiums earned increased 12.3 percent for the three months and 13.7
percent for the nine months ended September 30, 2003 from the same periods in
2002. These increases are primarily attributed to rate increases implemented
during the last two years in the property and casualty insurance business as
well as significant growth and improved pricing in the assumed reinsurance
business. The market for property and casualty insurance remained firm during
the third quarter of 2003 and this trend is expected to continue into 2004.
The Company has been able to implement moderate rate increases during the
first nine months of 2003 and additional rate increases are anticipated for
the remainder of the year. These increases will be targeted to specific
accounts, territories and lines of business where rates remain inadequate.
Policy counts have declined slightly as the Company continues to concentrate
on rate adequacy and is carefully reviewing under-priced or under-performing
accounts.
Net investment income decreased 11.6 percent for the three months and 9.3
percent for the nine months ended September 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 net realized investment gains of $1,174,000 for the
three months and $11,000 for the nine months ended September 30, 2003.
Reflected in the small gain for the nine months ended September 30, 2003 is
$1,567,000 of impairment losses recognized during the first quarter on the
Company's equity portfolio 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. These bonds were collateralized by
aircraft with an appraised value sufficient to recover the Company's
investment at December 31, 2002; 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 have been offset by gains recognized on the sale of
certain bond and equity investments during the first nine months of 2003. The
Company did not recognize any impairment losses during the second or third
quarter of 2003. The realized investment losses reported for the nine months
ended September 30, 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 8.0 percent for the three months
and 11.3 percent for the nine months ended September 30, 2003 from the same
periods in 2002. These increases, which are smaller than the increases in
earned premiums reported for these periods, were driven by unusually good loss
experience in the reinsurance segment during the third quarter. This
improvement in the loss experience of the reinsurance segment more than offset
a significant increase in storm activity for these periods and some necessary
reserve strengthening in the property and casualty insurance segment during
the second and third quarters. As reported on September 19, 2003, the Company
strengthened its bulk loss and settlement expense reserves by $4,583,000
during the third quarter of 2003 in response to a recently completed actuarial
evaluation of the carried reserves for the property and casualty insurance
segment. Actuarial evaluations of the Company's carried reserves are
performed on a regularly-scheduled basis and it is the Company's standard
practice to adjust its carried reserves as necessary in response to these
evaluations in an effort to maintain a consistent level of reserve adequacy.
Despite the moderate reserve strengthening that has occurred during the first
nine months of 2003, the quality of the Company's underlying book of business
has improved over the last several years due to a more focused underwriting
approach.
Acquisition and other expenses increased 17.1 percent for the three
months and 13.8 percent for the nine months ended September 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 nine months of 2003 as well as increased
participation in the MRB reinsurance pool by Employers Mutual, which is
assumed by the Company's reinsurance subsidiary. An increase in agent's
profit share expenses in the property and casualty insurance segment during
2003 was partially offset by a sharp decline in contingent commission expense
in the reinsurance subsidiary. Increased employee benefits costs also
contributed to the increase in acquisition and other expenses.
The Company incurred $278,000 and $1,042,000 of interest expense on
surplus notes during the three months and nine months ended September 30, 2003
compared to $484,000 and $1,156,000 for the same periods in 2002. The decline
in interest expense is attributed to the fact that these surplus notes were
refinanced with Employers Mutual effective April 1, 2003 at a reduced interest
rate of 3.09 percent. 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 increased for both the three months and nine months
ended September 30, 2003 from the same periods in 2002, primarily due to the
increase in pre-tax income reported 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 nine months ended September 30,
2002 reflect (income) expense after tax of ($92,000) and $7,000, respectively,
associated with stock options. Since these amounts are not material, the
financial statements for the three and nine months ended September 30, 2002
have not been restated.
