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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission File Number 0-18649
The National Security Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 63-1020300 661 East Davis Street, Elba, Alabama 36323
(State or other (IRS Employer (Address of principal (Zip code)
jurisdiction of identification executive offices)
incorporation or number)
organization)
Registrant's telephone number, including area code (334) 897-2273
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock par value $1.00 per share
Title of Each Class
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( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. (X)
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of February 27, 1998 (based upon the bid price of these shares on
NASDAQ on such date) - 15,122,840
Number of Shares of Common Stock outstanding as of February 27, 1998 - 2,312,820
Portions of the Annual Proxy Statement incorporated by reference into Part III.
Total Number of Sequentially Numbered Pages: 45
1
THE NATIONAL SECURITY GROUP, INC.
INDEX TO THE ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
Part I Page
Item 1. Business 3
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 8. Consolidated Financial Statements and Supplementary Data 17
Item 9. Changes in and Disagreements with Accountants and
Financial Disclosure 42
Part III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 43
Item 12. Security Ownership of Certain Beneficial Owners and Management 43
Item 13. Certain Relationships and Related Transactions 43
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports of Form 8-K 44
Signature Page 45
2
PART I
Item 1. Business
Summary Description of The National Security Group, Inc.
The National Security Group, Inc. (the Company), an insurance holding company,
was incorporated in Delaware on March 20, 1990. The Company, through its
property and casualty subsidiaries, writes primarily low value dwelling fire and
windstorm, homeowners, and personal non-standard automobile lines of insurance.
The Company's property and casualty subsidiaries also write commercial lines of
insurance for small businesses. The Company, through its life insurance
subsidiary, offers a basic line of life, and health and accident insurance
products. Property-casualty insurance is the most significant segment,
accounting for 87.2% of total premium revenues.
Industry Segment and Geographical Area Information
Property and Casualty Insurance Segment
The Company's property and casualty insurance business is conducted through
National Security Fire & Casualty Company (Fire Company), a wholly owned
subsidiary of the Company organized in 1959, and Omega One Insurance Company
(Omega), a wholly owned subsidiary of National Security Fire & Casualty Company
organized in 1993. NSFC is licensed to write insurance in eight states, and
operates on a surplus lines basis in four additional states. Omega is licensed
to write insurance in two states. During 1997, over 96% of the property-casualty
subsidiaries' premium revenues were written in the states of Alabama, Arkansas,
Georgia, Louisiana, Mississippi, South Carolina, and Texas.
In general, the property-casualty insurance business involves the transfer by
the insured, to an insurance company of all or a portion of certain risks for
the payment, by the insured, of a premium to the insurance company. A portion of
such risks is often retained by the insured in the form of deductibles which may
vary greatly from policy to policy.
The premiums or payments to be made by the insured for direct products of the
property-casualty subsidiaries are based upon expected cost of providing
benefits, writing, and administering the policies. In determining the premium to
be charged, the property-casualty subsidiaries utilize data from past claims
experience and anticipated claims estimates along with commissions and general
expenses. Historically, there has been more price competition among
property-casualty insurers than other types of insurers.
The operating results of the property-casualty insurance industry are subject to
significant fluctuations from quarter to quarter and from year to year due to
the effect of competition on pricing, the frequency and severity of losses
incurred in connection with weather-related and other catastrophic events,
general economic conditions, and other factors such as changes in tax laws and
the regulatory environment.
The following table sets forth the premiums earned and income during the periods
reported:
Year Ended December 31
(Amounts in Thousands)
1997 1996 1995
Net premiums earned:
Fire, Allied lines, and Homeowners ... $14,647 $13,835 $13,316
Automobile ........................... 11,082 6,181 4,114
Other ................................ 1,436 2,205 2,039
$27,165 $22,221 $19,469
Income before income taxes .................. $ 1,572 $ 1,192 $ 651
3
Life Insurance Segment
The Company's life insurance business is conducted by National Security
Insurance Company (Life Company), a wholly owned subsidiary organized in 1947.
NSIC is licensed to write insurance in five states. The following table
indicates those states which accounted for 5% or more of the total direct
premiums collected by the Life Company in 1997:
Percentage of Total
State Direct Premiums
Alabama 87
Mississippi 7
Georgia 5
The Life Company primarily writes home service life insurance products, which
means its agents collect premiums and sell new products directly at the home or
other premises of the insured. The products primarily consist of term and whole
life insurance and accident and health insurance. The Life Company does not sell
annuities.
Term life insurance policies provide death benefits if the insured's death
occurs during the specific premium paying term of the policy and generally do
not include a savings or investment element in the policy premium. Whole-life
insurance policies demand a higher premium than term life, but provide death
benefits which are payable under effective policies regardless of the time of
the insured's death and have a savings and investment element which may result
in the accumulation of a cash surrender value.
Accident and health business is primarily home service products and accident
policies sold through schools. Accident and health insurance provides coverage
for losses sustained through sickness or accident and includes individual
hospitalization and accident policies, group supplementary health policies and
specialty products, such as cancer policies. These policies generally provide a
stated benefit and have not experienced the escalating health care costs which
many health and accident insurance policies have experienced in recent years.
The following table sets forth certain information respecting the development of
the Life Company's business:
Year Ended December 31
(Amounts in Thousands)
1997 1996 1995
Life insurance in force at end of period:
Ordinary-whole life ............................ $ 70,000 $ 67,000 $ 71,900
term life ............................. 33,900 42,000 40,000
Industrial ..................................... 34,000 36,000 38,000
Other .......................................... 100 100 100
------- ------- -------
138,000 145,100 150,000
======= ======= =======
New life insurance issued:
Ordinary-whole life ............................ $ 39,000 $ 26,000 $ 31,000
term life ............................. 200 12,000 18,000
Industrial ..................................... 0 0 1,000
Other .......................................... 100 100 1,000
------ ------ ------
39,300 38,100 51,000
====== ====== ======
Net premiums earned:
Life insurance ................................. $ 2,979 $ 3,194 $ 3,331
Accident and health insurance .................. 1,012 1,239 1,572
----- ----- -----
3,991 4,433 4,903
===== ===== =====
4
Investments
The insurance subsidiaries are regulated as to the types of investments which
they may make and the amount of funds they may maintain in any one type of
investment. Through its investment policy, the Company seeks to conserve its
capital resources and assets, meet the investment requirements of its reserves
and provide a reasonable return on investments.
The following table sets forth certain information respecting the Company's
investments at the date shown:
Year Ended December 31
1997 1996
Investment Securities held-to-maturity, at amortized cost
(estimated fair value: 1997 - $30,807, 1996 - $36,038) ..... $29,995 $35,413
Investment Securities available-for-sale, at market
(cost: 1997 - $35,257, 1996 - $21,419) ..................... $52,819 32,716
Receivable for securities sold .............................. 400 0
Mortgage loans on real estate, at cost ...................... 320 405
Investment real estate, at cost ............................. 1,645 1,659
Policy loans ................................................ 648 622
Short-term investments ...................................... 3,524 4,575
------ ------
89,351 75,390
====== ======
The results with respect to the foregoing investments are as follows:
Year Ended December 31
1997 1996 1995
Net investment income ................................ $4,204 $3,935 $4,311
Average yield on investments ......................... 5.1% 5.4% 6.0%
Economic yield on investments (includes realized and
unrealized investment gains) .......................... 16.0% 9.7% 13.0%
Net realized gains on investments
(before income taxes).................................. 2,720 1,839 1,650
Changes in net unrealized gains on investments
(before income taxes) ................................. 6,266 1,340 3,356
As of December 31, 1997, the maturity schedule for all bonds and notes held by
the Company, stated at amortized cost, was as follows:
Maturity Schedule (Amounts in thousands)
Available Held to Percentage
Maturity for sale Maturity Total of Total
Maturity in less than 1 year ..$ 0 $ 1,976 $ 1,976 3.9%
Maturity in 1-5 years ......... 5,586 7,718 13,304 26.0
Maturity in 5-10 years ........ 7,668 10,485 18,153 35.5
Maturity after 10 years ....... 7,877 9,816 17,693 34.6
Totals ........................$21,131 $29,995 $51,126 100.0%
5
Certain Information Regarding Insurance Activities
Marketing and Distribution
The Life Company's products are marketed through a field force of agents and
service representatives who are employees of the Life Company. The Life Company
began in 1997 to add independent agents to its method of distribution. This
method of distribution is expected to be more cost effective and will become a
primary method of distribution in the future. The Fire Company's products are
marketed through a network of independent agents and brokers, who are
independent contractors and who generally maintain relationships with one or
more competing insurance companies.
Agents receive compensation for their sales efforts. In the case of life
insurance agents, compensation is paid in the form of sales commissions plus a
servicing commission. Commissions incurred by the Life Company in 1997 averaged
approximately 25.2% of premiums. Commissions incurred by the Fire Company in
1997 averaged approximately 17.8% of premiums and ranged from 12.5% to 22.5%
depending on the type and amount of insurance sold. During 1997, no one
independent agent accounted for more than 10% of total net earned premium of the
property-casualty insurance subsidiaries.
The Life Company began in 1997 the process of implementing changes in collection
of premium payments, and the method of marketing. If the policyholder so elects,
he or she may begin making payments by mail to the home office rather than have
a home service agent come to their house every month and collect premiums. This
change is being implemented in response to the change in lifestyles of our
policyholders. It is increasingly difficult to reach policyholders at home until
early evening, and they are usually to busy to be bothered. Those who elect to
pay by mail will still be provided service by an area representative for help
with claims and policy related questions. With this method of payment there has
been reductions in the number of Life Company agents. Also, because it is
becoming increasingly difficult to employ high quality people to contact our
policy owners at home, Life Company management is beginning to implement changes
in the method of marketing of life insurance products. This new method of
marketing utilizes independent agents to distribute products, and is just in the
preliminary stages of implementation.
Reinsurance
Both insurance subsidiaries customarily reinsure with other insurers certain
portions of the insurance risk. The primary purpose of such reinsurance
arrangements is to enable the Company to limit its risk on individual policies,
and in the case of property insurance, limit its risk in the event of a
catastrophe in various geographic areas. A reinsurance arrangement does not
discharge the issuing company from primary liability to the insured, and the
issuing company is required to discharge its liability to the insured even if
the reinsurer is unable to meet its obligations under the reinsurance
arrangements. Reinsurance, however, does make the reinsurer liable to the
issuing company to the extent of any reinsurance in force at the time of the
loss. Reinsurance arrangements also decrease premiums retained by the issuing
company since that company pays the reinsuring company a portion of total
premiums based upon the amount of liability reinsured.
The Life Company generally reinsures all risks in excess of $50,000 with respect
to any one policy. The Fire Company generally reinsures with third parties any
liability in excess of $100,000 on any one policy. In addition, the Fire Company
has catastrophe excess reinsurance which protects it in part with respect to
aggregate property losses arising out of a single catastrophe, such as a
hurricane. In 1995, 1996, and 1997, the Fire Company had catastrophe protection
up to a $26 million loss. On a $26 million catastrophe loss, the Fire Company
would pay about $7 million and reinsurers would pay $19 million.
