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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 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 October 29, 2004
----- -------------------------------
Common stock, $1.00 par value 13,564,153
Total pages 48
------
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
------------- ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $16,541,150 and $21,167,655) ... $ 15,454,308 $ 19,423,013
Securities available-for-sale, at fair value
(amortized cost $470,364,157 and
$382,326,388) .............................. 492,665,562 405,758,798
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $23,925,936 and $32,686,769) ... 23,064,082 30,422,335
Securities available-for-sale, at fair value
(amortized cost $68,298,857 and
$117,184,150) ............................. 68,696,468 118,026,960
Equity securities available-for-sale, at fair
value (cost $42,105,590 and $38,998,075) ..... 53,037,428 49,008,498
Other long-term investments, at cost ........... 5,233,448 4,758,019
Short-term investments, at cost ................ 49,334,579 63,568,064
------------ ------------
Total investments ........................ 707,485,875 690,965,687
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 18,907,928 15,861,754
Prepaid reinsurance premiums ................. 4,068,335 3,297,228
Intangible asset, defined benefit
retirement plan ............................ 1,016,492 1,016,492
Other assets ................................. 2,915,555 1,857,284
Indebtedness of related party ................ 21,332,660 -
Cash ............................................. 139,137 (14,069,102)
Accrued investment income ........................ 8,009,927 7,821,652
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $0) ........... 352,243 379,423
Income taxes recoverable ......................... 2,377,884 -
Deferred policy acquisition costs ................ 30,821,003 26,737,784
Deferred income taxes ............................ 11,018,838 10,345,429
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 95,076,692 154,556,758
------------ ------------
Total assets ............................. $904,464,155 $899,711,975
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
------------- ------------
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............... $408,575,101 $367,923,881
Unearned premiums ............................ 144,163,805 124,832,607
Other policyholders' funds ................... 2,094,794 1,390,594
Surplus notes payable ........................ 36,000,000 36,000,000
Indebtedness to related party ................ - 2,175,118
Employee retirement plans .................... 10,051,235 9,965,600
Other liabilities ............................ 18,559,689 19,336,366
Income taxes payable ............................. - 2,780,500
Securities lending obligation .................... 95,076,692 154,556,758
------------ ------------
Total liabilities ........................ 714,521,316 718,961,424
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,563,694
shares in 2004 and 11,501,065 shares in 2003 ... 11,563,694 11,501,065
Additional paid-in capital ....................... 70,468,709 69,113,228
Accumulated other comprehensive income ........... 21,860,055 22,285,668
Retained earnings ................................ 86,050,381 77,850,590
------------ ------------
Total stockholders' equity ............... 189,942,839 180,750,551
------------ ------------
Total liabilities and stockholders' equity $904,464,155 $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 net investment income,
realized investment gains and income tax expense (benefit), are the result of
related party transactions with Employers Mutual.
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ------------ ------------
REVENUES
Premiums earned ..........$87,587,991 $84,210,207 $255,030,560 $246,569,873
Net investment income .... 7,683,052 7,013,882 21,822,692 22,247,862
Realized investment gains 1,048,118 1,174,178 4,629,753 10,977
Other income ............. 136,227 195,993 477,818 628,151
----------- ----------- ------------ ------------
96,455,388 92,594,260 281,960,823 269,456,863
----------- ----------- ------------ ------------
LOSSES AND EXPENSES
Losses and settlement
expenses ............... 65,691,564 56,508,783 180,300,190 169,357,490
Dividends to policyholders 1,127,104 912,633 2,990,727 2,529,162
Amortization of deferred
policy acquisition costs 18,297,179 17,503,086 54,617,002 52,829,948
Other underwriting
expenses ............... 9,107,443 8,132,401 24,382,312 22,518,566
Interest expense ......... 278,100 278,100 834,300 1,042,166
Other expenses ........... 312,248 336,443 1,055,203 1,293,649
----------- ----------- ------------ ------------
94,813,638 83,671,446 264,179,734 249,570,981
----------- ----------- ------------ ------------
Income before income
tax expense (benefit) 1,641,750 8,922,814 17,781,089 19,885,882
----------- ----------- ------------ ------------
INCOME TAX EXPENSE (BENEFIT)
Current ................ 239,091 3,117,497 4,551,829 6,015,043
Deferred ............... (455,801) (576,787) (444,231) (387,135)
----------- ----------- ------------ ------------
(216,710) 2,540,710 4,107,598 5,627,908
----------- ----------- ------------ ------------
Net income .........$ 1,858,460 $ 6,382,104 $ 13,673,491 $ 14,257,974
=========== =========== ============ ============
Net income per common
share - basic and diluted $ .16 $ .56 $ 1.18 $ 1.25
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .45 $ .45
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,561,870 11,471,458 11,547,544 11,439,176
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income ................. $ 1,858,460 $ 6,382,104 $13,673,491 $14,257,974
OTHER COMPREHENSIVE INCOME
Unrealized holding
gains (losses) arising
during the period,
before deferred income
tax expense (benefit) .. 11,736,949 (2,628,828) 3,965,865 8,739,223
Deferred income tax
expense (benefit) ...... 4,107,932 (920,092) 1,388,053 3,058,728
----------- ----------- ----------- -----------
7,629,017 (1,708,736) 2,577,812 5,680,495
----------- ----------- ----------- -----------
Reclassification
adjustment for gains
included in net income,
before income tax
expense ................ (1,048,118) (1,174,178) (4,620,654) (10,244)
Income tax expense ....... 366,841 410,962 1,617,229 3,585
----------- ----------- ----------- -----------
(681,277) (763,216) (3,003,425) (6,659)
----------- ----------- ----------- -----------
Other comprehensive
income (loss) .... 6,947,740 (2,471,952) (425,613) 5,673,836
----------- ----------- ----------- -----------
Total comprehensive
income ........... $ 8,806,200 $ 3,910,152 $13,247,878 $19,931,810
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 13,673,491 $ 14,257,974
------------ ------------
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 ........ 40,651,220 25,899,593
Unearned premiums ..................... 19,331,198 21,748,744
Other policyholders' funds ............ 704,200 585,255
Indebtedness to related party ......... (23,507,778) (21,198,633)
Employee retirement plans ............. 85,635 1,433,824
Reinsurance receivables ............... (3,046,174) (3,389,500)
Prepaid reinsurance premiums .......... (771,107) (2,978,904)
Commissions payable ................... (40,818) 569,978
Interest payable ...................... - (1,281,166)
Prepaid assets ........................ (769,358) (1,070,154)
Deferred policy acquisition costs ......... (4,083,219) (4,129,365)
Accrued investment income ................. (188,275) 2,132,125
Accrued income taxes:
Current ................................. (5,158,386) 615,032
Deferred ................................ (444,231) (387,135)
Realized investment gains ................. (4,629,753) (10,977)
Other, net ................................ (839,968) (421,683)
------------ ------------
17,293,186 18,117,034
------------ ------------
Net cash provided by
operating activities .............. $ 30,966,677 $ 32,375,008
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Nine months ended
September 30,
--------------------------
2004 2003
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 11,328,683 $ 4,815,628
Purchases of fixed maturity securities
available-for-sale .......................... (581,640,239) (540,980,844)
Disposals of fixed maturity securities
available-for-sale .......................... 546,068,315 525,372,420
Purchases of equity securities
available-for-sale .......................... (26,995,502) (27,898,895)
Disposals of equity securities
available-for-sale .......................... 24,777,839 23,402,039
Purchase of other long-term investments ....... (2,124,000) (1,121,380)
Disposal of other long-term investments ....... 1,648,571 441,072
Net sales (purchases) of short-term investments 14,233,485 (11,977,814)
------------ ------------
Net cash used in investing activities ..... (12,702,848) (27,947,774)
------------ ------------
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 ............. 1,418,110 1,806,707
Dividends paid to Employers Mutual ........ (4,198,218) (4,132,584)
Dividends paid to Employers Mutual
(reimbursement for non-GAAP expense) .... (274,964) (494,378)
Dividends paid to public stockholders ......... (1,000,518) (1,016,983)
------------ ------------
Net cash used in financing activities ..... (4,055,590) (3,837,238)
------------ ------------
NET INCREASE IN CASH ............................ 14,208,239 589,996
Cash at beginning of year ....................... (14,069,102) (119,097)
------------ ------------
Cash at end of quarter .......................... $ 139,137 $ 470,899
============ ============
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 amended Form 10-K 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 nine months ended
September 30, 2004 and 2003 is presented below.
