UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2005
--------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________to_________________
Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- -------------------------------------- --------
(Address of principal executive office) (Zip Code)
(515) 280-2902
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at April 29, 2005
----- -----------------------------
Common stock, $1.00 par value 13,599,378
----------
Total pages 43
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2005 2004
ASSETS -------------- ------------
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized
cost (fair value $17,720,250 and
$16,908,726) ............................. $ 16,893,257 $ 15,895,607
Securities available-for-sale, at fair value
(amortized cost $693,107,458 and
$541,401,950) ............................ 709,388,705 565,000,931
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized
cost (fair value $3,299,513 and
$13,684,880) ............................. 3,164,466 13,310,264
Securities available-for-sale, at fair value
(amortized cost $1,366,976 and
$54,389,046) ............................. 1,524,960 54,653,472
Equity securities available-for-sale, at fair
value (cost $60,570,541 and $59,589,434) ... 79,854,556 78,692,893
Other long-term investments, at cost ......... 5,541,923 5,550,093
Short-term investments, at cost .............. 85,339,244 46,238,853
-------------- ------------
Total investments ................... 901,707,111 779,342,113
Balances resulting from related party
transactions with Employers Mutual:
Reinsurance receivables .................... 33,196,375 26,316,358
Prepaid reinsurance premiums ............... 4,768,035 3,682,676
Deferred policy acquisition costs .......... 33,668,539 27,940,583
Defined benefit retirement plan, prepaid
asset .................................... 2,819,822 2,684,463
Other assets ............................... 9,572,170 1,877,564
Cash ........................................... 118,753 61,088
Accrued investment income ...................... 8,341,383 8,726,292
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $0) ......... 201,605 216,836
Income taxes recoverable ....................... - 3,399,485
Deferred income taxes .......................... 13,435,017 9,504,193
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................. 941,586 941,586
Securities lending collateral .................. 5,012,693 70,122,695
-------------- ------------
Total assets ........................ $1,013,783,089 $934,815,932
============== ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2005 2004
LIABILITIES -------------- ------------
Balances resulting from related party
transactions with Employers Mutual:
Losses and settlement expenses ............. $ 520,249,140 $429,677,302
Unearned premiums .......................... 158,695,371 131,589,365
Other policyholders' funds ................. 3,977,424 2,825,809
Surplus notes payable ...................... 36,000,000 36,000,000
Indebtedness to related party .............. 1,889,490 6,058,848
Employee retirement plans .................. 12,716,691 9,764,406
Other liabilities .......................... 38,326,255 20,304,475
Income taxes payable ........................... 4,265,930 -
Securities lending obligation .................. 5,012,693 70,122,695
-------------- ------------
Total liabilities ....................... 781,132,994 706,342,900
-------------- ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized
20,000,000 shares; issued and outstanding,
13,595,398 shares in 2005 and 13,568,945
shares in 2004 ............................... 13,595,398 13,568,945
Additional paid-in capital ..................... 103,969,027 103,467,293
Accumulated other comprehensive income ......... 23,220,109 27,928,463
Retained earnings .............................. 91,865,561 83,508,331
-------------- ------------
Total stockholders' equity .............. 232,650,095 228,473,032
-------------- ------------
Total liabilities and stockholders'
equity ................................ $1,013,783,089 $934,815,932
============== ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
All balances presented below, with the exception of investment income,
realized investment gains and income tax expense, are the result of related
party transactions with Employers Mutual.
Three months ended
March 31,
-------------------------
2005 2004
REVENUES ------------ -----------
Premiums earned ................................. $101,294,070 $83,458,282
Investment income, net .......................... 8,931,710 7,273,977
Realized investment gains ....................... 728,442 400,527
Other income .................................... 96,096 76,479
------------ -----------
111,050,318 91,209,265
------------ -----------
LOSSES AND EXPENSES
Losses and settlement expenses .................. 62,843,008 50,961,177
Dividends to policyholders ...................... 1,550,859 768,042
Amortization of deferred policy acquisition costs 22,486,711 18,419,527
Other underwriting expenses ..................... 8,900,076 8,095,321
Interest expense ................................ 278,100 278,100
Other expenses .................................. 406,130 323,738
------------ -----------
96,464,884 78,845,905
------------ -----------
Income before income tax expense .......... 14,585,434 12,363,360
------------ -----------
INCOME TAX EXPENSE (BENEFIT)
Current ......................................... 5,478,393 3,810,484
Deferred ........................................ (1,395,555) 203,781
------------ -----------
4,082,838 4,014,265
------------ -----------
Net income ................................ $ 10,502,596 $ 8,349,095
============ ===========
Net income per common share - basic and diluted ... $ .77 $ .72
============ ===========
Dividends per common share ........................ $ .15 $ .15
============ ===========
Average number of shares outstanding - basic and
diluted ......................................... 13,585,110 11,522,643
============ ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended
March 31,
------------------------
2005 2004
----------- -----------
Net income ......................................... $10,502,596 $ 8,349,095
----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding gains (losses) arising during
the period, before deferred income tax expense
(benefit) ...................................... (6,515,178) 5,328,692
Deferred income tax expense (benefit) ............ (2,280,311) 1,865,041
----------- -----------
(4,234,867) 3,463,651
----------- -----------
Reclassification adjustment for gains
included in net income, before income tax
expense ........................................ (728,442) (398,221)
Income tax expense ............................... 254,955 139,377
----------- -----------
(473,487) (258,844)
----------- -----------
Other comprehensive income (loss) .......... (4,708,354) 3,204,807
----------- -----------
Total comprehensive income ................. $ 5,794,242 $11,553,902
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended
March 31,
--------------------------
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 10,502,596 $ 8,349,095
------------ ------------
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 ........ 4,813,319 3,542,395
Unearned premiums ..................... (3,543,219) 1,242,766
Other policyholders' funds ............ 370,008 (31,345)
Indebtedness to related party ......... (4,169,358) (4,008,540)
Employee retirement plans ............. 1,020,928 1,111,669
Reinsurance receivables ............... 60,197 (6,499)
Prepaid reinsurance premiums .......... (66,746) (267,497)
Deferred policy acquisition costs ..... 790,779 (225,941)
Commissions payable ................... (9,487,880) (4,466,442)
Interest payable ...................... (834,300) (556,200)
Prepaid assets ........................ (2,461,970) (1,692,066)
Other, net ............................ (217,790) (868,818)
Accrued investment income ................. 384,909 902,242
Accrued income taxes:
Current ................................. 7,665,415 1,255,855
Deferred ................................ (1,395,555) 203,781
Realized investment gains ................. (728,442) (400,527)
Other, net ................................ 221,211 247,801
------------ ------------
(7,578,494) (4,017,366)
Cash provided by the change in the property
and casualty insurance subsidiaries'
pooling agreement ....................... 107,801,259 -
------------ ------------
Net cash provided by
operating activities .............. $110,725,361 $ 4,331,729
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Three months ended
March 31,
--------------------------
2005 2004
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 9,142,890 $ 1,391,172
Purchases of fixed maturity securities
available-for-sale .......................... (177,508,302) (220,499,040)
Disposals of fixed maturity securities
available-for-sale .......................... 98,739,319 225,667,494
Purchases of equity securities
available-for-sale .......................... (13,234,393) (6,293,619)
Disposals of equity securities
available-for-sale .......................... 12,902,189 4,694,150
Purchase of other long-term investments ....... - (432,251)
Disposal of other long-term investments ....... 8,170 135,226
Net sales (purchases) of short-term investments (39,100,390) 6,083,140
------------ ------------
Net cash provided by (used in) investing
activities .............................. (109,050,517) 10,746,272
------------ ------------
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 ............. 528,187 1,063,954
Dividends paid to Employers Mutual ........ (1,093,960) (1,395,439)
Dividends paid to Employers Mutual
(reimbursement for non-GAAP expense) .... (106,647) (201,195)
Dividends paid to public stockholders.......... (944,759) (334,765)
------------ ------------
Net cash used in financing activities ..... (1,617,179) (867,445)
------------ ------------
NET INCREASE IN CASH ............................ 57,665 14,210,556
Cash at beginning of year ....................... 61,088 (14,069,102)
------------ ------------
Cash at end of quarter .......................... $ 118,753 $ 141,454
============ ============
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 on the basis of U.S. generally accepted accounting principles (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, 2004 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 2004 Form 10-K or the 2004 Annual Report to Shareholders for more
detailed footnote information.
