Commission File Number: 0-18649
| 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 and Zip code of principal executive offices)
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 August 8, 2004: 2,466,600
Exhibit index is located on 19.
1 of 23 pages
1
THE NATIONAL SECURITY GROUP, INC
INDEX
PART I. FINANCIAL INFORMATION
| Item 1. Financial Statements | Page No. |
Consolidated Statements of Income |
3 |
| Consolidated Balance Sheets | 4 |
| Consolidated Statements of Shareholders' Equity | 5 |
| Consolidated Statements of Cash Flows | 6 |
| Notes to Financial Statements | 7 |
| Accountant's Review Report | 10 |
Item 2. Management's Discussion and Analysis of Financial Condition and | |
| Results of Operations | 11 |
Item 3. Market Risk Disclosures |
17 |
Item 4. Controls and Procedures |
17 |
PART II. FINANCIAL INFORMATION | |
Item 1. Legal Proceedings |
18 |
| Item 2. Changes in Securities and Use of Proceeds | 18 |
| Item 3. Defaults Upon Senior Securities | 18 |
| Item 4. Submission of Matters to a Vote of Security Holders | 18 |
| Item 5. Other Information | 18 |
| Item 6. Exhibits and Reports on Form 8-K | 18 |
SIGNATURE |
19 |
Certifications |
20 |
2
Item 1. Financial
Statements
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED UNAUDITED STATEMENTS OF
INCOME
(In thousands, except per share amounts)
| Three Months Ended September 30 |
Nine Months Ended September 30 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 |
2004 |
2003 | |||||||||||
| Revenues | ||||||||||||||
| Net insurance premiums earned | $ | 11,972 | $ | 12,397 | $ | 39,872 | $ | 34,349 | ||||||
| Net investment income | 1,072 | 1,069 | 3,310 | 3,311 | ||||||||||
| Realized investment gains | 569 | 54 | 1,655 | 715 | ||||||||||
| Revenue from leasing operations | 989 | 465 | 1,892 | 1,030 | ||||||||||
| Other Income | 319 | 341 | 997 | 1,042 | ||||||||||
| Total Revenues | 14,921 | 14,326 | 47,726 | 40,447 | ||||||||||
| Benefits and Expenses | ||||||||||||||
| Policyholder benefits and settlement expenses | 11,924 | 6,960 | 27,533 | 20,543 | ||||||||||
| Policy acquisition costs | 2,510 | 2,896 | 8,309 | 7,382 | ||||||||||
| General insurance expenses | 1,693 | 1,896 | 5,820 | 5,231 | ||||||||||
| Expenses from leasing operations | 1,026 | 403 | 2,168 | 1,044 | ||||||||||
| Insurance taxes, licenses and fees | 545 | 517 | 1,800 | 1,531 | ||||||||||
| Total benefits and expense | 17,698 | 12,672 | 45,630 | 35,731 | ||||||||||
| Income before income taxes | (2,777 | ) | 1,654 | 2,096 | 4,716 | |||||||||
| Income taxes (current and deferred) | (1,132 | ) | 736 | 181 | 1,720 | |||||||||
| Income Before Equity in Income of Affiliate | $ | (1,645 | ) | $ | 918 | $ | 1,915 | $ | 2,996 | |||||
| (Earnings) Loss of Minority Interest | 23 | (6 | ) | (40 | ) | 12 | ||||||||
| Net Income | $ | (1,622 | ) | $ | 912 | $ | 1,875 | $ | 3,008 | |||||
| Earnings per share | $ | (0.66 | ) | $ | 0.37 | $ | 0.76 | $ | 1.22 | |||||
| Dividends Declared per Share | $ | 0.210 | $ | 0.205 | $ | 0.420 | $ | 0.410 | ||||||
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 amount)
| As of September 30, 2004 |
As of December 31, 2003 | |||||||
|---|---|---|---|---|---|---|---|---|
| (Unaudited) | ||||||||
| Assets | ||||||||
Investments: | ||||||||
| Fixed Maturities held-to maturity, at amortized cost | ||||||||
| (estimated fair value: 2004 -$24,068; 2003 - $18,198) | $ | 24,550 | $ | 18,631 | ||||
