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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
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: 0-18649
THE NATIONAL SECURITY GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-1020300
- ------------ ------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
661 East Davis Street, Elba, Alabama 36323
------------------------------------- ------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (334) 897-2273
--------------
Not Applicable
(Former name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 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.
Yes (X) No ( )
Number of Shares of Common Stock outstanding as of November 8, 2002: 2,466,600
Exhibit index is located on page 18.
Page 1 of 21 pages
1
THE NATIONAL SECURITY GROUP, INC
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income .................... 3
Consolidated Balance Sheets .......................... 4
Consolidated Statements of Shareholders' Equity ...... 5
Consolidated Statements of Cash Flow ................. 6
Notes to Financial Statements ........................ 7
Accountants' Review Report ........................... 11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................... 12
Item 3. Market Risk Disclosures ............................. 16
Item 4. Controls and Procedures ............................. 17
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................... 18
SIGNATURE 19
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .. 20
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED UNAUDITED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Three Months Nine Months
Ended September 30 Ended September 30
2002 2001 2002 2001
---- ---- ---- ----
Revenues
Net insurance premiums earned ......... $8,281 $6,309 $23,587 $18,613
Net investment income ................. 1,172 1,207 3,384 3,369
Realized investment gains ............. (313) 484 365 1,028
Other income .......................... 282 201 802 1,087
------- ----- ------ -------
Total revenues ...................... 9,422 8,201 28,138 24,097
Benefits and Expenses
Policyholder benefits and settlement expenses 5,421 3,387 16,425 10,924
Policy acquisition costs ............... 1,894 1,708 5,381 4,234
General insurance expneses ............. 1,522 1,418 4,524 4,353
Insurance taxes, licenses and fees...... 362 307 1,074 985
------ ----- ------ ------
Total benefits and expense ......... 9,199 6,820 27,404 20,496
Income Before Income Taxes ............. 223 1,381 734 3,601
Income Taxes (Current and deferred)..... 76 459 181 1,134
------ ----- ------ ------
Income Before Equity in Income of Affiliate 147 922 553 2,467
Equity in Income of Affiliate .......... 27 0 63 0
Net Income ....................... $ 174 $ 922 $ 616 $ 2,467
====== ===== ====== =======
Earnings per share ........... $ .07 $0.37 $ 0.25 $ 1.00
====== ===== ====== =======
Dividends Declared per Share .. $ .20 $0.19 $ 0.60 $ 0.57
====== ===== ====== =======
The Notes to Financial Statements are an integral part of these statements.
3
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
As of As of
September 30, December 31,
2002 2001
---- ----
(Unaudited)
Assets
Investments:
Debt Securities held-to-maturity at.
amortized cost(estimated fair
value: 2002 - $22,451; 2001 -$23,922) ........... $21,483 $23,135
Debt Securities available-for-sale,
at estimated fair value(cost: 2002 - $37,179;
2001 - $34,701) ................................. 39,089 35,145
Equity Securities, at market
(cost: 2002 - $11,526; 2001 - $11,274) ........ 18,510 22,503
Receivable for securities sold ....................... 0 50
Note receivable from affiliate........................ 275 250
Mortgage loans........................................ 336 275
Investment real estate, at cost....................... 1,594 1,563
Policy loans.......................................... 700 726
Investment in affiliate............................... 841 53
------ ------
Total investments................................ 82,828 83,700
------ ------
Cash and cash equivalents............................. 2,517 3,391
Accrued investment income............................. 995 938
Reinsurance recoverable............................... 2,158 3,524
Deferred policy acquisition costs..................... 5,416 4,615
Prepaid reinsurance premiums.......................... 347 291
Other assets.......................................... 4,153 3,025
------ ------
Total assets ...................................... $98,414 $99,484
======= =======
