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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 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
-------
EMC INSURANCE GROUP INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
------------------------------ -----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
------------------------------------- --------
(Address of principal executive office) (Zip Code)
(515) 280-2902
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at July 30, 2004
----- ----------------------------
Common stock, $1.00 par value 11,560,632
Total pages 43
------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $17,880,055 and $21,167,655) ... $ 16,708,333 $ 19,423,013
Securities available-for-sale, at fair value
(amortized cost $418,343,084 and
$382,326,388) .............................. 429,175,916 405,758,798
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $31,210,194 and $32,686,769) ... 30,042,475 30,422,335
Securities available-for-sale, at fair value
(amortized cost $95,186,307 and
$117,184,150) ............................. 95,823,261 118,026,960
Equity securities available-for-sale, at fair
value (cost $41,688,527 and $38,998,075) ..... 53,160,764 49,008,498
Other long-term investments, at cost ........... 5,535,133 4,758,019
Short-term investments, at cost ................ 61,689,723 63,568,064
------------ ------------
Total investments ........................ 692,135,605 690,965,687
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 18,219,202 15,861,754
Prepaid reinsurance premiums ................. 3,705,503 3,297,228
Intangible asset, defined benefit
retirement plan ............................ 1,016,492 1,016,492
Other assets ................................. 2,692,559 1,857,284
Indebtedness of related party ................ 11,643,050 -
Cash ............................................. 54,270 (14,069,102)
Accrued investment income ........................ 8,182,567 7,821,652
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $0) ........... 855,846 379,423
Income taxes recoverable ......................... 2,751,391 -
Deferred policy acquisition costs ................ 28,107,899 26,737,784
Deferred income taxes ............................ 14,304,125 10,345,429
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 130,530,274 154,556,758
------------ ------------
Total assets ............................. $915,140,369 $899,711,975
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------ ------------
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............... $393,049,602 $367,923,881
Unearned premiums ............................ 131,468,678 124,832,607
Other policyholders' funds ................... 1,608,747 1,390,594
Surplus notes payable ........................ 36,000,000 36,000,000
Indebtedness to related party ................ - 2,175,118
Employee retirement plans .................... 9,472,736 9,965,600
Other liabilities ............................ 30,188,682 19,336,366
Income taxes payable ............................. - 2,780,500
Securities lending obligation .................... 130,530,274 154,556,758
------------ ------------
Total liabilities ........................ 732,318,719 718,961,424
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,560,632
shares in 2004 and 11,501,065 shares in 2003 ... 11,560,632 11,501,065
Additional paid-in capital ....................... 70,409,648 69,113,228
Accumulated other comprehensive income ........... 14,912,315 22,285,668
Retained earnings ................................ 85,939,055 77,850,590
------------ ------------
Total stockholders' equity ............... 182,821,650 180,750,551
------------ ------------
Total liabilities and stockholders' equity $915,140,369 $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 (benefit), are the
result of related party transactions with Employers Mutual.
Three months ended Six months ended
June 30, June 30,
----------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ------------ ------------
REVENUES
Premiums earned ..........$83,984,287 $81,977,768 $167,442,569 $162,359,666
Net investment income .... 6,865,663 7,387,056 14,139,640 15,233,980
Realized investment
gains (losses) ......... 3,181,108 586,584 3,581,635 (1,163,201)
Other income ............. 265,112 264,328 341,591 432,158
----------- ----------- ------------ ------------
94,296,170 90,215,736 185,505,435 176,862,603
----------- ----------- ------------ ------------
LOSSES AND EXPENSES
Losses and settlement
expenses ............... 63,647,449 62,621,635 114,608,626 112,848,707
Dividends to policyholders 1,095,581 1,226,295 1,863,623 1,616,529
Amortization of deferred
policy acquisition costs 17,900,296 17,770,488 36,319,823 35,326,862
Other underwriting
expenses ............... 7,179,548 6,350,968 15,274,869 14,386,165
Interest expense ......... 278,100 278,100 556,200 764,066
Other expenses ........... 419,217 548,658 742,955 957,206
----------- ----------- ------------ ------------
90,520,191 88,796,144 169,366,096 165,899,535
----------- ----------- ------------ ------------
Income before income
tax expense (benefit) 3,775,979 1,419,592 16,139,339 10,963,068
----------- ----------- ------------ ------------
INCOME TAX EXPENSE
(BENEFIT)
Current ................ 502,254 910,365 4,312,738 2,897,546
Deferred ............... (192,211) (920,965) 11,570 189,652
----------- ----------- ------------ ------------
310,043 (10,600) 4,324,308 3,087,198
----------- ----------- ------------ ------------
Net income .........$ 3,465,936 $ 1,430,192 $ 11,815,031 $ 7,875,870
=========== =========== ============ ============
Net income per common
share - basic and diluted $ .30 $ .12 $ 1.02 $ .69
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,558,120 11,442,717 11,540,381 11,423,035
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income ................. $ 3,465,936 $ 1,430,192 $11,815,031 $ 7,875,870
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding
(losses) gains arising
during the period,
before deferred income
tax (benefit) expense .. (13,099,776) 11,807,739 (7,771,084) 11,368,051
Deferred income tax
(benefit) expense ...... (4,584,921) 4,132,710 (2,719,879) 3,978,820
----------- ----------- ----------- -----------
(8,514,855) 7,675,029 (5,051,205) 7,389,231
----------- ----------- ----------- -----------
Reclassification
adjustment for (gains)
losses included in net
income, before income
tax expense (benefit) .. (3,174,315) (585,140) (3,572,536) 1,163,934
Income tax expense
(benefit) .............. 1,111,010 204,799 1,250,388 (407,377)
----------- ----------- ----------- -----------
(2,063,305) (380,341) (2,322,148) 756,557
----------- ----------- ----------- -----------
Other comprehensive
(loss) income .... (10,578,160) 7,294,688 (7,373,353) 8,145,788
----------- ----------- ----------- -----------
Total comprehensive
(loss) income .... $(7,112,224)$ 8,724,880 $ 4,441,678 $16,021,658
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 11,815,031 $ 7,875,870
------------ ------------
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 ........ 25,125,721 19,758,981
Unearned premiums ..................... 6,636,071 10,215,251
Other policyholders' funds ............ 218,153 318,118
Indebtedness to related party ......... (13,818,168) (18,655,769)
Employee retirement plans ............. (492,864) 955,883
Reinsurance receivables ............... (2,357,448) (554,930)
Prepaid reinsurance premiums .......... (408,275) (2,199,307)
Commissions payable ................... (1,919,523) (1,347,023)
Interest payable ...................... (278,100) (1,559,266)
Prepaid assets ........................ (652,703) (1,556,967)
Deferred policy acquisition costs ......... (1,370,115) (1,763,508)
Accrued investment income ................. (360,915) 1,127,730
