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 MARCH 31, 2004
-------------------------------------
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 May 1, 2004
----- --------------------------
Common stock, $1.00 par value 11,558,805
Total pages 34
--
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2004 2003
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $18,573,752 and $21,167,655) ... $ 16,905,734 $ 19,423,013
Securities available-for-sale, at fair value
(amortized cost $383,706,346 and
$382,326,388) .............................. 411,247,825 405,758,798
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $33,458,969 and $32,686,769) ... 31,550,410 30,422,335
Securities available-for-sale, at fair value
(amortized cost $121,903,692 and
$117,184,150) .............................. 122,405,385 118,026,960
Equity securities available-for-sale, at fair
value (cost $40,764,861 and $38,998,075) ..... 51,937,803 49,008,498
Other long-term investments, at cost ........... 5,055,044 4,758,019
Short-term investments, at cost ................ 57,484,923 63,568,064
------------ ------------
Total investments ..................... 696,587,124 690,965,687
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 15,868,253 15,861,754
Prepaid reinsurance premiums ................. 3,564,725 3,297,228
Intangible asset, defined benefit
retirement plan ............................ 1,016,492 1,016,492
Other assets ................................. 3,518,058 1,857,284
Indebtedness of related party ................ 1,833,422 -
Cash ............................................. 141,454 (14,069,102)
Accrued investment income ........................ 6,919,410 7,821,652
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $0) ........... 197,473 379,423
Deferred policy acquisition costs ................ 26,963,725 26,737,784
Deferred income taxes ............................ 8,415,983 10,345,429
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 159,765,318 154,556,758
------------ ------------
Total assets .......................... $925,733,023 $899,711,975
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2004 2003
------------ ------------
(Unaudited)
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............... $371,466,276 $367,923,881
Unearned premiums ............................ 126,075,373 124,832,607
Other policyholders' funds ................... 1,359,249 1,390,594
Surplus notes payable ........................ 36,000,000 36,000,000
Indebtedness to related party ................ - 2,175,118
Employee retirement plans .................... 11,077,269 9,965,600
Other liabilities ............................ 24,516,175 19,336,366
Income taxes payable ............................. 4,036,355 2,780,500
Securities lending obligation .................... 159,765,318 154,556,758
------------ ------------
Total liabilities ......................... 734,296,015 718,961,424
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,548,083
shares in 2004 and 11,501,065 shares in 2003 ... 11,548,083 11,501,065
Additional paid-in capital ....................... 70,130,164 69,113,228
Accumulated other comprehensive income ........... 25,490,475 22,285,668
Retained earnings ................................ 84,268,286 77,850,590
------------ ------------
Total stockholders' equity ................ 191,437,008 180,750,551
------------ ------------
Total liabilities and stockholders' equity $925,733,023 $899,711,975
============ ============
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 expense, are the result of
related party transactions with Employers Mutual.
Three months ended
March 31,
------------------------
2004 2003
----------- -----------
REVENUES
Premiums earned .................................. $83,458,282 $80,381,898
Investment income, net ........................... 7,273,977 7,846,924
Realized investment gains (losses) ............... 400,527 (1,749,785)
Other income ..................................... 76,479 167,830
----------- -----------
91,209,265 86,646,867
----------- -----------
LOSSES AND EXPENSES
Losses and settlement expenses ................... 50,961,177 50,227,072
Dividends to policyholders ....................... 768,042 390,234
Amortization of deferred policy acquisition costs 18,419,527 17,556,374
Other underwriting expenses ...................... 8,095,321 8,035,197
Interest expense ................................. 278,100 485,966
Other expenses ................................... 323,738 408,548
----------- -----------
78,845,905 77,103,391
----------- -----------
Income before income tax expense ........... 12,363,360 9,543,476
----------- -----------
INCOME TAX EXPENSE
Current .......................................... 3,810,484 1,987,181
Deferred ......................................... 203,781 1,110,617
----------- -----------
4,014,265 3,097,798
----------- -----------
Net income ................................. $ 8,349,095 $ 6,445,678
=========== ===========
Net income per common share - basic and diluted .... $ .72 $ .57
=========== ===========
Dividends per common share ......................... $ .15 $ .15
=========== ===========
Average number of shares outstanding - basic and
diluted .......................................... 11,522,643 11,403,353
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended
March 31,
------------------------
2004 2003
----------- -----------
Net income ......................................... $ 8,349,095 $ 6,445,678
----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding gains (losses) arising during
the period, before deferred income tax benefit.. 5,328,692 (439,688)
Deferred income tax expense (benefit) ............ 1,865,041 (153,890)
----------- -----------
3,463,651 (285,798)
----------- -----------
Reclassification adjustment for (gains) losses
included in net income, before income tax
expense (benefit) .............................. (398,221) 1,749,074
Income tax expense (benefit)...................... 139,377 (612,176)
----------- -----------
(258,844) 1,136,898
----------- -----------
Other comprehensive income ................. 3,204,807 851,100
----------- -----------
Total comprehensive income ................. $11,553,902 $ 7,296,778
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended
March 31,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 8,349,095 $ 6,445,678
------------ ------------
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 ........ 3,542,395 (567,214)
Unearned premiums ..................... 1,242,766 3,896,569
Other policyholders' funds ............ (31,345) (162,045)
Indebtedness to related party ......... (4,008,540) (4,542,228)
Employee retirement plans ............. 1,111,669 477,942
Reinsurance receivables ............... (6,499) 307,735
Prepaid reinsurance premiums .......... (267,497) (1,198,669)