Three months ended September 30,
--------------------------------
2004 2003
-------------- -------------
Premiums written
Direct ............................ $ 54,554,679 $ 58,602,674
Assumed from non-affiliates ....... 989,903 879,138
Assumed from affiliates ........... 104,138,664 99,238,676
Ceded to non-affiliates ........... (5,102,294) (4,467,602)
Ceded to affiliates ............... (54,554,679) (58,602,674)
------------ ------------
Net premiums written ............ $100,026,273 $ 95,650,212
============ ============
Premiums earned
Direct ............................ $ 48,624,217 $ 54,366,209
Assumed from non-affiliates ....... 936,241 889,836
Assumed from affiliates ........... 91,391,212 87,008,376
Ceded to non-affiliates ........... (4,739,462) (3,688,005)
Ceded to affiliates ............... (48,624,217) (54,366,209)
------------ ------------
Net premiums earned ............. $ 87,587,991 $ 84,210,207
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 38,493,262 $ 46,630,264
Assumed from non-affiliates ....... 1,329,683 777,484
Assumed from affiliates ........... 66,286,471 59,668,579
Ceded to non-affiliates ........... (1,924,590) (3,937,280)
Ceded to affiliates ............... (38,493,262) (46,630,264)
------------ ------------
Net losses and settlement
expenses incurred ............. $ 65,691,564 $ 56,508,783
============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Nine months ended September 30,
-------------------------------
2004 2003
-------------- -------------
Premiums written
Direct ............................ $151,338,158 $175,697,066
Assumed from non-affiliates ....... 3,082,002 2,693,784
Assumed from affiliates ........... 284,325,432 275,822,223
Ceded to non-affiliates ........... (13,717,647) (12,255,050)
Ceded to affiliates ............... (151,338,158) (175,697,066)
------------ ------------
Net premiums written ............ $273,689,787 $266,260,957
============ ============
Premiums earned
Direct ............................ $149,258,970 $165,914,751
Assumed from non-affiliates ....... 2,988,694 2,563,065
Assumed from affiliates ........... 264,988,406 253,282,957
Ceded to non-affiliates ........... (12,946,540) (9,276,149)
Ceded to affiliates ............... (149,258,970) (165,914,751)
------------ ------------
Net premiums earned ............. $255,030,560 $246,569,873
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 91,628,768 $117,667,043
Assumed from non-affiliates ....... 2,261,168 2,322,964
Assumed from affiliates ........... 184,539,575 174,495,258
Ceded to non-affiliates ........... (6,500,553) (7,460,732)
Ceded to affiliates ............... (91,628,768) (117,667,043)
------------ ------------
Net losses and settlement
expenses incurred ............. $180,300,190 $169,357,490
============ ============
3. STOCK BASED COMPENSATION
The Company accounts for Employers Mutual's stock option plans using the
recognition and measurement principles of the intrinsic value method (APB 25).
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation," to Employers Mutual's stock option plans:
Three months ended Nine months ended
September 30, September 30,
--------------------- ------------------------
2004 2003 2004 2003
---------- ---------- ----------- -----------
Net income, as reported ...... $1,858,460 $6,382,104 $13,673,491 $14,257,974
Deduct: Total stock-based
employee compensation
expense determined under the
fair value method for all
awards, net of related tax
effects .................... 8,093 6,346 24,280 19,038
---------- ---------- ----------- -----------
Pro forma net income ......... $1,850,367 $6,375,758 $13,649,211 $14,238,936
========== ========== =========== ===========
Net income per share:
Basic and diluted -
As reported .............. $0.16 $0.56 $1.18 $1.25
Basic and diluted -
Pro forma ................ $0.16 $0.56 $1.18 $1.24
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
September 30, 2004 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 63,339,332 $ 24,248,659 $ 87,587,991
Underwriting
gain (loss) ........ (9,532,757) 2,897,458 (6,635,299)
Net investment income 5,321,217 2,329,909 $ 31,926 7,683,052
Realized investment
gains .............. 785,491 262,627 - 1,048,118
Other income ......... 136,227 - - 136,227
Interest expense ..... 193,125 84,975 - 278,100
Other expense ........ 171,959 - 140,289 312,248
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ (3,654,906) $ 5,405,019 $ (108,363) $ 1,641,750
============ ============ ============ ============
Property
Three months ended and casualty Parent
September 30, 2003 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 61,322,190 $ 22,888,017 $ 84,210,207
Underwriting
gain (loss) ........ (4,731,712) 5,885,016 1,153,304
Net investment
income (loss) ...... 4,880,947 2,168,690 $ (35,755) 7,013,882
Realized investment
gains .............. 1,058,176 116,002 - 1,174,178
Other income ......... 195,993 - - 195,993
Interest expense ..... 193,125 84,975 - 278,100
Other expense ........ 201,223 - 135,220 336,443
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit)........... $ 1,009,056 $ 8,084,733 $ (170,975) $ 8,922,814
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Property
Nine months ended and casualty Parent
September 30, 2004 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $186,908,651 $ 68,121,909 $255,030,560
Underwriting
gain (loss) ........ (13,553,017) 6,293,346 (7,259,671)
Net investment income 14,841,998 6,922,873 $ 57,821 21,822,692
Realized investment
gains .............. 3,527,524 1,102,229 - 4,629,753
Other income ......... 477,818 - - 477,818
Interest expense ..... 579,375 254,925 - 834,300
Other expense ........ 580,422 - 474,781 1,055,203
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 4,134,526 $ 14,063,523 $ (416,960) $ 17,781,089
============ ============ ============ ============
Property
Nine months ended and casualty Parent
September 20, 2003 insurance Reinsurance company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $180,870,135 $ 65,699,738 $246,569,873
Underwriting
gain (loss) ........ (5,946,040) 5,280,747 (665,293)
Net investment income 15,619,265 6,608,422 $ 20,175 22,247,862
Realized investment
gains (losses) ..... 114,645 (103,668) - 10,977
Other income ......... 628,151 - - 628,151
Interest expense ..... 726,237 315,929 - 1,042,166
Other expense ........ 811,645 - 482,004 1,293,649
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 8,878,139 $ 11,469,572 $ (461,829) $ 19,885,882
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
5. INCOME TAXES
The actual income tax expense (benefit) for the three and nine months
ended September 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 Nine months ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Computed "expected" tax
expense ................ $ 574,612 $ 3,122,985 $ 6,223,381 $ 6,960,059
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (941,446) (423,739) (2,341,735) (1,309,280)
Proration of
tax-exempt interest
and dividends
received deduction 148,091 42,140 370,518 126,049
Other, net ........... 2,033 (200,676) (144,566) (148,920)
----------- ----------- ----------- -----------
Income tax
expense
(benefit) ...... $ (216,710) $ 2,540,710 $ 4,107,598 $ 5,627,908
=========== =========== =========== ===========
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 Nine months ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Pension Plan:
Service cost .............. $1,704,630 $1,540,255 $5,113,890 $4,620,765
Interest cost ............. 1,755,222 1,748,164 5,265,666 5,244,492
Expected return on plan
assets .................. (1,690,132) (1,629,228) (5,070,396) (4,887,684)
Recognized net actuarial
loss .................... 213,922 241,807 641,766 725,421
Amortization of prior
service costs ........... 191,456 197,412 574,368 592,236
---------- ---------- ---------- ----------
Net periodic pension
benefit cost .......... $2,175,098 $2,098,410 $6,525,294 $6,295,230
========== ========== ========== ==========
Postretirement benefit plans:
Service cost .............. $ 737,462 $1,100,250 $3,025,716 $3,300,750
Interest cost ............. 732,040 1,065,750 2,889,058 3,197,250
Expected return on plan
assets .................. (225,221) (184,250) (675,663) (552,750)
Amortization of net loss
(gain) .................. (174,679) 252,750 120,981 758,250
---------- ---------- ---------- ----------
Net periodic
postretirement
benefit cost .......... $1,069,602 $2,234,500 $5,360,092 $6,703,500
========== ========== ========== ==========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Pension expense allocated to the Company was $528,721 and $1,586,168 for
the three months and nine months ended September 30, 2004 compared to $505,824
and $1,517,471 for the same periods in 2003.