Accrued income taxes:
Current ................................. (5,531,891) (2,502,465)
Deferred ................................ 11,570 189,652
Realized investment (gains) losses ........ (3,581,635) 1,163,201
Other, net ................................ (1,532,932) (1,528,778)
------------ ------------
(313,054) 2,060,803
------------ ------------
Net cash provided by
operating activities .............. $ 11,501,977 $ 9,936,673
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Six months ended
June 30,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 3,101,227 $ 4,159,415
Purchases of fixed maturity securities
available-for-sale .......................... (382,757,028) (355,084,966)
Disposals of fixed maturity securities
available-for-sale .......................... 385,443,985 365,111,374
Purchases of equity securities
available-for-sale .......................... (19,931,703) (14,067,053)
Disposals of equity securities
available-for-sale .......................... 18,034,266 13,709,963
Purchase of other long-term investments ....... (1,020,000) (750,000)
Disposal of other long-term investments ....... 242,886 331,527
Net sales (purchases) of short-term investments 1,878,341 (24,811,490)
------------ ------------
Net cash provided by (used in)
investing activities .................... 4,991,974 (11,401,230)
------------ ------------
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 ............. 1,355,987 1,151,078
Dividends paid to Employers Mutual ........ (2,795,176) (2,744,632)
Dividends paid to Employers Mutual
(reimbursement for non-GAAP expense) .... (262,268) (419,509)
Dividends paid to public stockholders ......... (669,122) (683,571)
------------ ------------
Net cash used in financing activities ..... (2,370,579) (2,696,634)
------------ ------------
NET INCREASE (DECREASE) IN CASH ................. 14,123 372 (4,161,191)
Cash at beginning of year ....................... (14,069,102) (119,097)
------------ ------------
Cash at end of quarter .......................... $ 54,270 $ (4,280,288)
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. REINSURANCE
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three and six months ended June 30, 2004
and 2003 is presented below.
Three months ended June 30,
---------------------------
2004 2003
------------ ------------
Premiums written
Direct ............................ $ 49,038,944 $ 60,623,701
Assumed from non-affiliates ....... 1,133,114 733,455
Assumed from affiliates ........... 92,155,771 90,627,827
Ceded to non-affiliates ........... (4,309,189) (4,074,611)
Ceded to affiliates ............... (49,038,944) (60,623,701)
------------ ------------
Net premiums written ............ $ 88,979,696 $ 87,286,671
============ ============
Premiums earned
Direct ............................ $ 48,864,449 $ 56,379,608
Assumed from non-affiliates ....... 1,092,929 757,500
Assumed from affiliates ........... 87,059,769 84,294,242
Ceded to non-affiliates ........... (4,168,411) (3,073,974)
Ceded to affiliates ............... (48,864,449) (56,379,608)
------------ ------------
Net premiums earned ............. $ 83,984,287 $ 81,977,768
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 26,092,955 $ 43,543,113
Assumed from non-affiliates ....... 172,396 862,689
Assumed from affiliates ........... 66,787,191 63,926,117
Ceded to non-affiliates ........... (3,312,138) (2,167,171)
Ceded to affiliates ............... (26,092,955) (43,543,113)
------------ ------------
Net losses and settlement
expenses incurred ............. $ 63,647,449 $ 62,621,635
============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Six months ended June 30,
---------------------------
2004 2003
------------ ------------
Premiums written
Direct ............................ $ 96,783,479 $117,094,392
Assumed from non-affiliates ....... 2,092,099 1,814,646
Assumed from affiliates ........... 180,186,768 176,583,547
Ceded to non-affiliates ........... (8,615,353) (7,787,448)
Ceded to affiliates ............... (96,783,479) (117,094,392)
------------ ------------
Net premiums written ............ $173,663,514 $170,610,745
============ ============
Premiums earned
Direct ............................ $100,634,753 $111,548,542
Assumed from non-affiliates ....... 2,052,453 1,673,229
Assumed from affiliates ........... 173,597,194 166,274,581
Ceded to non-affiliates ........... (8,207,078) (5,588,144)
Ceded to affiliates ............... (100,634,753) (111,548,542)
------------ ------------
Net premiums earned ............. $167,442,569 $162,359,666
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 53,135,506 $ 71,036,779
Assumed from non-affiliates ....... 931,485 1,545,480
Assumed from affiliates ........... 118,253,104 114,826,679
Ceded to non-affiliates ........... (4,575,963) (3,523,452)
Ceded to affiliates ............... (53,135,506) (71,036,779)
------------ ------------
Net losses and settlement
expenses incurred ............. $114,608,626 $112,848,707
============ ============
3. 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 Six months ended
June 30, June 30,
---------------------- -----------------------
2004 2003 2004 2003
---------- ---------- ----------- ----------
Net income, as reported ...... $3,465,936 $1,430,192 $11,815,031 $7,875,870
Deduct: Total stock-based
employee compensation
expense determined under the
fair value method for all
awards, net of related tax
effects .................... 8,170 6,346 16,187 12,692
---------- ---------- ----------- ----------
Pro forma net income ......... $3,457,766 $1,423,846 $11,798,844 $7,863,178
========== ========== =========== ==========
Net income per share:
Basic and diluted -
As reported .............. $0.30 $0.12 $1.02 $.69
Basic and diluted -
Pro forma ................ $0.30 $0.12 $1.02 $.69
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
4. 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
June 30, 2004 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 62,209,091 $ 21,775,196 $ 83,984,287
Underwriting (loss)
gain ............... (8,060,609) 2,222,022 (5,838,587)
Net investment income 4,554,410 2,297,481 $ 13,772 6,865,663
Realized investment
gains .............. 2,452,066 729,042 - 3,181,108
Other income ......... 265,112 - - 265,112
Interest expense ..... 193,125 84,975 - 278,100
Other expense ........ 228,066 - 191,151 419,217
------------ ------------ ------------ ------------
(Loss) income before
income tax (benefit)
expense ............ $ (1,210,212) $ 5,163,570 $ (177,379) $ 3,775,979
============ ============ ============ ============
Property
Three months ended and casualty Parent
June 30, 2003 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 60,342,141 $ 21,635,627 $ 81,977,768
Underwriting loss .... (5,684,419) (307,199) (5,991,618)
Net investment income 5,187,381 2,193,977 $ 5,698 7,387,056
Realized investment
gains .............. 415,383 171,201 - 586,584
Other income ......... 264,328 - - 264,328
Interest expense ..... 193,125 84,975 - 278,100
Other expense ........ 333,238 - 215,420 548,658
------------ ------------ ------------ ------------
(Loss) income before
income tax (benefit)
expense ............ $ (343,690) $ 1,973,004 $ (209,722) $ 1,419,592
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Property
Six months ended and casualty Parent
June 30, 2004 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $123,569,319 $ 43,873,250 $167,442,569
Underwriting (loss)
gain ............... (4,020,260) 3,395,888 (624,372)
Net investment income 9,520,781 4,592,964 $ 25,895 14,139,640
Realized investment
gains .............. 2,742,033 839,602 - 3,581,635
Other income ......... 341,591 - - 341,591
Interest expense ..... 386,250 169,950 - 556,200
Other expense ........ 408,463 - 334,492 742,955
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 7,789,432 $ 8,658,504 $ (308,597) $ 16,139,339