Liabilities
Policy liabilities and accruals-Life Insurance ..... $23,590 $22,734
Policy liabilities and accruals-Property and
Casualty Insurance................................ 12,417 11,890
Unearned premiums................................... 9,832 7,115
Other policyholder funds............................ 1,562 1,503
Notes payable....................................... 3,447 2,108
Current income tax payable.......................... 391 593
Deferred income tax................................. 2,277 3,083
Other liabilities................................... 3,096 5,574
------- ------
Total liabilities................................ $56,612 $54,600
------ ------
Shareholders' Equity
Common stock, $1 par value, 2,466,600 shares
outstanding ...................................... 2,467 2,467
Additional paid in capital........................ 4,951 4,951
Accumulated comprehensive income:
Net unrealized appreciation on investment
securities ..................................... 6,400 8,618
Retained earnings...................................... 27,984 28,848
------ ------
Total shareholders' equity ......................... 41,802 44,884
------ ------
Total liabilities and shareholder's equity ......... $98,414 $99,484
======= =======
Shareholders' Equity per Share ........................ 16.95 18.20
======= =======
The Notes to Financial Statements are an integral part of these statements
4
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except per share amounts)
Accumulated
Other
Retained Comprehensive Common Paid-in Treasury
Total Earnings Income Stock Capital Stock
Balance at December 31, 2000 $ 43,780 $ 35,225 $ 9,779 $ 2,340 $ 17 $ (3,581)
Comprehensive Income
Net Income for 2001 4,130 4,130
Other comprehensive income (net of tax)
Unrealized loss on securities, net of
reclassification adjustment (1,161) (1,161)
--------
Total Comprehensive Income 2,969
--------
Retirement of treasury stock ( 3,297) (284) 3,581
Stock dividend (20%) ( 5,345) 411 4,934
Cash dividends ( 1,865) ( 1,865)
------- ------- ------- ------ ----- ------
Balance at December 31, 2001 $ 44,884 $28,848 $ 8,618 $ 2,467 $4,951 $ 0
Comprehensive Income
Net Income three months ended 9/30/2002 616 616
Other comprehensive income (net of tax)
Unrealized loss on securities, net of
reclassification adjustment (2,218) (2,218)
------
Total Comprehensive Income (1,602)
------
Cash dividends (1,480) ( 1,480)
------- ------- ------- ------ ------ ---------
Balance at September 30, 2002 (Unaudited) $ 41,802 $27,984 $ 6,400 $ 2,467 $4,951 $ 0
======== ======= ======== ======= ===== ========
The Notes to the Financial Statements are an integral part of these statements.
5
THE NATIONAL SECURITY GROUP. INC.
CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months
Ended September 30,
2002 2001
---- ----
Cash Flows from Operating Activities
Income from continuing operations ..................... $ 616 $ 2,467
Adjustments to reconcile income from continuing
operations to net cash provided by (used in)
operating activities:
Accrued investment income............................ (57) (66)
Reinsurance receivables.............................. 1,366 (51)
Deferred Policy acquisition costs.................... (801) (313)
Income Taxes......................................... (1,008) (154)
Depreciation expense................................. (122) (112)
Policy liabilities and claims........................ 4,100 1,770
Other, net........................................... (3,365) (2,155)
------- -------
Net cash provided by operating activities.......... 729 1,386
------- -------
C0ash Flows from Investing Activities
Cost of investments acquired........................ (14,564) (9,488)
Sale and maturity of investments.................... 13,217 10,782
Purchase of property and equipment ................. (174) (149)
------- -------
Net cash (used in) provided by investing activities (1,521) 1,145
------- -------
Cash Flows from Financing Activities
Change in other policyholder funds.................. 59 22
Change in notes payable............................. 1,339 (286)
Dividends paid...................................... (1,480) (1,372)
------- -------
Net cash used in financing activities.............. (82) (1,636)
------- -------
Net change in cash and cash equivalents (874) 895
Cash and cash equivalents, beginning of period .......... 3,391 2,629
------- -------
Cash and cash equivalents, end of period ............... $ 2,517 $ 3,524
======== =========
The Notes to the Financial Statements are an integral part of these statements.