Postretirement benefit expense allocated to the Company was $240,889 and
$1,204,594 for the three months and nine months ended September 30, 2004
compared to $526,503 and $1,579,508 for the same periods in 2003.
As of September 30, 2004 Employers Mutual had contributed $10,000,000 to
the pension plan and $3,335,000 to the postretirement benefit plans.
Employers Mutual contributed an additional $11,600,000 to the pension plan in
October, 2004. There will be no additional contributions in 2004.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act expanded
Medicare to include, for the first time, coverage for prescription drugs. 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", which
permits a sponsor of a postretirement health care plan that provides
prescription drug benefits to make a one-time election to defer accounting for
the effects of the Act. In May 2004, the FASB issued Staff Position FAS No.
106-2 which superseded FAS 106-1 and was 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 concluded that the accounting guidance provided by FAS 106-2
is applicable since the prescription drug benefit provided under Employers
Mutual's postretirement benefit plan is actuarially equivalent to Medicare
Part D and the expected subsidy will reduce Employers Mutual's share of the
cost of the underlying postretirement prescription drug coverage. The Company
elected the retroactive method of transition to the date of the enactment of
the Act.
The effect of the subsidy on the measurement of the Employers Mutual
postretirement benefit plan resulted in a decrease in the accumulated
projected benefit obligation of $9,899,120 and the net periodic postretirement
benefit cost for 2004 was reduced by $1,075,643. The components of the
reduction in the net periodic postretirement benefit cost for 2004 are as
follows:
Postretirement benefit plans:
Service cost ........................ $ 406,665
Interest cost ....................... 346,468
Expected return on plan assets ...... -
Amortization of net loss ............ 322,510
----------
Total reduction in net periodic
postretirement benefit cost ..... $1,075,643
==========
Adoption of FAS 106-2 resulted in a $240,964 reduction to the Company's
share of the net periodic postretirement benefit cost for the nine months
ended September 30, 2004. The portion of the adjustment applicable to the
first and second quarters was immaterial; therefore, the entire adjustment
was reflected in the third quarter and the first and second quarters were
not restated.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
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
life insurance companies, under which the claimant is payee, to fund future
payments that are fixed pursuant to specific claim settlement provisions. The
Company's share of loss reserves eliminated by the purchase of these annuities
was $753,000 at December 31, 2003. The Company has a contingent liability of
$753,000 should the issuers of these annuities fail to perform under the terms
of the annuities. The Company's share of the amount due from any one life
insurance company does not equal or exceed one percent of its subsidiaries'
policyholders' surplus.
8. SUBSEQUENT EVENTS
On October 20, 2004 the Company sold 2,000,000 new shares of common stock
at a price of $18.75 per share. If this transaction had occurred on September
30, 2004, the effect on total shares outstanding would have been as follows:
Total shares outstanding:
As reported ............. 11,563,694
Pro forma ............... 13,563,694
Employers Mutual participated in the Company's stock offering as a
selling shareholder and sold 1.8 million shares of the Company's common stock
that it owned. As a result of these transactions, Employers Mutual's
ownership of the Company has been reduced to approximately 55.7 percent.
Employers Mutual granted the underwriters a 30-day option to purchase an
additional 570,000 shares of the Company's common stock to cover over-
allotments. On November 9, 2004, Employers Mutual received notice that the
underwriters would exercise this option and purchase an additional 260,542
shares of the Company's common stock from Employers Mutual. As a result,
Employers Mutual's ownership of the Company will decline to approximately 53.8
percent.
Net proceeds from the offering, after deducting the underwriting discount
and the Company's share of the offering expenses, is estimated to be
approximately $34.9 million. The net proceeds will be contributed to three of
the Company's property and casualty insurance subsidiaries to support a 6.5
percentage point increase in the Company's 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 will
increase from the current 23.5 percent to 30.0 percent and Employers Mutual's
participation interest will decrease from the current 65.5 percent to 59.0
percent.
As a result of Employers Mutual's ownership of the Company declining
below the 80 percent threshold, the Company will no longer be included in
Employers Mutual's consolidated tax return. The Company will file a short-
period tax return for the remainder of 2004.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
OVERVIEW
EMC Insurance Group Inc., an 80.9 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 73.3
percent of consolidated premiums earned for the first nine 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."
On October 20, 2004, the Company successfully completed a follow-on stock
offering and sold 2.0 million new shares of its common stock to the public.
Employers Mutual participated in the stock offering as a selling shareholder
and sold 1.8 million shares of the Company's common stock that it owned. As a
result of these transactions, Employers Mutual's ownership of the Company has
been reduced to approximately 55.7 percent. Employers Mutual granted the
underwriters a 30-day option to purchase an additional 570,000 shares of the
Company's common stock to cover over-allotments. On November 9, 2004,
Employers Mutual received notice that the underwriters would exercise this
option and purchase an additional 260,542 shares of the Company's common stock
from Employers Mutual. As a result, Employers Mutual's ownership of the
Company will decline to approximately 53.8 percent. For a detailed discussion
of the stock offering and the planned use of the proceeds, see the discussion
contained under the heading "Recent Developments" later in this document.