2. CHANGE IN POOLING AGREEMENT
The Company's aggregate participation in the pooling agreement increased
from 23.5 percent to 30.0 percent effective January 1, 2005. In connection
with this change in the pooling agreement, the Company's liabilities increased
$115,042,355, invested assets increased $107,801,259 and other assets
increased $722,361. The Company reimbursed Employers Mutual $6,518,735 for
expenses that were incurred to generate the additional business assumed by the
Company, but this expense was offset by an increase in deferred policy
acquisition costs. The Company also received $274,963 in interest income from
Employers Mutual as the actual cash settlement did not occur until February
15, 2005.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
3. REINSURANCE
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three months ended March 31, 2005 and
2004 is presented below.
Three months ended March 31,
--------------------------------
2005 2004
-------------- ---------------
Premiums written
Direct ............................ $ 45,183,821 $ 47,744,535
Assumed from non-affiliates ....... 1,080,913 958,985
Assumed from affiliates ........... 131,959,040 88,030,997
Ceded to non-affiliates ........... (5,952,318) (4,306,164)
Ceded to affiliates ............... (45,183,821) (47,744,535)
------------ ------------
Net premiums written ............ $127,087,635 $ 84,683,818
============ ============
Premiums earned
Direct ............................ $ 46,476,249 $ 51,770,304
Assumed from non-affiliates ....... 788,430 959,524
Assumed from affiliates ........... 105,372,597 86,537,425
Ceded to non-affiliates ........... (4,866,957) (4,038,667)
Ceded to affiliates ............... (46,476,249) (51,770,304)
------------ ------------
Net premiums earned ............. $101,294,070 $ 83,458,282
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 25,673,741 $ 27,042,551
Assumed from non-affiliates ....... 3,986,379 759,089
Assumed from affiliates ........... 68,590,906 51,465,913
Ceded to non-affiliates ........... (9,734,277) (1,263,825)
Ceded to affiliates ............... (25,673,741) (27,042,551)
------------ ------------
Net losses and settlement
expenses incurred ............. $ 62,843,008 $ 50,961,177
============ ============
The large increases in net premiums written and earned, and net losses
and settlement expenses incurred in 2005 reflect the increase in the Company's
aggregate participation interest in the pooling agreement. Net premiums
written for 2005 also include a $29,630,612 portfolio adjustment, which serves
as an offset to the increase in net unearned premiums recognized in connection
with the pooling change.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
4. STOCK BASED COMPENSATION
The Company has no stock based compensation plans of its own; however,
Employers Mutual has several stock plans that utilize the common stock of the
Company. The Company receives the current fair value for any shares issued
under these plans. Under the terms of the pooling and quota share agreements,
stock option expense is allocated to the Company as determined on a statutory
basis of accounting; however, for these GAAP basis financial statements the
Company accounts for the stock option plans using the intrinsic value method
of accounting as prescribed by Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees." Under the provisions of APB
25, no compensation expense is recognized from the operation of Employers
Mutual's stock option plans since the exercise price of the options is equal
to the fair value of the stock on the date of grant.
The Company's insurance subsidiaries reimburse Employers Mutual for their
share of the statutory-basis compensation expense associated with stock option
exercises under the terms of the pooling and quota share agreements. The
statutory-basis compensation expense that was paid by the Company's
subsidiaries to Employers Mutual ($106,647 and $201,195 for the three months
ended March 31, 2005 and 2004, respectively) was reclassified as a dividend
payment to Employers Mutual in these GAAP-basis financial statements.
The following table illustrates the effect on net income and net income
per share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS
148), "Accounting for Stock-Based Compensation," to Employers Mutual's stock
option plans:
Three months ended
March 31,
-------------------------
2005 2004
----------- ----------
Net income, as reported .................. $10,502,596 $8,349,095
Deduct: Stock-based employee compensation
expense determined under the fair
value method for all awards, net of
related tax effects ................ 19,128 8,017
----------- ----------
Pro forma net income ..................... $10,483,468 $8,341,078
=========== ==========
Net income per share:
Basic and diluted -
As reported .......................... $0.77 $0.72
Pro forma ............................ $0.77 $0.72
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
In December 2004, the Financial Accounting Standards Board issued SFAS
No. 123 (revised 2004) "Share-Based Payment," which is a revision of SFAS 123
and supersedes APB 25. SFAS 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their grant date fair values. The pro forma
disclosures previously allowed under SFAS 123 will no longer be an alternative
to financial statement recognition. The transition methods for adoption
include the modified-prospective and modified-retroactive methods. The
modified-prospective method requires that compensation expense be recorded for
all unvested stock options that exist upon the adoption of SFAS 123(R). Under
the modified-retroactive method, prior periods may be restated either as of
the beginning of the year of adoption or for all periods presented. The
effective date for SFAS 123(R) was originally the first interim and annual
periods beginning after June 15, 2005, with earlier adoption encouraged. On
April 14, 2005, the Securities and Exchange Commission approved a rule which
delayed the required effective date of SFAS 123(R) until fiscal years
beginning after June 15, 2005. The Company is currently evaluating the
requirements of SFAS 123(R), including the adoption method alternatives, but
does not expect adoption of this statement to have a material effect on the
operating results of the Company.
5. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium-sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate.
Property
Three months ended and casualty Parent
March 31, 2005 insurance Reinsurance company Consolidated
- ---------------- ------------ ------------ ------------- --------------
Premiums earned ..... $ 79,718,272 $ 21,575,798 $ 101,294,070
Underwriting gain ... 5,204,474 308,942 5,513,416
Net investment income 6,341,481 2,495,277 $ 94,952 8,931,710
Realized gains
(losses) .......... 867,114 (138,672) - 728,442
Other income ........ 96,096 - - 96,096
Interest expense .... 193,125 84,975 - 278,100
Other expense ....... 171,329 - 234,801 406,130
------------ ------------ ------------- --------------
Income (loss) before
income tax expense
(benefit) ......... $ 12,144,711 $ 2,580,572 $ (139,849) $ 14,585,434
============ ============ ============= ==============
Assets .............. $774,275,990 $237,344,672 $ 232,830,983 $1,244,451,645
Eliminations ........ - - (227,636,611) (227,636,611)
Reclassifications ... (278,623) (2,537,775) (215,547) (3,031,945)
------------ ------------ ------------- --------------
Net assets ..... $773,997,367 $234,806,897 $ 4,978,825 $1,013,783,089
============ ============ ============= ==============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Property
Three months ended and casualty Parent
March 31, 2004 insurance Reinsurance company Consolidated
- ---------------- ------------ ------------ ------------- --------------
Premiums earned ..... $ 61,360,228 $ 22,098,054 $ 83,458,282
Underwriting gain ... 4,040,349 1,173,866 5,214,215
Net investment income 4,966,371 2,295,483 $ 12,123 7,273,977
Realized gains ...... 289,967 110,560 - 400,527
Other income ........ 76,479 - - 76,479
Interest expense .... 193,125 84,975 - 278,100
Other expense ....... 180,397 - 143,341 323,738
------------ ------------ ------------- --------------
Income (loss) before
income tax expense
(benefit) ......... $ 8,999,644 $ 3,494,934 $ (131,218) $ 12,363,360
============ ============ ============= ==============
Assets .............. $658,572,895 $261,981,767 $ 191,402,682 $1,111,957,344
Eliminations ........ - - (186,143,463) (186,143,463)
Reclassifications ... (68,652) - (12,206) (80,858)
------------ ------------ ------------- --------------
Net assets ..... $658,504,243 $261,981,767 $ 5,247,013 $ 925,733,023
============ ============ ============= ==============
6. INCOME TAXES
The actual income tax expense for the three months ended March 31, 2005
and 2004 differed from the "expected" tax expense for those periods (computed
by applying the United States federal corporate tax rate of 35 percent to
income before income tax expense) as follows:
Three months ended
March 31,
------------------------
2005 2004
----------- -----------
Computed "expected" tax expense ................... $ 5,104,902 $ 4,327,176
Increases (decreases) in tax resulting from:
Tax-exempt interest income .................... (1,087,696) (611,073)
Proration of tax-exempt interest and dividends
received deduction .......................... 170,802 98,022
Other, net .................................... (105,170) 200,140
----------- -----------
Income tax expense ........................ $ 4,082,838 $ 4,014,265
=========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
7. EMPLOYEE RETIREMENT PLANS
The components of net periodic benefit cost for the Employers Mutual
pension plan and postretirement benefit plans are as follows:
Three months ended
March 31,
-------------------------
2005 2004
---------- ----------
Pension Plan:
Service cost .......................... $1,872,977 $1,704,630
Interest cost ......................... 1,947,072 1,755,222
Expected return on plan assets ........ (2,220,757) (1,690,132)
Amortization of net loss .............. 204,905 213,922
Amortization of prior service costs ... 111,864 191,456
---------- ----------
Net periodic pension benefit cost ... $1,916,061 $2,175,098
========== ==========
Postretirement benefit plans:
Service cost .......................... $1,039,981 $1,144,127
Interest cost ......................... 1,018,762 1,078,509
Expected return on plan assets ........ (272,282) (225,221)
Amortization of net loss .............. 10,023 147,830
---------- ----------
Net periodic postretirement
benefit cost ...................... $1,796,484 $2,145,245
========== ==========
Pension expense allocated to the Company amounted to $587,002 and
$528,723 for the three months ended March 31, 2005 and 2004, respectively.
Postretirement benefit expense allocated to the Company amounted to
$512,544 and $481,853 for the three months ended March 31, 2005 and 2004,
respectively.
Employers Mutual plans to contribute approximately $2,500,000 to the
pension plan and $3,770,000 to the postretirement benefit plans in 2005. As
of March 31, 2005, Employers Mutual has not made a contribution to the pension
plan and has contributed the $3,770,000 to the postretirement benefit plans.
8. 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 of 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 $699,913 at December 31, 2004. Due to the change in the Company's
aggregate participation in the pooling agreement, this amount increased to
$893,506 effective January 1, 2005. The Company has a contingent liability of
$893,506 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
(Unaudited)
COMPANY OVERVIEW
EMC Insurance Group Inc., a 53.6 percent owned subsidiary of Employers
Mutual Casualty Company (Employers Mutual), is an insurance holding company
with operations in property and casualty insurance and reinsurance. Property
and casualty insurance is the most significant segment, representing 78.7
percent of consolidated premiums earned in the first quarter of 2005. For
purposes of this discussion, the term "Company" is used interchangeably to
describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance
Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries
(including the Company) and an affiliate are referred to as the "EMC Insurance
Companies."
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All premiums, 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. Employers Mutual
negotiates reinsurance agreements that provide protection to the pool and each
of its participants, including protection against losses arising from
catastrophic events.
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 pooling agreement also provides 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.
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.
Effective January 1, 2005, the Company's aggregate participation in the
pooling agreement increased from 23.5 percent to 30.0 percent. In connection
with this change in the pooling agreement, the Company's liabilities increased
$115,042,000, invested assets increased $107,801,000 and other assets
increased $722,000. The Company reimbursed Employers Mutual $6,519,000 for
expenses that were incurred to generate the additional business assumed by the
Company, but this expense was offset by an increase in deferred policy
acquisition costs. The Company also received $275,000 in interest income from
Employers Mutual as the actual cash settlement did not occur until February
15, 2005.