============ ============ ============ ============
Property
Six months ended and casualty Parent
June 30, 2003 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $119,547,945 $ 42,811,721 $162,359,666
Underwriting loss .... (1,214,328) (604,269) (1,818,597)
Net investment income 10,738,318 4,439,732 $ 55,930 15,233,980
Realized investment
losses ............. (943,531) (219,670) - (1,163,201)
Other income ......... 432,158 - - 432,158
Interest expense ..... 533,112 230,954 - 764,066
Other expense ........ 610,422 - 346,784 957,206
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 7,869,083 $ 3,384,839 $ (290,854) $ 10,963,068
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
5. INCOME TAXES
The actual income tax expense (benefit) for the three and six months
ended June 30, 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 (benefit)) as follows:
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Computed "expected" tax
expense ................ $ 1,321,593 $ 496,857 $ 5,648,769 $ 3,837,074
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (789,216) (480,265) (1,400,289) (885,541)
Proration of
tax-exempt interest
and dividends
received deduction 124,405 43,635 222,427 83,909
Other, net ........... (346,739) (70,827) (146,599) 51,756
----------- ----------- ----------- -----------
Income tax
expense
(benefit) ...... $ 310,043 $ (10,600) $ 4,324,308 $ 3,087,198
=========== =========== =========== ===========
6. 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 Six months ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Pension Plan:
Service cost .............. $1,704,630 $1,540,255 $3,409,260 $3,080,510
Interest cost ............. 1,755,222 1,748,164 3,510,444 3,496,328
Expected return on plan
assets .................. (1,690,132) (1,629,228) (3,380,264) (3,258,456)
Recognized net actuarial
loss .................... 213,922 241,807 427,844 483,614
Amortization of prior
service costs ........... 191,456 197,412 382,912 394,824
---------- ---------- ---------- ----------
Net periodic pension
benefit cost .......... $2,175,098 $2,098,410 $4,350,196 $4,196,820
========== ========== ========== ==========
Postretirement benefit plans:
Service cost .............. $1,144,127 $1,100,250 $2,288,254 $2,200,500
Interest cost ............. 1,078,509 1,065,750 2,157,018 2,131,500
Expected return on plan
assets .................. (225,221) (184,250) (450,442) (368,500)
Amortization of net loss .. 147,830 252,750 295,660 505,500
---------- ---------- ---------- ----------
Net periodic
postretirement
benefit cost .......... $2,145,245 $2,234,500 $4,290,490 $4,469,000
========== ========== ========== ==========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Pension expense allocated to the Company was $528,724 and $1,057,447 for
the three months and six months ended June 30, 2004 compared to $505,825 and
$1,011,647 for the same periods in 2003.
Postretirement benefit expense allocated to the Company was $481,852 and
$963,705 for the three months and six months ended June 30, 2004 compared to
$526,502 and $1,053,005 for the same periods in 2003.
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. In
January 2004, the Financial Accounting Standards Board (FASB) issued Staff
Position FAS No. 106-1 "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003."
Because of various uncertainties, including Employers Mutual's response to
this legislation and the appropriate accounting methodology for this event,
the Company elected to defer financial recognition of this legislation as
permitted under FAS 106-1. In May 2004, the FASB issued Staff Position FAS
No. 106-2 which is effective for interim and annual periods beginning after
June 15, 2004. FAS No. 106-2 provides accounting guidance and disclosure
requirements for the prescription drug subsidy established under the Act. The
Company is currently evaluating the impact FSP No. 106-2 will have on net
income.
7. 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 net income. The
companies involved have reserves which are believed adequate to cover any
potential liabilities arising out of all such pending or threatened
proceedings.
The participants in 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 that this contingent liability, which would only arise 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 net
income.
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 81.0 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 73.8
percent of consolidated premiums earned for the first six months of 2004. 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. Additional changes to the pooling agreement have
recently been proposed that would become effective January 1, 2005. Please
see the discussion contained under the heading "Recent Developments" later in
this document. 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, 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 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 and the cost of producing,
underwriting and administering the business. An underwriting loss indicates
that premium income was not adequate.
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, which is considered to be the leading insurance rating agency, 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, CONTINUED
(Unaudited)
Management has long recognized the importance of adequate capitalization
for its insurance subsidiaries and has strived to maintain a strong capital
position by investing their assets conservatively and, more importantly,
maintaining a consistent level of loss and settlement expense 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 demonstrated during 2003 and again during the second
quarter of 2004 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. Management
has worked diligently over the last several years to improve profitability
through a combination of adequate pricing and focused underwriting practices.
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. 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. Achieving
an underwriting profit 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
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.
MEASUREMENT OF RESULTS
The Company's consolidated financial statements are prepared on the basis
of accounting principles generally accepted in the United States (also known
as "GAAP"). The Company also prepares financial statements for each of its
insurance subsidiaries based on statutory accounting principles that are filed
with insurance regulatory authorities in the states in which they do business.
Statutory accounting principles are based on liquidation accounting
principles and are directed toward the protection of policyholders.
Management evaluates the Company's operations by monitoring key measures
of growth and profitability. Management measures the Company's growth by
examining direct premiums written and, perhaps more importantly, premiums
written assumed from affiliates. Management generally measures the Company's
operating results by examining the Company's net income, return on equity, and
the loss and settlement expense, acquisition expense and combined ratios. The
following provides further explanation of the key measures management uses to
evaluate the Company's results:
Direct Premiums Written. Direct premiums written is the sum of the total
policy premiums, net of cancellations, associated with policies underwritten
and issued by the Company's property and casualty insurance subsidiaries.
These direct premiums written are transferred to Employers Mutual under the
terms of the pooling agreement and are reflected in the Company's consolidated
financial statements as premiums written ceded to affiliates. See note 2 of
Notes to Interim Consolidated Financial Statements.