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. The aggregate
participation of the Company's property and casualty insurance subsidiaries is
23.5 percent. Effective December 31, 2003, the pooling agreement was amended
to provide that Employers Mutual will make up any shortfall or difference
resulting from an error in its systems and/or computational processes that
would otherwise result in the required restatement of the pool participants'
financial statements. Operations of the pool give rise to inter-company
balances with Employers Mutual, which are settled on a quarterly basis. The
investment and income tax activities of the pool participants are not subject
to the pooling agreement.
The purpose of the pooling agreement is to spread the risk of an exposure
insured by any of the pool participants among all the companies. The pooling
agreement produces a more uniform and stable underwriting result from year to
year for all companies in the pool than might be experienced individually. In
addition, each company benefits from the capacity of the entire pool, rather
than being limited to policy exposures of a size commensurate with its own
assets, and from the wide range of policy forms, lines of insurance written,
rate filings and commission plans offered by each of the companies. A single
set of reinsurance treaties is maintained for the protection of all companies
in the pool.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
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.
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 amended Form 10-K.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
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.
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 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.
Catastrophe and storm losses are unpredictable and can vary significantly
from year to year. Management uses modeling software to help identify and
estimate its potential loss exposure to a variety of events, both natural and
manmade. Natural events that are modeled include hurricanes, tornados and
windstorms, and earthquakes. Modeling activities for manmade events are
primarily directed toward identifying concentrations of risk, such as workers'
compensation coverage for a business or property that is subject to a
terrorist attack or other manmade event. Management purchases reinsurance
protection to mitigate the Company's loss potential to these types of
exposures.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
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.
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
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.
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 amended 2003
Form 10-K.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
RESULTS OF OPERATIONS
Segment information and consolidated net income for the three months and
nine months ended September 30, 2004 and 2003 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2004 2003 2004 2003
Property and Casualty Insurance
Premiums earned ..................... $ 63,339 $ 61,322 $186,908 $180,870
Losses and settlement expenses ...... 51,926 45,726 136,797 126,653
Acquisition and other expenses ...... 20,946 20,328 63,665 60,163
-------- -------- -------- --------
Underwriting loss ................... $ (9,533)$ (4,732) $(13,554)$ (5,946)
======== ======== ======== ========
Loss and settlement expense ratio ... 82.0% 74.6% 73.2% 70.0%
Acquisition expense ratio ........... 33.1 33.1 34.1 33.3
-------- -------- -------- --------
Combined ratio ...................... 115.1% 107.7% 107.3% 103.3%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 45,909 $ 44,409 $127,091 $122,359
Increase in provision for insured
events of prior years ......... 6,017 1,317 9,706 4,294
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 51,926 $ 45,726 $136,797 $126,653
======== ======== ======== ========
Catastrophe and storm losses (1) .... $ 4,931 $ 7,004 $ 12,833 $ 17,007
======== ======== ======== ========
Reinsurance
Premiums earned ..................... $ 24,249 $ 22,888 $ 68,122 $ 65,700
Losses and settlement expenses ...... 13,765 10,782 43,503 42,704
Acquisition and other expenses ...... 7,586 6,220 18,325 17,715
-------- -------- -------- --------
Underwriting gain ................... $ 2,898 $ 5,886 $ 6,294 $ 5,281
======== ======== ======== ========
Loss and settlement expense ratio ... 56.8% 47.1% 63.9% 65.0%
Acquisition expense ratio ........... 31.3 27.2 26.9 27.0
-------- -------- -------- --------
Combined ratio ...................... 88.1% 74.3% 90.8% 92.0%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 17,270 $ 13,536 $ 48,490 $ 44,272
Decrease in provision for
insured events of prior years . (3,505) (2,754) (4,987) (1,568)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 13,765 $ 10,782 $ 43,503 $ 42,704
======== ======== ======== ========
Catastrophe and storm losses (1) .... $ 5,859 $ 1,699 $ 6,169 $ 3,124
======== ======== ======== ========
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 Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2004 2003 2004 2003
-------- -------- -------- --------
Consolidated
REVENUES
Premiums earned ..................... $ 87,588 $ 84,210 $255,030 $246,570
Net investment income ............... 7,682 7,014 21,822 22,248
Realized investment gains ........... 1,048 1,174 4,630 11
Other income ........................ 137 196 478 628
-------- -------- -------- --------
96,455 92,594 281,960 269,457
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ...... 65,691 56,508 180,300 169,357
Acquisition and other expenses ...... 28,532 26,548 81,990 77,878
Interest expense .................... 278 278 834 1,042
Other expense ....................... 312 337 1,055 1,294
-------- -------- -------- --------
94,813 83,671 264,179 249,571
-------- -------- -------- --------
Income before income tax (benefit)
expense ........................... 1,642 8,923 17,781 19,886
Income tax (benefit) expense ........ (216) 2,541 4,108 5,628
-------- -------- -------- --------
Net income .......................... $ 1,858 $ 6,382 $ 13,673 $ 14,258
======== ======== ======== ========
Loss and settlement expense ratio ... 75.0% 67.1% 70.7% 68.7%
Acquisition expense ratio ........... 32.6 31.5 32.1 31.6
-------- -------- -------- --------
Combined ratio ...................... 107.6% 98.6% 102.8% 100.3%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 63,179 $ 57,945 $175,581 $166,631
Increase (decrease) in provision
for insured events of prior
years ......................... 2,512 (1,437) 4,719 2,726
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 65,691 $ 56,508 $180,300 $169,357
======== ======== ======== ========
Catastrophe and storm losses (1) .... $ 10,790 $ 8,703 $ 19,002 $ 20,131
======== ======== ======== ========
(1) Amounts reflected for "catastrophe and storm losses" are included in
"losses and settlement expenses," but are also listed separately for
comparative purposes.
Net income declined significantly for the three months and moderately for
the nine months ended September 30, 2004 from the same periods in 2003. The
decline in net income for the three months ended September 30, 2004 is
attributed to a substantial increase in the amount of adverse development
experienced on prior years' reserves and a large increase in catastrophe and
storm losses. Net income for the nine months ended September 30, 2004 also
reflects a large increase in adverse development on prior years' reserves;
however, the impact was partially offset by a decline in catastrophe and storm
losses from the unusually high level experienced in 2003. Net income for the
nine months ended September 30, 2004 also reflects a significant amount of
realized investment gains recognized during the second quarter.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The large increase in adverse development on prior years' reserves is
entirely attributable to the property and casualty insurance segment. This
adverse development reflects an increase in loss and settlement expense
reserves associated with the re-evaluation of individual case reserves and the
establishment of bulk reserves in response to recently completed actuarial
evaluations. 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 large increase in catastrophe and storm losses in the third quarter of
2004 is primarily attributed to the four hurricanes that hit the Southern
United States in August and September. The Company's reinsurance segment had
exposure to all four hurricanes and reached its $1,500,000 cap on losses
assumed per occurrence on each of them. Hurricane losses in the property and
casualty insurance segment, the majority of which are associated with damage
caused by Hurricane Ivan in the Gulf States, totaled $2,389,000. Total losses
associated with these four hurricanes amounted to $8,389,000 or $5,453,000 on
an after-tax basis.