6
THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1-Basis of Presentation
The consolidated unaudited financial statements have been prepared in conformity
with generally accepted accounting principles. The interim financial statements
include all adjustments necessary, in the opinion of management, for fair
statement of financial position, results of operations and cash flows for the
periods reported. These adjustments are all normal recurring adjustments. A
summary of the more significant accounting policies are set forth in the notes
to the audited consolidated financial statements for the year ended December 31,
2001.
The accompanying consolidated unaudited financial statements include the
accounts of The National Security Group, Inc. (the Company) and its wholly owned
subsidiaries: National Security Insurance Company (NSIC), National Security Fire
and Casualty Company (NSFC) and Natsco, Inc. (Natsco). NSFC includes a wholly
owned subsidiary, Omega One Insurance Company (Omega).
The accompanying consolidated unaudited financial statements also include an
investment in affiliate, which consists of a fifty percent interest in The
Mobile Attic, Inc. The Mobile Attic, Inc. is a portable storage leasing company
which began operations in 2001. The Company accounts for this investment using
the equity method.
Note 2-Reinsurance
National Security Fire and Casualty Company ("NSFC"), Omega One Insurance
Company ("OMEGA"), and National Security Insurance Company ("NSIC") wholly owned
subsidiaries of the Company, reinsure certain portions of insurance risk, which
exceed various retention limits. NSFC, OMEGA, and NSIC are liable for these
amounts in the event assuming companies are unable to meet their obligations.
Note 3-Calculation of Earnings per Share
Earnings per share were based on net income divided by the weighted average
common shares outstanding. The weighted average number of shares outstanding for
the period ending September 30, 2002 was 2,466,600 and for the period ending
September 30, 2001 was 2,466,600.
Note 4-Changes in Shareholder's Equity (in thousands)
During the nine months ended September 30, 2002 and 2001, there were no changes
in shareholders' equity except for net income of $616 and $2,467 respectively;
dividends paid of $1,480 and $1,372 respectively; and unrealized investment
(losses), net of applicable taxes, of $(2,218) and $(1,550) respectively.
7
THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 5 - Deferred Taxes
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows: (in thousands)
September 30, January 1,
2002 2002
---- ----
Deferred policy acquisition costs ...................... (1,827) (1,569)
Policy liabilities ..................................... 296 349
Unearned premiums ...................................... 645 464
Claims liabilities ..................................... 355 310
General insurance expenses ............................. 766 757
Alternative minimum tax credit carry forward ........... 45 0
Unrealized gains on securities available-for-sale ...... (2,557) (3,394)
------- -------
Net deferred tax liability ............................. (2,277) (3,083)
======= =======
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities given the provisions of the enacted tax laws.
Note 6-Commitments and Contingencies
Commitments
The Company was obligated under a commitment to extend credit to a 50% owned
subsidiary, The Mobile Attic, Inc. in the form of a $1,000,000 credit line. The
credit line was secured by inventory and matured on September 18, 2002. In
accordance with the credit line agreement, at maturity the Company converted
$725,000 of the credit line to additional paid in capital of The Mobile Attic,
Inc. The remaining $275,000 was converted to a five year term note repayable in
equal quarterly installments with interest accruing at 6.25% per annum.
In April of 2002 the Company agreed to guarantee a $5,000,000 credit line of its
50% owned subsidiary, The Mobile Attic, Inc. The Mobile Attic will use the
proceeds from this borrowing to acquire portable storage units which are leased
to building contractors, retail establishments, and individual consumers through
a network of independently operated dealerships currently located in Alabama and
Florida. With the additional borrowing The Mobile Attic will be able to further
expand operations by granting additional independently operated dealerships
throughout the Southeastern United States.
Under the terms of the guarantee agreement, The Company will receive
compensation from Mobile Attic of 150 basis points on the average outstanding
monthly balance of the credit line. Mobile Attic will pay interest to the lender
quarterly and convert the credit line to a term note at the end of the two year
draw down period.