Commissions payable ................... (4,466,442) (2,316,471)
Interest payable ...................... (556,200) (1,649,771)
Prepaid assets ........................ (1,692,066) (2,801,351)
Deferred policy acquisition costs ......... (225,941) (593,539)
Accrued investment income ................. 902,242 1,829,346
Accrued income taxes:
Current ................................. 1,255,855 1,487,170
Deferred ................................ 203,781 1,110,617
Realized investment (gains) losses ........ (400,527) 1,749,785
Other, net ................................ (621,017) (586,885)
------------ ------------
(4,017,366) (3,559,009)
------------ ------------
Net cash provided by
operating activities .............. $ 4,331,729 $ 2,886,669
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Three months ended
March 31,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 1,391,172 $ 3,069,823
Purchases of fixed maturity securities
available-for-sale .......................... (220,499,040) (130,352,209)
Disposals of fixed maturity securities
available-for-sale .......................... 225,667,494 143,054,965
Purchases of equity securities
available-for-sale .......................... (6,293,619) (7,507,562)
Disposals of equity securities
available-for-sale .......................... 4,694,150 7,249,591
Purchase of other long-term investments ....... (432,251) (750,000)
Disposal of other long-term investments ....... 135,226 273,727
Net sales (purchases) of short-term investments 6,083,140 (14,609,364)
------------ ------------
Net cash provided by investing activities 10,746,272 428,971
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related party
transactions with Employers Mutual:
Issuance of common stock through Employers
Mutual's stock option plans ............. 1,063,954 211,360
Dividends paid to Employers Mutual ........ (1,395,439) (1,366,096)
Dividends paid to Employers Mutual
(reimbursement for non-GAAP expense) .... (201,195) (236,774)
Dividends paid to stockholders ................ (334,765) (344,613)
------------ ------------
Net cash used in financing activities ..... (867,445) (1,736,123)
------------ ------------
NET INCREASE IN CASH ............................ 14,210,556 1,579,517
Cash at beginning of year ....................... (14,069,102) (119,097)
------------ ------------
Cash at end of quarter .......................... $ 141,454 $ 1,460,420
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2004
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 of the interim financial statements 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, 2003 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 2003 Form 10-K or the 2003 Annual Report to Shareholders for more
detailed footnote information.
2. STOCK BASED COMPENSATION
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
March 31,
------------------------
2004 2003
---------- ----------
Net income, as reported .................. $8,349,095 $6,445,678
Deduct: Total stock-based employee
compensation expense determined
under the fair value method for all
awards, net of related tax effects 8,017 6,346
---------- ----------
Pro forma net income ..................... $8,341,078 $6,439,332
========== ==========
Net income per share:
Basic and diluted - As reported ........ $0.72 $0.57
Basic and diluted - Pro forma .......... $0.72 $0.56
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
March 31, 2004
3. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate.
Property
Three months ended and casualty Parent
March 31, 2004 insurance Reinsurance company Consolidated
- ------------------ ------------ ------------ ------------ ------------
Premiums earned ...... $ 61,360,228 $ 22,098,054 $ 83,458,282
Underwriting gain .... 4,040,349 1,173,866 5,214,215
Net investment income 4,966,371 2,295,483 $ 12,123 7,273,977
Realized gains ....... 289,967 110,560 - 400,527
Other income ......... 76,479 - - 76,479
Interest expense ..... (193,125) (84,975) - (278,100)
Other expense ........ (180,397) - (143,341) (323,738)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 8,999,644 $ 3,494,934 $ (131,218) $ 12,363,360
============ ============ ============ ============
Property
Three months ended and casualty Parent
March 31, 2003 insurance Reinsurance company Consolidated
- ------------------ ------------ ------------ ------------ ------------
Premiums earned ...... $ 59,205,804 $ 21,176,094 $ 80,381,898
Underwriting gain
(loss) ............. 4,470,091 (297,070) 4,173,021
Net investment income 5,550,937 2,245,755 $ 50,232 7,846,924
Realized losses ...... (1,358,914) (390,871) - (1,749,785)
Other income ......... 167,830 - - 167,830
Interest expense ..... (339,987) (145,979) - (485,966)
Other expense ........ (277,184) - (131,364) (408,548)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 8,212,773 $ 1,411,835 $ (81,132) $ 9,543,476
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
March 31, 2004
4. INCOME TAXES
The actual income tax expense for the three months ended March 31, 2004
and 2003 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
March 31,
------------------------
2004 2003
----------- -----------
Computed "expected" tax expense ................... $ 4,327 176 $ 3,340,217
Increases (decreases) in tax resulting from:
Tax-exempt interest income .................... (611,073) (405,276)
Proration of tax-exempt interest and dividends
received deduction .......................... 98,022 40,274
Other, net .................................... 200,140 122,583
----------- -----------
Income tax expense ........................ $ 4,014,265 $ 3,097,798
=========== ===========
5. EMPLOYEE RETIREMENT PLANS
The components of net periodic benefit cost for the Employers Mutual
pension plan and postretirement benefit plans are as follows:
Three months ended
March 31,
-------------------------
2004 2003
---------- ----------
Pension Plan:
Service cost .......................... $1,704,630 $1,540,255
Interest cost ......................... 1,755,222 1,748,164
Expected return on plan assets ........ (1,690,132) (1,629,228)
Recognized net actuarial loss ......... 213,922 241,807
Amortization of prior service costs ... 191,456 197,412
---------- ----------
Net periodic pension benefit cost ... $2,175,098 $2,098,410
========== ==========
Postretirement benefit plans:
Service cost .......................... $1,144,127 $1,100,250
Interest cost ......................... 1,078,509 1,065,750
Expected return on plan assets ........ (225,221) (184,250)
Amortization of net loss .............. 147,830 252,750
---------- ----------
Net periodic postretirement
benefit cost ...................... $2,145,245 $2,234,500
========== ==========
Pension expense allocated to the Company amounted to $528,723 and
$505,825 for the three months ended March 31, 2004 and 2003, respectively.