Premiums Earned
Premiums earned increased 4.0 percent and 3.4 percent to $87,588,000 and
$255,030,000 for the three months and nine months ended September 30, 2004
from $84,210,000 and $246,570,000 for the same periods in 2003. These
increases are primarily attributed to rate increases implemented during the
last few 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 stable during the
third 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 impact of these rate increases is expected to be smaller than
those implemented during the recent past. Management is not able to determine
what impact, if any, the four hurricanes that hit the Southern United States
in the third quarter will have on future rate levels. Significant rate
increases are not considered likely, but the recent increase in price
competition may subside, which could help stabilize rates at current levels.
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 property and casualty insurance segment increased
3.3 percent for both the three months and nine months ended September 30, 2004
to $63,339,000 and $186,908,000 from $61,322,000 and $180,870,000 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 nine 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 nine months of
2004, premiums written increased only 2.4 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.
Premiums earned for the reinsurance segment increased 5.9 percent and 3.7
percent to $24,249,000 and $68,122,000 for the three months and nine months
ended September 30, 2004 from $22,888,000 and $65,700,000 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 $1,819,000 and $6,628,000 of additional premiums earned in the three
months and nine months ended September 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 nine months 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. Premiums earned for the three
months ended September 30, 2004 reflect a decrease in the estimate of earned
but not reported premiums of $650,000, compared to an increase of $748,000 for
the same period in 2003. For the nine months ended September 30, 2004, the
estimate of earned but not reported premiums decreased by $40,000 compared to
an increase of $2,495,000 for the same period in 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The board of directors of the MRB reinsurance pool recently authorized
management to pursue the addition of one or two new assuming companies to the
MRB pool. If additional assuming companies are added to the MRB pool,
Employers Mutual's participation would be reduced and the reinsurance
segment's premium volume would decline. Assuming companies can only be added
prior to the beginning of a calendar year and it is not currently known
whether Employers Mutual's participation in the MRB pool will change in 2005.
Losses and settlement expenses
Losses and settlement expenses increased 16.3 percent and 6.5 percent to
$65,691,000 and $180,300,000 for the three months and nine months ended
September 30, 2004 from $56,508,000 and $169,357,000 for the same periods in
2003. The loss and settlement expense ratio increased to 75.0 percent and
70.7 percent for the three months and nine months ended September 30, 2004
from 67.1 percent and 68.7 percent for the same periods in 2003. The large
increase in the ratio for the three months ended September 30, 2004 is
primarily attributed to a significant amount of adverse development on prior
years' reserves and an increase in catastrophe and storm losses. The increase
in the ratio for the nine months ended September 30, 2004 was not as large due
to an unusually high level of catastrophe and storm losses experienced in the
first nine months of 2003 and a significant decline in reported losses in the
reinsurance segment in 2004.
The loss and settlement expense ratio for the property and casualty
insurance segment increased to 82.0 percent and 73.2 percent for the three
months and nine months ended September 30, 2004 from 74.6 percent and 70.0
percent for the same periods in 2003. The increase in the 2004 ratios is
primarily attributed to a significant increase in adverse development on prior
years' reserves. The adverse development for 2004 reflects $2,383,000 of
explicit reserve strengthening ($588,000 in the third quarter and $1,795,000
in the second quarter), $5,217,000 of direct case reserve development
(primarily in the workers' compensation line of business), $1,810,000 of
development on settlement expense reserves (largely attributed to IBNR
emergence on umbrella business) and $940,000 of development from non-voluntary
pools. This adverse development was partially offset by $3,008,000 of
reinsurance recoveries associated with the case reserve development and IBNR
emergence. The reserve strengthening actions taken were in response to
recently completed actuarial evaluations of the segment's carried reserves
that indicated a continued upward trend in projected ultimate losses. Loss
severity continued to trend upward during the first nine months 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, which include $2,389,000 of hurricane losses, declined from the
elevated levels experienced in 2003.
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 reinsurance segment
increased to 56.8 percent for the three months ended September 30, 2004 from
47.1 percent for the same period in 2003, but declined to 63.9 percent for the
nine months ended September 30, 2004 from 65.0 percent for the same period in
2003. The increase in the ratio for the three months ended September 30, 2004
is largely due to the four hurricanes that hit the Southern United States in
August and September. The reinsurance segment had exposure to all four
hurricanes and reached its $1,500,000 cap on losses assumed per occurrence on
each of them. The decline in the ratio for the nine months ended September
30, 2004 reflects a decrease in reported losses (including large excess-of-
loss business), an increase in favorable development on prior years' reserves
and continued improvement in overall premium rate adequacy. The favorable
development experienced in 2004 and 2003 is from the 2003 and 2002 accident
years in the HORAD book of business and reflects very low reported loss
activity.
Acquisition and other expenses
Acquisition and other expenses increased 7.5 percent and 5.3 percent to
$28,532,000 and $81,990,000 for the three months and nine months ended
September 30, 2004 from $26,548,000 and $77,878,000 for the same periods in
2003. The acquisition expense ratio increased to 32.6 percent and 32.1
percent for the three and nine months ended September 30, 2004 from 31.5
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 policyholder dividends.
For the property and casualty insurance segment, the acquisition expense
ratio remained constant at 33.1 percent for the three months ended September
30, 2004 and 2003, but increased to 34.1 percent for the nine months ended
September 30, 2004 from 33.3 percent for the same period in 2003. This
increase primarily reflects an increase in contingent commission and
policyholder dividend expenses. 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.
For the reinsurance segment, the acquisition expense ratio increased to
31.3 percent for the three months ended September 30, 2004 from 27.2 percent
for the same period in 2003, but declined slightly to 26.9 percent for the
nine months ended September 30, 2004 from 27.0 percent for the same period in
2003. The increase in the ratio for the three months ended September 30, 2004
is primarily due to a large amount of contingent commission expense reported
by MRB in the third quarter of 2004. For the nine months ended September 30,
2004, the large increase in the MRB third quarter contingent commission
expense was more than offset by $1,064,000 of contingent commission income
recognized during the second quarter of 2004 as a result of favorable
underwriting performance on the HORAD book of business and a decline in
commission expense. Commission expense for the nine months ended September
30, 2004 and 2003 includes $1,033,000 and $782,000, respectively, incurred in
connection with the increased participation in the MRB pool.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Investment results
Net investment income increased 9.5 percent to $7,682,000 for the three
months ended September 30, 2004 from $7,014,000 for the same period in 2003,
but declined 1.9 percent to $21,822,000 for the nine months ended September
30, 2004 from $22,248,000 for the same period in 2003. The increase for the
three months ended September 30, 2004 reflects an increase in invested assets
and the reinvestment of a portion of the short-term portfolio into longer term
investments (primarily tax-exempt bonds) to achieve a higher after-tax rate of
return. The decrease for the nine months ended September 30, 2004 is
attributed to the lingering low interest rate environment, which more than
offset an increase in invested assets. 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's reluctance to
invest in long-term securities during this period of low interest rates
resulted in the accumulation of 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.
Net proceeds from the Company's recent follow-on stock offering, after
deducting the underwriting discount and the Company's share of the offering
expenses, is expected to be approximately $34.9 million. These proceeds are
currently being held by the holding company and are invested in short-term
funds. During the fourth quarter of 2004, these proceeds will be contributed
to three of the property and casualty insurance subsidiaries to support the
January 1, 2005 increase in the Company's aggregate participation interest in
the pooling agreement. Long-term investment opportunities will be evaluated
after the proceeds are contributed to the property and casualty insurance
subsidiaries.