8
THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Contingencies
The Company and its subsidiaries continue to be named as parties to litigation
related to the conduct of their insurance operations. These suits involve
alleged breaches of contracts, torts, including bad faith and fraud claims based
on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries,
and miscellaneous other causes of action. Most of these lawsuits include claims
for punitive damages in addition to other specified relief.
In two separately filed actions, NSIC is named as a defendant in purported class
actions relating to the past sale of industrial burial insurance. The actions
address whether the premiums charged were "excessive" relative to the benefit
provided and whether the premiums charged were in any manner discriminatory
relative to the race of the person insured.
In addition, several individual actions on behalf of specifically named persons
have been filed with similar allegations. These actions are in the initial
phases and little discovery has been undertaken and no class has been certified.
While the cases entail separate and distinguishable facts, the legal issues are
similar to the issues pending in numerous other actions currently pending
nationwide against numerous insurers. While NSIC did at one time sell industrial
burial insurance, no such plans have been sold for several decades.
The company establishes and maintains reserves on contingent liabilities to the
extent losses are probable and amounts are estimable. In many instances,
however, it is not feasible to predict the ultimate outcome with any degree of
accuracy. While a resolution of these matters may significantly impact
consolidated earnings and the Company's consolidated financial position, it
remains management's opinion, based on information presently available, that the
ultimate resolution of these matters will not have a material impact on the
Company's consolidated financial position. However, it should be noted that
instances of class action lawsuits against insurance companies appear to be
increasing in several states in which insurance subsidiaries of the company
operate.
Note 7-Long-Term Debt
In the first quarter of 2002 the Company refinanced long term debt totaling $2.1
million dollars. In conjunction with the refinancing of existing long term debt
the Company borrowed an additional $1.5 million. The primary use of the proceeds
from the additional borrowing will be to upgrade information systems, the most
significant of which involves the installation of a new policy administration
system in the life insurance subsidiary.
The refinancing and additional borrowing consists of a note payable to a local
bank with a variable interest rate of LIBOR plus 275 basis points (currently
4.15%). The interest rate is adjusted quarterly. Repayment of the note is to be
made in quarterly installments of $112,953.40 with a final payment of
$2,114,610.46 due March 28, 2007.
9
THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 8 - Subsequent Events
Fourth quarter earnings of the Company will be materially impacted as a result
of insured catastrophe losses incurred early in the fourth quarter. On October
3rd and 4th of 2002, Hurricane Lili (Cat #74) hit the coast of Louisiana with
wind speeds of over 100 miles per hour. The Company's property and casualty
subsidiaries, NSFC and Omega, insure property in the state of Louisiana, and
will incur material insured losses due to the impact of the hurricane.
Management's current range of estimates (as of November 11, 2002) is that
insured losses will be between $1,000,000 and $1,500,000 ($650,000 to $1,000,000
net of tax).
In accordance with the Company's catastrophe reinsurance agreement, losses in
excess of $1,000,000 (up to $2,000,000) are reinsured with a 27.5% placement.
The second layer of the Company's reinsurance protection begins at losses in
excess of $2,000,000 are 100% reinsured subject to a 5% retention by the
Company.
10
ACCOUNTANTS REVIEW REPORT
Board of Directors
The National Security Group, Inc.
Elba, Alabama
We have reviewed the accompanying balance sheet of The National Security Group,
Inc. as of September 30, 2002, and the related statements of income and cash
flows for the period then ended in accordance with Statements on Standards for
Accounting and Review Services issued by the American Institute of Certified
Public Accountants. All information included in these financial statements is
the representation of the management of The National Security Group, Inc.
A review consists principally of inquiries of Company personnel and analytical
procedures applied to financial data. It is substantially less in scope than an
audit in accordance with generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements in order for them to be in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Barfield, Murphy, Shank & Smith, P.C.
November 13, 2002
11
Item 2.