Postretirement benefit expense allocated to the Company amounted to
$481,853 and $526,503 for the three months ended March 31, 2004 and 2003,
respectively.
Employers Mutual plans to contribute approximately $10,000,000 to the
pension plan and $3,300,000 to the postretirement benefit plans in 2004. As
of March 31, 2004 Employers Mutual has not made a contribution to the pension
plan and has contributed $3,335,000 to the postretirement benefit plans.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
March 31, 2004
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act expanded
Medicare to include, for the first time, coverage for prescription drugs.
This legislation is expected to eventually reduce the cost of Employers
Mutual's health care postretirement benefit plan. Because of various
uncertainties, including Employers Mutual's response to this legislation and
the appropriate accounting methodology for this event, the Company has elected
to defer financial recognition of this legislation until the Financial
Accounting Standards Board issues final accounting guidance. When issued,
that final guidance could require the Company to change previously reported
information. This deferral election is permitted under Financial Accounting
Standards Board Staff Position No. FAS 106-1 "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003."
6. 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.
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 80.8 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 73.5
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. Effective December 31, 2003, the pooling agreement was amended
to provide that Employers Mutual will make up any shortfall or difference
resulting from an error in its systems and/or computational processes that
would otherwise result in the required restatement of the pool participants'
financial statements. 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.
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
-----------------------------------
(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 of the
interim financial statements have been included. The results of operations
for the interim periods reported are not necessarily indicative of results to
be expected for the year.
INDUSTRY OVERVIEW
An insurance company's underwriting results reflect the profitability of
its insurance operations, excluding investment income. Underwriting results
are calculated by subtracting losses and expenses incurred from premiums
earned. An underwriting profit indicates that a sufficient amount of premium
income was received to cover the risks insured. An underwriting loss
indicates that premium income was not adequate. The combined ratio is another
measure utilized by insurance companies to gauge underwriting profitability
and is calculated by dividing losses and expenses incurred by premiums earned.
A number less than 100 generally indicates an underwriting gain; a number
greater than 100 generally indicates an underwriting loss.
Insurance companies collect cash in the form of insurance premiums and
pay out cash in the form of loss and settlement expense payments. Additional
cash outflows occur through the payment of acquisition and underwriting costs
such as commissions, premium taxes, salaries and general overhead. During the
loss settlement period, which varies by line of business and by the
circumstances surrounding each claim and may cover several years, insurance
companies invest the cash premiums and earn interest and dividend income.
This investment income supplements underwriting results and contributes to net
earnings.
Additional information regarding issues affecting the insurance industry
is presented in the Company's 2003 Form 10-K.
MANAGEMENT ISSUES AND PERSPECTIVES
The insurance industry is highly regulated and very competitive, and its
operations are impacted by many economic and social factors. In order to be a
viable source of insurance protection in today's marketplace, an insurance
company must be strongly capitalized, carry a secure rating from A.M. Best
Company and offer competitive products and excellent service. Management
recognizes that insurance agents and their customers have many options to
choose from when selecting an insurance carrier and continually emphasizes the
need to meet and exceed customers' expectations in these areas.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Management has long recognized the importance of an insurance company's
capitalization and has always strived to maintain a strong capital position by
investing its assets conservatively and, more importantly, maintaining a
consistent level of reserve adequacy. Carried reserves are analyzed on a
regular basis and adjustments, if necessary, are implemented on a timely
basis. This procedure not only assures a consistent level of reserve
adequacy, it also minimizes the impact that any required adjustment will have
on current operations. This dedication to reserve adequacy was again
demonstrated during 2003 as the Company strengthened loss and settlement
reserves in the property and casualty insurance segment in response to the
findings of regularly-scheduled actuarial evaluations.