| Fixed Maturities available-for-sale, at estimated fair value | ||||||||
| (cost: 2004 - $48,635; 2003 - $53,300) | 49,355 | 55,015 | ||||||
| Equity securities available-for-sale at estimated fair value | ||||||||
| (cost: 2004 - $10,071; 2003 - $10,205) | 20,395 | 20,432 | ||||||
| Mortgage loans | 240 | 245 | ||||||
| Investment real estate, at cost | 1,579 | 1,564 | ||||||
| Policy loans | 775 | 730 | ||||||
| Other invested assets | 205 | -- | ||||||
| Short-term investments | -- | 300 | ||||||
| Total investments | 97,099 | 96,917 | ||||||
| Cash and cash equivalents | 2,101 | 1,295 | ||||||
| Accrued investment income | 828 | 930 | ||||||
| Receivable from agents, less allowance for credit losses | 2,377 | 2,602 | ||||||
| Reinsurance recoverable | 9,970 | 1,799 | ||||||
| Deferred policy acquisition costs | 6,223 | 5,817 | ||||||
| Prepaid reinsurance premiums | 514 | 496 | ||||||
| Property and equipment, net | 16,826 | 16,513 | ||||||
| Other assets | 1,010 | 867 | ||||||
| Total assets | 136,948 | 127,236 | ||||||
| Liabilities | ||||||||
| Note Payable | -- | 5,000 | ||||||
| Policy liabilities and accruals-Life Insurance | 24,622 | 24,218 | ||||||
| Policy liabilities and accruals-Property and Casualty Insurance | 23,927 | 11,343 | ||||||
| Unearned premiums | 15,247 | 13,750 | ||||||
| Other policyholder funds | 1,409 | 1,416 | ||||||
| Long-term debt | 15,915 | 10,921 | ||||||
| Current income tax payable | 335 | 1,486 | ||||||
| Deferred income tax | 2,190 | 3,223 | ||||||
| Other liabilities | 7,045 | 9,122 | ||||||
| Total liabilities | 90,690 | 80,479 | ||||||
| Minority Interest in Affiliate | 899 | 885 | ||||||
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 | 7,795 | 8,629 | ||||||
| Retained Earnings | 30,146 | 29,825 | ||||||
| Total shareholders' equity | 45,359 | 45,872 | ||||||
| Total liabilities and shareholder's equity | 136,948 | 127,236 | ||||||
| Shareholders' Equity per Share | 18.39 | 18.60 | ||||||
The Notes to the 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)
| Total |
Retained Earnings |
Accumulated Other Comprehensive Income |
Common Stock |
Paid-in Capital | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance at December 31, 2002 | $ | 42,159 | $ | 27,770 | $ | 6,971 | $ | 2,467 | $ | 4,951 | |||||||
| Comprehensive Income | |||||||||||||||||
| Net Income for 2003 | 4,090 | 4,090 | |||||||||||||||
| Other comprehensive income (net of tax) | |||||||||||||||||
| Unrealized gain on securities, net of | |||||||||||||||||
| reclassification adjustment | 1,658 | 1,658 | |||||||||||||||
| Total Comprehensive Income | 5,748 | ||||||||||||||||
| Cash dividends | (2,035 | ) | (2,035 | ) | |||||||||||||
| Balance at December 31, 2003 | $ | 45,872 | $ | 29,825 | $ | 8,629 | $ | 2,467 | $ | 4,951 | |||||||
| Comprehensive Income | |||||||||||||||||
| Net Income nine months ended 9/30/2004 | 1,875 | 1,875 | |||||||||||||||
| Other comprehensive income (net of tax) | |||||||||||||||||
| Unrealized gain on securities, net of | |||||||||||||||||
| reclassification adjustment | (834 | ) | (834 | ) | |||||||||||||
| Total Comprehensive Income | 1,041 | ||||||||||||||||
| Cash dividends | (1,554 | ) | (1,554 | ) | |||||||||||||
| Balance at September 30, 2004 (Unaudited) | $ | 45,359 | $ | 30,146 | $ | 7,795 | $ | 2,467 | $ | 4,951 | |||||||
5
The Notes to the Financial
Statements are an integral part of these statements.