Premiums Written Assumed From Affiliates. Premiums written assumed from
affiliates reflects the Company's property and casualty insurance
subsidiaries' 23.5 percent aggregate participation interest in the total
direct premiums written by all the participants in the pooling arrangement and
the premiums written assumed by the Company's reinsurance subsidiary from
Employers Mutual under the quota share agreement. See note 2 of Notes to
Interim Consolidated Financial Statements. Management uses premiums written
assumed from affiliates and non-affiliates, which excludes the impact of
written premiums ceded to reinsurers, as a measure of the underlying growth of
the Company's insurance business from period to period.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Net Premiums Written. Net premiums written is the sum of the premiums
written assumed from affiliates plus premiums written assumed from non-
affiliates less premiums written ceded to non-affiliates. Premiums written
ceded to non-affiliates is the portion of the Company's direct and assumed
premiums written that is transferred to reinsurers in accordance with the
terms of the reinsurance contracts and based upon the risks they accept. See
note 2 of Notes to Interim Consolidated Financial Statements. Management uses
net premiums written to measure the amount of business retained after cessions
to reinsurers.
Loss and Settlement Expense Ratio. The loss and settlement expense ratio
is the ratio (expressed as a percentage) of losses and settlement expenses to
premiums earned and measures the underwriting profitability of a company's
insurance business. The loss and settlement expense ratio is generally
measured on both a gross (direct and assumed) and net (gross less ceded)
basis. Management uses the gross loss and settlement expense ratio as a
measure of the Company's overall underwriting profitability of the insurance
business it writes and to assess the adequacy of the Company's pricing. The
net loss and settlement expense ratio is meaningful in evaluating the
Company's financial results, which are net of ceded reinsurance, as reflected
in the consolidated financial statements. The loss and settlement expense
ratios are generally calculated in the same way for GAAP and statutory
accounting purposes.
Acquisition Expense Ratio. The acquisition expense ratio is the ratio
(expressed as a percentage) of net acquisition and other expenses to premiums
earned and measures a company's operational efficiency in producing,
underwriting and administering its insurance business. For statutory
accounting purposes, acquisition and other expenses of an insurance company
exclude investment expenses. There is no such industry definition for
determining an acquisition expense ratio for GAAP purposes. As a result,
management applies the statutory definition to calculate the Company's
acquisition expense ratio on a GAAP basis. The net acquisition expense ratio
is meaningful in evaluating the Company's financial results, which are net of
ceded reinsurance, as reflected in the consolidated financial statements.
GAAP Combined Ratio. The combined ratio is the sum of the loss and
settlement expense ratio and the acquisition expense ratio and measures a
company's overall underwriting profit. If the combined ratio is at or above
100, an insurance company cannot be profitable without investment income (and
may not be profitable if investment income is insufficient). Management uses
the GAAP combined ratio in evaluating the Company's overall underwriting
profitability and as a measure for comparison of the Company's profitability
relative to the profitability of its competitors who prepare GAAP-basis
financial statements.
Statutory Combined Ratio. The statutory combined ratio is calculated in
the same manner as the GAAP combined ratio, but is based on results determined
pursuant to statutory accounting rules and regulations. The statutory "trade
combined ratio" differs from the statutory combined ratio in that the
acquisition expense ratio is based on net premiums written rather than
premiums earned. Management uses the statutory trade combined ratio as a
measure for comparison of the Company's profitability relative to the
profitability of its competitors, all of whom must file statutory-basis
financial statements with insurance regulatory authorities.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
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 and
six months ended June 30, 2004 and 2003 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2004 2003 2004 2003
-------- -------- -------- --------
Property and Casualty Insurance
Premiums earned ..................... $ 62,209 $ 60,342 $123,569 $119,548
Losses and settlement expenses ...... 48,476 45,638 84,871 80,927
Acquisition and other expenses ...... 21,794 20,388 42,719 39,835
-------- -------- -------- --------
Underwriting loss ................... $ (8,061)$ (5,684) $ (4,021)$ (1,214)
======== ======== ======== ========
Loss and settlement expense ratio ... 77.9% 75.6% 68.7% 67.7%
Acquisition expense ratio ........... 35.1 33.8 34.6 33.3
-------- -------- -------- --------
Combined ratio ...................... 113.0% 109.4% 103.3% 101.0%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 41,362 $ 41,287 $ 81,182 $ 77,950
Increase in provision for insured
events of prior years ......... 7,114 4,351 3,689 2,977
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 48,476 $ 45,638 $ 84,871 $ 80,927
======== ======== ======== ========
Catastrophe and storm losses ........ $ 7,032 $ 9,090 $ 7,902 $ 10,003
======== ======== ======== ========
Reinsurance
Premiums earned ..................... $ 21,775 $ 21,636 $ 43,873 $ 42,812
Losses and settlement expenses ...... 15,172 16,984 29,738 31,922
Acquisition and other expenses ...... 4,381 4,960 10,739 11,495
-------- -------- -------- --------
Underwriting gain (loss) ............ $ 2,222 $ (308) $ 3,396 $ (605)
======== ======== ======== ========
Loss and settlement expense ratio ... 69.7% 78.5% 67.8% 74.6%
Acquisition expense ratio ........... 20.1 22.9 24.5 26.8
-------- -------- -------- --------
Combined ratio ...................... 89.8% 101.4% 92.3% 101.4%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 16,289 $ 17,858 $ 31,220 $ 30,736
(Decrease) increase in provision
for insured events of prior
years ......................... (1,117) (874) (1,482) 1,186
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 15,172 $ 16,984 $ 29,738 $ 31,922
======== ======== ======== ========
Catastrophe and storm losses ........ $ 165 $ 1,251 $ 310 $ 1,425
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2004 2003 2004 2003
-------- -------- -------- --------
Consolidated
REVENUES
Premiums earned ..................... $ 83,984 $ 81,978 $167,442 $162,360
Net investment income ............... 6,866 7,387 14,140 15,234
Realized investment gains (losses) .. 3,181 587 3,582 (1,163)
Other income ........................ 265 264 341 432
-------- -------- -------- --------
94,296 90,216 185,505 176,863
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ...... 63,648 62,622 114,609 112,849
Acquisition and other expenses ...... 26,175 25,348 53,458 51,330
Interest expense .................... 278 278 556 764
Other expense ....................... 419 549 743 957
-------- -------- -------- --------
90,520 88,797 169,366 165,900
-------- -------- -------- --------
Income before income tax expense
(benefit) ......................... 3,776 1,419 16,139 10,963
Income tax expense (benefit) ........ 310 (11) 4,324 3,087
-------- -------- -------- --------
Net income .......................... $ 3,466 $ 1,430 $ 11,815 $ 7,876
======== ======== ======== ========
Loss and settlement expense ratio ... 75.8% 76.4% 68.4% 69.5%
Acquisition expense ratio ........... 31.2 30.9 32.0 31.6
-------- -------- -------- --------