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,
settlement expenses, and other underwriting and administrative expenses of
this business, subject to a maximum loss of $1,500,000 per event. The
reinsurance subsidiary does not directly reinsure any of the insurance
business written by Employers Mutual; however, the reinsurance subsidiary
assumes reinsurance business from the Mutual Reinsurance Bureau (MRB) pool and
this pool provides a very small amount of reinsurance protection to the EMC
Insurance Companies. As a result, the reinsurance subsidiary's assumed
exposures include a very small portion of the EMC Insurance Companies' direct
business, after ceded reinsurance protections purchased by the MRB pool are
applied. In addition, the reinsurance subsidiary does not reinsure 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. An underwriting loss
indicates that premium income was not adequate. The combined ratio is a
measure utilized by insurance companies to gauge underwriting profitability
and is calculated by dividing losses and expenses incurred by premiums earned.
A number less than 100 generally indicates an underwriting gain; a number
greater than 100 generally indicates an underwriting loss.
Insurance companies collect cash in the form of insurance premiums and pay
out cash in the form of loss and settlement expense payments. Additional cash
outflows occur through the payment of acquisition and underwriting costs such
as commissions, premium taxes, salaries and general overhead. During the loss
settlement period, which varies by line of business and by the circumstances
surrounding each claim and may cover several years, insurance companies invest
the cash premiums and earn interest and dividend income. This investment
income supplements underwriting results and contributes to net earnings.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Additional information regarding issues affecting the insurance industry
is presented in the Management's Discussion and Analysis of Financial
Condition and Results of Operations section of the Company's 2004 Form 10-K.
MANAGEMENT ISSUES AND PERSPECTIVES
During the first quarter of 2005 management focused its attention on
three primary issues affecting the Company. These issues include establishing
and maintaining adequate loss and settlement expense reserves, balancing
profitability and production as the insurance marketplace becomes increasingly
competitive and preparing to comply with the requirements of Section 404 of
the Sarbanes-Oxley Act of 2002. These issues are discussed further in the
following paragraphs. A discussion of other issues affecting the Company is
presented in the Management's Discussion and Analysis of Financial Condition
and Results of Operations section of the Company's 2004 Form 10-K.
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.
In addition to an ongoing review of claim files in the normal course of
business, the Company has for many years required each of its 16 branch
offices to perform a complete inventory of its open claim files during the
fourth quarter of each year and to review the adequacy of each carried reserve
based on current information. This fourth quarter review process has not
historically resulted in a significant increase in carried reserves; however,
because of heightened emphasis placed on case reserve adequacy during 2004,
the review performed in the fourth quarter of 2004 generated a significant and
unanticipated increase in carried reserves and a corresponding increase in
settlement expense reserves. In an effort to minimize the likelihood of this
occurring in the future, beginning in 2005 the branch offices are required to
perform a complete inventory and review of their open claim files semi-
annually rather than annually as previously required. The first review is to
be completed by the end of May and the second review is to be completed
by the end of November each year. This new procedure is designed to help
assure that necessary reserve adjustments are implemented on a timely basis.
In addition to recent actions taken to improve reserve adequacy,
effective March 1, 2005, Richard K. Schulz, an employee of Employers Mutual,
became the senior claims executive officer. Mr. Schulz was the claims manager
at the Chicago branch office for the last five years and has over ten years of
prior insurance industry experience. Mr. Schulz reports to William A. Murray,
Executive Vice President and Chief Operating Officer.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
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.
The Company, which is not currently an accelerated filer, has completed
the majority of the documentation of its work flow and internal controls over
financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
2002. Efforts during the first quarter of 2005 focused on the remediation of
identified gaps in existing controls and the verification of controls at the
various branch offices. Efforts for the remainder of 2005 will include
testing of the documented controls, remediation of any controls that are found
to be not working as designed and the establishment of a maintenance process.
Management expects to complete its initial assessment of the Company's
internal control over financial reporting by mid July, which will allow
sufficient time for the Company's independent auditors to perform their
analysis and testing procedures and issue their report on the Company's
internal control over financial reporting as of December 31, 2005.
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 Management's
Discussion and Analysis of Financial Condition and Results of Operations
section of the Company's 2004 Form 10-K.
RESULTS OF OPERATIONS
Segment information and consolidated net income for the three months
ended March 31, 2005 and 2004 is as follows:
Three months ended
March 31,
--------------------
($ in thousands) 2005 2004
-------- --------
Property and Casualty Insurance
Premiums earned ...................................... $ 79,718 $ 61,360
Losses and settlement expenses ....................... 47,131 36,395
Acquisition and other expenses ....................... 27,383 20,925
-------- --------
Underwriting gain .................................... $ 5,204 $ 4,040
======== ========
Loss and settlement expense ratio .................... 59.1% 59.3%
Acquisition expense ratio ............................ 34.4 34.1
-------- --------
Combined ratio ....................................... 93.5% 93.4%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 53,724 $ 39,820
Decrease in provision for insured
events of prior years .......................... (6,593) (3,425)
-------- --------
Total losses and settlement expenses ......... $ 47,131 $ 36,395
======== ========
Catastrophe and storm losses ......................... $ 1,764 $ 870
======== ========
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
March 31,
--------------------
($ in thousands) 2005 2004
-------- --------
Reinsurance
Premiums earned ...................................... $ 21,576 $ 22,098
Losses and settlement expenses ....................... 15,712 14,566
Acquisition and other expenses ....................... 5,555 6,358
-------- --------
Underwriting gain .................................... $ 309 $ 1,174
======== ========
Loss and settlement expense ratio .................... 72.8% 65.9%
Acquisition expense ratio ............................ 25.8 28.8
-------- --------
Combined ratio ....................................... 98.6% 94.7%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 15,005 $ 14,931
Increase (decrease) in provision for
insured events of prior years .................. 707 (365)
-------- --------
Total losses and settlement expenses ......... $ 15,712 $ 14,566
======== ========
Catastrophe and storm losses ......................... $ 861 $ 145
======== ========
Consolidated
REVENUES
Premiums earned ...................................... $101,294 $ 83,458
Net investment income ................................ 8,932 7,274
Realized investment gains ............................ 728 401
Other income ......................................... 96 76
-------- --------
111,050 91,209
-------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ....................... 62,843 50,961
Acquisition and other expenses ....................... 32,938 27,283
Interest expense ..................................... 278 278
Other expense ........................................ 406 324
-------- --------
96,465 78,846
-------- --------
Income before income tax expense ..................... 14,585 12,363
Income tax expense ................................... 4,082 4,014
-------- --------
Net income ........................................... $ 10,503 $ 8,349
======== ========
Net income per share ................................. $ 0.77 $ 0.72
======== ========
Loss and settlement expense ratio .................... 62.0% 61.1%
Acquisition expense ratio ............................ 32.6 32.7
-------- --------
Combined ratio ....................................... 94.6% 93.8%
======== ========
Losses and settlement expenses:
Insured events of current year ................... $ 68,729 $ 54,751
Decrease in provision for insured
events of prior years .......................... (5,886) (3,790)
-------- --------
Total losses and settlement expenses ......... $ 62,843 $ 50,961
======== ========
Catastrophe and storm losses ......................... $ 2,625 $ 1,015
======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Net income increased 25.8 percent to a record $10,503,000 ($0.77 per
share) in the first quarter of 2005 from the previous record of $8,349,000
($0.72 per share) reported in the first quarter of 2004. This increase is
primarily attributed to an increase in investment income stemming from a large
increase in invested assets. The Company's invested assets increased as a
result of $34,890,000 of net proceeds received from the follow-on stock
offering completed in October 2004 and the receipt of $107,801,000 in cash in
February 2005 in connection with the change in the pooling agreement. Also
contributing to the increase in net income was a lower effective tax rate and
a moderate increase in underwriting profits to $5,513,000 in the first quarter
of 2005 from $5,214,000 in 2004. There have been indications of increased
rate competition during the first quarter of 2005, but management continues to
emphasize its goal of achieving profitability over production. Achieving an
underwriting profit is always stressed, but has become even more critical in
this lingering low interest rate environment.