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
| Nine Months Ended September 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| Cash Flows from Operating Activities | ||||||||
| Income from continuing operations | $ | 1,875 | $ | 3,008 | ||||
| Adjustments to reconcile income from continuing operations to net cash | ||||||||
| provided by operating activities: | ||||||||
| Accrued investment income | 102 | 61 | ||||||
| Reinsurance receivables | (8,171 | ) | (335 | ) | ||||
| Deferred Policy acquisition costs | (406 | ) | (584 | ) | ||||
| Income Taxes | (2,184 | ) | 1,416 | |||||
| Depreciation expense | 599 | 475 | ||||||
| Policy liabilities and claims | 12,988 | 5,759 | ||||||
| Other, net | 252 | (1,179 | ) | |||||
| Net cash provided by operating activities | 5,055 | 8,621 | ||||||
| Cash Flows from Investing Activities | ||||||||
| Cost of investments acquired | (23,906 | ) | (30,321 | ) | ||||
| Sale and maturity of investments | 22,890 | 24,425 | ||||||
| Purchase of property and equipment | (705 | ) | (6,778 | ) | ||||
| Change in Minority Interest | 14 | (12 | ) | |||||
| Net cash used in investing activities | (1,707 | ) | (12,686 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
| Change in other policyholder funds | (7 | ) | 38 | |||||
| Change in notes payable | (6 | ) | 5,992 | |||||
| Dividends paid | (1,554 | ) | (1,517 | ) | ||||
| Change in drafts outstanding | (975 | ) | 1,190 | |||||
| Net cash provided by financing activities | (2,542 | ) | 5,703 | |||||
| Net change in cash and cash equivalents | 806 | 1,638 | ||||||
| Cash and cash equivalents, beginning of period | 1,295 | 2,055 | ||||||
| Cash and cash equivalents, end of period | $ | 2,101 | $ | 3,693 | ||||
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, 2003.
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.
The accompanying consolidated unaudited financial statements also include an investment in affiliate, which consists of a fifty percent interest in The Mobile Attic, Inc and its wholly owned subsidiary established in January of 2004, Mobile Attic Franchising Company (MAFCO). The Mobile Attic, Inc. is a portable storage leasing company that began operations in 2001. MAFCO was established in the first quarter of 2004 to conduct the business of selling Mobile Attic portable storage leasing franchises. Effective in the first quarter of 2004 the Company consolidates the accounts Mobile Attic Inc and subsidiary MAFCO according to guidance in Financial Accounting Standards Board Interpretation 46 as revised December 2003 (FIN 46R).
Changes in financial statement presentation as a result of the adoption of recently issued accounting standards:
As disclosed in the notes to the audited consolidated financial statements for the year ended December 31, 2003, the Company adopted Financial Accounting Standards Board Interpretation 46 as revised December 2003 (FIN 46R), in the first quarter of 2004. As a result of the adoption of FIN 46R, triggered by previously existing and disclosed guarantees of Mobile Attic debt by the Company, the Company consolidated an investment in a subsidiary Mobile Attic, Inc. Further details of the debt guarantees are discussed in Note 6 to these consolidated financial statements.
Mobile Attic was previously reported using the equity method of accounting. For comparative purposes, the Company made adjustments to the December 31, 2003 Balance Sheet shown in this Form 10-Q and the Income Statement for the period ended September 30, 2003. These adjustments increased December 31, 2003 assets by $15,109,000 and liabilities by $13,394,000. The adjustment had no effect on consolidated stockholders equity. Certain accounts in the Income Statement for the period ended September 30, 2004 were adjusted as a result of the consolidation of Mobile Attic, but because the results of Mobile Attic were previously reported under the equity method, the adjustments had no effect on the consolidated results of operations for the period ended September 30, 2004.
Change in financial statement presentation as a result of reclassifying financial statement line items:
In previous financial statements, the Company reported Mobile Attic’s income and expense activities as individual line items on the income statement. The Company has elected to combine rental revenue, franchise fees and container sales under revenue from leasing operations. The changes in individual components of leasing operations are disclosed and discussed in the management discussion and analysis.
7
THE NATIONAL SECURITY
GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
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 ended September 30, 2004 was 2,466,600 and for the period ended September 30, 2003 was 2,466,600.
Note 4-Changes in Shareholder’s Equity (in thousands)
During the nine months ended September 30, 2004 and 2003, there were no changes in shareholders’ equity except for net income of $1,875,000 and $3,008,000 respectively; dividends paid of $1,554,000 and $1,517,000 respectively; and unrealized investment (losses) gains, net of applicable taxes, of $(834,000) and $1,460,000 respectively.