MANAGEMENTS' DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion addresses the financial condition of The National
Security Group, Inc. as of September 30, 2002, compared with December 31, 2001
and its results of operations and cash flows for the quarter ending September
30, 2002, compared with the same period last year. The reader is assumed to have
access to the Company's 2001 Annual Report. This discussion should be read in
conjunction with the Annual Report and with consolidated financial statements on
pages 3 through 6 of this form 10-Q.
Information is presented in whole dollars.
CONSOLIDATED RESULTS OF OPERATIONS
Premium revenues:
Premium revenue of the Company is generated by three wholly owned subsidiaries,
National Security Insurance Company (NSIC), National Security Fire & Casualty
Company (NSFC), and Omega One Insurance Company (Omega). NSIC is a life,
accident and health insurance company. NSFC and Omega write property and
casualty lines of insurance, primarily dwelling fire, homeowners, and private
passenger auto.
The following table sets forth premium revenue by major line of business for the
nine months ended September 30, 2002 compared to the same period last year:
Nine months ended Sept 30,
Percent
2002 2001 increase (decrease)
Life, accident and health operations:
Traditional life insurance ............. $ 3,262,870 $ 3,110,451 4.90%
Accident and health insurance .......... 902,971 760,285 18.77%
Other .................................. 1,121 1,313 (14.63%)
------------ ----------- ---------
Total life, accident and health 4,166,962 3,872,049 7.62%
Property and Casualty operations:
Dwelling fire & extended coverage ...... 9,314,193 8,095,982 15.05%
Homeowners (Including mobile homeowners) 4,959,919 2,918,805 69.93%
Ocean marine ........................... 1,108,298 904,533 22.53%
Other liability ........................ 439,847 358,325
22.75%
Private passenger auto liability ....... 2,512,058 1,788,411 40.46%
Commercial auto liability .............. 386,408 751,918 (48.61%)
Auto physical damage ................... 2,137,092 1,157,632 84.61%
Reinsurance premium ceded .............. (1,437,519) (1,231,535) 16.73%
------------ ------------- -------
Total property and casualty ... 19,420,296 14,744,071 31.72%
------------ ------------- -------
Total earned premium revenue ........... $ 23,587,258 $ 18,613,120 26.71%
============ ============ =======
12
Premium revenue in the life insurance subsidiary, NSIC accounts for 18% of total
premium income of the Company. NSIC has two primary methods of distribution of
insurance products, employee agents and independent agents. Employee agents
primarily consist of home service agents that sell policies and collect premium
primarily in the insured's home. Premium production from home service agents is
down 3.4% compared to last year. In an effort to increase production of new
business and penetrate markets in states outside of Alabama, NSIC began
appointing independent agents in 1998. Independent agents now account for over
90% of all new business production in NSIC.
Premium revenue in NSIC consists of traditional life insurance products and
supplemental accident and health products. As set forth in the preceding table,
traditional life insurance premium revenue increased 4.9% in the first nine
months of 2002 compared to the same period last year. Accident and health
insurance premium revenue increased 18.8%. Increased sales of simplified and
guaranteed issue whole life products and lump sum cancer and critical illness
health products through independent agents are the primary factors contributing
to the increase in NSIC premium revenue.
Premium revenue in the property/casualty insurance subsidiaries continued to
grow with an increase of 31.72% in the first nine months of 2002 compared to the
same period last year. Dwelling fire insurance premium, which accounts for
47.96% of total property/casualty premium revenue, increased 15.05%. Homeowners
insurance premium increased 69.93%. Increased marketing efforts, modernization
of product line including increases in policy limits and decreased competition
in several markets are the primary contributing factors to the increase in
dwelling property premium revenue. The remaining primary lines of insurance
contributing to the increased growth in property/casualty premium revenue are
automobile liability and physical damage. In the year 2000 the property/casualty
subsidiaries began a non-standard auto program in Alabama with a monthly premium
payment option. The program was expanded into Mississippi in the fourth quarter
of 2001. This program was acquired through the acquisition on Liberty Southern
Insurance Company of Mobile, Alabama. This non-standard auto program is the
primary contributor to the increase in automobile premium revenue.