The Company reported net realized investment gains of $1,048,000 and
$4,630,000 for the three months and nine months ended September 30, 2004
compared to $1,174,000 and $11,000 for the same periods in 2003. The large
amount of realized investment gains for the nine months ended September 30,
2004 reflects $2,558,000 of net gains recognized during the second quarter 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." The MCI bonds had previously been determined to be
other-than-temporarily impaired during the second quarter of 2002. The new
MCI bonds were sold during the third quarter of 2004, resulting in a realized
gain of $187,000. Realized investment gains for the first nine months of 2003
reflect $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 as of September 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 $834,000 of interest expense on surplus
notes during the three months and nine months ended September 30, 2004
compared to $278,000 and $1,042,000 for the same periods in 2003. The decline
in interest expense for the nine months ended September 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 decreased for both the three months and nine months
ended September 30, 2004 from the same periods in 2003, primarily due to the
decline in pre-tax income for these periods. The effective tax rate for the
first nine months of 2004 declined to 23.1 percent from 28.3 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.
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 Company's recent stock
offering, Employers Mutual discontinued its participation in the plan for the
third quarter of 2004 and has indicated that it will not participate in the
plan during the fourth quarter of 2004.
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 has recently debated
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; however, no action is expected on this legislation until
2005.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Recent Developments
On October 20, 2004, the Company successfully completed a follow-on stock
offering and sold 2.0 million new shares of its common stock to the public at
$18.75 per share. Net proceeds from the offering, after deducting the
underwriting discount and the Company's share of the offering expenses, is
estimated to be approximately $34.9 million. The net proceeds will be
contributed to three of the Company's property and casualty insurance
subsidiaries to support a 6.5 percentage point increase in the Company's
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 will increase from the current 23.5 percent
to 30.0 percent and Employers Mutual's participation interest will decrease
from the current 65.5 percent to 59.0 percent.
In addition to changing the individual pool participation percentages of
Employers Mutual and three of the Company's property and casualty insurance
subsidiaries, the pooling agreement has been amended effective January 1, 2005
to comply with certain conditions established by the Iowa Insurance Department
and A.M. Best Company. These amendments: (1) provide for a fixed term of
three years commencing January 1, 2005 and continuing until December 31, 2007,
during which period the pooling agreement may not be terminated and the
revised participation interests will not be further amended, absent the
occurrence of a material event not in the ordinary course of business that
could reasonably be expected to impact the appropriateness of the
participation interests in the pool; (2) provide that if a pool participant
becomes insolvent, or is otherwise subject to liquidation or receivership
proceedings, each of the other participants will, on a pro rata basis, adjust
their assumed portions of the pool liabilities in order to assume in full the
liabilities of the impaired participant, subject to compliance with all
regulatory requirements applicable to such adjustment under the laws of all
states in which the participants are domiciled; (3) clarify that all
development on prior years' outstanding losses and settlement expenses of the
participants will remain in the pool and be pro rated pursuant to the pooling
agreement; and (4) clarify that all liabilities incurred prior to a
participant withdrawing from the pool, and associated with such withdrawing
participant, shall remain a part of the pool and subject to the pooling
agreement.
As a result of the stock offering, Employers Mutual's ownership of the
Company has declined below the 80 percent threshold and the Company will no
longer be included in Employers Mutual's consolidated tax return. The Company
will file a short-period tax return for the remainder of 2004.
The weighted average number of shares outstanding for the fourth quarter
of 2004 will increase significantly due to the recently completed stock
offering; however, the increase in the Company's aggregate participation
interest in the pooling agreement will not occur until January 1, 2005. While
the Company will earn interest income on the net proceeds of the offering
during the forth quarter, it will not be sufficient to avoid dilution in
fourth quarter earnings per share.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Recent actions by New York Attorney General Eliot Spitzer have raised
questions concerning the use of contingent commission arrangements whereby
insurance companies provide agents with financial incentives in addition to
the traditional commission structure. The arrangements targeted by Attorney
General Spitzer are variously referred to as "placement service agreements" or
"market service agreements" and, in essence, compensate an agent for directing
business to a particular insurance company. The Company, like many others in
the insurance industry, has used contingent compensation arrangements to
compensate independent agents for the valuable services they provide to their
clients.
Attorney General Spitzer has also alleged the use of bid-rigging
practices by some in the insurance industry. Bid-rigging constitutes a
violation of federal and state laws and, in addition, is strictly prohibited
by the Company's Code of Conduct.
Determination of the legality and propriety of the activities targeted by
Attorney General Spitzer will take time to resolve through the investigative
and judicial processes. The Company intends to closely monitor these
developments and will be proactive in reviewing and assessing its internal
practices, as well as its contingent compensation arrangements, with a goal of
ensuring that they conform with all legal requirements.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of a company's ability to generate sufficient cash
to meet cash obligations as they come due. The Company generated positive
cash flows from operations of $30,967,000 in the first nine months of 2004 and
$32,375,000 in the first nine months of 2003. The Company typically generates
substantial positive cash flows from operations because cash from premium
payments is generally received in advance of cash payments made to settle
claims. These positive cash flows provide the foundation of the Company's
asset/liability management program and are the primary drivers of the
Company's liquidity. When investing funds made available from operations, the
Company invests in securities with maturities that approximate the anticipated
liabilities of the insurance issued. In addition, the Company maintains a
portion of its investment portfolio in relatively short-term and highly liquid
assets as a secondary source of liquidity should net cash flows from operating
activities prove inadequate to fund current operating needs. As of September
30, 2004, the Company did not have any significant variations between the
maturity dates of its investments and the expected payment of its loss and
settlement expense reserves.
The Company is a holding company whose principal assets are its
investments in its insurance subsidiaries. As a holding company, the Company
is dependent upon cash dividends from its insurance company subsidiaries to
meet its obligations and to pay cash dividends to its stockholders. State
insurance regulations restrict the maximum amount of dividends insurance
companies can pay without prior regulatory approval. The maximum amount of
dividends that the insurance company subsidiaries can pay to the Company in
2004 without prior regulatory approval is approximately $22.2 million. The
Company received $5,060,000 and $4,200,000 of dividends from its insurance
company subsidiaries and paid cash dividends to its stockholders totaling
$5,199,000 and $5,150,000 in the first nine months of 2004 and 2003,
respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The Company's insurance company subsidiaries must have adequate liquidity
to ensure that their cash obligations are met; however, because of their
participation in the pooling agreement and the quota share agreement, they do
not have the daily liquidity concerns normally associated with an insurance or
reinsurance company. This is due to the fact that under the terms of the
pooling and quota share agreements, Employers Mutual receives all premiums and
pays all losses and expenses associated with the insurance business produced
by the pool participants and the assumed reinsurance business and then settles
the inter-company balances generated by these transactions with the
participating companies on a quarterly basis.
At the insurance company subsidiary level, the primary sources of cash
are premium income, investment income and maturing 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. Cash outflows can be variable because of uncertainties
regarding settlement dates for unpaid losses and because of the potential for
large losses, either individually or in the aggregate. Accordingly, the
insurance company subsidiaries maintain investment and reinsurance programs
generally intended to provide adequate funds to pay claims without forced
sales of investments.