Premium income
Premiums earned increased 21.4 percent to $101,294,000 in the first
quarter of 2005 from $83,458,000 in the first quarter of 2004. This increase
is primarily attributed to the Company's increased participation in the
pooling agreement, but also reflects the impact of rate increases that were
implemented during 2004. On an overall basis, rate competition increased
moderately in the property and casualty insurance marketplace during the first
quarter of 2005. However, there were indications of more intense rate
competition in select territories and lines of business, and the Company
expects market conditions to remain competitive for the remainder of the year.
The Company will continue to implement rate increases in those lines of
business and/or territories where such action is warranted, but the overall
level of these rate increases is expected to be smaller than those implemented
during 2004.
Premiums earned for the property and casualty insurance segment increased
29.9 percent to $79,718,000 in the first quarter of 2005 from $61,360,000 in
the first quarter of 2004, primarily as a result of the change in the pooling
agreement. To better understand the first quarter results, it is helpful to
look at the net pool numbers, which are not impacted by the pool change.
Comparing first quarter 2005 to first quarter 2004, net premiums earned
increased 2.9 percent as a result of rate increases implemented during the
last two years. Premium rate levels for most lines of business were
considered to be at, or near, adequate levels at the end of 2002.
Accordingly, progressively smaller and more targeted rate increases were
implemented during 2003 and 2004 and the first quarter of 2005. 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Premiums written for the property and casualty insurance segment
increased 75.9 percent to 105,853,000 in the first quarter of 2005 from
$60,184,000 in the first quarter of 2004. This large increase is attributed
to the change in the pooling agreement and includes a portfolio adjustment of
$29,631,000, which serves as an offset to the increase in the unearned premium
reserve. Excluding this portfolio adjustment, premiums written increased 26.6
percent in 2005. Looking at the net pool numbers, which are not impacted by
the pool change, premiums written increased 0.3 percent in the first quarter
of 2005. This slight increase reflects a decline in new business and a
decline in the number of rate increases implemented due to increased
competition in the marketplace and the current level of rate adequacy. The
overall rate level on new and renewal policies increased approximately
0.5 percent for the first quarter of 2005 compared to approximately 4.0
percent in 2004, which is consistent with the marketplace. Commercial lines
new business premium decreased approximately 3.0 percent during the first
quarter of 2005, and personal lines new business premium decreased
approximately 18.5 percent. However, policy retention remained at
approximately 86.0 percent in commercial lines and 82.0 percent in personal
lines. Though the Company will continue to implement rate increases in select
lines of business and/or territories, premium rate levels for most lines of
business are not expected to change significantly in 2005. 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 decreased 2.4 percent to
$21,576,000 in the first quarter of 2005 from $22,098,000 in the first quarter
of 2004, primarily as a result of the loss of a significant account.
Employers Mutual has not been able to retain several accounts in recent years
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; however, no significant new accounts were
added during the first quarter of 2005. Premium rate increases on excess-of-
loss contracts remained relatively flat for January 2005 renewals, but there
were some signs of softening during the first quarter. Premium rate levels
continue to be considered adequate, as the rate increases implemented during
the last several years were realized in conjunction with moderate declines in
the related exposure base due to increased retention levels and coverage
exclusions for terrorist activities. In addition, both excess-of-loss and
pro-rata contracts have benefited from improved industry-wide rate levels at
the primary company level. The estimate of earned but not reported premiums
increased $400,000 during the first quarter of 2005, compared to a decrease of
$790,000 in the first quarter of 2004.
As previously reported, the board of directors of the MRB pool, of which
Employers Mutual is a member, has authorized management to pursue the addition
of one or two new assuming companies to the pool. No action was taken during
the first quarter of 2005 and the earliest that a new member could begin
participating in the pool would therefore be January 2006. If additional
assuming companies are added to the pool, Employers Mutual's participation
will be reduced and the reinsurance segment's premium volume will decline in
the short-term; however, this action will strengthen MRB's surplus base and
should favorably impact their ability to attract new business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Losses and settlement expenses
Losses and settlement expenses increased 23.3 percent to $62,843,000 in
the first quarter of 2005 from $50,961,000 in the first quarter of 2004. The
majority of this increase is attributed to the Company's increased
participation in the pooling agreement. The loss and settlement expense ratio
(losses and settlement expenses expressed as a percentage of premiums earned)
increased slightly to 62.0 percent in 2005 from 61.1 percent in 2004. The
Company benefited from an increase in the amount of favorable development
experienced on prior years' reserves; however, this benefit was partially
offset by an increase in catastrophe and storm losses.
The loss and settlement expense ratio for the property and casualty
insurance segment decreased slightly to 59.1 percent in the first quarter of
2005 from 59.3 percent in the first quarter of 2004. An increase in the
amount of favorable development experienced on prior years' reserves more than
offset increases in claim severity and catastrophe and storm losses. The rise
in claim severity in the first quarter of 2005 is generally attributed to the
establishment of more adequate case reserves on current accident year losses.
Overall loss frequency continued to trend downward in the first quarter of
2005; however, there are some signs that loss frequency may be leveling out,
especially in the workers' compensation line of business.