The participants in the EMC Insurance Companies pooling agreement
currently carry an "A-" (Excellent) rating from A.M. Best Company, which is
considered to be the leading insurance rating agency. Management has worked
diligently over the last several years to improve profitability through a
combination of adequate pricing and focused underwriting practices. These
efforts have been successful to date and management has taken the necessary
steps to prepare for market changes that will inevitably occur. Maintaining a
consistent level of profitability is a primary goal of management that will
assist the Company in its quest to achieve an even higher rating from A.M.
Best Company.
The products offered by an insurance company must be priced so that they
are competitive in the marketplace, yet offer the prospect of producing an
underwriting profit. This fact has become increasingly important during the
last several years as investment income, which is used to supplement
underwriting results and contribute to net earnings, has been negatively
impacted by the lingering low interest rate environment. Management is keenly
aware of the need to achieve an underwriting profit in today's marketplace and
has implemented focused underwriting initiatives that stress profitability
over production.
Workers' compensation is a significant line of business for the Company,
representing 13.9 percent of the 2003 premiums earned. Underwriting results
for the workers' compensation line of business are difficult to control
because premium rates are highly regulated and are often subject to political
pressures. In addition, reserves established for workers' compensation claims
often reflect long-term or life-time medical care that may increase
significantly in cost due to inflationary pressures, increases in utilization
of medical procedures and advancements in technology. Management has many
years of experience in the workers' compensation business and continuously
monitors these issues. It is also important to recognize that workers'
compensation coverage is generally not issued on a stand-alone basis, but is
provided in combination with other coverages in commercial package policies
that are priced on a total coverage basis.
Catastrophe and storm losses are unpredictable and can vary significantly
from year to year. Management uses modeling software to help identify and
estimate its potential loss exposure to a variety of events, both natural and
manmade. Natural events that are modeled include hurricanes, tornados and
windstorms, and earthquakes. Modeling activities for manmade events are
primarily directed toward identifying concentrations of risk, such as workers'
compensation coverage for a business or property that is subject to a
terrorist attack or other manmade event. Management purchases reinsurance
protection to mitigate the Company's loss potential to these types of
exposures.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Losses from mold related claims continue to hamper the insurance industry
as a whole, but are not considered to be significant exposures to the Company.
The Company is using exclusionary endorsements and sub-limits to control mold
losses. In addition, an improved understanding of these types of claims has
resulted in prompt attention to water damage losses.
CRITICAL ACCOUNTING POLICIES
The accounting policies considered by management to be critically
important in the preparation and understanding of the Company's financial
statements and related disclosures are presented in the Company's 2003 Form
10-K.
RESULTS OF OPERATIONS
Segment information and consolidated net income for the three months
ended March 31, 2004 and 2003 is as follows:
Three months ended
March 31,
--------------------
($ in thousands) 2004 2003
-------- --------
Property and Casualty Insurance
Premiums earned ...................................... $ 61,360 $ 59,206
Losses and settlement expenses ....................... 36,395 35,289
Acquisition and other expenses ....................... 20,925 19,447
-------- --------
Underwriting gain .................................... $ 4,040 $ 4,470
======== ========
Loss and settlement expense ratio .................... 59.3% 59.6%
Acquisition expense ratio ............................ 34.1 32.8
-------- --------
Combined ratio ....................................... 93.4% 92.4%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 39,820 $ 36,663
Decrease in provision for insured
events of prior years .......................... (3,425) (1,374)
-------- --------
Total losses and settlement expenses ......... $ 36,395 $ 35,289
======== ========
Catastrophe and storm losses ......................... $ 870 $ 913
======== ========
Reinsurance
Premiums earned ...................................... $ 22,098 $ 21,176
Losses and settlement expenses ....................... 14,566 14,938
Acquisition and other expenses ....................... 6,358 6,535
-------- --------
Underwriting gain(loss) .............................. $ 1,174 $ (297)
======== ========
Loss and settlement expense ratio .................... 65.9% 70.5%
Acquisition expense ratio ............................ 28.8 30.9
-------- --------
Combined ratio ....................................... 94.7% 101.4%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 14,931 $ 12,878
(Decrease) increase in provision for
insured events of prior years .................. (365) 2,060
-------- --------
Total losses and settlement expenses ......... $ 14,566 $ 14,938
======== ========
Catastrophe and storm losses ......................... $ 145 $ 174
======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Three months ended
March 31,
--------------------
($ in thousands) 2004 2003
-------- --------
Consolidated
REVENUES
Premiums earned ...................................... $ 83,458 $ 80,382
Net investment income ................................ 7,274 7,847
Realized investment gains (losses) ................... 401 (1,750)
Other income ......................................... 76 168
-------- --------
91,209 86,647
-------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ....................... 50,961 50,227
Acquisition and other expenses ....................... 27,283 25,982
Interest expense ..................................... 278 486
Other expense ........................................ 324 408
-------- --------
78,846 77,103
-------- --------
Income before income tax expense ..................... 12,363 9,544
Income tax expense ................................... 4,014 3,098
-------- --------
Net income ........................................... $ 8,349 $ 6,446
======== ========
Loss and settlement expense ratio .................... 61.1% 62.5%
Acquisition expense ratio ............................ 32.7 32.3
-------- --------
Combined ratio ....................................... 93.8% 94.8%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 54,751 $ 49,541
(Decrease) increase in provision for insured
events of prior years .......................... (3,790) 686
-------- --------
Total losses and settlement expenses ......... $ 50,961 $ 50,227
======== ========
Catastrophe and storm losses ......................... $ 1,015 $ 1,087
======== ========
Net income increased 29.5 percent to a record $8,349,000 ($0.72 per
share) in the first quarter of 2004 from $6,446,000 ($0.57 per share) in the
first quarter of 2003. This increase is primarily attributed to a $2,151,000
change in realized investment gains that resulted from the recognition of
$401,000 of net realized investment gains in the first quarter of 2004
compared to $1,750,000 of net realized investment losses recognized in the
first quarter of 2003. Reflected in the first quarter results of 2004 and
2003 are underwriting profits of $5,214,000 and $4,173,000, respectively, that
are the result of focused underwriting initiatives and some necessary rate
increases that were implemented during the last several years. Achieving an
underwriting profit is always stressed, but has become even more critical in
this lingering low interest rate environment.