Note 5 — Deferred Taxes
The tax effect of significant
temporary differences representing deferred tax assets and liabilities are as follows:
(in thousands)
| September 30, 2004 |
January 1, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Deferred policy acquisition costs | (2,116 | ) | (1,978 | ) | ||||
| Policy liabilities | 157 | 209 | ||||||
| Unearned premiums | 1,002 | 908 | ||||||
| Claims liabilities | 491 | 279 | ||||||
| General insurance expenses | 1,307 | 1,107 | ||||||
| Mobile Attic | 217 | (135 | ) | |||||
| Unrealized gains on securities available-for-sale | (3,248 | ) | (3,613 | ) | ||||
| Net deferred tax liability | (2,190 | ) | (3,223 | ) | ||||
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-Contingencies
Financial Guarantee
At September 30, 2004, the Company guaranteed 90% of a line of credit in the amount of $13 million of its affiliate, Mobile Attic, Inc. The Company is paid a guaranty fee based on the average balance of the lines of credit. The guarantees expire in June 2007. Credit risk represents the accounting loss that would be recognized at the reporting date if Mobile Attic, Inc. failed to perform completely as contracted. The maximum credit risk of approximately $11.8 million assumes that no amounts could be recovered from other parties. The note is secured by the assets of Mobile Attic, Inc which totaled $15.8 million at September 30, 2004. As a result of the existence of the guarantees, the Company consolidated the accounts of Mobile Attic, Inc. in September 2004 financial statements according to the provisions of FASB Interpretation 46 (revised December 2003) of Accounting Research Bulletin No. 51.
8
THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Note 6-Contingencies Continued)
Litigation
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. No class has been certified in either of the purported class actions although a Motion for Class Certification has been filed in one of the actions. 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.
9
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
and Shareholders of
The National Security Group, Inc.
We have reviewed the accompanying consolidated balance sheet of The National Security Group, Inc. and its subsidiaries as of September 30, 2004, and the related consolidated statements of income for each of the three-month and nine-month periods ended September 30, 2004 and 2003, the consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003, and the consolidated statement of shareholders’ equity for the nine-month period ended September 30, 2004. This interim financial information is the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), 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 consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2003, and the related consolidated statements of income, cash flows and shareholders’ equity for the year then ended (not presented herein), and in our report dated February 26, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2003, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
/S/ Barfield, Murphy, Shank & Smith, P.C.
Birmingham, Alabama
November
12, 2004
10
The following discussion and analysis addresses the financial position, operating results and cash flow during the periods included in the accompanying consolidated financial 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. Please review our disclosure regarding forward-looking statements on page 17 of this report.
The National Security Group Inc. through its insurance subsidiaries provides property, liability, life, accident and supplemental health insurance products in thirteen states. Primary property and casualty insurance subsidiaries are National Security Fire and Casualty Company and Omega One Insurance Company, which provide primarily personal lines dwelling, homeowners, mobile homeowners, and automobile insurance coverage in twelve states, primarily in the Southeastern United States. National Security Insurance Company is a wholly owned subsidiary providing life, accident and supplemental health insurance coverage in five states. Natsco, Inc. is an inactive wholly owned subsidiary formed in 1984. The Company has found its niche focusing on developing new and existing markets and specializing in meeting needs unique to the markets we serve. The Company has one 50% owned subsidiary, The Mobile Attic, Inc. which, like its wholly owned subsidiaries, generates the majority of its income from serving a niche market in the portable storage leasing industry. The Company is listed on the NASDAQ National Market under the symbol: NSEC.
The Company’s revenue consists primarily of premiums earned, policy charges and net investment income. Policyholder benefits and settlement expenses consist mainly of claims paid and claims in process and pending. This includes an estimate of amounts incurred but not yet reported as well as loss adjustment expenses. General insurance expenses consist primarily of compensation expenses and other home office overhead. Operating results are reported through 3 business segments: property and casualty insurance operations, life insurance operations and leasing operations. Property and casualty operations (NSFC and Omega One) accounted for 88.33% of premium revenues. Life insurance operations (NSIC) accounted for 11.67% of premium revenues.
Third quarter operating results were materially impacted by losses sustained in the property and casualty insurance segment from losses incurred from Hurricane Ivan. Further details of losses from Hurricane Ivan are discussed in the Property and Casualty Insurance Operations segment of this Management Discussion and Analysis.