In addition to catastrophe reinsurance, the Fire Company also had three quota
share reinsurance agreements as follows:
1. 81% quota share on commercial and other property exposure written by Anchor
General Agency.
2. 90% quota share on casualty exposure written by Anchor General Agency.
3. 50% quota share on ocean marine exposure with additional excess of loss
coverage.
The Anchor programs have been discontinued and had no policies in force at
December 31, 1997.
6
Reserve liabilities
The Life Company maintains reserves for future policy benefits to meet future
obligations under outstanding policies. These reserves are calculated to be
sufficient to meet policy and contract obligations as they arise. Liabilities
for future policy benefits are calculated using assumptions for interest,
mortality, morbidity, expense, and withdrawals determined at the time the
policies were issued. As of December 31, 1997, the total reserves of the Life
Company (including the reserves for accident and health insurance) were
approximately $18.6 million. The Life Company believes that such reserves for
future policy benefits were calculated in accordance with generally accepted
actuarial methods and that such reserves are adequate to provide for future
policy benefits. Wakely & Associates, consulting actuaries, provided actuarial
services in calculating reserves.
The property-casualty subsidiaries are also required to maintain loss reserves
(claim liabilities) for all lines of insurance. Such reserves are intended to
cover the probable ultimate cost of settling all claims, including those
incurred but not yet reported. The reserves of the property-casualty
subsidiaries reflect estimates of the liability with respect to incurred claims
and are determined by evaluating reported claims on an ongoing basis and by
estimating liabilities for incurred but not reported claims. Such reserves
include adjustment expenses to cover the cost of investigating losses and
defending lawsuits. The establishment of accurate reserves is complicated by the
fact that claims in some lines of insurance are settled many years after the
policies have been issued, thus raising the possibility that inflation may have
a significant effect on the amount of ultimate loss payment, especially when
compared to initial loss estimates. The subsidiaries, however, attempt to
restrict their writing to risks that settle within one to four years of issuance
of the policy. As of December 31, 1997, the property-casualty subsidiaries had
reserves for unpaid claims of approximately $22 million before subtracting
unpaid claims which will be due from reinsurers of $7.3 million leaving net
unpaid claims of $14.7 million. The reserves are not discounted for the time
value of money. No changes were made in the assumptions used in estimating the
reserves during the years ending December 31, 1997, 1996 or 1995. The Company
believes such reserves are adequate to provide for settlement of claims. The
Fire Company's loss reserves are calculated by employees of the Company.
Milliman & Robertson, an independent actuarial consulting firm, certified the
reserves.
Underwriting Activities
The insurance subsidiaries maintain underwriting departments which seek to
evaluate the risks associated with the issuance of an insurance policy. The Life
Company accepts standard risks and, to an extent, substandard risks and engages
medical doctors who review certain applications for insurance.
In the case of the property-casualty subsidiaries, the underwriting staff
attempts to assess, in light of the type of insurance sought by an applicant,
the risks associated with a prospective insured or insurance situation.
Depending upon the type of insurance involved, the process by which the risks
are assessed will vary. In the case of automobile liability insurance, the
underwriting staff assesses the risks involved in insuring a particular driver,
and in the case of fire insurance, the underwriting staff assesses the risks
involved in insuring a particular dwelling. Where possible, the underwriting
staff of the property-casualty insurance subsidiary utilizes standard procedures
as guides that quantify the hazards associated with a particular business
activity. In general, the property-casualty subsidiaries specialize in writing
nonstandard risks.
The nonstandard market in which the property-casualty subsidiaries operate
reacts to general economic conditions in much the same way as the standard
market. When insurers' profits and equity are strong, companies generally cut
rates or not seek increases. Also, underwriting rules are less restrictive. As
profit and/or capital fall, companies tighten underwriting rules, and seek rate
increases. Premiums in the nonstandard market are higher than the standard
market because of the increased risk of the insured, which generally comprises
more frequent claims. Drivers of autos who have prior traffic convictions are
one such increased risk which warrants higher premiums. Low valued dwellings and
mobile homes also warrant higher premiums because of the nature of the risk. The
costs of placing such nonstandard policies and making risk determinations are
similar to those of the standard market. The added costs due to more frequent
claims servicing is reflected in the higher premiums which are charged.
7
Regulation
The insurance subsidiaries are each subject to regulation by the insurance
departments of those states in which they are licensed to conduct business.
Although the extent of regulation varies from state to state, the insurance laws
of the various states generally establish supervisory departments having broad
administrative powers with respect to, among other matters, the granting and
revocation of licenses to transact business; the licensing of agents; the
establishment of standards of financial solvency, including reserves to be
maintained, the nature of investments and, in most cases premium rates; the
approval of forms and policies; and the form and content of financial
statements. These regulations have as their primary purpose the protection of
policyholders and do not necessarily confer a benefit upon stockholders.
Many states in which the insurance subsidiaries operate, including Alabama, have
laws which require that insurers become members of guaranty associations. These
associations guarantee that benefits due policyholders of insurance companies
will continue to be provided even if the insurance company which wrote the
business is financially unable to fulfill its obligations. To provide there
benefits, the associations assess the insurance companies licensed in a state
that write the line of insurance for which coverage is guaranteed. The amount of
an insurer's assessment is generally based on the relationship between that
company's premium volume in the state and the premium volume of all companies
writing the particular line of insurance in the state. The Company paid $77,000,
$18,700, and $142,721 in various association assessments in 1997, 1996, and 1995
respectively. These payments are principally related to association costs
incurred due to the insolvency of various insurance companies. Future
assessments depend on the number and magnitude of insurance company insolvencies
and such assessments are therefore difficult to predict.
Most states have enacted legislation or adopted administrative rules and
regulations covering such matters as the acquisition of control of insurance
companies, transactions between insurance companies and the persons controlling
them. The National Association of Insurance Commissioners has recommended model
legislation on these subjects and all states where the Company's subsidiaries
transact business have adopted, with some modifications, that model legislation.
Among the matters regulated by such statutes are the payments of dividends.
These regulations have a direct impact on the Company since its cash flow is
substantially derived from dividends from its subsidiaries. However, the Company
has not had nor does it foresee a problem obtaining the necessary funds to
operate because of the regulation.
Competition
The insurance subsidiaries are engaged in a highly competitive business and
compete with many insurance companies of substantially greater financial
resources, including stock and mutual insurance companies. Mutual insurance
companies return profits, if any, to policyholders rather than stockholders;
therefore, mutual insurance companies may be able to charge lower net premiums
than those charged by stock insurers. Accordingly, stock insurers must attempt
to achieve competitive premium rates through greater volume, efficiency of
operations and control of expenses.
The Life Company primarily markets its life and health insurance products
through the home service system. Direct competition comes from other home
service companies, of which there are many. The Life Company's life and health
products also compete to a lesser extent with products sold by ordinary life
companies. The Life Company writes policies primarily in Alabama. The market
share of the total life and health premiums written is small because of the
number of insurers in this highly competitive field. The primary methods of
competition in the field are service and price. The Life Company attempts to
price its products with other home service companies. Because of the increased
costs associated with a home service company, premium rates are generally higher
than ordinary products, so competition from these ordinary insurers must be met
through service and home collection of premium.
The property-casualty subsidiaries market their products through independent
agents and brokers, concentrating on low value dwellings and nonstandard auto
coverage. The Fire Company, though one of the larger writers of low-value
dwelling fire insurance in Alabama, nevertheless faces a number of competitors
in this niche. Moreover, larger general line insurers also compete with the Fire
Company. The market share in states other than Alabama is small. Price is the
8
primary method of competition. Due to the method of marketing through
independent agents, commission rates and service to the agent are also important
factors in whether the independent agent agrees to offer the Fire Company's
products over its competitors.
Inflation
The Company has not determined the effects of inflation on its operations, but
it shares the same risks from inflation as other companies. Inflation causes
operating expenses to increase and erodes the purchasing power of the Company's
assets. A large portion of the Company's assets are invested in fixed maturity
investments. The purchasing power of these investments will be less at maturity
because of inflation. This is generally offset by the reserves which are a fixed
liability and will be paid with cheaper dollars. Also, inflation tends to
increase investment yields, which may reduce the impact of the increased
operating expenses caused by inflation.
Item 2. Properties
The Company owns no property. 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. The Company's
subsidiaries own certain real estate properties, including approximately 2,700
acres of timberland in Alabama.
Item 3. Legal Proceedings
The Company and its subsidiaries continue to be named as parties to litigation
related to the conduct of their insurance operations. Further information
regarding details of pending suits can be found in note 11 to the consolidated
financial statements.
Item 4. Submission of Matters to a vote of Security Holders
There were no matters submitted to a vote of security holders during the three
months ended December 31, 1997.
9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The capital stock of the Company is traded in the Over-the-Counter (OTC) market.
Quotations are furnished by the National Association of Security Dealers
Automated Quotations System (NASDAQ). The trade symbol is NSEC.
The number of shareholders of the Company's capital stock as of January 31,
1998, was approximately 1,100.
Stock Bid Price Dividends
High Low Per Share
1997
First Quarter .............. $13 3/4 $12 3/4 $ .17
Second Quarter ............. 15 13 1/4 .17
Third Quarter .............. 16 1/2 13 15/16 .17
Fourth Quarter ............. 24 15 1/2 .19
1996
First Quarter .............. $14 $12 $ .16
Second Quarter ............. 14 11 5/8 .16
Third Quarter .............. 14 1/4 12 .16
Fourth Quarter .............. 14 1/4 12 1/2 .17
10
Item 6. Selected Financial Data
(Amounts in thousands, except per share)
Operating results 1997 1996 1995 1994 1993
==== ==== ==== ==== ====
Net premiums earned ....... 31,156 $26,654 $24,372 $26,289 $29,240
Net investment income ..... 4,294 3,935 4,311 4,001 3,894
Net realized investment
gains ................ 2,716 1,839 1,650 1,720 661
Other income .............. 695 582 505 400 602
Total revenues .................$38,775 $33,010 $30,838 $32,410 $34,397
Income before extraordinary
Items .....................$ 2,998 $ 1,356 $ 214 $ 3,674 $ 3,438
Extraordinary gain ............. 0 0 0 0 263
$ 2,998 $ 1,356 $ 214 $ 3,674 $ 3,701
Net income per share before
extraordinary items .......$ 1.28 $ 0.58 $ 0.09 $ 1.57 $ 1.47
Extraordinary gain ............. 0.00 0.00 0.00 0.00 0.11
$ 1.28 $ 0.58 $ 0.09 $ 1.57 $ 1.58
Other Selected Financial Data
Total shareholders' equity .....$ 46,352 $ 40,519 $ 39,774 $ 38,482 $ 39,140
Book value per share ...........$ 20.04 $ 17.43 $ 17.11 $ 16.44 $ 16.73
Dividends per share ............$ 0.70 $ 0.65 $ 0.61 $ 0.57 $ 0.52
Net change in unrealized
capital gains (net of tax) ....$ 4,556 $ 968 $ 2,726 ($ 3,030) $ 850
Total assets ...................$106,958 $ 98,219 $ 97,266 $ 89,986 $ 86,875
11
Item 7.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following analysis of the consolidated results of operations and financial
condition of the Company should be read in conjunction with the Selected
Financial Data and Consolidated Financial Statements and related notes included
elsewhere herein.