Combined ratio ...................... 107.0% 107.3% 100.4% 101.1%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 57,651 $ 59,145 $112,402 $108,686
Increase in provision for insured
events of prior years ......... 5,997 3,477 2,207 4,163
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 63,648 $ 62,622 $114,609 $112,849
======== ======== ======== ========
Catastrophe and storm losses ........ $ 7,197 $ 10,341 $ 8,212 $ 11,428
======== ======== ======== ========
Net income improved substantially for both the three months and six months
ended June 30, 2004 from the same periods in 2003, primarily due to the
recognition of a significant amount of realized investment gains during the
second quarter of 2004. Reflected in the results for the three months and six
months ended June 30, 2004 are underwriting losses of $5,839,000 and $625,000,
respectively, compared to underwriting losses of $5,992,000 and $1,819,000 for
the same periods in 2003. As reported on June 15, 2004, the Company
strengthened its bulk loss and settlement expense reserves during the second
quarter of 2004 in response to a recently completed actuarial evaluation of
the carried reserves for the property and casualty insurance segment. This
increase in reserves amounted to $2,940,000 and reduced second quarter
earnings by $1,910,000 ($0.17 per share) on an after tax basis. Actuarial
evaluations of the Company's carried reserves are performed on a regularly-
scheduled basis and additional evaluations will be performed during the
remainder of the year. The Company's standard practice is 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 second quarter of 2004 represents an increase of 0.8
percent of total loss and settlement expense reserves carried at March 31,
2004.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Premiums Earned
Premiums earned increased 2.4 percent and 3.1 percent to $83,984,000 and
$167,442,000 for the three months and six months ended June 30, 2004 from
$81,978,000 and $162,360,000 for the same periods in 2003. These increases
are primarily attributed to rate increases implemented during the prior two
years in the property and casualty insurance business as well as moderate
growth and improved pricing in the assumed reinsurance business. The overall
market for property and casualty insurance remained firm during the second
quarter of 2004, but moderated slightly in certain lines of business and
select territories due to an increase in price competition. No significant
changes are anticipated in the commercial lines marketplace for the remainder
of the year and the Company will continue to implement rate increases in those
lines of business and/or territories where such action is warranted; however,
the overall level of these rate increases is expected to be smaller than those
implemented during the past several months.
Premiums earned for the property and casualty insurance segment increased
3.1 percent and 3.4 percent to 62,209,000 and $123,569,000 for the three
months and six months ended June 30, 2004 from $60,342,000 and $119,548,000
for the same periods in 2003. These increases are primarily the result of
rate increases that were implemented during the prior two 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 the first six months 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.
For the first six months of 2004, premiums written increased only 1.6 percent
due to a decline in policy count and an increase in ceded premiums. The
decline in policy count is attributed to 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 price
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 the
remainder of 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Premiums earned for the reinsurance segment increased 0.6 percent and 2.5
percent to $21,775,000 and $43,873,000 for the three months and six months
ended June 30, 2004 from $21,636,000 and $42,812,000 for the same periods in
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
$2,440,000 and $4,809,000 of additional premiums earned in the three months
and six months ended June 30, 2004. The increase in the MRB premiums earned
was largely offset by a decline in the HORAD book of business because
Employers Mutual was unsuccessful in its attempt to renew several accounts
during the January 1 and July 1, 2004 renewal seasons due to its current "A-"
(Excellent) A.M. Best rating. Employers Mutual is attempting to replace this
business with new accounts and increased participation on existing accounts.
Following large across-the-board rate increases implemented in 2002, premium
rate increases on excess-of-loss contracts moderated during 2003 and the first
half 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 premiums earned for the three months and six months
ended June 30, 2004 reflects an increase in the estimate of earned but not
reported premiums of $1,400,000 and $610,000, respectively, compared to an
increase of $1,265,000 and $1,747,000 in the same periods in 2003.
Losses and settlement expenses
Losses and settlement expenses increased 1.6 percent and 1.6 percent to
$63,648,000 and $114,609,000 for the three months and six months ended June
30, 2004 from $62,622,000 and $112,849,000 for the same periods in 2003. The
loss and settlement expense ratios declined moderately to 75.8 percent and
68.4 percent for the three months and six months ended June 30, 2004 from 76.4
percent and 69.5 percent for the same periods in 2003. The decrease in the
loss and settlement expense ratios for 2004 is primarily attributed to a
decline in catastrophe and storm losses from the unusually high level
experienced during 2003. Other factors contributing to the improvement
include a significant decline in reported losses in the reinsurance segment
and a decrease in the amount of adverse development experienced on prior
years' reserves during the first six months of 2004.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The loss and settlement expense ratio for the property and casualty
insurance segment increased to 77.9 percent and 68.7 percent for the three
months and six months ended June 30, 2004 from 75.6 percent and 67.7 percent
for the same periods in 2003. The increase in the 2004 ratios primarily
reflects a $2,940,000 increase in bulk loss and settlement expense reserves
implemented during the second quarter. This reserve strengthening was
implemented in response to a recently completed actuarial evaluation of the
segment's carried reserves that indicated a continued upward trend in
projected ultimate losses. The increase in adverse development experienced on
prior years' reserves during the second quarter of 2004 includes approximately
$1,795,000 associated with this reserve strengthening, in addition to
$1,410,000 of adverse case reserve development in the workers' compensation
line of business and $940,000 of adverse development from non-voluntary pools
in which the Company participates. Loss severity continued to trend upward
during the first half of 2004 while overall loss frequency continued to trend
downward; however, there are some indications that loss frequency may be
leveling out. Catastrophe and storm losses, while still considered high,
declined from the elevated levels reported in 2003.
The loss and settlement expense ratio for the reinsurance segment
decreased to 69.7 percent and 67.8 percent for the three months and six months
ended June 30, 2004 from 78.5 percent and 74.6 percent for the same periods in
2003. The decline in the 2004 ratios reflects a decrease in catastrophe and
storm losses, a decline in reported losses (including large excess-of-loss
business losses), an increase in favorable development on prior years'
reserves and continued improvement in overall premium rate adequacy. The
majority of the adverse development reported for the first six months of 2003
came from ocean marine business; however, this development was offset by
additional premium income.