Information is presented in whole dollars.
On September 16, 2004 Hurricane Ivan made landfall on the Alabama Gulf Coast. Widespread damage related to Ivan’s destructive winds occurred in the NSFC subsidiary of the property and casualty segment, primarily in the coverage areas in Alabama, Georgia, and Mississippi. Total estimated insured catastrophe losses and loss adjustment expenses from Hurricane Ivan, before reinsurance recoveries, were $11,983,000. NSFC maintains catastrophe reinsurance protection to mitigate the impact of catastrophic event such as Hurricane Ivan. Under the catastrophe reinsurance protection, other insurers assume portions of NSFC’s risk beyond retention limits defined in the reinsurance contract. Losses from Hurricane Ivan will exceed NSFC retention limits under the reinsurance contract. NSFC has estimated reinsurance recoveries under the catastrophe reinsurance agreement of $7,997,000 associated with Hurricane Ivan losses. Total losses net of reinsurance recoveries are estimated to be $3,986,000 and are reflected at such amount in the Consolidated Statement of Income for the period ending September 30, 2004. In addition to estimated losses from Ivan, NSFC was also obligated to pay reinstatement premiums to insure against a second catastrophic event in the same contract year (2004 calendar year). The cost of reinstatement premiums, triggered by Hurricane Ivan, in the amount of $1,181,000 are reflected in consolidated results of operations as a decrease in net insurance premium earned.
11
The following table sets for the components of property and casualty insurance earned premiums for the nine month periods ended September 30, 2004 and 2003.
| Nine months ended September 30, | Percent | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | increase(decrease) | |||||||||
| Property and Casualty operations: | |||||||||||
| Dwelling fire & extended coverage | 16,987,613 | 14,258,166 | 19 | .14% | |||||||
| Homeowners (Including mobile homeowners) | 14,048,619 | 10,397,181 | 35 | .12% | |||||||
| Ocean marine | 1,644,836 | 1,382,616 | 18 | .97% | |||||||
| Other liability | 473,733 | 598,945 | (20 | .91)% | |||||||
| Private passenger auto liability | 2,829,313 | 2,666,808 | 6 | .09% | |||||||
| Commercial auto liability | 560,475 | 665,393 | (15 | .77)% | |||||||
| Auto physical damage | 2,402,604 | 2,251,257 | 6 | .72% | |||||||
| Reinsurance premium ceded | (3,727,972 | ) | (2,253,074 | ) | 65 | .46% | |||||
| Total earned premium revenue | $ | 35,219,221 | $ | 29,967,292 | 17 | .53% | |||||
Premium revenue from the Company’s property and casualty operations continues to experience growth. Direct earned premium in the core lines of dwelling fire and homeowners are up 19% and 35% respectively in the first nine months of 2004 compared to 2003. These two programs are the primary catalyst of a 17.53% increase in total property and casualty premium revenue for the year to date in 2004 compared to 2003.
Combined income for Property and Casualty operations was $2,117,000 for the period ended September 30, 2004 compared to $2,691,000 the same period last year.
Premium revenue in NSIC consists of traditional life insurance products and supplemental accident and health products. Premium revenue in the life insurance subsidiary accounts for 11.67% of total premium income of the Company. Independent agents account for over 90% of all new business production in NSIC. Employee agents primarily consist of home service agents that sell policies and collect premium primarily in the insured’s home. The following table sets forth life insurance premiums for the nine month periods ended September 30, 2004 and 2003:
| Nine months ended September 30, | Percent | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | increase(decrease) | |||||||||
| Life, accident and health operations: | |||||||||||
| Traditional life insurance | $ | 3,616,950 | $ | 3,362,307 | 7 | .57% | |||||
| Accident and health insurance | 1,035,767 | 1,018,880 | 1 | .66% | |||||||
| Other | -- | 743 | (100 | .00)% | |||||||
| Total life, accident and health earned premium revenue | 4,652,717 | 4,381,930 | 6 | .18% | |||||||
The increase in premium revenue for the period ended September 30, 2004 depicted in the above table is primarily attributed to growth generated by the independent agent method of distribution. Although revenue growth generated through the independent agent distribution channel is beginning to stabilize, profitability is improving with field cost down eight percentage points to 48.68% of premium revenue for the period ended September 30, 2004 compared to 57.01% for the same period last year. Net income for the period ended September 30, 2004 declined to $182,700 compared to $860,000 for the same period last year. Decreases in adjuster fees, realized capital gains and a slight increase in claims compared to the prior year are the primary factors contributing to the decline.