Premium income
Premiums earned increased 3.8 percent to $83,458,000 in the first quarter
of 2004 from $80,382,000 in the first quarter of 2003. This increase is
primarily attributed to rate increases implemented during the last several
years in the property and casualty insurance business as well as moderate
growth and improved pricing in the assumed reinsurance business. The market
for property and casualty insurance remained firm during the first quarter of
2004 and no significant changes are anticipated in the marketplace for the
remainder of the year. The Company will continue to implement rate increases
in those lines of business and/or territories where such action is warranted,
but the overall level of these rate increases is expected to be smaller than
those implemented during 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Premiums earned for the property and casualty insurance segment increased
3.6 percent to $61,360,000 in the first quarter of 2004 from $59,206,000 in
the first quarter of 2003, primarily as a result of rate increases that were
implemented during the last several years. After several years of broad-based
rate increases, premium rate levels for most lines of business were considered
to be at, or near, adequate levels at the end of 2002. Accordingly, moderate
and more targeted rate increases were implemented during 2003 and into the
first quarter of 2004. This fine tuning of the Company's rate structure has
been directed toward specific accounts, territories and lines of business
where additional rate increases were 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 2004 reflect this
delay and continued to show growth as past rate increases became earned, even
though production increased only 0.3 percent due to a decline in policy count
and an increase in ceded premiums. The decline in policy count reflects
several factors, including the non-renewal of existing business that was
under-priced and/or under-performing, a reluctance to accept new risks in
under-priced lines of business and a decrease in new business associated with
a moderate increase in rate competition. The increase in ceded premiums
primarily reflects an increase in the cost of the Company's reinsurance
programs. Premium rate levels for most lines of business are not expected to
change significantly during 2004, with the notable exception of the homeowners
and workers' compensation lines of business where premium rates remain
inadequate. In light of the improvements that have been achieved in both the
pricing and the quality of the Company's book of business, management has
become more receptive to opportunities to write new business, but continues to
stress profitability over production.
Premiums earned for the reinsurance segment increased 4.4 percent to
$22,098,000 in the first quarter of 2004 from $21,176,000 in the first quarter
of 2003, primarily as a result of increased participation in the MRB
reinsurance pool. For 2004, Employers Mutual's participation in the MRB
reinsurance pool (which is ceded to the reinsurance segment under the terms of
the quota share agreement) increased to 33 percent from 25 percent in 2003,
producing $2,369,000 of additional earned premiums. Following large across-
the-board rate increases implemented in 2002, premium rate increases on
excess-of-loss contracts moderated during 2003 and the first quarter of 2004
due to the influx of new capital into the reinsurance marketplace; however,
contracts with poor loss experience continue to receive large rate increases.
The rate increases implemented during the last several years 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 have
benefited from improved industry-wide rate levels at the primary company
level. The growth in earned premiums for the first quarter of 2004 reflects a
decline in the estimate of earned but not reported premiums of $790,000
compared to an increase of $482,000 in the first quarter of 2003. Employers
Mutual was unsuccessful in its attempt to renew several accounts during the
January 1, 2004 renewal season due to it's current "A-" (Excellent) A.M. Best
rating and is attempting to replace this business with new accounts and
increased participation on existing accounts.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Losses and settlement expenses
Losses and settlement expenses increased 1.5 percent to $50,961,000 in
the first quarter of 2004 from $50,227,000 in the first quarter of 2003. The
loss and settlement expense ratio (losses and settlement expenses expressed as
a percentage of premiums earned) decreased to 61.1 percent in 2004 from 62.5
percent in 2003. This decline in the loss and settlement expense ratio is
primarily attributed to favorable development on prior years' reserves, as
well as continued improvements in both premium rate adequacy and the overall
quality of the Company's book of business.