Acquisition and other expenses
Acquisition and other expenses increased 3.3 percent and 4.1 percent to
$26,175,000 and $53,458,000 for the three months and six months ended June 30,
2004 from $25,348,000 and $51,330,000 for the same periods in 2003. The
acquisition expense ratio increased to 31.2 percent and 32.0 percent for the
three and six months ended June 30, 2004 from 30.9 percent and 31.6 percent
for the same periods in 2003. The increase in the 2004 ratios is primarily
attributed to an increase in contingent commission expense and a smaller
increase in deferred policy acquisition costs.
For the property and casualty insurance segment, the acquisition expense
ratio increased to 35.1 percent and 34.6 percent for the three months and six
months ended June 30, 2004 from 33.8 percent and 33.3 percent for the same
periods in 2003. These increases primarily reflect an increase in contingent
commission expense and a decline in the amount of acquisition costs that were
deferred due to the relatively small increase in production experienced during
the first six months of 2004. The Company will be implementing a new agent
profit share program, which is designed to better equate agent compensation
with the quality and quantity of the insurance business produced, effective
January 1, 2005. Under the new program, the Company's best performing agents
will be rewarded with increased compensation while agents with marginal
business will experience a decline in compensation. Total profit share
expense under the new program is expected to decline slightly.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
For the reinsurance segment, the acquisition expense ratio decreased to
20.1 percent and 24.5 percent for the three months and six months ended June
30, 2004 from 22.9 percent and 26.8 percent for the same periods in 2003. The
decline in the 2004 ratios is primarily attributed to $1,064,000 of contingent
commission income recognized during the second quarter of 2004 as a result of
the favorable underwriting performance of Employers Mutual's assumed
reinsurance book of business. A decline in commission expense also
contributed to the decrease in the acquisition expense ratio, but to a much
lesser extent. Commission expense for the six months ended June 30, 2004 and
2003 includes $1,033,000 and $782,000, respectively, incurred in connection
with the increased participation in the MRB reinsurance pool.
Investment results
Net investment income decreased 7.1 percent and 7.2 percent to $6,866,000
and $14,140,000 for the three months and six months ended June 30, 2004 from
$7,387,000 and $15,234,000 for the same periods in 2003, despite an increase
in invested assets. These decreases are 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.
The Company reported net realized investment gains of $3,181,000 and
$3,582,000 for the three months and six months ended June 30, 2004 compared to
net realized investment gains of $587,000 for the three months and net
realized investment losses of $1,163,000 for the six months ended June 30,
2003. The large increase in realized investment gains in the second quarter
of 2004 reflects $2,558,000 of net gains recognized on the Company's
investment in MCI Communications Corporation bonds in conjunction with a
payout award received under a bankruptcy court approved "Plan of
Reorganization." These bonds had previously been determined to be other-than-
temporarily impaired during the second quarter of 2002. Reflected in the
realized investment losses for the first six months 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 at June 30, 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, CONTINUED
(Unaudited)
Other information
The Company incurred $278,000 and $556,000 of interest expense on surplus
notes during the three months and six months ended June 30, 2004 compared to
$278,000 and $764,000 for the same periods in 2003. The decline in interest
expense for the six months ended June 30, 2004 is attributed to the fact that
the surplus notes were refinanced with Employers Mutual effective April 1,
2003. The interest expense incurred on these surplus notes did not have a
material impact on the Company's net income 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 six months
ended June 30, 2004 from the same periods in 2003, primarily due to the
increase in pre-tax income for these periods. The effective tax rate for the
first six months of 2004 declined to 26.8 percent from 28.2 percent for the
same period in 2003, primarily due to an increase in tax-exempt investment
income. 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.
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 increased from seven percent in 2003 to ten percent in
2004, and will increase to 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.
Recent Developments
On July 16, 2004 the Company filed a registration statement with the
Securities and Exchange Commission for a proposed follow-on offering of
4,400,000 shares of its common stock. The Company intends to sell 2,000,000
million shares of common stock in the offering. Additionally, 2,400,000
shares of the Company's common stock is intended to be sold by a selling
shareholder, Employers Mutual, thereby reducing Employers Mutual's ownership
of the Company from 81.0 percent currently to approximately 51.3 percent.
Under the terms of the proposed offering, the underwriters would be granted an
option to purchase up to an additional 660,000 shares of the Company's common
stock from Employers Mutual to cover over-allotments, if any. If this over-
allotment option were to be exercised in full, Employers Mutual's ownership of
the Company would decline to approximately 46.5 percent. The Company will not
receive any of the proceeds from the sale of shares of common stock currently
owned by Employers Mutual. Exact terms of the offering will be available only
by a prospectus, which is not yet available.
The lead underwriter and sole book-running manager for the offering is
Keefe, Bruyette & Woods, Inc. The co-managers for the offering are A.G.
Edwards & Sons, Inc. and KeyBanc Capital Markets, a division of McDonald
Investments Inc.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
On July 19, 2004, the Company announced plans for a proposed 6.5
percentage point increase in its aggregate participation interest in the
pooling agreement effective January 1, 2005. As a result of this change, the
Company's aggregate participation interest in the pooling agreement would
increase from the current 23.5 percent to 30.0 percent. This increase in the
Company's aggregate participation interest is subject to the approval of the
Iowa Insurance Division and the successful completion of the stock offering
noted above.
Employers Mutual participated in the Company's Dividend Reinvestment and
Common Stock Purchase Plan during the first two quarters of 2004 and
reinvested 50 percent of its dividends in additional shares of the Company's
common stock. Due to its participation in the above referenced stock
offering, Employers Mutual discontinued its participation in the plan for the
third quarter of 2004 and has indicated that it will likely not participate in
the plan during the fourth quarter of 2004.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The Company maintains a portion of its investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to meet claims and expenses. The remainder of the investment portfolio,
excluding investments in equity securities, is invested in securities with
maturities that approximate the anticipated liabilities of the insurance
issued. At June 30, 2004, approximately 23 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 $7,455,000 at June 30, 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, CONTINUED
(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 $5,535,000 and $4,758,000 in minority ownership
interests in limited partnerships and limited liability companies at June 30,
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 $11,502,000
during the first half of 2004 compared to $9,937,000 for the same period in
2003.
The Company's cash balance was $54,000 and ($14,069,000) at June 30, 2004
and December 31, 2003, respectively. The balance at December 31, 2003
reflects a $14,346,000 transfer of funds out of the cash account on December
31, 2003 to purchase a fixed maturity security; however, due to timing, the
account does not reflect the corresponding transfer of cash into the account
to fund the purchase. This timing difference resulted in the negative balance
in the account.