12
The Company holds a 50% interest in The Mobile Attic, Inc. and its wholly owned subsidiary Mobile Attic Franchising Company (MAFCO) which due to the implementation FIN 46 is now consolidated in the Company’s financial statements. The Mobile Attic, Inc., through a network of independent dealers, is in the business of leasing portable storage units to construction companies, retail establishments and household customers. MAFCO, established in the first quarter of 2004, is in the business of establishing Mobile Attic portable storage leasing franchises. Net income from leasing operations was $80,328 for the nine months ended September 30, 2004 after expensing approximately $104,500 in organization costs related to the establishment of MAFCO in the first quarter of 2004. The Mobile Attic, Inc. had a net loss of $23,000 during the same period last year.
Significant components of Mobile Attic revenue are as follows:
| Nine months ended September 30, | Percent | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | increase(decrease) | |||||||||
| Rental Revenue | $ | 1,301,560 | $ | 1,030,067 | 26 | .36% | |||||
| Franchise Fees | 210,000 | -- | 100 | .00% | |||||||
| Container Sales | 380,000 | -- | 100 | .00% | |||||||
| Total | $ | 1,891,560 | $ | 1,030,067 | 83 | .63% | |||||
Rental revenue consists of revenue generated from rental of Company owned portable storage containers rented through a network of independent dealers. Rental revenue is currently highly seasonal with approximately 50% of revenue generated in the last four months of the year. As the business continues to mature management expects rental revenue to become less seasonal.
Franchise fee revenue consists of fees collected from new franchisees upon execution of franchise agreements for establishment of a Mobile Attic portable storage leasing franchise. Franchise fees are earned upon substantial completion of the terms of the franchise agreement, which generally takes a period of four to six months to complete. Under the franchise operating structure, franchisees purchase portable storage containers through Mobile Attic. The franchise structure will allow Mobile Attic to expand growth opportunities while limiting additional capital requirements. Franchise fees for six franchises were earned during the third quarter of 2004.
Mobile Attic will also collect royalty fees from franchisees, which are set as a percentage of base rental rates in the franchise agreement. Because MAFCO has just began to market Mobile Attic franchises in early 2004, royalty fees are currently an immaterial component of segment revenue, but it is anticipated that royalty revenue will compose a significant component of total revenue as franchise operations become more established over the next three to five years. Mobile Attic established four new franchises during the third quarter of 2004.
The Company’s home office is located in Elba, Alabama. The Life insurance subsidiary owns its principal executive offices located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 and consists of approximately 26,000 square feet. The Company believes this space to be adequate for its foreseeable future needs. Also located on premises is a 2,800 square foot conference center. The home office employs approximately 105 employees.
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Investment Philosophy
The Company seeks to invest in securities that will increase earnings through increases in income and/or reductions of tax liabilities. 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, 2004 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.