The Company maintains a portion of its investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to pay 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
written. At September 30, 2004, approximately 32 percent of the Company's
fixed maturity securities were in U.S. government or U.S. government agency
issued securities. A variety of maturities are maintained in the Company's
portfolio to assure adequate liquidity. The maturity structure of the fixed
maturity investments is also established by the relative attractiveness of
yields on short, intermediate and long-term securities. The Company does not
invest in any high-yield debt investments (commonly referred to as junk
bonds.)
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
Despite this intent, the Company has historically classified a portion of its
fixed maturity investments as available-for-sale securities to provide
flexibility in the management of the portfolio. Since the third quarter of
1999, all newly acquired fixed maturity investments have been classified as
available-for-sale securities to provide increased management flexibility.
The Company had unrealized holding gains, net of deferred taxes, on fixed
maturity securities available-for-sale totaling $14,754,000 at September 30,
2004 and $15,779,000 at December 31, 2003, respectively. The fluctuation in
the market value of these investments is primarily due to changes in the
interest rate environment during this time period. Since the Company does not
actively trade in the bond market, such fluctuations in the fair value of
these investments are not expected to have a material impact on the operations
of the Company, as forced liquidations of investments are not anticipated.
The Company closely monitors the bond market and makes appropriate adjustments
in its portfolio as changing conditions warrant.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of investment
income that supplements underwriting results and contributes to net earnings.
As these investments mature, or are called, the proceeds will be reinvested at
current rates, which may be higher or lower than those now being earned;
therefore, more or less investment income may be available to contribute to
net earnings depending on the interest rate level.
The Company participates in a securities lending program administered by
Mellon Bank, N.A. 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 cash collateral that
secures the Company's loaned securities is invested in a Delaware statutory
trust that is managed by Mellon Bank. The earnings from this trust are used,
in part, to pay the fee the Company receives for each security loaned under
the program.
The Company held $5,233,000 and $4,758,000 in minority ownership
interests in limited partnerships and limited liability companies at September
30, 2004 and December 31, 2003, respectively. The Company does not hold any
other unregistered securities.
The Company's cash balance was $139,000 and ($14,069,000) at September
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 $634,000 (including $1,016,000 of additional minimum liability) at
September 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
September 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 September 30, 2004
and December 31, 2003, respectively. Postretirement benefit liabilities
reflected in the Company's financial statements totaled $9,417,000 and
$8,512,000 at September 30, 2004 and December 31, 2003, respectively.
Capital Resources
Capital resources consist of stockholders' equity and debt, representing
funds deployed or available to be deployed to support business operations.
For the Company's insurance subsidiaries, capital resources are required to
support premium writings. Regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to its statutory
surplus should not exceed 3 to 1. All of the Company's insurance subsidiaries
were well under this guideline at December 31, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The Company's insurance subsidiaries are required to maintain certain
minimum surplus on a statutory basis and are subject to regulations under
which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
The Company's insurance subsidiaries are also subject to Risk Based Capital
(RBC) requirements that may further impact their ability to pay dividends.
RBC requirements attempt to measure minimum statutory capital needs based upon
the risks in a company's mix of products and investment portfolio. At
December 31, 2003, the Company's insurance subsidiaries had total adjusted
statutory capital of $170,233,000, which is well in excess of the minimum RBC
requirement of $39,609,000.
The Company had total cash and invested assets with a carrying value of
$707.6 million and $676.9 million as of September 30, 2004 and December 31,
2003, respectively. The following table summarizes the Company's cash and
invested assets as of the dates indicated:
September 30, 2004
-----------------------------------
Percent of
Amortized total at
($ in thousands) cost Fair value fair value
--------- ---------- ----------
Fixed maturities, held-to-maturity .... $ 38,519 $ 40,467 5.7%
Fixed maturities, available-for-sale .. 538,662 561,361 79.1
Equity securities, available-for-sale 42,106 53,038 7.5
Cash .................................. 139 139 -
Short-term investments ................ 49,335 49,335 7.0
Other long-term investments ........... 5,233 5,233 0.7
-------- -------- -----
$673,994 $709,573 100.0%
======== ======== =====
December 31, 2003
-----------------------------------
Percent of
Amortized total at
($ 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 $680,905 100.0%
======== ======== =====
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The amortized cost and estimated fair value of fixed maturity and equity
securities at September 30, 2004 were as follows:
Held-to maturity
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
($ in thousands) cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 37,045 $ 1,803 $ - $ 38,848
Mortgage-backed securities 1,474 145 - 1,619
--------- ---------- ---------- ---------
Total securities
held-to-maturity ..... $ 38,519 $ 1,948 $ - $ 40,467
========= ========== ========== =========
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 ............. $ 133,988 $ 195 $ 290 $ 133,893
Obligations of states and
political subdivisions ... 227,416 9,215 262 236,369
Mortgage-backed securities 11,878 885 - 12,763
Public utilities ........... 13,226 1,263 - 14,489
Corporate securities ....... 152,154 11,903 210 163,847
---------- ---------- ---------- ---------
Total fixed maturity
securities ........... 538,662 23,461 762 561,361
---------- ---------- ---------- ---------
Equity securities .......... 42,106 11,626 694 53,038
---------- ---------- ---------- ---------
Total securities
available-for-sale $ 580,768 $ 35,087 $ 1,456 $ 614,399
========== ========== ========== =========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
In December 2001, three of the Company's property and casualty insurance
subsidiaries issued surplus notes totaling $25.0 million to Employers Mutual
at an annual interest rate of 5.38 percent. In June, 2002, the Company's
reinsurance subsidiary issued an $11.0 million surplus note to Employers
Mutual at an annual interest rate of 5.25 percent. Effective April 1, 2003,
these surplus notes were reissued at an annual interest rate of 3.09 percent.
These notes do not have a maturity date. Payment of interest and repayment of
principal can only be made out of the applicable subsidiary's statutory
surplus and is subject to prior approval by the insurance commissioner of the
respective state of domicile. The surplus notes are subordinate and junior in
right of payment to all obligations or liabilities of the applicable insurance
subsidiaries. The Company's subsidiaries incurred interest expense of
$834,000 and $1,042,000 for the nine months ended September 30, 2004 and 2003,
respectively, on these surplus notes. The surplus notes were issued in
response to statutory capital adequacy concerns raised by certain rating
agencies because the statutory surplus position of the subsidiaries had
declined over the preceding three years due to unfavorable operating results
and the payment of dividends to the parent corporation.
As of September 30, 2004, the Company had no material commitments for
capital expenditures.
Off-Balance Sheet Arrangements
Employers Mutual receives all premiums and pays all losses and expenses
associated with the insurance business produced by the pool participants and
the assumed reinsurance business and then settles the inter-company balances
generated by these transactions with the participating companies on a
quarterly basis. When settling the inter-company pool balances, Employers
Mutual provides the pool participants with full credit for the premiums
written during the quarter and retains all receivable amounts. Any receivable
amounts that are ultimately deemed to be uncollectible are charged-off by
Employers Mutual and the expense is allocated to the pool members on the basis
of pool participation. As a result, the Company has an off-balance sheet
arrangement with an unconsolidated entity that results in a credit-risk
exposure that is not reflected in the Company's financial statements. Based
on historical data, this credit-risk exposure is not considered to be material
to the Company's results of operations or financial position.