Results of Operations
Consolidated Results of Operations: Consolidated net income from The National
Security Group was $2.998 million in 1997, more than double the 1996 results of
$1.356 million. Net income from 1996 was up over $1.1 million from the 1995
total of $215,000. Earnings per share were $1.28 in 1997 compared to $.58 in
1996, and $.09 in 1995. The increase in net income is primarily due to a
reduction in litigation expenses and an increase in realized capital gains from
the sale of common stock investments which have flourished in the current Bull
Market. Consolidated revenues grew 17% to $38.8 million compared to $33.0
million in 1996. Revenues in 1996 increased $2.2 million from $30.8 million in
1995. Revenue increases are primarily due to growth in the property/casualty
subsidiaries private passenger automobile programs in Louisiana and Georgia.
Industry Segment Data
Certain financial information for The National Security Group's three segments
(life and accident and health insurance, property and casualty insurance, and
other) is summarized as follows:
Premium revenues: 1997 % 1996 % 1995 %
Life and accident and health
insurance ......$ 3,991 12.8 $ 4,433 16.6 $ 4,903 20.1
Property and casualty insurance . 27,165 87.2 22,221 83.4 19,469 79.9
------ ----- ------- ----- ------ ----
$ 31,156 100.0 $ 26,654 100.0 $ 24,372 100.0
Income before taxes and cumulative effect adjustment:
1997 % 1996 % 1995 %
Life and accident and
health insurance ..... $ 2,171 64.6 $ 1,141 70.4 $(178) (64.5)
Property and casualty insurance . 1,572 46.8 1,192 73.4 651 235.9
Other ........................... (383) (11.4) (710) (43.8) (197) (71.4)
------ ------ ------ ----- ----- -----
$ 3,360 100.0 $ 1,621 100.0 $ 276 100.0
Life and Accident and Health Insurance Operations: Pretax earnings in 1997 of
$2.2 million were significantly better than 1996 earnings of $1.1 million. There
was a pretax loss in 1995 of $178,000. The primary factor contributing to the
improvement in earnings was a reduction in litigation expenses. In 1997
litigation expenses were only $80,000 compared to $760,000 in 1996. Litigation
expenses in 1995 were $2.3 million. Also contributing to the increase in
earnings was realized capital gains which increased over $400,000 in 1997
compared to 1996.
Premium income, which totaled $4.0 million in 1997, has declined gradually over
the last five years and has decreased by 27% over this period of time. The
reduction in premium income is due to a reduction in the number of sales agents.
The number of sales agents has declined by 69% over the last five years to the
current total of 31. Premium income decreased $400,000 to $4.0 million in 1997
compared to 1996 premium income of $4.4 million. Premium income in 1996 was down
$500,000 from the total in 1995 of $4.9 million. A new agents contract which
became effective January 1, 1998 is expected to improve retention of premiums.
Also, new products and distribution methods will be introduced in 1998 which is
expected to improve prospects for future premium growth.
The decrease in the agency force has reduced sales commissions and general
expenses for field operations which has reduced expenses as a percent of premium
income. Administrative and tax expenses have also decreased from last year.
12
Property & Casualty Operations: Pretax earnings were $1.572 million in 1997, a
32% increase over 1996 pretax earnings of $1.191 million. Pretax earnings in
1996 were up 45% compared to $651,000 in 1995. The low valued dwelling fire and
extended coverage program (LVD) was much improved in 1997. The LVD program
incurred a greater than normal amount of fire and windstorm losses in 1996, and
was hit by Hurricane Opal in 1995 which reduced earnings by $2 million.
Unfortunately the improved results in the LVD program were offset by adverse
loss development in the automobile programs in Georgia and Louisiana. The
property/casualty subsidiary attempted to obtain rate increases in Louisiana due
to the adverse loss development, but the rate filings were denied by the State
Insurance Rating Bureau. Due to the failed attempts to adjust rates, the
Louisiana automobile program will be discontinued in 1998. A rate increase was
granted in the State of Georgia, and more stringent underwriting guidelines have
been implemented so this program will continue, but will be monitored closely
for signs of improvement. The primary reason for the improvement in earnings was
the capital gains realized from the sale of common stock investments.
A measure used to analyze a property/casualty insurer's underwriting performance
is the statutory combined ratio. It is the sum of two ratios:
a. The loss and loss expense ratio, which measures losses and loss
adjustment expenses incurred as a percentage of premiums earned.
b. The underwriting expense ratio, which measures underwriting
expenses incurred (e.g., agents' commissions, premium taxes,
and other administrative underwriting expenses) as a percentage
of premiums written during the year.
The results of these ratios for the past three years were:
1997 1996 1995
---- ---- ----
Loss and LAE Ratio 79.3% 79.8% 82.8%
Underwriting Expense Ratio 31.0% 30.9% 31.4%
----- ------ ------
Combined Ratio 110.3% 110.7% 114.2%
===== ===== ======
The combined ratio for 1997 did not improve compared to 1996 due to increased
losses in the private passenger automobile programs. The low value dwelling
program loss ratio improved greatly in 1997 but was offset by the increase in
automobile losses. The combined ratio for 1996, though improved over 1995 was
still higher than historical averages for the property-casualty subsidiaries.
The primary reason for the high combined ratio was higher than normal incurred
losses in the low value dwelling program in the first quarter of 1996. These
losses were attributable to the colder than normal winter which led to more fire
losses and several tornado producing storms which hit the Southeastern United
States. The combined ratio for 1995 was abnormally high due to losses sustained
in Hurricane Opal.
Maintaining a combined ratio below 100%, which indicates that the company is
making an underwriting profit, depends upon many factors including hurricane
activity in the Gulf of Mexico, strict underwriting of risks, and adequate and
timely premium rates. A major hurricane, such as Opal, hitting the coast of
Alabama, Georgia, South Carolina, Mississippi, Louisiana, or Texas could cause
the combined ratio to fluctuate materially from prior years. The fire & casualty
subsidiary maintains catastrophe reinsurance to minimize the effect of a major
catastrophe.
Premium income increased 22% to $27.165 million verses $22.222 million in 1996
which increased 14% from $19.469 million in 1995. The premium growth came
primarily from automobile programs in Louisiana and Georgia. As mentioned above,
a Louisiana automobile program was discontinued in February 1998 because of
unfavorable underwriting experience and a proposed rate increase being denied.
To help offset this loss of premium, a Florida automobile and a Louisiana mobile
homeowners program began in 1997.
13
Asset Portfolio Review: The life insurance and property/casualty subsidiaries
primarily invest in highly liquid investment grade debt and equity securities.
At December 31, 1997, the company's holdings in debt securities amounted to 57%
of total investments and 48% of total assets. The following is a breakdown of
the bond portfolio quality according to National Association of Insurance
Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the
nationally recognized rating organization equivalents of Moody's and Standard
and Poor's:
SVO Equivalents % of Total
SVO Class Moody's Standard and Poor's Bond Portfolio
- --------- ---------- ------------------- --------------
1 Aaa to A3 AAA to A- 90.4
2 Baa to Baa3 BBB+ to BBB- 7.3
3 Ba1 to Ba3 BB+ to BB- 0.6
4 B1 to B3 B+ to B- 0.9
5 Caa to Ca CCC+ to C 0.8
6 C Ci to D 0.0
As of January 1, 1994, the Company adopted Financial Accounting Standards Board
Statement 115 and reclassified a portion of its fixed maturity securities
portfolio as "available-for-sale," with the remainder being classified as
"held-to-maturity." With that reclassification, the fixed maturity securities
classified as "available-for-sale" are carried at fair value and changes in fair
values, net of related income taxes, are charged or credited to shareholders'
equity (see Note 3 to the consolidated financial statements).
The insurance subsidiaries' fixed maturity securities include mortgage-backed
bonds, primarily collateralized mortgage obligations (CMO's), of $14.1 million
and $11.2 million at December 31, 1997 and 1996 respectively. The
mortgage-backed bonds are subject to risks associated with variable prepayments
of the underlying mortgage loans. Prepayments cause those securities to have
different actual maturities than that expected at the time of purchase.
Securities that are purchased at a premium to par value and prepay faster than
expected will incur a reduction in yield or loss. Securities that are purchased
at a discount to par value and prepay faster than expected will generate an
increase in yield or gain. The degree to which a security is susceptible to
either gains or losses is influenced by the difference between amortized cost
and par value, the relative sensitivity of the underlying mortgages backing the
assets to prepayments in a changing interest rate environment and the repayment
priority of the securities in the overall securitization structure.
The Company limits the extent of its credit risk by purchasing securities that
are backed by stable collateral, the majority of the assets are guaranteed by
U.S. government sponsored entities. Also, the majority of all of the
subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are
typically the lowest risk CMO's, and provide greater cash flow predictability.
Such securities with reduced risk typically have a lower yield, but higher
liquidity, than higher- risk mortgage backed bonds. To reduce the risk of loss
of principal should prepayments exceed expectations, the Company does not
purchase mortgage backed securities at significant premiums over par value.
The Company's investment approach in the equity markets is based primarily on a
fundamental analysis of value. This approach requires the investment committee
to invest in well managed, primarily dividend paying companies, which have a low
debt to capital ratio, above average return on net worth for a sustained period
of time, and low price to book value or low volatility rating (beta) relative to
the market. The dividends provide a steady cash flow to help pay current claim
liabilities, and it has been the Company's experience that by following this
investment strategy, investment results have been superior to those offered by
bonds, while keeping the risk of loss of capital to a minimum.
Liquidity and Capital Resources: Due to regulatory restrictions, the majority of
the Company's cash is required to be invested in investment-grade securities to
provide ample protection for policyholders. The liabilities of the insurance
subsidiaries are of various terms and, therefore, those subsidiaries invest in
securities with various maturities spread over periods usually not exceeding 10
years.
14
The liquidity requirements for the Company are primarily met by funds generated
from operations of the life insurance and property/casualty insurance
subsidiaries. Premium and investment income as well as maturities and sales of
invested assets provide the primary sources of cash for both the life and
property/casualty businesses, while applications of cash are applied by both
businesses to the payment of policy benefits, the cost of acquiring new business
(principally commissions), operating expenses, purchases of new investment, and
in the case of life insurance, policy loans.
The National Security Group's consolidated statement of cash flows indicate that
operating activities provided (used) cash of $7.48 million, $1.45 million,
$(3.6) million in 1997, 1996, and 1995 respectively. Those statements also
classify the other sources and uses of cash by investing activities, and
financing activities and disclose the amount of cash available at the end of the
year to meet the Company's obligations. An increase in profits of $1.6 million,
and a large decrease in reinsurance recoveries of $4 million are the major
causes of a $6 million increase in cash provided from operations in 1997.