SEGMENT RESULTS
Property and Casualty Insurance
Income before income tax expense for the three months and nine months
ended September 30, 2003 and 2002 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Premiums earned ..................... $ 61,322 $ 58,179 $180,870 $165,990
Losses and settlement expenses ...... 45,726 39,601 126,653 114,691
Acquisition and other expenses ...... 20,328 17,620 60,163 52,138
-------- -------- -------- --------
Underwriting (loss) income .......... (4,732) 958 (5,946) (839)
Net investment income ............... 4,881 5,634 15,619 17,669
Realized gains (losses) ............. 1,058 (1,372) 115 (3,428)
Other income ........................ 196 191 628 568
Interest expense .................... 193 339 726 1,006
Other expense ....................... 201 228 812 559
-------- -------- -------- --------
Income before income tax expense .... $ 1,009 $ 4,844 $ 8,878 $ 12,405
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 44,409 $ 38,671 $122,359 $117,449
Increase (decrease) in provision
for insured events of prior
years ......................... 1,317 930 4,294 (2,758)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 45,726 $ 39,601 $126,653 $114,691
======== ======== ======== ========
Catastrophe and storm losses ........ $ 7,004 $ 1,481 $ 17,007 $ 5,653
======== ======== ======== ========
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 5.4 percent for the three months and 9.0
percent for the nine months ended September 30, 2003 from the same periods in
2002. These increases are primarily attributable to rate increases that were
implemented during the last two years, as current policy counts have declined
in nearly all lines of business. The rate increases implemented during 2002
and 2001 were broad based in nature and resulted in premium rate levels for
most lines of business that 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 nine 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 accounts,
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 for 2003 reflect this delay and continue to show strong growth
as the rate increases obtained in 2002 become earned; however, the growth rate
for the third quarter, and to a lesser extent the first nine months of 2003,
has been limited by a decline in policy count that has resulted from the
careful review of under-priced and under-performing accounts and a general
decline in new business.
Losses and settlement expenses increased 15.5 percent for the three
months and 10.4 percent for the nine months ended September 30, 2003 compared
to the same periods in 2002. These increases are attributed to a significant
increase in storm losses and adverse development on prior years' reserves. As
a result of the large amount of storm losses experienced in the third quarter,
storm losses for the first nine months of 2003 exceed the amount experienced
during the storm-plagued first nine months of 2001; however, the impact of
these losses is 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, a strengthening of incurred but not reported
loss reserves, and a strengthening of settlement expense reserves in the
workers' compensation and other liability lines of business. Reserve
strengthening in the third quarter amounted to approximately $4,583,000 and
was based on a recently completed actuarial evaluation of the property and
casualty insurance segment's carried reserves. Actuarial evaluations of the
Company's carried reserves are performed on a regularly-scheduled basis and it
is the Company's standard practice to adjust its carried reserves as necessary
in response to these evaluations in an effort to maintain a consistent level
of reserve adequacy. The adjustment in reserves implemented in the third
quarter represents an increase of only 1.9 percent of the total loss and
settlement expense reserves carried by the property and casualty insurance
subsidiaries at June 30, 2003. Loss frequency continued its downward trend in
the third quarter of 2003 while loss severity continued to increase.
Acquisition and other expenses increased 15.4 percent for both the three
months and nine months ended September 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 and higher employee benefit costs.