Investment Impairments and Considerations
At the beginning of the third quarter of 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 reflected 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 in the second quarter of 2004 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. During the third quarter of 2004 these bonds were sold, resulting in
a realized gain of $187,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
At September 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 September 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 $946,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position as of September 30, 2004.
Description of securities Fair value Unrealized losses
- ------------------------- ---------- -----------------
($ in thousands)
Fixed maturity securities:
Less than six months ........ $118,578 $ 389
Six to twelve months ........ 5,370 56
Twelve months or longer ..... 11,041 317
-------- ------
Total fixed maturity
securities .............. 134,989 762
-------- ------
Equity securities:
Less than six months ........ 8,273 468
Six to twelve months ........ 794 224
Twelve months or longer ..... 17 2
-------- ------
Total equity securities ... 9,084 694
-------- ------
Total temporarily
impaired securities ... $144,073 $1,456
======== ======
The Company has no fixed maturity securities available-for-sale that are
non-investment grade and have unrealized losses at September 30, 2004. As
previously noted, the Company does not invest in junk bonds. Any
non-investment grade securities held by the Company are the result of rating
downgrades that occurred subsequent to their purchase.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Following is a schedule of gross realized losses recognized in 2004 along
with the associated book values and sales prices aged according to the length
of time the underlying securities were in an unrealized loss position. This
schedule does not include realized losses stemming from corporate actions such
as calls, pay-downs, redemptions, etc. The Company's equity portfolio is
managed on a "tax-aware" basis, which generally results in sales of securities
at a loss to offset sales of securities at a gain, thus minimizing the
Company's income tax expense. Fixed maturity securities are generally held
until maturity.
Gross
Book Sales realized
($ 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 ............... $ 8,837 $ 7,933 $ 904
Over three months to six months .... 1,434 1,179 255
Over six months to nine months ..... 231 210 21
Over nine months to twelve months .. - - -
Over twelve months ................. 1,267 1,110 157
--------- --------- ---------
$ 11,769 $ 10,432 $ 1,337
========= ========= =========
The realized losses recognized on fixed maturity securities that were in
an unrealized loss position for three months or less reflects the $1,268,000
other-than-temporary impairment loss recognized during the second quarter of
2004 on a new series of bonds issued by MCI Communications Corporation in
conjunction with a bankruptcy court approved payout award. The bonds were
sold at a gain during the third quarter of 2004.
LEASES, COMMITMENTS AND CONTINGENT LIABILITIES
The following table reflects the Company's contractual obligations as of
September 30, 2004. Included in the table are the estimated payments that the
Company expects to make in the settlement of its loss reserves and with
respect to its long-term debt. Employers Mutual has entered into various
leases for branch office facilities with lease terms expiring through 2013.
Employers Mutual also leases computer software under various operating lease
agreements expiring through 2005. All lease costs are included as expenses
under the pooling agreement after allocation of the portion of these expenses
to the subsidiaries that do not participate in the pool.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Payments due by period
-----------------------------------------------
Less More
than 1-3 4-5 than
Total 1 year years years 5 years
-------- -------- -------- ------- --------
($ in thousands)
Contractual Obligations
Loss and settlement expense
reserves (1) ............. $408,575 $137,125 $158,578 $37,102 $ 75,770
Long-term debt (2) ......... 36,000 - - - 36,000
Real estate operating leases 6,536 261 2,969 1,474 1,832
Software operating leases .. 1,183 808 375 - -
-------- -------- -------- ------- --------
Total ...................... $452,294 $138,194 $161,922 $38,576 $113,602
======== ======== ======== ======= ========
(1) The amounts presented are estimates of the dollar amounts and time period
in which the Company expects to pay out its gross loss and settlement expense
reserves. These amounts are based on historical payment patterns and do not
represent actual contractual obligations. The actual payment amounts and the
related timing of those amounts could differ significantly from these
estimates.
(2) Long-term debt reflects the surplus notes issued by the Company's
insurance subsidiaries to Employer Mutual, which have no maturity date.
Excluded from long-term debt are pension and other postretirement benefit
obligations.
Estimated guaranty fund assessments of $1,421,000 and $1,253,000, which
are used by states to pay claims of insolvent insurers domiciled in that
state, have been accrued as of September 30, 2004 and December 31, 2003,
respectively. The guaranty fund assessments are expected to be paid over the
next two years with premium tax offsets of $1,800,000 expected to be realized
within ten years of the payments. Estimated second injury fund assessments of
$1,178,000 and $1,109,000, which are designed to encourage employers to employ
a worker with a pre-existing disability, have been accrued as of September 30,
2004 and December 31, 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
life insurance companies, under which the claimant is payee, to fund future
payments that are fixed pursuant to specific claim settlement provisions. The
Company's share of loss reserves eliminated by the purchase of these annuities
was $753,000 at December 31, 2003. The Company has a contingent liability of
$753,000 should the issuers of these annuities fail to perform under the terms
of the annuities. The Company's share of the amount due from any one life
insurance company does not equal or exceed one percent of its subsidiaries'
policyholders' surplus.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
NEW ACCOUNTING PRONOUNCEMENTS
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 became 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 effect of the subsidy on the measurement of the Employers Mutual
postretirement benefit plan resulted in a decrease in the accumulated
projected benefit obligation of $9,899,000 and the net periodic postretirement
benefit cost for 2004 was reduced by $1,076,000.
Adoption of FAS 106-2 resulted in a $241,000 reduction to the Company's
share of the net periodic postretirement benefit cost for the nine months
ended September 30, 2004. The portion of the adjustment applicable to the
first and second quarters was immaterial; therefore, the entire adjustment
was reflected in the third quarter and the first and second quarters were
not restated.
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 market; 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
September 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
- ---------------- ---------- ---------- -------------- -----------------
7/1/04 - 7/31/04 78 (1) $23.83 - -
8/1/04 - 8/31/04 233 (1) 20.15 - -
9/1/04 - 9/30/04 1,360 (1) 18.75 - -
------ ------- ------ -------
Total 1,671 $19.18 - -
====== ======= ====== =======
(1) All shares were purchased in the open market under the Company's dividend
reinvestment and common stock purchase plan.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(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 July 16, 2004 announcing the Company's filing
of an S-1 Registration Statement in connection with a proposed stock
offering.
An 8-K was filed on July 19, 2004 announcing the Company's
proposed increase in its property and casualty insurance companies'
aggregate participation interest in the EMC Insurance Companies
pooling agreement effective January 1, 2005 and Employers Mutual
Casualty Company's withdrawal from participating in the Company's
Dividend Reinvestment and Common Stock Purchase Plan.
An 8-K was filed on August 5, 2004 announcing the Company's
second quarter 2004 financial results.
An 8-K was filed on August 17, 2004 announcing the Company's
declaration of a quarterly dividend of fifteen cents per share of
common stock payable September 3, 2004 to shareholders of record
as of August 27, 2004.
An 8-K was filed on September 27, 2004 announcing a reduction in
the number of shares to be offered by the selling shareholder in the
Company's proposed stock offering.
An 8-K was fled on September 27, 2004 reporting third quarter 2004
estimated hurricane losses and reserve strengthening actions.
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: November 12, 2004