The primary reason for the increase in cash provided by operating activities for
1996 was the increased cash flow from the new automobile programs. The primary
reason for the large increase in cash used for operating activities in 1995 was
Hurricane Opal which hit Alabama in early October. The cash provided from the
sale of available-for-sale securities helped offset the increase in cash
required to pay hurricane claims.
The Company has standby letters of credit of less than $25,000. These letters
are used to guarantee obligations of the property/casualty subsidiary under
assumed reinsurance contracts. The letters of credit are secured by certain
invested assets of the Company. The Company also routinely incurs liability for
declared but unpaid dividends. Long term liquidity needs of the Company
constitute only those items which are directly related to the principal business
operations of the Company. The Company has long term debt of $133,000 at
December 31, 1997.
The ability of the Company to meet its commitments for timely payment of claims
and other expenses depends, in addition to current cash flow, on the liquidity
of its investments. On December 31, 1997, the Company had no known impairments
of assets or changes in operation which would have a material adverse effect
upon liquidity. Approximately 81% of the Company's assets are invested in cash,
investment grade fixed income securities, short-term investments and broadly
traded equity securities which are highly liquid. The values of these
investments are subject to the conditions of the markets in which they are
traded. Past fluctuations in these markets have had little effect on the
liquidity of the Company. The Company has relatively little exposure to lower
grade fixed income investments which might be especially subject to liquidity
problems due to thinly traded markets.
Except as discussed in Note 11 to the consolidated financial statements, the
Company is aware of no known trends, events, or uncertainties reasonably likely
to have a material effect in its liquidity, capital resources, or operations.
Additionally, the Company has not been made aware of any recommendations of
regulatory authorities, which if implemented, would have such an effect.
As disclosed in note 8 to the consolidated financial statements, in 1998, the
amount that The National Security Group's insurance subsidiaries can transfer in
the form of dividends to the parent company is limited to $842,000 in the life
insurance subsidiary and $2.7 million in the property/casualty insurance
subsidiary. However, that condition poses no short-term or long-term liquidity
concerns for the parent company.
15
Statutory Risk-Based Capital of Insurance Subsidiaries: The NAIC has adopted
Risk-Based Capital (RBC) requirements for life/health and property/casualty
insurance companies to evaluate the adequacy of statutory capital and surplus in
relation to investment and insurance risks such as asset quality, mortality and
morbidity, asset and liability matching, benefit and loss reserve adequacy, and
other business factors. The RBC formula will be used by state insurance
regulators as an early warning tool to identify, for the purpose of initiating
regulatory action, insurance companies that potentially are inadequately
capitalized. In addition, the formula defines new minimum capital standards that
will supplement the current system of low fixed minimum capital and surplus
requirements on a state-by-state basis. Regulatory compliance is determined by a
ratio of the company's regulatory total adjusted capital, as defined by the
NAIC, to its authorized control level RBC, as defined by the NAIC. Companies
below specific trigger points or ratios are classified within levels, each of
which requires corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (Less Than or Equal to)
Company action level 2
Regulatory action level 1.5
Authorized control level 1
Mandatory control level 0.7
The ratios of Total Adjusted Capital to Authorized Control Level RBC for The
National Security Group's life/health and property/casualty insurance
subsidiaries are all in excess of five to one at December 31, 1997.
National Security Insurance Company (life insurer) has regulatory adjusted
capital of $13.4 million and $10.1 million at December 31, 1997 and 1996,
respectively, and a ratio of regulatory total adjusted capital to authorized
control level RBC of 8.5 and 8.3 at December 31, 1997 and 1996 respectively.
Accordingly, National Security Insurance Company meets the minimum RBC
requirements.
National Security Fire & Casualty Company (property/casualty insurer) has
regulatory adjusted capital of $27.2 million and $24.1 million at December 31,
1997 and 1996, respectively, and a ratio of regulatory total adjusted capital to
authorized control level RBC of 8.4 and 8.3 at December 31, 1997 and 1996
respectively. Accordingly, National Security Fire & Casualty Company meets the
minimum RBC requirements.
Omega One Insurance Company (property/casualty insurer), which began writing
business in late 1995, has regulatory adjusted capital of $4.4 million and $5.2
million at December 31, 1997 and 1996, respectively, and a ratio of regulatory
total adjusted capital to authorized control level RBC of 5.2 and 10.6 at
December 31, 1997 and 1996 respectively.
Accordingly, Omega One Insurance Company meets the minimum RBC requirements.
Year 2000 Issue
The year 2000 issue relates to computer system programs which may not properly
recognize the change in date years from 1999 to 2000. As a result of this time
sensitivity of existing software, any business entity is at risk for possible
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send
billings, or engage in similar normal business activities.
The Company is currently modifying significant portions of its computer programs
so that its computer systems will function properly with respect to the year
2000 date recognition. The Company presently believes that with modifications to
existing software, the year 2000 issue will not pose a significant operational
problem. However, if such modifications are not made, or not completed timely,
the year 2000 issue could have a material impact on the operations of the
Company.
The Company is utilizing internal resources to reprogram and test software for
year 2000 modifications. The Company anticipates completing the year 2000
project no later than June 30, 1999. The total cost of the year 2000 project is
not material to the financial results of the Company.
16
Item 8. Consolidated Financial Statements and Supplementary Data
Index to Financial Statements
Consolidated Financial Statements:
Report of Independent Certified Public Accountants .................... 18
Consolidated Statements of Income -
Years Ended December 31, 1997, 1996, and 1995......................... 19
Consolidated Balance Sheets - December 31, 1997 and 1996................ 20
Consolidated Statements of Shareholders' Equity -
Years Ended December 31, 1997, 1996, and 1995......................... 21
Consolidated Statements of Cash Flows -
Years Ended December 31, 1997, 1996, and 1995......................... 22
Notes to Consolidated Financial Statements - December 31, 1997.......... 23
Financial Statement Schedules:
Report of Independent Certified Public Accountants on
Financial Statement Schedules......................................... 34
Schedule I. Summary of Investments - December 31, 1997 and 1996........ 35
Schedule III. Condensed Financial Information of Registrant -
December 31, 1997 and 1996............................................. 36
Schedule V. Supplementary Insurance Information -
December 31, 1997, 1996, and 1995...................................... 40
Schedule VI. Reinsurance -
Years Ended December 31, 1997, 1996, and 1995........................... 41
All other Schedules are not required under related instructions or are
inapplicable and therefore have been omitted.
17
The National Security Group, Inc.
Report of Independent Certified Public Accountants
To the Board of Directors
and Shareholders of
The National Security Group, Inc.
We have audited the accompanying consolidated balance sheets of The National
Security Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall consolidated financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of The
National Security Group, Inc. and subsidiaries at December 31, 1997 and 1996,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Birmingham, Alabama Dudley, Hopton-Jones, Sims & Freeman PLLP
February 20, 1998
18
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands
except per share amounts)
Years Ended December 31,
1997 1996 1995
REVENUES
Net premiums earned ...................... $ 31,156 $ 26,654 $ 24,372
Net investment income .................... 4,204 3,935 4,311
Net realized investment gains ............ 2,720 1,839 1,650
Other income ............................. 695 582 505
-------- -------- --------
38,775 33,010 30,838
-------- -------- --------
BENEFITS AND EXPENSES
Policyholder benefits paid or provided ... 22,995 19,677 17,721
Amortization of deferred policy
acquisition costs ....................... 1,488 995 1,142
Commissions .............................. 4,334 3,726 3,539
General insurance expenses ............... 5,229 5,515 6,709
Insurance taxes, licenses and fees ....... 1,258 1,367 1,339
Interest expense ......................... 111 109 112
-------- -------- --------
35,415 31,389 30,562
-------- -------- --------
Income Before Income Taxes .... 3,360 1,621 276
-------- -------- --------
INCOME TAX EXPENSE
Current .................................. 848 421 45
Deferred ................................. (486) (156) 17
-------- -------- --------
362 265 62
-------- -------- --------
Net Income ..................... $ 2,998 $ 1,356 $ 214
-------- -------- --------
EARNINGS PER COMMON SHARE
Net Income .................... $ 1.28 $ .58 $ .09
-------- -------- --------
See accompanying notes to consolidated financial statements.
19
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31,
1997 1996
ASSETS ------ ------
Investments
Securities held-to-maturity at amortized cost (estimated fair value: 1997 - $30,807
1996 - $36,038)............................................................................... $ 29,995 $ 35,413
Securities available-for-sale, at estimated fair value (cost: 1997 - $35,257, 1996 - $21,419)... 52,819 32,716
Receivable for securities 400 -
Mortgage loans on real estate, at cost.......................................................... 320 405
Investment real estate, at cost (accumulated depreciation: 1997 - $36, 1996 - $35).............. 1,645 1,659
Policy loans.................................................................................... 648 622
Short-term investments.......................................................................... 3,524 4,575
------ ------
Total Investments 89,351 75,390
Cash............................................................................................... 364 147
Accrued investment income.......................................................................... 833 803
Reinsurance recoverable............................................................................ 8,489 12,488
Deferred policy acquisition costs.................................................................. 4,216 4,013
Prepaid reinsurance premiums....................................................................... 341 1,908
Current income tax recoverable..................................................................... - 258
Other assets....................................................................................... 3,364 3,212
------- --------
Total Assets $ 106,958 $ 98,219
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and claims
Policy liabilities.............................................................................. $ 18,677 $ 18,558
Unearned premiums............................................................................... 8,853 10,398
Claim liabilities............................................................................... 22,246 19,447
------ ------
49,776 48,403
Checks outstanding in excess of bank balance....................................................... 1,190 1,516
Other policyholder funds........................................................................... 1,729 1,842
Accrued income taxes.............................................................................. 147 -
Other liabilities.................................................................................. 3,686 3,087
Deferred income tax................................................................................ 4,078 2,852
------ ------
Total Liabilities 60,606 57,700
------ ------
Contingencies
Preferred stock, $1 par value, 500,000 shares authorized, none issued or outstanding...............
Class A common stock, $1 par value, 2,000,000 shares authorized, none issued or outstanding........
Common stock, $1 par value, 2,500,000 shares authorized and 2,339,848 shares issued................ 2,340 2,340
Additional paid-in capital......................................................................... 17 17
Net unrealized appreciation on securities available-for-sale, net of deferred income taxes......... 12,497 7,941
Retained earnings.................................................................................. 31,888 30,513
Treasury stock, at cost (Shares: 1997 - 27,028, 1996 - 20,085)..................................... (390) (292)
-------- -------
Total Shareholders' Equity 46,352 40,519
-------- -------
Total Liabilities and Shareholders' Equity $ 106,958 $ 98,219
======= =======
See accompanying notes to consolidated financial statements.