The loss and settlement expense ratio for the property and casualty
segment decreased slightly to 59.3 percent in the first quarter of 2004 from
59.6 percent in the first quarter of 2003. An increase in the amount of
favorable development experienced on prior years' reserves more than offset an
increase in current accident year losses. Overall loss frequency continued to
trend downward in the first quarter of 2004, but there are some indications
that loss frequency may be leveling out. Loss severity continued to trend
upward during the first quarter of 2004 while catastrophe and storm losses
remained fairly constant.
The loss and settlement expense ratio for the reinsurance segment
decreased to 65.9 percent in the first quarter of 2004 from 70.5 percent in
the first quarter of 2003. This improvement is attributed to favorable
development on prior years' reserves, continued improvement in overall premium
rate adequacy and a decline in large excess-of-loss business losses. The
favorable development reported for the first quarter of 2004 was produced by
the MRB reinsurance pool. The majority of the adverse development reported in
the first quarter of 2003 came from property pro rata and ocean marine
business, in addition to approximately $330,000 from the MRB reinsurance pool
and $326,000 of additional IBNR reserves established in response to the
findings of an independent study conducted on the Company's asbestos
exposures.
Acquisition and other expenses
Acquisition and other expenses increased 5.0 percent to $27,283,000 in
the first quarter of 2004 from $25,982,000 in the first quarter of 2003. The
expense ratio (acquisition and other expenses expressed as a percentage of
premiums earned) increased to 32.7 percent in 2004 from 32.3 percent in 2003,
primarily due to an increase in policyholder dividends and a smaller increase
in deferred policy acquisition costs.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
For the property and casualty insurance segment, the expense ratio
increased to 34.1 percent in the first quarter of 2004 from 32.8 percent in
the first quarter of 2003. This increase is primarily due to an increase in
policyholder dividends and contingent commissions (both of which reflect the
fundamental improvement in underwriting results), and a decline in the amount
of acquisition costs that were deferred due to the relatively small increase
in production.
For the reinsurance segment, the expense ratio decreased to 28.8 percent
in the first quarter of 2004 from 30.9 percent in the first quarter of 2003.
This decrease is attributed to a decline in both commission and contingent
commission expense. Commission expense for 2004 and 2003 includes $1,033,000
and $782,000, respectively, incurred in connection with the increased
participation in the MRB reinsurance pool noted above.
Investment results
Net investment income decreased 7.3 percent to $7,274,000 in the first
quarter of 2004 from $7,847,000 in the first quarter of 2003, despite an
increase in invested assets. This decrease is primarily attributed to the
lingering low interest rate environment, which continues to negatively impact
the rate of return earned on the Company's investments. During this prolonged
period of low interest rates, many of the Company's higher yielding securities
have been called. The proceeds from these called securities, and from
maturing securities, have been reinvested at the current lower interest rates,
resulting in less investment income. In addition, the Company has been
reluctant to invest in long-term securities during this period of low interest
rates and has therefore accumulated a significant amount of short-term and
cash equivalent investments. Since these investments carry lower interest
rates than long-term fixed maturity securities, the decline in the Company's
rate of return has been magnified.
Realized investment gains totaled $401,000 in the first quarter of 2004
compared to realized investment losses of $1,750,000 in the first quarter of
2003. The Company did not recognize any other-than-temporary impairment
losses during the first quarter of 2004. Reflected in the realized investment
losses for the first quarter of 2003 were $1,567,000 of other-than-temporary
impairment losses recognized in the Company's equity portfolio, $2,689,000 of
net losses recognized by the Company's equity managers as they rebalanced the
Company's portfolios to enhance future returns, and $4,342,000 of losses
recognized on the sale of American Airlines and United Airlines bonds. All
the equity securities that were determined to be other-than-temporarily
impaired in the first quarter of 2003 were sold before year-end.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Other information
Income tax expense increased 29.6 percent to $4,014,000 in the first
quarter of 2004 from $3,098,000 in the first quarter of 2003. The effective
tax rate remained unchanged at 32.5 percent. 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 filed a short-period tax return for the period
January 1, 2003 through March 31, 2003.
Pension liabilities reflected in the Company's financial statements
totaled $1,982,000 (including $1,016,000 of additional minimum liability) at
March 31, 2004 and $1,453,000 (including $1,016,000 of additional minimum
liability) at December 31, 2003. The intangible asset reflected in the
Company's financial statements totaled $1,016,000 at both March 31, 2004 and
December 31, 2003. Postretirement benefit liabilities reflected in the
Company's financial statements totaled $9,095,000 and $8,512,000 at March 31,
2004 and December 31, 2003, respectively.