Pension liabilities reflected in the Company's financial statements
totaled $87,000 (including $1,016,000 of additional minimum liability) at June
30, 2004 and $1,453,000 (including $1,016,000 of additional minimum liability)
at December 31, 2003. The decline in the pension liability at June 30, 2004
is associated with a $2,424,000 pension plan contribution made during the
second quarter of 2004. The intangible asset reflected in the Company's
financial statements totaled $1,016,000 at both June 30, 2004 and December 31,
2003. Postretirement benefit liabilities reflected in the Company's financial
statements totaled $9,386,000 and $8,512,000 at June 30, 2004 and December 31,
2003, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Capital Resources
The Company had total cash and invested assets with a carrying value of
$692.2 million and $676.9 million as of June 30, 2004 and December 31, 2003,
respectively. The following table summarizes the Company's cash and invested
assets as of the dates indicated:
June 30, 2004
-----------------------------------
Percent of
Amortized total at
($ in thousands) cost Fair value fair value
-------- ---------- ----------
Fixed maturities, held-to-maturity .... $ 46,751 $ 49,090 7.1%
Fixed maturities, available-for-sale .. 513,529 524,999 75.5
Equity securities, available-for-sale 41,689 53,161 7.7
Cash .................................. 54 54 0.0
Short-term investments ................ 61,690 61,690 8.9
Other long-term investments ........... 5,535 5,535 0.8
-------- -------- -----
$669,248 $694,529 100.0%
======== ======== =====
December 31, 2003
-----------------------------------
Percent of
Amortized total at
($ in thousands) cost Fair value fair value
--------- ---------- ----------
Fixed maturities, held-to-maturity .... $ 49,845 $ 53,854 7.9%
Fixed maturities, available-for-sale .. 499,511 523,786 76.9
Equity securities, available-for-sale 38,998 49,008 7.2
Cash .................................. (14,069) (14,069) (2.0)
Short-term investments ................ 63,568 63,568 9.3
Other long-term investments ........... 4,758 4,758 0.7
-------- -------- -----
$642,611 $680,905 100.0%
======== ======== =====
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The amortized cost and estimated fair value of fixed maturities and
equity securities at June 30, 2004 were as follows:
Held-to maturity
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
($ in thousands) cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 45,051 $ 2,178 $ - $ 47,229
Mortgage-backed securities 1,700 162 - 1,862
--------- ---------- ---------- ---------
Total securities
held-to-maturity ..... $ 46,751 $ 2,340 $ - $ 49,091
========= ========== ========== =========
Available-for sale
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
($ in thousands) cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 107,617 $ 10 $ 490 $ 107,137
Obligations of states and
political subdivisions ... 222,833 3,924 2,559 224,198
Mortgage-backed securities 17,577 1,487 16 19,048
Public utilities ........... 20,178 1,740 59 21,859
Corporate securities ....... 145,324 8,133 700 152,757
---------- ---------- ---------- ---------
Total fixed maturity
securities ........... 513,529 15,294 3,824 524,999
---------- ---------- ---------- ---------
Equity securities .......... 41,689 11,887 415 53,161
---------- ---------- ---------- ---------
Total securities
available-for-sale $ 555,218 $ 27,181 $ 4,239 $ 578,160
========== ========== ========== =========
As of June 30, 2004, the Company had no material commitments for capital
expenditures.
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
At June 30, 2004, the Company had three series of fixed maturity
securities issued by MCI Communications Corporation with impaired book values.
These bonds were received during the second quarter of 2004 in conjunction
with a payout award received under a bankruptcy court approved "Plan of
Reorganization." This payout was recorded as a tax-free exchange and the new
bonds were assigned a book value equal to the book value of the defaulted
bonds that were replaced ($5,509,000). The par value of the new bonds
reflects the settlement amount of 79.2 cents per dollar ($4,552,000) and the
fair value of the new bonds was $4,241,000 at the time of the payout. Based
on these facts, a realized investment gain of $3,826,000 was recognized to
offset the other-than-temporary impairment loss previously recognized in the
second quarter of 2002 and an other-than-temporary impairment loss of
$1,268,000 was recognized to reduce the book value of the new bonds to fair
value at the time of the payout.
At June 30, 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 June 30, 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 $2,755,000, net of tax; however,
the Company's financial position would not be affected due to the fact that
unrealized losses on available-for-sale securities are reflected in the
Company's financial statements as a component of stockholders' equity, net of
deferred taxes.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position as of June 30, 2004.
Description of securities Fair value Unrealized losses
- ------------------------- ---------- -----------------
($ in thousands)
Fixed maturity securities:
Less than six months ........ $215,480 $2,919
Six to twelve months ........ 7,715 284
Twelve months or longer ..... 14,200 621
-------- ------
Total fixed maturity
securities .............. 237,395 3,824
-------- ------
Equity securities:
Less than six months ........ 6,542 413
Six to twelve months ........ - -
Twelve months or longer ..... 16 2
-------- ------
Total equity securities ... 6,558 415
-------- ------
Total temporarily
impaired securities ... $243,953 $4,239
======== ======
Following is a schedule of fixed maturity securities available-for-sale
that are non-investment grade and have unrealized losses at June 30, 2004. As
previously noted, the Company does not invest in junk bonds. The non-
investment grade securities held by the Company are the result of rating
downgrades that occurred subsequent to their purchase. The percentages
displayed are of the fair values of these securities to the total fair value
of fixed maturity securities available-for-sale, and of the unrealized losses
on these securities to the total gross unrealized losses on fixed maturity
securities available-for-sale. This schedule does not include fixed maturity
securities held-to-maturity due to the fact that none of these securities have
unrealized losses or are below investment grade at June 30, 2004. This
schedule also does not include the new MCI Communications Corporation bonds
received during the second quarter of 2004 in conjunction with a bankruptcy
court approved payout award. These bonds are currently not rated and are
deemed to be non-investment grade, but had a fair value that was greater than
book value at June 30, 2004.
Percent Percent
Moody's of of gross
bond Carrying Unrealized market unrealized
($ in thousands) rating value Loss value losses
------ ---------- ---------- ----- ----------
Potomac Edison .......... BA1 $ 2,513 $ 59 0.5% 1.5%
========== ========== ===== ==========
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 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 ............... $ 6,972 $ 5,702 $ 1,270
Over three months to six months .... - - -
Over six months to nine months ..... 2,600 2,550 50
Over nine months to twelve months .. - - -
Over twelve months ................. - - -
--------- --------- ---------
$ 9,572 $ 8,252 $ 1,320
========= ========= =========
Equity securities:
Three months or less ............... $ 6,392 $ 5,848 $ 544
Over three months to six months .... 417 373 44
Over six months to nine months ..... 231 211 20
Over nine months to twelve months .. - - -
Over twelve months ................. 1,267 1,110 157
--------- --------- ---------
$ 8,307 $ 7,542 $ 765
========= ========= =========
The $1,270,000 of realized losses recognized on fixed maturity securities
that were in an unrealized loss position for three months or less represents
an other-than-temporary impairment loss recognized on a new series of bonds
issued by MCI Communications Corporation in conjunction with a bankruptcy
court approved payout award.