-20-
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands)
Net
Unrealized
Appreciation
Additional on Securities Total
Common Paid-in Available- Retained Treasury Shareholders'
Stock Capital for-Sale Earnings Stock Equity
Balance at December 31, 1995..................... 2,340 17 6,973 30,666 ( 222) 39,774
Net income for 1996........................... - - - 1,356 - 1,356
Cash dividends ($.65 per share)............... - - - (1,509) - (1,509)
Net increase in unrealized appreciation of
securities available-for-sale............... - - 968 - - 968
Treasury stock purchased...................... - - - - ( 70) ( 70)
------ ---- ------ ------- ---- -------
Balance at December 31, 1996.....................$ 2,340 $ 17 $ 7,941 $ 30,513 $( 292) $ 40,519
======= ==== ====== ======= ==== =======
Net income for 1997........................... - - - 2,998 - 2,998
Cash dividends ($.70 per share)............... - - - (1,623) - (1,623)
Net increase in unrealized appreciation of
securities available-for-sale............... - - 4,556 - - 4,556
Treasury stock purchased...................... - - - - ( 98) ( 98)
------ ---- ------ ------- ---- -------
Balance at December 31, 1997.....................$ 2,340 $ 17 $12,497 $ 31,888 $( 390) $ 46,352
======= ==== ====== ======= ==== =======
See accompanying notes to consolidated financial statements.
-21-
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year ended December 31,
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net Income ............................................................................... $ 2,998 $ 1,356 $ 214
Adjustments to reconcile net income to net cash provided by operating
activities:
(Increase) decrease in accrued investment income .................................... (30) 77 (34)
(Increase) decrease in reinsurance recoverable ...................................... 3,999 (596) (5,499)
Amortization of deferred policy acquisition costs ................................... 1,488 995 1,142
Net realized gains on investments ................................................... (2,720) (1,839) (1,648)
Policy acquisition costs deferred ................................................... (1,691) (1,608) (1,019)
(Increase) decrease in current income taxes receivable .............................. 258 571 (829)
Decrease (increase) in prepaid reinsurance premiums ................................. 1,567 3,345 (263)
Depreciation and amortization expense ............................................... 118 116 68
Increase in policy liabilities and claims ........................................... 1,373 1,108 4,653
(Increase) decrease in income tax payable ........................................... 147 -- (226)
(Decrease)increase in deferred income taxes ......................................... (484) (156) 17
Increase (decrease) in other liabilities ............................................ 599 (1,952) 420
Other, net .......................................................................... (144) (37) (609)
-------- -------- --------
Net cash provided by (used for) operating activities ....... 7,478 1,454 (3,613)
-------- -------- --------
Cash flows from investing activities:
Purchases of held-to-maturity securities .............................................. -- (2,741) (3,486)
Purchases of available-for-sale securities ............................................ (17,239) (6,370) (1,411)
Purchase of real estate held for investment ........................................... -- (36) (5)
Proceeds from maturities of held-to-maturity securities ............................... 4,859 5,774 2,238
Proceeds from sales of available-for-sale securities .................................. 6,333 4,474 3,623
Proceeds from real estate held for investment ......................................... 13 81 1,666
Proceeds from sales and maturities of short-term investments .......................... 1,051 -- 2,319
Receipts from repayment of loans ...................................................... 59 79 54
Purchase of property and equipment .................................................... (210) (66) (344)
Proceeds from sale of property and equipment .......................................... 33 -- 65
Purchases of short-term investments ................................................... -- (1,959) --
-------- -------- --------
Net cash provided by (used for) investing activities ....... (5,101) (764) 4,719
-------- -------- --------
Cash flows from financing activities:
(Decrease) increase in other policyholder funds ....................................... (113) (85) (230)
Dividends paid ........................................................................ (1,623) (1,509) (1,427)
Purchase of treasury stock ............................................................ (98) (70) (222)
Increase (decrease) in checks outstanding in excess of bank balances .................. (326) 921 595
-------- -------- --------
Net cash used for financing activities ....... (2,160) (743) (1,284)
-------- -------- --------
Net increase (decrease) in cash ....... 217 (53) (178)
Cash at beginning of year ................................................................ 147 201 379
-------- -------- --------
Cash at end of year ...................................................................... $ 364 $ 147 $ 201
======== ======== ========
Cash paid during the year for:
Interest .............................................................................. $ 14 $ 111 $ 119
======== ======== ========
Income taxes .......................................................................... $ 440 $ 531 $ 1,100
======== ======== ========
See accompanying notes to consolidated financial statements.
-22-
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The accompanying consolidated 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). During 1993, NSFC formed a
wholly-owned subsidiary - Omega One Insurance Company (OMEGA). All significant
intercompany transactions and accounts have been eliminated.
Description of Major Products
NSIC is licensed in the states of Alabama, Georgia, Mississippi, Texas and
Florida and was organized in 1947 to provide life and burial insurance policies
to the home service market. Premiums sold and serviced by company agents
primarily include industrial life, larger ordinary life, accident and health,
limited hospital, cancer and low valued life insurance. NSFC operates in various
property and casualty lines, the most significant of which are low valued
dwelling property, home service fire, nonstandard automobile physical damage and
liability, nonstandard commercial, ocean marine and inland marine. Omega
operates in property and casualty lines, the most significant of which is
commercial auto liability.
Basis of Presentation
The significant accounting policies followed by The National Security Group,
Inc. and subsidiaries that materially affect financial reporting are summarized
below. The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) which, as to the
subsidiary insurance companies, differ from statutory accounting practices
permitted by regulatory authorities.
Investments
The Company's securities are classified in two categories and accounted for as
follows:
o Securities Held-to-Maturity. Bonds, notes and redeemable preferred stock for
which the Company has the positive intent and ability to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts which are recognized in interest income using methods which
approximate level yields over the period to maturity.
o Securities Available-for-Sale. Bonds, notes, common stock and non-redeemable
preferred stock not classified as either held-to-maturity, or trading are
reported at fair value, adjusted for other-than-temporary declines in fair
value.
The Company and its subsidiaries have no trading securities.
Unrealized holding gains and losses, net of tax, on securities
available-for-sale are reported as a net amount in a separate component of
shareholders' equity until realized.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific-identification method.
Mortgage loans and policy loans are stated at the unpaid principal balance of
such loans. Investment real estate is reported at cost, less allowances for
depreciation computed on the straight-line basis. Short-term investments are
carried at cost, which approximates market value. Investments with other than
temporary impairment in value are written down to estimated realizable values.
23
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 CONTINUED
Disclosures About Fair Value of Financial Instruments
In 1995, the Company adopted Statement of Financial Accounting Standards No.
107, Disclosures about Fair Value of Financial Instruments (SFAS 107) which
requires companies to disclose fair value information about certain financial
instruments. SFAS No. 107 defines fair value as the quoted market prices for
those instruments that are actively traded in financial markets. In cases where
quoted market prices are not available, fair values are estimated using present
value or other valuation techniques. The fair value estimates are made at a
specific point in time, based on available market information and judgments
about the financial instrument, such as estimates of timing and amount of
expected future cash flows. Such estimates do not reflect any premium or
discount that could result from offering for sale at one time the Company's
entire holdings of a particular financial instrument, nor do they consider the
tax impact of the realization of unrealized gains or losses. In many cases, the
fair value estimates cannot be substantiated by comparison to independent
markets, nor can the disclosed value be realized in immediate settlement of the
instrument.
SFAS No. 107 excludes certain financial instruments, particularly insurance
liabilities other than financial guarantees and investment contracts, from its
disclosure requirements. In evaluating the Company's management of interest rate
and liquidity risk, the fair values of all assets and liabilities should be
taken into consideration.
The fair values of cash, cash equivalents, short-term investments and balances
due on account from agents, reinsurers and other approximate their carrying
amounts as reflected in the consolidated balance sheets due to their short-term
availability or maturity.
The fair values of debt and equity securities have been determined using values
supplied by independent pricing services and are disclosed together with
carrying amounts in Note 3.
The fair value of the mortgage loan portfolio was approximately equal to the
carrying amount of $320,000 on December 31, 1997 and $405,000 on December 31,
1996.
As of December 31, 1997 and 1996, the fair value of policy loans approximated
their carrying amount of $648,000 and $622,000, respectively.
The fair value of other policyholder funds on deposit is estimated to
approximate carrying amount of $1,729,000 on December 31, 1997 and $1,842,000 on
December 31, 1996.
Statement of Cash Flows
For purposes of reporting cash flows, cash includes cash-on-hand and demand
deposits with banks.
Premium Revenues
Life insurance premiums are recognized as revenues when due. Property and
casualty insurance premiums, less amounts ceded to reinsurers, are recognized on
a pro rata basis over the terms of the policies. Reinsurance premiums assumed
are recognized as reported by the ceding company.
Deferred Policy Acquisition Costs
The costs of acquiring new insurance business are deferred and amortized over
the lives of the policies. Deferred costs include commissions, other agency
compensation and expenses, and other underwriting expenses directly related to
the level of new business produced.
Acquisition costs relating to life contracts are amortized over the premium
paying period of the contracts, or the first renewal period of term policies, if
earlier. Assumptions utilized in amortization are consistent with those utilized
in computing policy liabilities.
The method of computing the deferred policy acquisition costs for property and
casualty policies limits the amount deferred to a percentage of related unearned
premiums.
24
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 1 CONTINUED
Policy Liabilities
The liability for future life insurance policy benefits is computed using a net
level premium method including the following assumptions:
Years of Issue Interest Rate
1947 - 1968 4%
1969 - 1978 6% graded to 5%
1979 - 1997 7% graded to 6%
Mortality assumptions include various percentages of the 1955-60 and 1965-70
Select and Ultimate Basic Male Mortality Table. Withdrawal assumptions are based
on the Company's experience.
Claim Liabilities
The liability for unpaid claims represents the estimated liability for claims
reported to the Company and its subsidiaries plus claims incurred but not yet
reported and the related adjustment expenses. The liabilities for claims and
related adjustment expenses are determined using case-basis evaluations and
statistical analyses and represent estimates of the ultimate net cost of all
losses incurred through December 31 of each year. Although considerable
variability is inherent in such estimates, management believes that the
liabilities for unpaid claims and related adjustment expenses are adequate. The
estimates are continually reviewed and adjusted as necessary; such adjustments
are included in current operations.
Earnings Per Share
Earnings per share of common stock is based on the weighted average number of
shares outstanding during each year. The adjusted weighted average shares
outstanding was 2,339,848 in 1997 and 2,339,848 in 1996 and 2,337,090 in 1995.
Reinsurance
In the normal course of business, NSFC seeks to reduce the loss that may arise
from catastrophes or other events that cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurance enterprises or reinsurers. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policy. Amounts paid for prospective reinsurance contracts are
reported as prepaid reinsurance premiums and amortized over the remaining
contract period.
In the normal course of business, NSIC seeks to limit its exposure to loss on
any single insured and to recover a portion of benefits paid by ceding
reinsurance to other insurance enterprises or reinsurers under excess coverage
contracts. NSIC retains a maximum of $30,000 of coverage per individual life.