The loss and settlement expense ratio for the reinsurance segment
increased to 72.8 percent in the first quarter of 2005 from 65.9 percent in
the first quarter of 2004. This increase reflects adverse development on
prior years' reserves reported by the MRB pool and an increase in catastrophe
and storm losses, most notably European storm Erwin.
Acquisition and other expenses
Acquisition and other expenses increased 20.7 percent to $32,938,000 in
the first quarter of 2005 from $27,283,000 in the first quarter of 2004. This
increase is primarily attributed to the Company's increased participation in
the pooling agreement. The expense ratio (acquisition and other expenses
expressed as a percentage of premiums earned) decreased slightly to 32.6
percent in 2005 from 32.7 percent in 2004, primarily due to lower commission
expenses in the reinsurance segment.
For the property and casualty insurance segment, the expense ratio
increased to 34.4 percent in the first quarter of 2005 from 34.1 percent in
the first quarter of 2004. This increase is primarily due to an increase in
policyholder dividends, which reflects improved underwriting results on
eligible accounts, and to a much lesser extent, an increase in agents' profit
share expense.
The property and casualty insurance subsidiaries incurred $6,519,000 of
commission expense in connection with the change in the pooling agreement.
This commission expense is used to reimburse Employers Mutual for the expenses
it incurred to generate the additional insurance business that was transferred
to the Company on January 1, 2005. However, due to the fact that acquisition
expenses, which include commissions, are deferred and amortized to expense as
the related premiums are earned, all of the $6,519,000 of commission expense
was capitalized as a deferred policy acquisition cost, and is being amortized
to expense as the unearned premiums become earned. This provides a proper
matching of acquisition expenses and premium income.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
For the reinsurance segment, the expense ratio decreased to 25.8 percent
in the first quarter of 2005 from 28.8 percent in the first quarter of 2004.
This decrease is attributed to a decline in both commission and contingent
commission expense reported by the MRB pool. The commission expense for 2004
includes $1,033,000 related to an increase in participation in the MRB pool
from 25 percent to 33 percent; however, this expense was partially offset by
an increase in the asset for deferred policy acquisition costs.
Investment results
Net investment income increased 22.8 percent to $8,932,000 in the first
quarter of 2005 from $7,274,000 in the first quarter of 2004 due to a
significant increase in invested assets. As previously discussed, the Company
received $34,890,000 of net proceeds from the follow-on stock offering in
October 2004 and received $107,801,000 in February 2005 in connection with the
change in the pooling agreement. The Company also received $275,000 of
interest income from Employers Mutual as the cash settlement for the pooling
change did not occur until February 15, 2005. Investment rates of return
continue to be negatively impacted by the lingering low interest rate
environment. 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. During
the second quarter of 2004, interest rates became more attractive and the
Company began investing in long-term securities; however, the majority of
these purchases were in tax-exempt bonds, which carry a lower interest rate
but a higher after-tax rate of return. Realized investment gains totaled
$728,000 in the first quarter of 2005 and $401,000 in the first quarter of
2004. The Company did not recognize any other-than-temporary impairment
losses in the first quarter of 2005 or 2004.
Income Tax
Income tax expense increased 1.7 percent to $4,082,000 in the first
quarter of 2005 from $4,014,000 in the first quarter of 2004. The effective
tax rate declined to 28.0 percent for the first quarter of 2005 from 32.5
percent for the same period of 2004. The decrease in the effective tax rate
primarily reflects the Company's increased emphasis on tax-exempt securities.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
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 $110,725,000 during the first quarter of 2005
compared to $4,332,000 for the first quarter of 2004. Included in cash flows
from operations for the first quarter of 2005 is $107,801,000 received from
Employers Mutual in connection with the change in the pooling agreement.
Excluding this amount, cash flows from operations for the first quarter of
2005 amounted to $2,924,000. 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 payments of losses
and settlement expenses of the underlying insurance policies. 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 March 31, 2005, the Company did not have any
significant variations between the maturity dates of its investments and the
expected payments 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
2005 without prior regulatory approval is approximately $32.2 million. The
Company received $1,357,000 and $1,576,000 of dividends from its insurance
company subsidiaries and paid cash dividends to its stockholders totaling
$2,039,000 and $1,730,000 in the first quarter of 2005 and 2004, 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 ceded to the
Company's reinsurance subsidiary, 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 March 31, 2005, approximately 39 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
high-yield, non-investment grade debt securities; however, an exception was
made to this policy in 2004 when non-investment grade MCI debt securities were
sold and then repurchased in order to recognize a current income tax benefit.
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 $10,685,000 and $15,511,000 at
March 31, 2005 and December 31, 2004, 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 $5,542,000 and $5,550,000 in minority ownership
interests in limited partnerships and limited liability companies at March 31,
2005 and December 31, 2004, respectively. The Company does not hold any other
unregistered securities.
The Company carried a pension asset of $2,820,000 and $2,684,000 at March
31, 2005 and December 31, 2004, respectively. Postretirement benefit
liabilities reflected in the Company's financial statements totaled
$12,248,000 and $9,486,000 at March 31, 2005 and December 31, 2004,
respectively. Included in these increases is $722,000 of pension assets and
$2,518,000 of postretirement benefit liabilities transferred to the Company in
connection with the change in the pooling agreement.
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 March 31, 2005.