LEASES, COMMITMENTS AND CONTINGENT LIABILITIES
Employers Mutual has entered into various leases for branch office
facilities with lease terms expiring through 2013. Employers Mutual also
leases computer software under various operating lease agreements expiring
through 2005. All lease costs are included as expenses under the pooling
agreement after allocation of the portion of these expenses to the
subsidiaries that do not participate in the pool. The following table shows
the Company's significant contractual obligations as of June 30, 2004 under
these non-cancelable operating leases.
Payments due by period
---------------------------------------------
Less than 1-3 4-5 More than
Total 1 year years years 5 years
------ --------- ------ ------ --------
($ in thousands)
Contractual Obligations
Real estate operating leases $6,813 $ 523 $2,976 $1,479 $1,835
Software operating leases .. 1,183 808 375 - -
------ ------ ------ ------- ------
Total ...................... $7,996 $1,331 $3,351 $1,479 $1,835
====== ====== ====== ====== ======
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Estimated quaranty fund assessments of $1,380,000 and $1,089,000, which
are used by states to pay claims of insolvent insurers domiciled in that
state, have been accrued as of June 30, 2004 and 2003, respectively. The
guaranty fund assessments are expected to be paid over the next two years with
premium tax offsets of $1,674,000 expected to be realized within ten years of
the payments. Estimated second injury fund assessments of $1,125,000 and
$981,000, which are designed to encourage employers to employ a worker with a
pre-existing disability, have been accrued as of June 30, 2004 and 2003,
respectively. The second injury fund assessment accruals are based on
projected loss payments. The periods over which the assessments will be paid
is not known.
The participants in 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 that this contingent liability, which would only arise 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 net
income.
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. In
January 2004, the Financial Accounting Standards Board (FASB) issued Staff
Position FAS No. 106-1 "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003."
Because of various uncertainties, including Employers Mutual's response to
this legislation and the appropriate accounting methodology for this event,
the Company elected to defer financial recognition of this legislation as
permitted under FAS 106-1. In May 2004, the FASB issued Staff Position FAS
No. 106-2 which is effective for interim and annual periods beginning after
June 15, 2004. FAS No. 106-2 provides accounting guidance and disclosure
requirements for the prescription drug subsidy established under the Act. The
Company is currently evaluating the impact FSP No. 106-2 will have on net
income.
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: general volatility of the property and
casualty insurance and reinsurance markets; 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
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 influence 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, 2003 and
into 2004. For equity price risk, the poor performance of the markets during
this period resulted in declines in the value of the Company's equity
investments. This risk appears to have declined somewhat due to the recovery
of the markets in the latter part of 2003 and into 2004. Credit quality risk
rose, resulting in a decline in the value of several bond investments stemming
from the many high-profile bankruptcies and other downgrade activities during
this period. This risk also appears to be subsiding as general economic
conditions continue to show signs of strengthening in 2004. Prepayment risk
increased, primarily for the mortgage-backed securities, as declines in
interest rates during this 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 this period. 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 has continued its
commitment to controlling non-systematic risk through sound investment
policies and diversification.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are functioning effectively to provide reasonable
assurance that the Company can meet its disclosure obligations. Since the
date of the most recent evaluation of the Company's internal controls by the
Chief Executive Officer and Chief Financial Officer there have been no
significant changes in the Company's internal controls or in other factors
that could significantly affect these controls.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASE OF EQUITY
SECURITIES
The following table sets forth information regarding purchases of equity
securities by the Company and affiliated purchasers for the three months ended
June 30, 2004:
Issurer Purchases of Equity Securities
- ----------------------------------------------------------------------------
(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
- ---------------- ----------- --------- ------------- ------------------
4/1/04 - 4/30/04 111 (1) $23.44 - -
5/1/04 - 5/31/04 107 (1) 19.96 - -
6/1/04 - 6/30/04 29,388 (1) 24.97 - -
- ---------------- ----------- --------- ------------- ------------------
Total 29,606 $24.95 - -
=========== ========= ============= ==================
(1) All shares were purchased in the open market under the Company's dividend
reinvestment and common stock purchase plan.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 20, 2004
(b) The following eight persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter, III Margaret A. Ball
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek Joanne L. Stockdale
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
------------------------ ---------- ----------
George C. Carpenter, III 11,128,166 49,587
Margaret A. Ball 10,988,330 189,423
David J. Fisher 11,129,616 48,137
Bruce G. Kelley 10,987,178 190,575
George W. Kochheiser 10,990,038 187,715
Raymond A. Michel 11,149,742 28,011
Fredrick A. Schiek 10,988,730 189,023
Joanne L. Stockdale 11,028,969 148,784
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED)
(c) Items voted upon and number of votes cast(continued):
2. Proposal to ratify the appointment of Ernst & Young LLP as
the independent auditors of the Company:
For 11,147,407 Against 25,121 Withheld 5,225
---------- ------- ------
3. Proposal to ratify Restated Articles of Incorporation:
For 11,139,405 Against 31,186 Withheld 7,162
---------- ------- ------
The total number of qualified shares voted by proxy
was: 11,177,753
(d) None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 31.1 Certification of the President and Chief Executive
Officer as required by Section 302 of the Sarbanes-
Oxley Act of 2002.
Exhibit 31.2 Certification of the Vice President and Chief Financial
Officer as required by Section 302 of the Sarbanes-
Oxley Act of 2002.
Exhibit 32.1 Certification of the President and Chief Executive
Officer pursuant to 18 U.S.C. Section 1350, as
Adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
Exhibit 32.2 Certification of the Vice President and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as
Adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) An 8-K was filed on April 29, 2004 announcing the Company's financial
results for the first quarter of 2004.
An 8-K was filed on May 24, 2004 announcing the Company's declaration
of a quarterly dividend of fifteen cents per share of common stock
payable June 10, 2004 to shareholders of record as of June 3, 2004.
The Company also announced the election of two new directors,
Margaret A. Ball and Joanne L. Stockdale.
An 8-K was filed on June 15, 2004 announcing second quarter 2004
reserve strengthening actions and estimated storm losses.
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: August 13, 2004