Net investment income:
Net investment income increased marginally in the first nine months of 2002
compared to the same period last year. The Company has significantly reduced
holdings of equity securities over the last three years and proceeds from
disposals of equity securities were reinvested in debt securities which
typically produce more current income. However, the potential increase in
investment income has been diminished due to the current record low interest
rate environment.
Realized capital gains and losses:
Realized capital gains are generated primarily by the sale of common stock
investments from the insurance subsidiaries investment portfolio. However, the
Company experienced a decline in realized capital gains in the quarter due to
the write down of a security presumed to be permanently impaired, and the sell
of a bond investment in WorldCom for significantly less than face value.
Realized capital gains were $365,000 for the nine months ended September 30,
2002 compared to $1,028,000 in the same period last year, a decrease of 65%.
Other income:
Other income is down $285,000 for the nine months ended September 30, 2002
compared to the same period last year. Other income was higher in 2001 primarily
due to a subsidiary of the Company, NSFC, recovering $580,000 from a third party
in connection with a previously settled lawsuit. Other income was $282,000 for
the three months ended September 30, 2002 compared to $201,000 for the same
period last year, an increase of 40.3%. Increased billing fees associated with
the monthly billed private passenger auto insurance program is the primary
factor contributing to the increase in other income for the quarter.
13
Policyholder benefits and settlement expenses:
Policyholder benefits and settlement expenses are up significantly for the
quarter and year to date compared to last year. Two primary factors contributed
to the sharp increase in policyholder benefits in the second quarter. In June of
2002 a property/casualty subsidiary, NSFC settled a longstanding lawsuit in
connection with a claim that incurred in 1989. NSFC set up reserves for the
anticipated cost of settling the claim, but the final settlement exceeded
reserves by over $400,000. The second factor contributing to the increase in
policyholder benefits is related to the large increase in premium revenue.
Historically, in the product lines that property/casualty subsidiaries
underwrite, new business has carried a much higher frequency and severity of
claims than business that has been renewed for several years. With earned
premium up nearly 25% for the year to date, the new business has brought a
significant increase in severity of losses, particularly total fire losses to
dwellings. In the first nine months of 2002, NSFC incurred 46 claims in excess
of $25,000 totaling $2,453,000 on policies issued in the last twelve months.
These 46 claims accounted for 18% of total property and casualty settlement
expenses.
In order to bring down loss ratios on dwelling lines of business, NSFC has
implemented more stringent underwriting procedures, terminated independent
agents with poor loss experience, and has temporarily put a moratorium on
appointments of new agents in several states. In addition, the overall market
for dwelling insurance products is hardening, which allows the property/casualty
subsidiaries to more easily implement rate increase in unprofitable programs.
Some of the more significant rate increases being implemented include an overall
13% rate increase in comprehensive mobile homeowners in Alabama, an overall 3.2%
rate increase in NSFC's traditional auto program in Alabama, an overall 9.8%
rate increase in Omega's non-standard monthly bill auto program in Alabama, an
overall 6% to 7% rate increase on homeowners rates in Arkansas and Mississippi,
and an overall 8.7% rate increase in mobile homeowners in Mississippi. These
rate increases took affect during the third quarter of 2002.
Policy acquisition costs:
Policy acquisition costs are up $1,147,000 for the nine months ended September
30, 2002 compared to the same period last year. Policy acquisition cost
primarily consists of salaries and commissions paid to employee and independent
insurance agents and generally rise and fall in relation to premium revenue.
Policy acquisition cost as a percent of earned premium is unchanged at 22.8%
compared to last year.
General insurance expenses:
General insurance expenses are up 4% for the year to date compared to last year.
Even though premium revenue has increased nearly 27% over last year, the Company
has not had to add significant staff or greatly increase general overhead to
achieve the increased level of growth.