The cost of reinsurance is amortized over the contract period of the
reinsurance.
Reclassifications
Certain reclassifications have been made in the previously reported financial
statements to make the prior year amounts comparable to those of the current
year. Such reclassifications had no effect on the previously reported net income
or shareholders' equity.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
25
THE NATIONAL SECURITY GROUP, INC.
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - STATUTORY ACCOUNTING PRACTICES:
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles (GAAP) which vary in
certain respects from reporting practices prescribed or permitted by insurance
regulatory authorities. The significant differences for statutory reporting
include: (a) acquisition costs of acquiring new business are charged to
operations as incurred, (b) life policy liabilities are established utilizing
interest and mortality factors specified by regulatory authorities, (c) the
Asset Valuation Reserve (AVR) and the Interest Maintenance Reserve (IMR) are
recorded as liabilities, (d) deferred income taxes are not provided, and (e)
non-admitted assets (furniture and equipment, agents' debit balances and prepaid
expenses) are charged directly to surplus.
Statutory net gains from operations and capital and surplus, excluding
intercompany transactions, are summarized as follows:
(Dollars in thousands)
Year ended December 31,
1997 1996 1995
Net gain from operations:
NSIC - including realized capital gains of $651, $333 and $121,
respectively ................................................................. $ 1,755 $ 802 $ (73)
NSFC - including realized capital gains of $1,988, $1,506 and $1,528,
respectively ................................................................. $ 2,258 $ 613 $ 156
OMEGA ............................................................................ $ (1,529) $ (352) $ 164
Statutory capital and surplus:
NSIC - including AVR of $2,539, $2,141 and $1,772, respectively .................. $ 10,526 $ 10,079 $ 12,083
NSFC ............................................................................. $ 26,359 $ 22,384 $ 22,148
OMEGA ............................................................................ $ 4,367 $ 5,180 $ 5,240
The above amounts exclude allocation of overhead from the Company. NSIC, NSFC
and OMEGA are in compliance with statutory restrictions with regard to minimum
amounts of surplus and capital.
NOTE 3 - INVESTMENT SECURITIES:
The amortized cost and aggregate fair values of investments in securities are as
follows:
(Dollars in thousands)
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale securities:
Corporate debt securities ........................... $ 5,620 $ 140 $ (281) $ 5,479
U.S. treasury securities and obligations of U.S
government corporations and agencies ............ 15,511 115 (2) 15,624
Equity securities ................................... 14,126 17,784 (195) 31,715
------- ------ ----- ------
Total .... $35,257 $18,039 $ (478) $52,818
26
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3 CONTINUED
(Dollars in thousands)
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Held-to-maturity securities:
Corporate debt securities ............................. $11,255 $ 162 $ (20) $11,397
Obligations of states and political subdivisions ...... 8,801 488 0 9,289
U.S. treasury securities and obligations of U.S
government corporations and agencies ................. 9,939 185 (3) 10,121
----- ---- ----- ------
Total ............... $29,995 $ 835 $ (23) $30,807
(Dollars in thousands)
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale securities:
Corporate debt securities ........................... $ 5,412 $ 52 $ (305) $ 5,159
U.S. treasury securities and obligations of U.S
government corporations and agencies ............ 4,333 40 (0) 4,373
Equity securities ................................... 11,674 11,814 (304) 23,184
------- ------- ------- -------
Total .... $21,419 $11,906 $ (609) $32,716
Held-to-maturity securities:
Corporate debt securities ............................. $16,037 $ 236 $ (20) $16,121
Obligations of states and political subdivisions ...... 5,005 496 0 5,500
U.S. treasury securities and obligations of U.S
government corporations and agencies ................. 14,371 70 (3) 14,417
------- ------ ------- -------
Total ............... $35,413 $ 802 $ (23) $36,038
The amortized cost and aggregate fair value of debt securities at December 31,
1997, by contractual maturity, are as follows. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call prepayment penalties.
Amortized Fair
Cost Value
Available-for-sale securities:
Due in one year or less $ 0 $ 0
Due after one year through five years 5,586,418 5,634,726
Due after five years through ten years 7,667,898 7,790,173
Due after ten years 7,876,498 7,679,283
Total $ 21,130,81 $ 21,104,182
Held-to-maturity securities:
Due in one year or less $ 1,976,325 $ 1,989,228
Due after one year through five years 7,717,801 7,987,579
Due after five years through ten year 10,484,881 10,881,124
Due after ten years 9,815,890 9,949,631
Total $ 29,994,897 $ 30,807,562
Proceeds from the maturity or call of held-to-maturity securities during 1997
and 1996 were $5,258,588 and $5,773,992, respectively. Gross gains of $50,619
and $29,565 and gross losses of $531 and $342 for 1997 and 1996, respectively,
were realized on those maturities or calls.
27
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3 CONTINUED
Proceeds from the sale of available-for-sale securities during 1997 were
$6,001,536. Gross gains of $2,392,684 and gross losses of $53,157 for 1997 were
realized on those sales.
NOTE 4 - NET INVESTMENT INCOME:
Major categories of investment income are summarized as follows:
(Dollars in thousands)
Year ended December 31,
1997 1996 1995
Fixed maturities ............................ $ 3,334 $ 3,112 $ 3,336
Equity securities ........................... 654 559 663
Mortgage loans on real estate ............... 29 39 45
Investment real estate ...................... 18 13 17
Policy loans ................................ 37 37 34
Other, principally short-term investments ... 222 230 234
------- ------- -------
4,294 3,990 4,329
Less: Investment expenses .................. (90) (55) (18)
------- ------- -------
Net investment income ....................... $ 4,204 $ 3,935 $ 4,311
An analysis of investment gains follows:
Year ended December 31,
1997 1996 1995
Net realized investment gains:
Fixed maturities ........................... $ 66 $ 12 $ 56
Other, principally equity securities 2,654 1,827 1,594
------- ------- -------
$ 2,720 $ 1,839 $ 1,650
An analysis of the net increase (decrease) in unrealized appreciation on
available-for-sale securities follows:
Year ended December 31,
1997 1996 1995
Net increase (decrease) in unrealized
appreciation on available-for-sale
securities before deferred income tax .... $ 6,266 $ 1,340 $ 3,356
Deferred income tax ......................... (1,711) (372) (630)
------- ------- -------
Net increase (decrease) in unrealized
appreciation on available-for-sale
securities ............................... $ 4,555 $ 968 $ 2,726
------- ------- -------
Investment real estate with a carrying value of approximately $2,000,000
produced insignificant income during the year ended December 31, 1995. This
property was sold during the year ended December 31, 1995.
28
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 5 - INCOME TAXES: Total income tax expense varies from amounts computed by
applying current federal income tax rates to income before income taxes. The
reasons for these differences and the approximate tax effects are as follows:
Year ended December 31,
1997 1996 1995
Federal income tax rate applied to
pre-tax income .......................... $ 1,142 $ 551 $ 94
Dividends received deduction and
tax-exempt interest ..................... (239) (256) (261)
Other, net ................................. (134) (30) 229
Small life insurance company deduction ..... (407) -- --
------- ------- -------
Federal income tax expense ................. $ 362 $ 265 $ 62
------- ------- -------
Net deferred tax liabilities 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.
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
(Dollars in Thousands)
December 31, December 31
1997 1996
----- ------
Deferred policy acquisition costs .................... $(1,434) $(1,364)
Policy liabilities ................................... 519 516
Unearned premiums .................................... 442 440
Claim liabilities .................................... 530 329
General insurance expenses ........................... 931 582
Unrealized gains on securities available-for-sale .... (5,066) (3,355)
------- -------
Net deferred tax liabilities ......................... $(4,078) $(2,852)
------- -------
The approximate income tax effects of changes in temporary differences are as
follows:
Year ended December 31,
1997 1996 1995
Deferred policy acquisition costs .......... $ 70 $ 226 $ (59)
Policy liabilities ......................... (3) (17) (76)
Unearned premiums .......................... (2) (87) (21)
General insurance expenses ................. (349) (268) (3)
Claim liabilities .......................... (201) (38) --
Other ...................................... -- 28 176
----- ----- -----
$(485) $(156) $ 17
----- ----- -----
Under pre-1984 life insurance company tax laws, a portion of NSIC's gain from
operations was not subject to current income taxation, but was accumulated for
tax purposes in a memorandum account designated "policyholders' surplus". The
aggregate balance in this account, $3,720,000 at December 31, 1997, would be
taxed at current rates only if distributed to shareholders or if the account
exceeded a prescribed minimum. The Deficit Reduction Act of 1984 eliminated
additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have
not been provided on amounts designated as policyholders' surplus. The deferred
tax liability not recognized is approximately $1,270,000 at December 31, 1997.
29
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 6 - REINSURANCE:
NSFC is involved as a reinsurer in which it assumes some of the risk originally
undertaken by another insurance company. Conversely, NSFC and NSIC also are
involved in transactions in which another insurance company assumes some of the
risk originally undertaken by NSFC and NSIC. Reinsurance contracts do not
relieve NSIC and NSFC from their obligations to policyholders. Failure of
reinsurers to honor their obligations could result in losses to NSIC and NSFC.
NSIC and NSFC evaluate the financial condition of their reinsurers and monitor
concentrations of credit risk arising from similar geographic regions,
activities, or economic characteristics of the reinsurers to minimize their
exposure to significant losses from reinsurance insolvences. At December 31,
1997, reinsurance receivables with a carrying value of $406,000 and prepaid
reinsurance premiums of $341,000 were associated with a single reinsurer.
The effect of reinsurance on premiums written and earned is as follows:
(Dollars in Thousands)
1997
----------------------------------
NSIC NSFC
---------------- ----------------
Written Earned Written Earned
------- ------ ------- --------
Direct ......... $ 4,118 $ 4,039 $ 29,270 $ 30,815
Assumed ........ -- -- -- --
Ceded .......... (48) (48) (2,086) (520)
-------- -------- -------- --------
Net ............ $ 4,070 $ 3,991 $ 27,185 $ 30,295
-------- -------- -------- --------
(Dollars in Thousands)
1996
----------------------------------
NSIC NSFC
---------------- ----------------
Written Earned Written Earned
------- ------ ------- --------
Direct ......... $ 4,451 $ 4,483 $ 31,920 $ 27,299
Assumed ........ -- -- 1 --
Ceded .......... (51) (51) (8,422) (5,077)
-------- -------- -------- --------
Net ............ $ 4,400 $ 4,432 $ 23,499 $ 22,222
-------- -------- -------- --------
NSFC also reinsures certain portions of insurance risk which exceed various
retention limits. Claim liabilities for NSFC are stated after a deduction for
reinsurance ceded to other companies totaling $7,146,000 at December 31, 1997.
Reinsurance recoveries for claims and claim settlement expense were $1,343,000
during 1997.