On November 26, 2002, President Bush signed into law the Terrorism Risk
Insurance Act of 2002 ("TRIA"). TRIA provides a temporary Federal backstop on
losses from certified terrorism events from foreign sources and is effective
until December 31, 2005. Coverage includes most direct commercial lines of
business, including coverage for losses from nuclear, biological and chemical
exposures. Each insurer has a deductible amount, which is calculated as a
percentage of the prior year's direct earned commercial lines premium and a
ten percent retention above the deductible. The percentage used in the
deductible calculation will increase from seven percent in 2003 to ten percent
in 2004 and 15 percent in 2005. TRIA caps losses at $100 billion annually; no
insurer that has met its deductible will be liable for payment of any portion
above that amount. Congress is currently debating whether TRIA should be
extended for one or possibly two years due to concerns that terrorism
insurance may not be available in the private insurance market when TRIA
expires.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
LIQUIDITY AND INVESTMENTS
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 March 31, 2004, approximately 33 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 totaling $18,228,000 at March 31, 2004
and $15,779,000 at December 31, 2003. 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.
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
The Company participates in a securities lending program whereby certain
fixed maturity securities from the investment portfolio are loaned to other
institutions for short periods of time. The Company receives a fee for each
security loaned out under this program and requires initial collateral,
primarily cash, equal to 102 percent of the market value of the loaned
securities.
The Company holds $5,055,000 and $4,758,000 in minor ownership interests
in limited partnerships and limited liability companies at March 31, 2004 and
December 31, 2003, respectively. 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 $4,332,000
during the first quarter of 2004 compared to $2,887,000 for the same period of
2003.
The Company became an 80 percent owned subsidiary of Employers Mutual at
the end of March, 2003. In order to build and maintain a sufficient cushion
above the 80 percent ownership threshold, Employers Mutual conducted two
separate 30,000-share open market stock purchase programs during 2003.
Employers Mutual reinvested 50 percent of its dividends in additional shares
of the Company's common stock during the first quarter of 2004 and is expected
to continue participating in this plan for the remainder of 2004.
As a result of being an 80 percent owned subsidiary of Employers Mutual,
the Company is included in Employers Mutual's consolidated tax return
effective April 1, 2003.
Investment Impairments and Considerations
At March 31, 2004, the Company had one fixed maturity security series, MCI
Communications Corporation, which has 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 March 31, 2004, the fair value of the
MCI bonds had partially recovered, resulting in pre-tax unrealized gains
(losses) of $1,811,000 recognized during 2003 and ($58,000) recognized during
the first quarter of 2004. The MCI Communications bonds were 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. Under this "Plan of
Reorganization", the Company will redeem its current bonds for new bonds
during the second quarter of 2004. The factors surrounding this other-than-
temporary impairment did not have any impact on the carrying value of any
other investments held by the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
At March 31, 2004, 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 other-than-temporarily impaired. Such factors
include, but are not limited to, the security's value and performance in the
context of the overall markets, length of time and extent the security's fair
value has been below carrying value, key corporate events and
collateralization of fixed maturity securities. Based on these factors, and
the Company's ability and intent to hold the fixed maturity securities until
maturity, it was determined that the carrying value of these securities was
not other-than-temporarily impaired at March 31, 2004. 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 $544,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position as of March 31, 2004.
Less than twelve Twelve months
($ in thousands) months or longer Total
----------------- ----------------- ------------------
Description of Fair Unrealized Fair Unrealized Fair Unrealized
Securities Value Losses Value Losses Value Losses
- -------------- ----------------- ----------------- ------------------
U.S. treasury
securities and
obligations of
U.S. government
corporations
and agencies ... $112,933 $ 6 $ - $ - $112,933 $ 6
Obligations of
states and
political
subdivisions ... 36,971 148 - - 36,971 148
Public
utilities ...... 2,500 73 - - 2,500 73
Corporate
securities ..... - - 5,578 162 5,578 162
-------- ---- ------ ---- -------- ----
Subtotal, debt
securities ..... 152,404 227 5,578 162 157,982 389
-------- ---- ------ ---- -------- ----
Common stock ..... 5,866 358 654 90 6,520 448
-------- ---- ------ ---- -------- ----
Total temporarily
impaired
securities ..... $158,270 $585 $6,232 $252 $164,502 $837
======== ==== ====== ==== ======== ====
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
Following is a schedule of fixed maturity securities available-for-sale
that are non-investment grade and have unrealized losses at March 31, 2004.
As previously noted, the Company does not invest in junk bonds. The non-
investment grade securities held by the Company are the result of rating
downgrades that occurred subsequent to their purchase. The percentages
displayed are of the fair values of these securities to the total fair value
of fixed maturity securities available-for-sale, and of the unrealized losses
on these securities to the total gross unrealized losses on fixed maturity
securities available-for-sale. This schedule does not include fixed maturity
securities held-to-maturity due to the fact that none of these securities have
unrealized losses or are below investment grade at March 31, 2004. This
schedule also does not include the Company's MCI bonds, which carry a Moody's
Bond Rating of CA, due to the fact that these bonds were written-down to their
fair value in the second quarter of 2002 and have since partially recovered,
resulting in cumulative net unrealized gains of $2,788,000 as of March 31,
2004.