Insurance taxes, licenses, and fees:
Insurance taxes, licenses and fees as a percent of earned premium are down
compared to last year. Insurance fees were adversely impacted in 2001 due to the
cost of a routine statutory financial examination conducted by the Alabama
Department of Insurance.
Equity in income of Affiliate:
Equity in the income of a 50% owned affiliate, The Mobile Attic, Inc.,
contributed $63,000 to net income for the nine months ended September 30, 2002.
The Mobile Attic, Inc. began operations in the fourth quarter of 2001. The
Mobile Attic is in the business of leasing portable storage units to
construction companies, retail establishments, and household customers.
14
Summary:
The Company has a year to date net income of $616,000 versus net income of
$2,467,000 in 2001. As discussed in previous sections of this Management
Discussion and Analysis, the insurance subsidiaries have achieved significant
top line growth, with premium revenue increasing 26%. However, an increase in
incurred losses in the property/casualty subsidiaries had an adverse impact on
underwriting results.
Investments:
Invested assets are down $872,000 at September 30, 2002 compared to December 31,
2001. Decrease in market value of equity securities is the primary factor
contributing to the decline in invested assets.
The Company considers any fixed income investment with a Standard & Poor's
rating of BB+ or lower to be below investment grade (Commonly referred to as
"Junk Bonds"). At September 30, 2002 less than 1% of the Company's investment
portfolio was invested in fixed income investments rated below investment grade.
The Company currently has no bonds in the investment portfolio in default.
The Company monitors its level of investments in debt and equity securities held
in issuers of below investment grade debt securities. Management believes the
level of such investments is not significant to the Company's financial
condition.
Income taxes:
The effective tax rate in the first nine months of 2002 was 24.7% compared to
31.5% for the first nine months of 2001. A higher proportionate share of total
income from the Company's life insurance subsidiary, which generally operates in
a more favorable income tax position, is the primary factor contributing to the
decrease in the effective tax rate.
Capital resources:
At September 30, 2002, the Company had aggregate equity capital, unrealized
investment gains (net of income taxes) and retained earnings of $41.8 million,
down $3,082,000 compared to December 31, 2001. The decrease reflects net income
of $616,000, a decrease in accumulated unrealized investment gains of
$2,218,000, and dividends paid of $1,480,000.
The Company has $3.4 million in notes from local banks.
Liquidity:
The liquidity requirements of the Company are primarily met by funds provided
from operations of the life insurance and property/casualty insurance
subsidiaries. Premium and investment income, as well as maturities, calls, and
sales of invested assets, provide the primary sources of cash for both
subsidiaries. Cash is used by subsidiaries for payments of policy benefits, the
acquisition of new business (principally commissions), operating expenses, and
purchases of new investments.
The Company had $2,517,000 in cash and cash equivalents at September 30, 2002.
Net cash provided by operating activities was $729,000 for the current period,
compared to net cash provided of $1,386,000 for the period ended September 30,
2001. Cash used in investing activities was $1,521,000. Cash dividends paid to
stockholders' of $1,480,000 and an increase in notes payable of $1,339,000 were
the primary uses of cash in financing activities.
15
The liquidity requirements of the Company are primarily met by funds provided
from operations of the life insurance and property/casualty subsidiaries. The
Company receives funds from its subsidiaries consisting of dividends, payments
for federal income taxes, and reimbursement of expenses incurred at the
corporate level for the subsidiaries. These funds are used to pay stockholder
dividends, corporate interest, corporate administrative expenses, federal income
taxes, and for funding investments in subsidiaries.
The Company's subsidiaries require cash in order to fund policy acquisition
costs, claims, other policy benefits, interest expense, general expenses, and
dividends to the Company. Premium and investment income, as well as maturities,
calls, and sales of invested assets, provide the primary sources of cash for
both subsidiaries. A significant portion of the Company's investment portfolio
consists of readily marketable securities which can be sold for cash.