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 for both the three months and the nine months ended September
30, 2003 compared to the same periods in 2002. Results for 2003 have been
negatively impacted by a high level of storm losses and some necessary reserve
strengthening, but the quality of the underlying book of business has improved
as a result of improved premium rate adequacy and a more focused underwriting
approach. Future underwriting results will benefit from the actions that have
been taken during 2003, 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 nine months
ended September 30, 2003 and 2002 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Premiums earned ..................... $ 22,888 $ 16,800 $ 65,700 $ 50,847
Losses and settlement expenses ...... 10,782 12,735 42,704 37,412
Acquisition and other expenses ...... 6,220 5,053 17,715 16,284
-------- -------- -------- --------
Underwriting income (loss) .......... 5,886 (988) 5,281 (2,849)
Net investment income ............... 2,168 2,277 6,609 6,776
Realized gains (losses) ............. 116 30 (104) (1,019)
Interest expense .................... 85 145 316 150
-------- -------- -------- --------
Income before income tax expense .... $ 8,085 $ 1,174 $ 11,470 $ 2,758
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 13,536 $ 11,681 $ 44,272 $ 35,401
(Decrease) increase in
provision for insured events
of prior years ................ (2,754) 1,054 (1,568) 2,011
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 10,782 $ 12,735 $ 42,704 $ 37,412
======== ======== ======== ========
Catastrophe losses .................. $ 1,699 $ (356) $ 3,124 $ 291
======== ======== ======== ========
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 36.2 percent for the three months and 29.2
percent for the nine months ended September 30, 2003 from the same periods in
2002. Approximately 40 percent of this growth is attributed to Employers
Mutual's participation in the MRB reinsurance pool, which 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. The large
increase for the three months ended September 30, 2003 also includes an early
booking of German industrial business that is typically reported in the fourth
quarter. Premium rate increases on excess of loss contracts continued to
moderate in the third 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
implemented in 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 decreased 15.3 percent for the three
months and increased 14.1 percent for the nine months ended September 30, 2003
from the same periods in 2002. The large decrease experienced for the three
months ended September 30, 2003 is attributed to an unusually low level of
reported loss activity during this period. This unusually low level of
reported loss activity was broad-based in nature, with both the proportional
and the excess-of-loss business reporting much improved results. The increase
in losses and expenses reported for the nine months ended September 30, 2003
primarily reflects the increase in the exposure base of the MRB reinsurance
pool and the marine syndicate account noted above. Results for both the three
months and nine months ended September 30, 2003 were adversely affected by a
significant increase in catastrophe losses. Storms that rolled through the
Midwest during the month of May generated $1,250,000 of catastrophe losses in
the second quarter and hurricane Isabel produced $1,000,000 of catastrophe
losses in the third quarter. The reinsurance subsidiary experienced a large
amount of favorable development on prior years' reserves during the third
quarter of 2003, more than offsetting the adverse development that had been
reported through the first six months of this year. The majority of this
favorable development is attributed to the 2002 accident year, which has
experienced a very low level of reported loss activity. The adverse
development reported in 2002 was primarily attributed to the MRB reinsurance
pool.
Acquisition and other expenses increased 23.1 percent for the three
months and 8.8 percent for the nine months ended September 30, 2003 from the
same periods in 2002. The increase for the three months ended September 30,
2003 is primarily attributed to the growth in premium volume noted above while
the increase for the nine months ended September 30, 2003 reflects a
significant decline in contingent commission expense. The decline in
contingent commission expense is attributed to several sources, including a
decline of approximately $420,000 associated with the MRB pool and a marine
syndicate account, a decline of approximately $400,000 associated with the
commutation of a retrocession contract related to the World Trade Center
catastrophe, and a general trend toward a reduction in the number of contracts
with contingent commission provisions. Commission expense for the first nine
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.
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 months and nine months ended September 30, 2003 is primarily
attributed to an unusually low level of loss activity and favorable
development experienced on prior years' reserves during the third quarter of
2003. A significant decline in contingent commission expense in the second
quarter of 2003 also contributed to the improvement in underwriting results
for the nine months ended September 30, 2003, but to a much lesser extent.
Although 2003 results were negatively impacted by catastrophe losses
associated with Midwest storms and hurricane Isabel, premium rates on most
reinsurance contracts are now considered to be near adequate levels, which
will benefit future underwriting results. In addition to pricing its
reinsurance contracts at adequate rate levels, 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 $171,000 and
$462,000 for the three months and nine months ended September 30, 2003
compared to a loss of $46,000 and $202,000 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 September 30, 2003, approximately 32 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 $16,882,000 at September 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.
During the third quarter of 2003 the Company invested additional funds of
approximately $4,200,000 into common stock investments.