Percent Percent
Moody's of of gross
bond Carrying Unrealized market unrealized
($ in thousands) rating value Loss value losses
------ ---------- ---------- ----- ----------
Potomac Edison .......... BA1 $ 2,500 $ 73 6.1% 18.8%
---------- ---------- ----- ----------
$ 2,500 $ 73 6.1% 18.8%
========== ========== ===== ==========
Following is a schedule of gross realized losses recognized in 2004 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
($ in thousands) value price loss
------- ------- --------
Fixed maturity securities
available-for-sale:
Three months or less ............... $ - $ - $ -
Over three months to six months .... - - -
Over six months to nine months ..... - - -
Over nine months to twelve months .. - - -
Over twelve months ................. - - -
------- ------- -------
$ - $ - $ -
======= ======= =======
Equity securities:
Three months or less ............... $ 1,078 $ 948 $ 130
Over three months to six months .... 121 105 16
Over six months to nine months ..... 231 211 20
Over nine months to twelve months .. - - -
Over twelve months ................. 542 466 76
------- ------- -------
$ 1,972 $ 1,730 $ 242
======= ======= =======
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
NEW ACCOUNTING PRONOUNCEMENTS
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act expanded
Medicare to include, for the first time, coverage for prescription drugs.
This legislation is expected to eventually reduce the cost of Employers
Mutual's health care postretirement benefit plan. Because of various
uncertainties, including Employers Mutual's response to this legislation and
the appropriate accounting methodology for this event, the Company has elected
to defer financial recognition of this legislation until the Financial
Accounting Standards Board issues final accounting guidance. When issued,
that final guidance could require the Company to change previously reported
information. This deferral election is permitted under Financial Accounting
Standards Board Staff Position No. FAS 106-1 "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003."
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
(Unaudited)
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective board of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Two categories of influences on market risk exist as it relates to
financial instruments. First are systematic aspects, which relate to the
investing environment and are out of the control of the investment manager.
Second are non-systematic aspects, which relate to the construction of the
investment portfolio through investment policies and decisions, and are under
the direct control of the investment manager. Due to systematic changes,
several components of market risk increased noticeably during 2002 and 2003
and continue into 2004. As it relates to equity price risk, the poor
performance of the markets during that period resulted in declines in the
values of the Company's equity investments. This risk appears to be declining
due to the recovery of the markets in the latter part of 2003 and into 2004.
Credit quality risk rose, resulting in declines in the values of several bond
investments stemming from the many high-profile bankruptcies and other
downgrade activities during that period. This risk also appears to be
subsiding as the general economic condition continues to show signs of
strengthening in 2004. Prepayment risk increased, primarily for the mortgage-
backed securities, as declines in interest rates during that period
accelerated the payment of higher-interest rate mortgages through re-financing
activity. And finally, to a lesser extent interest rate risk increased due to
interest rates bottoming-out during that period. Future interest rate
increases will result in declines in the values of fixed maturity securities
from their current values. Throughout all these systematic changes, the
Company has continued its commitment to controlling non-systematic risk
through sound investment policies and diversification.
ITEM 4. CONTROLS AND PROCEDURES
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Within the 90 days prior to the filing date of this report, the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are functioning effectively to provide reasonable
assurance that the Company can meet its disclosure obligations. Since the
date of the most recent evaluation of the Company's internal controls by the
Chief Executive Officer and Chief Financial Officer there have been no
significant changes in the Company's internal controls or in other factors
that could significantly affect these controls.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASE OF EQUITY
- ------- --------------------------------------------------------------------
SECURITIES
----------
The following table sets forth information regarding purchases of equity
securities for the three months ended March 31, 2004:
(a) Total (b) Average (c) Total (d) Maximum Number
Number of Price Paid Number of (or Approximate
Shares Per Share Shares (or Dollar Value) of
(or Units) (or Unit) Units) Shares (or Units)
Purchased Purchased as that May Yet Be
Part of Purchased Under
Publicly The Plans or
Announced Programs
Plans or
Period Programs
- ---------------- ---------- ------------ ------------ -----------------
1/1/04 - 1/31/04 148 (1) $22.09 - -
2/1/04 - 2/29/04 74 (1) 22.65 - -
3/1/04 - 3/31/04 29,895 (1) 24.35 - -
---------- ------------ ------------ -----------------
Total 30,117 $24.33 - -
========== ============ ============ =================
(1) All shares were purchased in the open market under the Company's dividend
reinvestment and common stock purchase plan.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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(a) 31.1 Certification of President and Chief Executive Officer as
required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Vice President and Chief Financial Officer as
required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of President and Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Vice President and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) On January 23, 2004, the Company filed a report on Form 8-K
announcing the discontinuance of Nonstandard Risk Automobile
Insurance Business.
On January 29, 2004, the Company filed a report on Form 8-K
clarifying financial information released by its parent company,
Employers Mutual Casualty Company.
On February 24, 2004, the Company filed a report on Form 8-K
announcing its earning for the fourth quarter and year ended
December 31, 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 E. Reese
-----------------------------------
Mark E. Reese
Vice President and
Chief Financial Officer
Date: May 14, 2004