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, 2004, the Company's insurance subsidiaries had total adjusted
statutory capital of $216,868,000, which is well in excess of the minimum RBC
requirement of $43,485,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The Company had total cash and invested assets with a carrying value of
$901.8 million and $779.4 million as of March 31, 2005 and December 31, 2004,
respectively. The following table summarizes the Company's cash and invested
assets as of the dates indicated:
March 31, 2005
---------------------------------------------
Amortized Total at Carrying
($ in thousands) Cost Fair Value Fair Value Value
--------- ---------- ---------- --------
Fixed maturities,
held-to-maturity ........ $ 20,058 $ 21,020 2.3% $ 20,058
Fixed maturities,
available-for-sale ...... 694,474 710,913 78.8% 710,913
Equity securities,
available-for-sale ...... 60,571 79,855 8.8% 79,855
Cash ...................... 119 119 - 119
Short-term investments .... 85,339 85,339 9.5% 85,339
Other long-term
investments ............. 5,542 5,542 0.6% 5,542
-------- -------- ----- --------
$866,103 $902,788 100.0% $901,826
======== ======== ===== ========
December 31, 2004
---------------------------------------------
Amortized Total at Carrying
($ in thousands) Cost Fair Value Fair Value Value
--------- ---------- ---------- --------
Fixed maturities,
held-to-maturity ........ $ 29,206 $ 30,594 3.9% $ 29,206
Fixed maturities,
available-for-sale ...... 595,791 619,654 79.4 619,654
Equity securities,
available-for-sale ...... 59,589 78,693 10.1 78,693
Cash ...................... 61 61 - 61
Short-term investments .... 46,239 46,239 5.9 46,239
Other long-term
investments ............. 5,550 5,550 0.7 5,550
-------- -------- ----- --------
$736,436 $780,791 100.0% $779,403
======== ======== ===== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The amortized cost and estimated fair value of fixed maturity and equity
securities at March 31, 2005 were as follows:
Held-to maturity
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
($ in thousands) cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 19,031 $ 877 $ - $ 19,908
Mortgage-backed securities 1,027 85 - 1,112
--------- ---------- ---------- ---------
Total securities
held-to-maturity ..... $ 20,058 $ 962 $ - $ 21,020
========= ========== ========== =========
Available-for sale
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 273,088 $ 138 $ 1,037 $ 272,189
Obligations of states and
political subdivisions ... 255,293 8,660 452 263,501
Mortgage-backed securities 10,893 588 - 11,481
Public utilities ........... 9,196 1,054 - 10,250
Debt securities issued by
foreign governments ...... 7,145 149 - 7,294
Corporate securities ....... 138,859 8,094 754 146,199
---------- ---------- ---------- ---------
Total fixed maturity
securities ........... 694,474 18,683 2,243 710,914
---------- ---------- ---------- ---------
Equity securities .......... 60,571 19,903 619 79,855
---------- ---------- ---------- ---------
Total securities
available-for-sale $ 755,045 $ 38,586 $ 2,862 $ 790,769
========== ========== ========== =========
The Company's insurance and reinsurance subsidiaries have $36,000,000 of
surplus notes issued to Employer Mutual. These surplus notes have an annual
interest rate of 3.09 percent and 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 $278,000 of interest expense on these surplus notes in
the first quarter of 2005 and 2004. At December 31, 2004, the Company's
subsidiaries had received approval for the payment of interest accrued on the
surplus notes during 2004.
As of March 31, 2005, the Company had no material commitments for capital
expenditures.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Off-Balance Sheet Arrangements
Employers Mutual receives all premiums and pays all losses and expenses
associated with the assumed reinsurance business ceded to the reinsurance
subsidiary and the insurance business produced by the pool participants, and
then settles the inter-company balances generated by these transactions with
the participating companies on a quarterly basis. When settling the inter-
company balances, Employers Mutual provides the reinsurance subsidiary and 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 charged to the reinsurance subsidiary or 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
During 2004 the Company had one fixed maturity security series (MCI
Communications Corporation) that was determined other-than-temporarily
impaired. MCI Communications Corporation was owned by WorldCom Inc., whose
corporate bonds were downgraded to junk status in May 2002 when it reported
the detection of accounting irregularities. On June 30, 2002 the Company
recognized $3,821,000 of realized loss when the carrying value of this
investment was reduced from an aggregate book value of $5,604,000 to the then
current fair value of $1,783,000. The fair value of the MCI bonds then
partially recovered, resulting in pre-tax unrealized gains of $1,035,000
recognized during 2002 and $1,811,000 recognized during 2003. During the
second quarter of 2004 the Company received three new series of fixed maturity
securities (with impaired book values) issued by MCI Communications
Corporation 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. The new bonds were sold during the third quarter of 2004 for income
tax purposes, resulting in an additional 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 March 31, 2005, the Company had unrealized losses on held-to-maturity
and available-for-sale securities as presented in the table below. The
estimated fair value is based on quoted market prices, where available, or
on values obtained from independent pricing services. None of these
securities are considered to be in concentrations by either security type or
industry. The Company uses several factors to determine whether the carrying
value of an individual security has been other-than-temporarily impaired.
Such factors include, but are not limited to, the security's value and
performance in the context of the overall markets, length of time and extent
the security's fair value has been below carrying value, key corporate events
and collateralization of fixed maturity securities. Based on these factors,
and the Company's ability and intent to hold the fixed maturity securities
until maturity, it was determined that the carrying value of these securities
was not other-than-temporarily impaired at March 31, 2005. 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 $1,860,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position as of March 31, 2005.
Description of securities Fair value Unrealized losses
- ---------------------------- ---------- -----------------
($ in thousands)
Fixed maturity securities:
Less than six months ........ $276,255 $1,894
Six to twelve months ........ 5,946 55
Twelve months or longer ..... 14,703 294
-------- ------
Total fixed maturity
securities .............. 296,904 2,243
-------- ------
Equity securities:
Less than six months ........ 10,908 609
Six to twelve months ........ 101 10
Twelve months or longer ..... - -
-------- ------
Total equity securities ... 11,009 619
-------- ------
Total temporarily
impaired securities ... $307,913 $2,862
======== ======
The Company has no fixed maturity securities that are non-investment
grade and have unrealized losses at March 31, 2005. The Company does not
invest in non-investment grade securities. Any non-investment grade
securities held by the Company are the result of rating downgrades that
occurred subsequent to their purchase. An exception was made to this policy
in 2004 when the Company sold and then repurchased non-investment grade MCI
debt securities (Moody's bond rating of B) in order to recognize a current
income tax benefit. The MCI debt securities are considered non-investment
grade, but are carried at their fair value of $4,780,000, which exceeded their
book value of $4,480,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Following is a schedule of gross realized losses recognized in 2005 along
with the associated book values and sales prices aged according to the length
of time the underlying securities were in an unrealized loss position. This
schedule does not include realized losses stemming from corporate actions such
as calls, pay-downs, redemptions, etc. The Company's equity portfolio is
managed on a "tax-aware" basis, which generally results in sales of securities
at a loss to offset sales of securities at a gain, thus minimizing the
Company's income tax expense. Fixed maturity securities were not included in
the schedule since no realized losses were recognized on these investments
stemming from disposals other than corporate actions. Fixed maturity
securities are generally held until maturity.
Gross
Book Sales realized
($ in thousands) value price loss
--------- --------- ---------
Equity securities:
Three months or less ............... $ 6,212 $ 5,735 $ 477
Over three months to six months .... 342 283 59
Over six months to nine months ..... - - -
Over nine months to twelve months .. 297 254 43
Over twelve months ................. - - -
--------- --------- ---------
$ 6,851 $ 6,272 $ 579
========= ========= =========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
LEASES, COMMITMENTS AND CONTINGENT LIABILITIES
The increase in the Company's aggregate participation in the pooling
agreement effective January 1, 2005 had a significant affect on its
contractual obligations for expected payments in the settlement of its loss
reserves and its share of real estate operating leases and software operating
leases expensed through the pool. The Company's contractual obligation for
long-term debt did not change from that presented in the Company's 2004 Form
10-K. The following table reflects the Company's contractual obligations as
of March 31, 2005.