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 $680,000 in the first nine months 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 $32,375,000
during the first nine months of 2003 compared to $28,068,000 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 its dividend reinvestment percentage to 75 percent
in the second quarter and announced two separate 30,000-share open market
stock purchase programs. Employers Mutual reduced its dividend reinvestment
percentage to 25 percent in the third quarter of 2003 but has informed the
Company that it will increase its dividend reinvestment percentage to 50
percent for the fourth 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 September 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 conducting business under the
MCI, Inc. brand name), whose corporate bonds were downgraded to junk status in
May 2002 when it reported the detection of accounting irregularities. 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 September 30,
2003, the fair value of the MCI bonds had partially recovered, resulting in
pre-tax unrealized gains of $1,035,000 recognized during 2002 and $1,711,000
recognized during the first nine months of 2003. The MCI Communications bonds
were recently awarded a payout of 79.2 cents per dollar in a "Plan of
Reorganization" that was approved by the bankruptcy court on October 31, 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
September 30, 2003, the fair value of four of the remaining five common stock
issues had partially recovered, resulting in a pre-tax unrealized gain of
$290,000. The impaired stock whose fair value has not recovered had a pre-tax
unrealized loss of $47,000 at September 30, 2003. 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 September 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 September 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 $992,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
-----------------------------------------------
(Unaudited)
Gross
unrealized
losses
----------
($ in thousands)
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 ... 503
Mortgage-backed securities ......................... -
Debt securities issued by foreign governments ...... -
Public utilities ................................... -
Corporate securities ............................... 246
----------
Total fixed maturity securities ................ 749
----------
Equity securities:
Common stocks ...................................... 777
Non-redeemable preferred stocks .................... -
----------
Total equity securities ........................ 777
----------
Total securities available-for-sale ............ 1,526
----------
Total all securities ...........................$ 1,526
==========
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
------- ------- ----------
($ in thousands)
Fixed maturity securities
available-for-sale:
Three months or less ............... $15,241 $15,012 $ 229
Over three months to six months .... 13,087 12,810 277
Over six months to nine months ..... - - -
Over nine months to twelve months .. 1,000 970 30
Over twelve months ................. 5,872 5,659 213
------- ------- -------
$35,200 $34,451 $ 749
======= ======= =======
Equity securities:
Three months or less ............... $ 6,297 $ 5,950 $ 347
Over three months to six months .... 792 711 81
Over six months to nine months ..... 21 16 5
Over nine months to twelve months .. 396 346 50
Over twelve months ................. 1,656 1,362 294
------- ------- -------
$ 9,162 $ 8,385 $ 777
======= ======= =======
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
------- ------- --------
($ in thousands)
Fixed maturity securities
available-for-sale:
Three months or less ............... $ 186 $ 183 $ 3
Over three months to six months .... - - -
Over six months to nine months ..... - - -
Over nine months to twelve months .. - - -
Over twelve months ................. 11,272 6,712 4,560
------- ------- -------
$11,458 $ 6,895 $ 4,563
======= ======= =======
Equity securities:
Three months or less ............... $ 5,139 $ 4,429 $ 710
Over three months to six months .... 3,352 2,819 533
Over six months to nine months ..... 4,970 3,302 1,668
Over nine months to twelve months .. 2,064 1,552 512
Over twelve months ................. 737 509 228
------- ------- -------
$16,262 $12,611 $ 3,651
======= ======= =======
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 did 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 September 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 and third quarters 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 nine months 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 September 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 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.
(b) An 8-K was filed on August 7, 2003 announcing the Company's financial
results for the second quarter of 2003.
An 8-K was filed on August 12, 2003 announcing the Company's
declaration of a quarterly dividend of fifteen cents per share of
common stock payable August 29, 2003 to shareholders of record as of
August 22, 2003.
An 8-K was filed on September 19, 2003 announcing the Company's
strengthening of its bulk loss and settlement expense reserves by
approximately $4,600,000 in the third quarter of 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: November 14, 2003