NOTE 7 - EMPLOYEE BENEFIT PLAN:
In 1989, the Company and its subsidiaries established a retirement savings plan
and transferred the assets from the defined contribution profit sharing plan
into the new plan. All full-time employees who have completed one year of
service at January 1 or July 1 are eligible to participate and all employee
contributions are fully vested for employees who have completed 1,000 hours of
service in the year of contribution. Contributions for 1997, 1996 and 1995
amounted to $170,000, $90,708 and $-0-, respectively. Contributions are at the
Board of Directors' discretion subject to governmental limitations.
In 1987, the Company established a deferred compensation plan for its Board of
Directors. The Board members have an option of deferring their fees to a cash
account or to a stock account and all share deferrals are recorded at the fair
market value on the date of the award. Costs of the deferred compensation plan
for 1997, 1996 and 1995 amounted to approximately $228,525, $61,813 and $13,000,
respectively.
30
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 8 - REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS:
The amount of dividends paid from NSIC to the Company in any year may not
exceed, without prior approval of regulatory authorities, the greater of 10% of
statutory surplus as of the end of the preceding year, or the statutory net gain
from operations for the preceding year. At December 31, 1997, NSIC's retained
earnings unrestricted for the payment of dividends in 1998 amounted to $842,377.
NSFC is similarly restricted in the amount of dividends payable to the Company;
dividends may not exceed the greater of 10% of statutory surplus as of the end
of the preceding year, or net income for the preceding year. As a result,
dividends from NSFC to the Company are limited to $2,722,430 in 1998.
Securities with market values of $3,306,062 and $3,314,044, at December 31, 1997
and 1996, respectively, were deposited with various states pursuant to statutory
requirements.
Under applicable Alabama insurance laws and regulations, NSFC is required to
maintain a minimum total surplus (to include both paid-in and contributed and
unassigned surplus) of $100,000.
Under applicable Alabama insurance laws and regulations, NSIC is required to
maintain a minimum total surplus (to include both paid-in and contributed and
unassigned surplus) of $200,000.
NOTE 9 - SHAREHOLDERS' EQUITY:
Preferred Stock
The Preferred Stock may be issued in one or more series as shall from time to
time be determined and authorized by the Board of Directors. The directors may
make specific provisions regarding (a) the voting rights, if any (b) whether
such dividends are to be cumulative or noncumulative (c) the redemption
provisions, if any (d) participating rights, if any (e) any sinking fund or
other retirement provisions (f) dividend rates (g) the number of shares of such
series and (h) liquidation preference.
Common Stock
The holders of the Class A Common Stock will have one-twentieth of one vote per
share, and the holders of the common stock will have one vote per share.
In the event of any liquidation, dissolution or distribution of the assets of
the Company remaining after the payments to the holders of the Preferred Stock
of the full preferential amounts to which they may be entitled as provided in
the resolution or resolutions creating any series thereof, the remaining assets
of the Company shall be divided and distributed among the holders of both
classes of common stock, except as may otherwise be provided in any such
resolution or resolutions.
NOTE 10 - INDUSTRY SEGMENTS:
The Company and its subsidiaries operate primarily in the insurance industry.
Premium revenues and operating income by industry segment for the years ended
December 31, 1997, 1996 and 1995 are summarized below:
(Dollars in thousands)
Year ended December 31,
1997 1996 1995
Premium revenues:
Individual life and accident and health
insurance ................................ $ 3,991 $ 4,432 $ 4,903
Property and casualty insurance ............ 27,165 22,222 19,469
------- ------- -------
$31,156 $26,654 $24,372
------- ------- -------
Income (loss) before income taxes and cumulative effect adjustment:
Individual life and accident and health
insurance ................................ $ 2,171 $ 1,140 $ (178)
Property and casualty insurance ............ 1,572 1,191 651
Other ...................................... (272) (601) (85)
------- ------- -------
3,471 1,730 388
Interest expense ..................... (111) (109) (112)
------- ------- -------
$ 3,360 $ 1,621 $ 276
------- ------- -------
31
(Dollars in thousands)
Year ended December 31,
1997 1996 1995
Assets:
Individual life and accident and health
insurance ................................ $ 39,569 $ 35,590 $ 35,870
Property and casualty insurance ............ 67,286 62,538 61,192
Other ...................................... 103 91 204
------- ------- -------
$106,958 $ 98,219 $ 97,266
------- ------- -------
Amortization of deferred policy acquisition costs and depreciation expense:
Individual life and accident and health
insurance ................................ $ 319 $ 232 $ 271
Property and casualty insurance ............ 1,339 879 939
------- ------- -------
$ 1,658 $ 1,111 $ 1,210
------- ------- -------
Capital expenditures are not material, and consequently, are not reported.
NOTE 11 - 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. The frequency of
these lawsuits has increased significantly in recent years, particularly in
Alabama where the Company conducts the majority of its business. Certain of
these actions are filed in jurisdictions in Alabama where local juries have
returned large punitive damage verdicts against insurance companies and
financial institutions with, in many cases, the punitive damage award bearing
little or no relation to the actual damages. It is not feasible to predict or
determine the ultimate outcome of these matters.
On October 4, 1996, a jury in the Circuit Court of Palm Beach County, Florida
returned a verdict against National Security Fire & Casualty Company, a
subsidiary of the Company, in the amount of $995,252. The plaintiff, Leon B.
King, had alleged that the Company's subsidiary had acted in bad faith in, among
other actions, failing to timely deliver a settlement check in connection with a
1986 automobile accident. This same case was previously tried in 1993 with the
jury returning a verdict in favor of the Company's subsidiary on all counts
alleged. This verdict was subsequently reversed on appeal which resulted in the
subject trial. Various post-trial motions including a motion for a new trial
were denied and this verdict is being appealed. The amount of this verdict is
reflected in the accompanying financial statements. It should be noted, however,
that in the event that this verdict is ultimately upheld, there could be an
award of additional amounts including interest and attorneys' fees.
A resolution of these matters may significantly impact consolidated earnings and
may significantly impact the Company's consolidated financial position, although
it remains management's opinion, based upon information presently available,
that the ultimate resolution of these matters will not have a material impact on
the Company's consolidated financial position. It should be noted, however, that
management is unable to assess with any degree of accuracy the potential
liability to the Company arising from these matters. The civil tort system,
particularly in Alabama, must be presently regarded as, for the most part,
hostile to insurance companies.
32
THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 12 - CONCENTRATION OF CREDIT RISK:
The Company maintains its cash accounts primarily with banks located in Alabama.
The total cash balances are insured by the FDIC up to $100,000 per bank. A
summary of the total insured and uninsured amounts held by all banks at December
31, 1997 follows:
(Dollars in thousands)
Cash and cash equivalents per balance sheet $ 364
Checks outstanding in excess of bank balance per balance sheet ( 1,190)
--------
Cash on hand ( 826)
Deposit in transit ( 771)
Outstanding checks 2,666
--------
Total cash held at banks 1,069
Portion secured by FDIC ( 613)
--------
Uninsured cash balances $ 456
--------
33
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Board of Directors
and Shareholders of
The National Security Group, Inc.
We have audited in accordance with generally accepted auditing standards, the
financial statements of The National Security Group, Inc. as of December 31,
1997 and 1996 and for the years then ended included in this Form 10-K, and have
issued our report thereon dated February 20, 1998. Our audits were made for the
purpose of forming an opinion on those statements taken as a whole. The
schedules listed in the accompanying index are the responsibility of the
Company's management and are presented for purposes of complying with the
Securities and Exchange Commission's rules and are not part of the basic
financial statements. These schedules as of December 31, 1997 and 1996 and for
the years then ended have been subjected to the auditing procedures applied in
the audits of the basic financial statements and, in our opinion, fairly state
in all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Birmingham, Alabama
February 20, 1998 Dudley, Hopton-Jones, Sims & Freeman PLLP
34
THE NATIONAL SECURITY GROUP, INC.
SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED)
(AMOUNTS IN THOUSANDS)
December 31, 1997 December 31, 1996
--------------------------------------- --------------------------------
Amount per Amount per
Original Market the Balance Original Market the Balance
Cost Value Sheet Cost Value Sheet
------------- ------------ ------------ ---------- -------- -----------
Securities Held to Maturity:
United States government ........................ 10,388 10,416 10,386 14,413 14,417 14,373
States, municipalities and
political subdivisions .......... 4,527 5,081 4,592 4,947 5,500 5,005
Public Utilities ................................ 3,527 3,592 3,596 3,511 3,550 3,559
Industrial and Miscellaneous .................... 11,341 11,719 11,421 12,382 12,571 12,476
------ ------ ------ ------ ------ ------
Total Securities Held to Maturity ............... 29,783 30,808 29,995 35,253 36,038 35,413
------ ------ ------ ------ ------ ------
Securities Available for Sale:
Equity Securities:
Public utilities ................................ 2,857 4,788 4,788 2,108 3,428 3,428
Banks and insurance companies ................... 2,456 7,141 7,141 2,361 5,863 5,863
Industrial and all other ........................ 8,813 19,786 19,786 7,237 13,893 13,893
------ ------ ------ ------ ------ ------
Total equity securities ......................... 14,126 31,715 31,715 11,706 23,184 23,184
------ ------ ------ ------ ------ ------
Debt Securities:
United States government ............ 15,511 15,625 15,625 4,332 4,373 4,373
Public Utilities .................... 694 710 710 687 701 701
Industrial and Miscellaneous ........ 4,926 4,769 4,769 4,694 4,458 4,458
------ ------ ------ ------ ------ ------
Total Debt Securities ............... 21,131 21,104 21,104 9,713 9,532 9,532
------ ------ ------ ------ ------ ------
Total Available for Sale ............ 35,257 52,819 52,819 21,419 32,716 32,716
------ ------ ------ ------ ------ ------
Total Securities .................... 65,040 83,627 82,814 56,672 68,754 68,129
Mortgage loans on real estate ................... 320 320 405 405
Investment real estate .......................... 1,645 1,645 1,659 1,659
Policy loans .................................... 648 648 622 622
Short term investments .......................... 3,924 3,924 4,575 4,575
------ ------ ------ ------
Total investments ... 71,577 89,351 63,933 75,390
====== ====== ====== ======
35
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
December 31,
---------------------
1997 1996
------- ------
Assets
Cash ................................................. $ 167 $ 155
Investment in subsidiaries (equity method)
eliminated upon consolidation ........................ 46,721 40,854
Other assets ......................................... 380 318
------- -------
Total Assets ......................................... $47,268 $41,327
======= =======
Liabilities and Shareholders' Equity
Accrued general expenses ............................. $ 916 $ 808
Total Liabilities .................................... 916 808
Total Shareholders' Equity ........................... $46,352 $40,519
------- -------
Total Liabilities and Shareholders' Equity ........... $47,268 $41,327
======= =======
The "Notes to Consolidated Financial Statements of The National Security Group,
Inc." are an integral part this condensed financial information of the
registrant.