Investment Activities
The composition of the Company’s investment portfolio is as follows at September 30, 2004 and December 31, 2003:
| Available for Sale | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||||||||
| Market | Book | Market | Book | |||||||||||
| US Govt & Agencies | 24,401,202 | 24,527,575 | 21,733,325 | 21,648,048 | ||||||||||
| Collateralized Mortgage Obligation | 3,038,700 | 3,032,576 | 3,077,906 | 3,118,087 | ||||||||||
| States and political subdivisions | 9,667,392 | 9,365,099 | 9,496,159 | 9,191,860 | ||||||||||
| Public Utility | 1,091,073 | 1,056,663 | 1,116,497 | 1,056,142 | ||||||||||
| Corporate | 11,156,582 | 10,653,172 | 19,590,472 | 18,285,926 | ||||||||||
| Subtotal | 49,354,949 | 48,635,085 | 55,014,359 | 53,300,063 | ||||||||||
Held to Maturity | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||||||||
| Market | Book | Market | Book | |||||||||||
| US Govt & Agencies | 13,952,745 | 14,288,855 | 13,661,769 | 13,996,409 | ||||||||||
| Collateralized Mortgage Obligation | 4,869,829 | 4,983,578 | 4,536,311 | 4,635,065 | ||||||||||
| States and political subdivisions | 2,581,657 | 2,613,777 | -- | -- | ||||||||||
| Public Utility | -- | -- | -- | -- | ||||||||||
| Corporate | 2,663,999 | 2,663,999 | -- | -- | ||||||||||
| Subtotal | 24,068,230 | 24,550,209 | 18,198,080 | 18,631,474 | ||||||||||
Balance Sheet Total | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2004 |
2003 | |||||||
| US Govt &Agencies | 38,690,057 | 35,729,734 | ||||||
| Collateralized Mortgage Obligation | 8,022,278 | 7,712,971 | ||||||
| States and political subdivisions | 12,281,169 | 9,496,159 | ||||||
| Public Utility | 1,091,073 | 1,116,497 | ||||||
| Corporate | 13,820,581 | 19,590,472 | ||||||
| Total | 73,905,158 | 73,645,833 | ||||||
| Equity Securities | 2004 |
2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| Preferred Stock | 1,807,570 | 1,850,350 | ||||||
| Common Stock | 18,587,125 | 18,881,926 | ||||||
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The reinsurance recoverable for the period ended September 30, 2004 was $9,970,000 compared to $1,799,000 at December 31, 2003, an increase of $8,261,000. As discussed on page 12 of this management discussion and analysis, NSFC incurred significant losses from Hurricane Ivan. NSFC maintains catastrophe reinsurance to mitigate the risk of such an event on the financial condition of the Company. The increase in reinsurance recoverable is due to the recording of estimated recoveries from reinsuring companies for claims associated with Hurricane Ivan.
Policyholder benefits and settlement expenses increased $6,990,000 or from 51% of premium revenue to 58% of premium revenue. The most significant factors contributing to the increase in property and casualty policyholder benefits to premium revenue was the increase in paid losses and loss adjustment expenses primarily attributable to Hurricane Ivan. Management has made numerous rate adjustments and improvements in underwriting procedures, which have positively impacted underwriting results for the dwelling lines of business. As previously discussed, $3.9 million in incurred catastrophe losses and loss adjustment expense adversely impacted the nine months ended September 30, 2004. Results for the same period last year were impacted by catastrophe related losses and loss adjustment expenses of $1,028,000.
Policy acquisition costs are up $927,000 compared to last year, an increase of 13%. However, as a percentage of premium earned, policy acquisition costs are virtually unchanged from last year at 21%. Policy acquisition costs consist primarily of insurance sales commissions paid to independent agents and consequently generally tend to rise and fall with the level of premium revenue.
General expenses are up $589,000 for the period ended September 30, 2004 compared to the same period last year, but as a percentage of earned premiums, are unchanged from last year at 13%. General insurance expenses primarily consist of expenses associated with home office operations of the insurance subsidiaries.
Insurance taxes, licenses and fees have increased with premium revenue in 2004, but as a percent of premium revenue are virtually unchanged compared to 2003. Insurance taxes, licenses and fees generally rise and fall consistent with respective increases and decreases in premium revenue.
The Company has a year to date net income of $1,875,000 versus net income of $3,008,000 for the same period last year. The Company has a loss of $1,622,000 for the third quarter of 2004 compared to net income of $912,000 for the same quarter last year. Catastrophe losses resulting from Hurricane Ivan are the primary contributor to this decline in net income for the year to date and loss for the quarter. While it is disappointing that the Company incurred hurricane losses that materially impacted earnings for the quarter and year to date, management remains confident that improvements made in insurance operations not only lessened the impact of Hurricane Ivan, but also will aid in quickly returning the Company to more acceptable levels of profitability.
15
The effective tax rate is down significantly for the year to date due to the significant decline in earnings in the property and casualty insurance subsidiary. Generally the property/casualty subsidiaries pay a higher effective tax rate due to several factors, including, but not limited to, a tax on 20% of unearned premiums, the discounting of loss reserves for federal income tax purposes, and tax on a portion of income from otherwise “tax-free” bonds. A higher percentage of earnings from property/casualty operations compared to life insurance operations generally lead to a higher effective tax rate.