The Company's business is concentrated primarily in the Southeastern United
States. Accordingly, unusually severe storms or other disasters in the
Southeastern United States might have a more significant effect on the Company
than on a more geographically diversified insurance company. Unusually severe
storms, other natural disasters and other events could have an adverse impact on
the Company's financial condition and operating results. However, the Company
maintains a catastrophe reinsurance program to limit the effect on such
catastrophic events on the Company's financial condition.
Information about Forward-Looking Statements
Any statement contained in this report which is not a historical fact, or which
might otherwise be considered an opinion or projection concerning the Company or
its business, whether expressed or implied, is meant as and should be considered
a forward-looking statement as that term is defined in the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are based on
assumptions and opinions concerning a variety of known and unknown risks,
including but not limited to changes in market conditions, natural disasters and
other catastrophic events, increased competition, changes in availability and
cost of reinsurance, changes in governmental regulations, technological changes,
political and legal contingencies and general economic conditions, as well as
other risks and uncertainties more completely described in the Company's filings
with the Securities and Exchange Commission. If any of these assumptions or
opinions prove incorrect, any forward-looking statements made on the basis of
such assumptions or opinions may also prove materially incorrect in one or more
respects and may cause future results to differ materially from those
contemplated, projected, estimated or budgeted in such forward-looking
statements.
Item 3. Market Risk Disclosures
The Company's primary objectives in managing its investment portfolio are to
maximize investment income and total investment returns while minimizing overall
credit risk. Investment strategies are developed based on many factors including
changes in interest rates, overall market conditions, underwriting results,
regulatory requirements, and tax position. Investment decisions are made by
management and reviewed and approved by the Board of Directors. Market risk
represents the potential for loss due to adverse changes in fair value of
securities. The three potential risks related to the Company's fixed maturity
portfolio are interest rate risk, prepayment risk, and default risk. The primary
risk related to the Company's equity portfolio is equity price risk. There have
been no material changes to the Company's market risk for the nine months ended
September 30, 2002. For further information reference is made to the Company's
Form 10-K for the year ended December 31, 2001.
16
Item 4. Controls and Procedures
Company management, including the Chief Executive Officer and Chief Financial
Officer, have conducted an evaluation of the effectiveness of disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this quarterly report has been made
known to them in a timely fashion. There have been no significant changes in
internal controls, or in factors that could significantly affect internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.
17
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
11. Computation of Earnings Per Share Filed Herewith, See Note 3 to Consolidated
Financial Statements
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
b. Reports on Form 8-K during the quarter ended September 30, 2002
NONE
18
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed by the undersigned duly
authorized officer, on its behalf and in the capacity indicated.
The National Security Group, Inc.
By /s/ William L. Brunson Jr. By /s/ Brian R. McLeod
-------------------------- -------------------
William L. Brunson, Jr. Brian R. McLeod
President and Chief Executive Officer Treasurer and Chief Financial Officer
Dated: November 11, 2002
19
The National Security Group, Inc.
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, William L. Brunson, Jr. certify that:
1. I have reviewed this quarterly report on Form 10-Q of The National Security
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statement
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14 for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared; b) evaluated the
effectiveness of the registrant's disclosure controls and procedures as of a
date within 90 days prior to the filing date of this quarterly report (the
"Evaluation Date"); and c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weakness in internal controls: and b) any fraud, whether
or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weakness.
Date: November 11, 2002
/s/ William L. Brunson, Jr.
- ---------------------------------
William L. Brunson, Jr.
Chief Executive Officer
20
The National Security Group, Inc.
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Brian R. McLeod certify that:
1. I have reviewed this quarterly report on Form 10-Q of The National Security
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statement
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14 for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared; b) evaluated the
effectiveness of the registrant's disclosure controls and procedures as of a
date within 90 days prior to the filing date of this quarterly report (the
"Evaluation Date"); and c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weakness in internal controls: and b) any fraud, whether
or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weakness.
Date: November 11, 2002
/s/ Brian R McLeod
- ---------------------------------
Brian R. McLeod
Chief Financial Officer
21