See accompanying "Notes to Condensed Financial Information of Registrant"
36
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS)
For the Years Ended December 31,
--------------------------------
1997 1996 1995
--------------------------------
Income
From subsidiaries-eliminated upon consolidation
Dividends ..................................... $ 1,850 $ 1,800 $ 1,680
------- ------- -------
Expenses
State taxes ................................... 26 25 25
Other expenses ................................ 246 575 60
------- ------- -------
272 600 85
------- ------- -------
Income before income taxes and equity in
undistributed earnings of subsidiaries ........ 1,578 1,200 1,595
Income tax benefit ............................ (109) (175) (43)
------- ------- -------
Income before equity in undistributed earnings
of subsidiaries ............................... 1,687 1,375 1,638
Equity in undistributed earnings (losses)
of subsidiaries ............................... 1,311 (19) (1,424)
------- ------- -------
Net Income .................................... $ 2,998 $ 1,356 $ 214
======= ======= =======
The "Notes to Consolidated Financial Statements of The National Security Group,
Inc." are an integral part of this condensed financial information of the
registrant.
See accompanying "Notes to Condensed Financial Information of Registrant"
37
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
For the Years Ended December 31,
----------------------------------
1997 1996 1995
----------------------------------
Cash flows from operating activities:
Net income .......................................... $ 2,998 $ 1,356 $ 214
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed (income) loss of subsidiaries (1,311) 19 1,424
Provision for amortization .......................... 0 22 12
(Increase)decrease in other assets ................. (62) (157) 64
Increase (decrease) in other liabilities ............ 107 433 (43)
------- ------- -------
Net cash provided by
operating activities ................................ 1,732 1,673 1,671
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock .......................... (98) (70) (222)
Cash dividends ...................................... (1,622) (1,509) (1,427)
------- ------- -------
Net cash used in
financing activities ................................ (1,720) (1,579) (1,649)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 12 94 22
Cash and due from banks at beginning of year ........ 155 61 39
------- ------- -------
Cash and due from banks at end of year .............. $ 167 $ 155 $ 61
======= ======= =======
The "Notes to Consolidated Financial Statements of The National Security Group,
Inc." are an integral part of this condensed financial information of the
registrant.
See accompanying "Notes to Condensed Financial Information of Registrant"
38
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
Notes to Condensed Financial Information of Registrant
Note 1-Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the Condensed Financial Information of the Registrant does not include all of
the information and notes normally included with financial statements prepared
in accordance with generally accepted accounting principles. It is, therefore,
suggested that these Condensed Financial Statements be read in conjunction with
the Consolidated Financial Statements and Notes thereto included in the
Registrant's Annual Report as referenced in Form 10-K, Part II, Item 8, page 23.
Note 2-Cash Dividends from Subsidiaries
Dividends of $1.85 million in 1997, $1.80 million in 1996 and $1.68 million in
1995 were paid to the Registrant by its subsidiaries.
39
THE NATIONAL SECURITY GROUP, INC.
SCHEDULE V. SUPPLEMENTARY INSURANCE INFORMATION (CONSOLIDATED)
(Amounts in thousands)
Policy Claims
Deferred Future and Other
Acquisition Policy Unearned Benefits
Costs Benefits Premiums Payable
---------- -------------- ---------- ----------
At December 31, 1997:
Life and accident and health insurance ......................................... $ 2,659 $18,667 $ 0 $ 386
Property and casualty insurance ................................................ 1,557 0 8,853 21,860
------- ------- ------- -------
Total .......................................................................... $ 4,216 $18,667 $ 8,853 $22,246
======= ======= ======= =======
At December 31, 1996:
Life and accident and health insurance ......................................... $ 2,700 $18,558 $ 0 $ 360
Property and casualty insurance ................................................ 1,313 0 10,398 19,087
------- ------- ------- -------
Total .......................................................................... $ 4,013 $18,558 $10,398 $19,447
======= ======= ======= =======
At December 31, 1995:
Life and accident and health insurance ......................................... $ 2,544 $18,290 $ 0 $ 477
Property and casualty insurance ................................................ 856 0 12,467 16,061
------- ------- ------- -------
Total .......................................................................... $ 3,400 $18,290 $12,467 $16,538
======= ======= ======= =======
Commissions,
Benefits, Amortization General
Claims, of Deferred Expenses,
Net Losses and Policy Taxes,
Premium Investment Other Settlement Acquisition Licenses Premiums
Revenue Income Income Expenses Costs and Fees Written
---------- --------- -------- -------- ---------- -------- --------
For the year ended December 31, 1997:
Life and accident and health insurance ................ $ 3,991 $ 2,048 $ 3 $ 2,106 $ 1,087 $ 2,089 $ 3,991
Property and casualty insurance ....................... 27,165 2,156 692 20,889 4,735 4,290 27,185
Other ................................................. 0 0 0 0 0 219 0
------- ------- ------- ------- ------- ------- -------
Total ................................................. $31,156 $ 4,204 $ 695 $22,995 $ 5,822 $ 6,598 $31,176
======= ======= ======= ======= ======= ======= =======
For the year ended December 31, 1996:
Life and accident and health insurance................. $ 4,432 $ 1,861 $ 8 $ 2,484 $ 1,234 $ 2,804 $ 4,400
Property and casualty insurance ....................... 22,222 2,074 574 17,193 3,487 3,825 23,498
Other ................................................. 0 0 0 0 0 362 0
------- ------- ------- ------- ------- ------- -------
Total ................................................. $26,654 $ 3,935 $ 582 $19,677 $ 4,721 $ 6,991 $27,898
======= ======= ======= ======= ======= ======= =======
For the year ended December 31, 1995:
Life and accident and health insurance................. $ 4,903 $ 2,074 $ 3 $ 2,166 $ 1,275 $ 4,587 $ 4,947
Property and casualty insurance ....................... 19,469 2,237 502 15,555 3,406 3,488 20,119
Other ................................................. 0 0 0 0 0 85 0
------- ------- ------- ------- ------- ------- -------
Total ................................................. $24,372 $ 4,311 $ 505 $17,721 $ 4,681 $ 8,160 $25,066
======= ======= ======= ======= ======= ======= =======
Note: Investment income and other operating expenses are reported separately by
segment and not allocated.
40
THE NATIONAL SECURITY GROUP, INC.
SCHEDULE VI. REINSURANCE (CONSOLIDATED)
(Amounts in thousands)
Percentage
Ceded Assumed of Amount
Gross to Other from Other Net Assumed
Amount Companies Companies Amount to Net
----------- ---------- ------------ ----------- -------------
For the year ended December 31, 1997:
Life insurance in force ................................... $138,059 $ 6,332 $ 0 $131,727 0.0%
======== ======== ======== ======== ===
Premiums:
Life insurance and accident and health insurance .......... $ 4,039 $ 48 $ 0 $ 3,991 0.0%
Property and casualty insurance ........................... 30,815 3,652 0 27,163 0.0%
-------- -------- -------- -------- ---
Total premiums ............................................ $ 34,854 $ 3,700 $ 0 $ 31,154 0.0%
======== ======== ======== ======== ===
For the year ended December 31, 1996:
Life insurance in force . . . . . . . . . . ............... $145,054 $ 6,764 $ 0 $138,290 0.0%
======== ======== ======== ======== ===
Premiums:
Life insurance and accident and health insurance .......... $ 4,484 $ 51 $ 0 $ 4,433 0.0%
Property and casualty insurance ........................... 33,987 11,768 0 22,219 0.0%
-------- -------- -------- -------- ---
Total premiums ............................................ $ 38,471 $ 11,819 $ 0 $ 26,652 0.0%
======== ======== ======== ======== ===
For the year ended December 31, 1995:
Life insurance in force ................................... $149,855 $ 7,886 $ 0 $141,969 0.0%
======== ======== ======== ======== ===
Premiums:
Life insurance and accident and health insurance .......... $ 4,961 $ 58 $ 0 $ 4,903 0.0%
Property and casualty insurance ........................... 32,702 13,234 1 19,469 0.0%
-------- -------- -------- -------- ---
Total premiums ............................................ $ 37,663 $ 13,292 $ 1 $ 24,372 0.0%
======== ======== ======== ======== ===
Note: Net reinsurance assumed premiums were, $0, $0, and $(2) for 1997, 1996,
and 1995, respectively.
41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
42
PART III
Item 10. Directors and Officers of the Registrant
The information contained on pages 2-4 of The National Security Group's
Proxy Statement dated April 14, 1998, with respect to directors and
executive officers of the Company, is incorporated herein by reference
in response to this item.
Item 11. Executive Compensation
The information contained on pages 7 and 8 of The National Security
Group's Proxy Statement dated April 14, 1998, with respect to executive
compensation and transactions, is incorporated herein by reference in
response to this item.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information contained on page 9 of The National Security Group's
Proxy Statement dated April 14, 1998, with respect to security
ownership of certain beneficial owners and management, is incorporated
herein by reference to this item.
Item 13. Certain Relationships and Related Transactions
The information contained on pages 6 and 7 of The National Security
Group's Proxy Statement dated April 14, 1998, with respect to certain
relationships and related transactions, is incorporated herein by
reference in response to this item.
43
PART IV
Item 14. Exhibits, financial statement schedules, and reports on Form 8-K
a. The following documents are filed as part of this report: Page #
Report of Independent Certified Public Accountants 18
Consolidated Statements of Income--
Years Ended December 31, 1997, 1996, and 1995 19
Consolidated Balance Sheets--December 31, 1997 and 1996 20
Consolidated Statements of Shareholders' Equity--
Years Ended December 31, 1997, 1996, and 1995 21
Consolidated Statements of Cash Flows--
Years Ended December 31, 1997, 1996, and 1995 22
Notes To Consolidated Financial Statements--December 31, 1997 23
Schedule I. Summary Of Investments--December 31, 1997 and 1996 35
Schedule III. Condensed Financial Information of Registrant--
December 31, 1997 and 1996 36
Schedule V. Supplementary Insurance Information--
December 31, 1997, 1996, and 1995 40
Schedule VI. Reinsurance--
Years Ended December 31, 1997, 1996, and 1995 41
All other Schedules are not required under the related instructions or are
inapplicable and therefore have been omitted.
b. Reports on Form 8-K
The Company did not file any Form 8-K during the fourth quarter of 1997.
44
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
THE NATIONAL SECURITY GROUP, INC.
/s/ M.L. Murdock /s/ J.R. Brunson
- --------------------------- --------------------------
M.L. Murdock J.R. Brunson
Senior Vice President, Chief Financial Officer, President, Chief Executive
Treasurer and Director Officer and Director
Date: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in their capacity as a Director of The National Security Group, Inc. On February
21, 1998.
SIGNATURE
/s/ Lewis Avinger /s/ D.M. English
/s/ Winfield Baird /s/ M.L. Murdock
/s/ Carolyn Brunson /s/ Craig S. Pittman
/s/ J.R. Brunson /s/ James B. Saxon
/s/ Jerry B. Brunson /s/ Walter P. Wilkerson
/s/ Fred D. Clark Jr.
45