The deferred tax liability decreased significantly the nine months ended September 30, 2004 to $2,190,000 compared to $3,223,000 the December 31, 2003 balance. A decline in the leasing segment’s deferred tax liability due to a decrease in the difference between book and tax depreciation and a decline in accumulated unrealized capital gains are the primary factors leading to the decline in deferred taxes. Deferred taxes are also affected fluctuations in changes in deferred directors’ compensation, deferred acquisition cost, accrued vacation leave, non-deductible litigation accruals, discounted loss reserves, and taxable unearned premiums.
At September 30, 2004, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $45.36 million, down $513 thousand compared to December 31, 2003. The change in equity reflects net income of $1,875,000, a decrease in accumulated unrealized investment gains of $834,000, and dividends paid of $1,554,000.
The Company has $2.8 million in notes from local banks which management intends to repay and/or refinance within the next three years. Management does not anticipate any liquidity issues related to repayment or refinancing of this debt. Remaining debt of $13.1 million is a note of Mobile Attic, Inc. Management believes future cash flows of the portable storage-leasing segment will be adequate to cover future principal and interest payments on this debt.
The Company had $2,101,000 in cash and cash equivalents at September 30, 2004. Net cash provided by operating activities was $5,055,000 for the current period, compared to $7,671,000 for the period ended September 30, 2003. Cash used in investing activities was $1,707,000. Cash dividends paid to stockholders’ of $1,554,000 was the primary change in cash provided by financing activities.
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 a material adverse impact on the Company’s operating results in the period in which such event occurs. However, the Company maintains a catastrophe reinsurance program to limit the effect of such catastrophic natural disasters on the Company’s financial condition.
16
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, 2004. For further information reference is made to the Company’s Form 10-K for the year ended December 31, 2003.
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.
Management is currently performing documentation procedures in preliminary assessment on internal controls over financial reporting in order to document and evaluate the current controls in place in order to form a basis for future testing required for compliance with Section 404 of the Sarbanes-Oxley Act. In the past, management has relied on existing controls although said controls may not have been in unabridged written form.
17
| Item 1. | Legal Proceedings |
| Please refer to Note 6 to the financial statements | |
| Item 2. | Changes in Securities and Use of Proceeds None |
| Item 3. | Defaults Upon Senior Securities None |
| Item 4. | Submission of Matters to a Vote of Security Holders None |
| Item 5. | 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 |
31.1 |
Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the |
| Sarbanes-Oxley Act of 2002 | |
31.2 |
Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the |
| Sarbanes-Oxley Act of 2002 | |
32.1 |
Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the |
| Sarbanes-Oxley Act of 2002 | |
32.2 |
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, 2003 |
| Date of Report |
Date Filed |
Description |
|---|---|---|
| August 13, 2004 | August 16, 2004 | Press release, dated August 13, 2004, issued by The National Security Group, Inc. |
| September 16, 2004 | September 20, 2004 | Press release, dated September 20. 2004, issued by The National Security Group, Inc. |
18
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/ W L Brunson Jr. —————————————— William L. Brunson, Jr. President and Chief Executive Officer |
BY: /S/ Brian R McLeod —————————————— Brian R. McLeod Treasurer and Chief Financial Officer |
Dated: November 12, 2004
19
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 report does not contain any untrue statement of a material fact or omit to state a material 2 fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present 3 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 report; |
| 4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): the periods presented in this report; |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: November 12, 2004
BY: /S/ William L. Brunson Jr. —————————————— William L. Brunson, Jr. Chief Executive Officer |
20
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 report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this 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 report; |
| 4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: November 12, 2004
BY: /S/ Brian R. McLeod —————————————— Brian R. McLeod, CPA Chief Financial Officer |
21
Exhibit 32.1 Certification of Chief Executive Officer
Pursuant to 18 U.S.C. § 1350, the undersigned officer of the National Security Group, Inc. (the “Company”), hereby certifies, to such officer’s knowledge, that the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (the “Report”) fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the Securities Exchange Act of 1934 and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: November 12, 2004
BY: /S/ William L. Brunson Jr. —————————————— Name: William L. Brunson, Jr. Title: Chief Executive Officer |
22
Exhibit 32.2 Certification of Chief Financial Officer
Pursuant to 18 U.S.C. § 1350, the undersigned officer of The National Security Group, Inc. (the “Company”), hereby certifies, to such officer’s knowledge, that the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (the “Report”) fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the Securities Exchange Act of 1934 and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: November 12, 2004
BY: /S/ Brian R. McLeod —————————————— Name: Brian R. McLeod, CPA Title: Chief Financial Officer |
23