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) ............. $520,249 $207,215 $190,255 $64,147 $ 58,632
Long-term debt ............. 36,000 - - - 36,000
Real estate operating leases 9,506 1,063 2,675 2,164 3,604
Software operating leases .. 479 479 - - -
-------- -------- -------- ------- ---------
Total ...................... $566,234 $208,757 $192,930 $66,311 $ 98,236
======== ======== ======== ======= ========
(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.
Estimated guaranty fund assessments of $1,238,000 and $1,207,000, which
are used by states to pay claims of insolvent insurers domiciled in that
state, have been accrued as of March 31, 2005 and December 31, 2004,
respectively. The guaranty fund assessments are expected to be paid over the
next two years with premium tax offsets of $1,629,000 expected to be realized
within ten years of the payments. Estimated second injury fund assessments of
$1,620,000 and $1,390,000, which are designed to encourage employers to employ
a worker with a pre-existing disability, have been accrued as of March 31,
2005 and December 31, 2004, 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
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 $700,000 at December 31, 2004. Due to the change in the Company's
aggregate participation in the pooling agreement, this amount increased to
$894,000 effective January 1, 2005, therefore, the Company has a contingent
liability of $894,000 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.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004)
"Share-Based Payment," which is a revision of SFAS No. 123 "Accounting for
Stock-Based Compensation" and supersedes Accounting Principles Board (APB)
Opinion No. 25 "Accounting for Stock Issued to Employees." SFAS 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the financial statements based on their
grant date fair values. The pro forma disclosures previously allowed under
SFAS 123 will no longer be an alternative to financial statement recognition.
The transition methods for adoption include the modified-prospective and
modified-retroactive methods. The modified-prospective method requires that
compensation expense be recorded for all unvested stock options that exist
upon the adoption of SFAS 123(R). Under the modified-retroactive method,
prior periods may be restated either as of the beginning of the year of
adoption or for all periods presented. The effective date for SFAS 123(R) was
originally the first interim and annual periods beginning after June 15, 2005,
with earlier adoption encouraged. On April 14, 2005, the Securities and
Exchange Commission approved a rule which delayed the required effective date
of SFAS 123(R) until fiscal years beginning after June 15, 2005. The Company
is currently evaluating the requirements of SFAS 123(R), including the
adoption method alternatives, but does not expect adoption of this statement
to have a material effect on the operating results of the Company.
SUBSEQUENT EVENTS
On May 5, 2005 Standard & Poors downgraded the credit rating of General
Motors Corporation to non-investment grade status. The Company has $3,000,000
of General Motors Acceptance Corporation bonds that mature in September 2006
and an additional $3,000,000 of bonds that mature in September 2016.
Management does not believe that any of these securities are other-than-
temporarily impaired at this time, but will continue to monitor this situation
closely.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained in this
report is based on management's current beliefs, assumptions and expectations
of the Company's future performance, taking into account all information
currently available to management. These beliefs, assumptions and expectations
can change as the result of many possible events or factors, not all of which
are known to management. If a change occurs, the Company's business, financial
condition, liquidity, results of operations, plans and objectives may vary
materially from those expressed in the forward-looking statements The risks
and uncertainties that may affect the actual results of the Company include,
but are not limited to, the following: catastrophic events and the occurrence
of significant severe weather conditions; the adequacy of loss and settlement
expense reserves; state and federal legislation and regulations; changes in
our industry, interest rates or the performance of financial markets and the
general economy; rating agency actions and other risks and uncertainties
inherent to the Company's business. When the Company uses the words
"believe", "expect", "anticipate", "estimate" or similar expressions, the
Company intends to identify forward-looking statements. You should not place
undue reliance on these forward-looking statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Unaudited)
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective board of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Two categories of influences on market risk exist as it relates to
financial instruments. First are systematic aspects, which relate to the
investing environment and are out of the control of the investment manager.
Second are non-systematic aspects, which relate to the construction of the
investment portfolio through investment policies and decisions, and are under
the direct control of the investment manager. Due to systematic changes,
several components of market risk increased noticeably during 2002 and 2003,
but appear to have leveled off or declined in 2004 and the first quarter of
2005. As it relates to equity price risk, the poor performance of the markets
during that period resulted in declines in the values of the Company's equity
investments. This risk appears to be declining due to the recovery of the
markets. Credit quality risk rose, resulting in declines in the values of
several bond investments stemming from the many high-profile bankruptcies and
other downgrade activities during that period. This risk also appears to be
subsiding as the general economic condition continues to show signs of
strengthening. Prepayment risk increased, primarily for the mortgage-backed
securities, as declines in interest rates during that period accelerated the
payment of higher-interest rate mortgages through re-financing activity. And
finally, to a lesser extent interest rate risk increased due to interest rates
bottoming-out during that period. Future interest rate increases will result
in declines in the values of fixed maturity securities from their current
values. Throughout all these systematic changes, the Company has continued
its commitment to controlling non-systematic risk through sound investment
policies and diversification.
Further analysis of the components of the Company's market risk
(including interest rate risk, equity price risk, credit quality risk, and
prepayment risk) can be found in the Company's 2004 Form 10-K.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including
the Chief Executive Officer and the Chief Financial Officer, the Company has
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company's
disclosure controls and procedures were functioning effectively as of the end
of the period covered by this report to provide reasonable assurance that the
Company can meet its disclosure obligations. There were no changes in the
Company's internal control over financial reporting that occurred during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth information regarding purchases of equity
securities for the three months ended March 31, 2005:
(a) Total (b) Average (c) Total (d) Maximum Number
Number of Price Paid Number of (or Approximate
Shares Per Share Shares (or Dollar Value) of
(or Units) (or Unit) Units) Shares (or Units)
Purchased Purchased as that May Yet Be
Part of Purchased Under
Publicly The Plans or
Announced Programs
Plans or
Period Programs
- ---------------- ---------- ----------- ------------- -----------------
1/1/05 - 1/31/05 141 (1) $20.97 - -
2/1/05 - 2/28/05 120 (1) 18.07 - -
3/1/05 - 3/31/05 1,632 (1) 19.72 - -
---------- ----------- ------------- -----------------
Total 1,893 $19.71 - -
========== =========== ============= =================
(1) All shares were purchased in the open market under the Company's dividend
reinvestment and common stock purchase plan.
ITEM 6. EXHIBITS
(b) 31.1 Certification of President and Chief Executive Officer as
required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Senior Vice President and Chief Financial
Officer as required by Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of President and Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Senior Vice President and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
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
Senior Vice President and
Chief Financial Officer
Date: May 13, 2005