EMC Insurance (EMCI) 10-Q 2017 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________to __________________

Commission File Number: 0-10956

EMC INSURANCE GROUP INC.

(Exact name of registrant as specified in its charter)

Iowa	42-6234555
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

717 Mulberry Street, Des Moines, Iowa	50309
(Address of principal executive offices)	(Zip Code)

(515) 345-2902

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by 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.

ý  Yes    o  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

ý  Yes    o  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

o	Large accelerated filer	ý	Accelerated filer	o	Non-accelerated filer
o	Smaller reporting company	o	Emerging growth company		(Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o  Yes    ý  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at October 31, 2017
Common stock, $1.00 par value	21,399,578

TABLE OF CONTENTS

		PAGE
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements	3
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	53
Item 4.	Controls and Procedures	53
PART II	OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 6.	Exhibits	55
Signatures		56

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	September 30,   2017		December 31,   2016
($ in thousands, except share and per share amounts)	(Unaudited)
ASSETS
Investments:
Fixed maturity securities available-for-sale, at fair value (amortized cost $1,233,772 and $1,189,525)	$	1,258,340	$	1,199,699
Equity securities available-for-sale, at fair value (cost $150,428 and $147,479)	231,719		213,839
Other long-term investments	14,471		12,506
Short-term investments	25,255		39,670
Total investments	1,529,785		1,465,714
Cash	402		307
Reinsurance receivables due from affiliate	26,079		21,326
Prepaid reinsurance premiums due from affiliate	15,759		9,309
Deferred policy acquisition costs (affiliated $43,836 and $40,660)	44,110		40,939
Amounts due from affiliate to settle inter-company transaction balances	4,210		—
Prepaid pension and postretirement benefits due from affiliate	11,407		12,314
Accrued investment income	11,963		11,050
Amounts receivable under reverse repurchase agreements	16,500		20,000
Accounts receivable	813		2,076
Income taxes recoverable	3,850		—
Goodwill	942		942
Other assets (affiliated $4,818 and $4,632)	5,018		4,836
Total assets	$	1,670,838	$	1,588,813

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

3

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	September 30,   2017		December 31,   2016
($ in thousands, except share and per share amounts)	(Unaudited)
LIABILITIES
Losses and settlement expenses (affiliated $720,901 and $685,533)	$	726,461	$	690,532
Unearned premiums (affiliated $281,055 and $243,682)	282,443		244,885
Other policyholders' funds (all affiliated)	9,847		13,068
Surplus notes payable to affiliate	25,000		25,000
Amounts due affiliate to settle inter-company transaction balances	—		11,222
Pension benefits payable to affiliate	3,807		4,097
Income taxes payable	—		2,359
Deferred income taxes	21,403		11,321
Other liabilities (affiliated $24,155 and $27,871)	26,815		32,987
Total liabilities	1,095,776		1,035,471
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 30,000,000 shares; issued and outstanding, 21,379,763 shares in 2017 and 21,222,535 shares in 2016	21,380		21,223
Additional paid-in capital	122,640		119,054
Accumulated other comprehensive income	64,326		46,081
Retained earnings	366,716		366,984
Total stockholders' equity	575,062		553,342
Total liabilities and stockholders' equity	$	1,670,838	$	1,588,813

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

4

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three months ended   September 30,
($ in thousands, except share and per share amounts)	2017			2016
REVENUES
Premiums earned (affiliated $154,451 and $149,988)	$	155,190		$	152,181
Net investment income	11,501			11,474
Net realized investment gains (losses), excluding impairment losses on securities available-for-sale	(239		)	(917		)
Total "other-than-temporary" impairment losses on securities available-for-sale	(355		)	(275		)
Portion of "other-than-temporary" impairment losses on fixed maturity securities available-for-sale reclassified from other comprehensive income (before taxes)	—			—
Net impairment losses on securities available-for-sale	(355		)	(275		)
Net realized investment gains (losses)	(594		)	(1,192		)
Other income (loss) (affiliated $(30) and $39)	(179		)	(85		)
Total revenues	165,918			162,378
LOSSES AND EXPENSES
Losses and settlement expenses (affiliated $116,908 and $106,795)	119,576			108,173
Dividends to policyholders (all affiliated)	46			3,944
Amortization of deferred policy acquisition costs (affiliated $26,177 and $26,256)	26,430			26,845
Other underwriting expenses (affiliated $19,520 and $17,600)	19,521			17,606
Interest expense (all affiliated)	84			84
Other expenses (affiliated $442 and $481)	701			679
Total losses and expenses	166,358			157,331
Income (loss) before income tax expense (benefit)	(440		)	5,047
INCOME TAX EXPENSE (BENEFIT)
Current	(2,197		)	1,448
Deferred	1,011			(530		)
Total income tax expense (benefit)	(1,186		)	918
Net income	$	746		$	4,129
Net income per common share - basic and diluted	$	0.03		$	0.20
Dividend per common share	$	0.21		$	0.19
Average number of common shares outstanding - basic and diluted	21,356,588			21,060,665

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

5

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Nine months ended September 30,
($ in thousands, except share and per share amounts)	2017			2016
REVENUES
Premiums earned (affiliated $446,522, and $436,804)	$	449,514		$	441,364
Net investment income	33,679			35,883
Net realized investment gains (losses), excluding impairment losses on securities available-for-sale	3,254			333
Total "other-than-temporary" impairment losses on securities available-for-sale	(1,088		)	(976		)
Portion of "other-than-temporary" impairment losses on fixed maturity securities available-for-sale reclassified from other comprehensive income (before taxes)	—			—
Net impairment losses on securities available-for-sale	(1,088		)	(976		)
Net realized investment gains (losses)	2,166			(643		)
Other income (loss) (affiliated $(350) and $307)	(834		)	(19		)
Total revenues	484,525			476,585
LOSSES AND EXPENSES
Losses and settlement expenses (affiliated $318,902 and $295,061)	323,089			296,102
Dividends to policyholders (all affiliated)	5,184			11,292
Amortization of deferred policy acquisition costs (affiliated $79,957 and $79,584)	80,774			80,740
Other underwriting expenses (affiliated $57,803 and $52,120)	57,732			52,134
Interest expense (all affiliated)	253			253
Other expenses (affiliated $1,423 and $1,414)	2,264			2,053
Total losses and expenses	469,296			442,574
Income (loss) before income tax expense (benefit)	15,229			34,011
INCOME TAX EXPENSE (BENEFIT)
Current	1,918			11,440
Deferred	257			(2,340		)
Total income tax expense (benefit)	2,175			9,100
Net income	$	13,054		$	24,911
Net income per common share - basic and diluted	$	0.61		$	1.19
Dividend per common share	$	0.63		$	0.57
Average number of common shares outstanding - basic and diluted	21,295,882			20,964,236

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

6

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three months ended   September 30,
($ in thousands)	2017			2016
Net income	$	746		$	4,129
OTHER COMPREHENSIVE INCOME (LOSS)
Unrealized holding gains (losses) on investment securities, net of deferred income tax expense (benefit) of $2,951 and $(1,226)	5,481			(2,275		)
Reclassification adjustment for net realized investment gains included in net income, net of income tax expense of $(141) and $(252)	(264		)	(466		)
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income, net of deferred income tax expense of $(146) and $(62):
Net actuarial loss	240			722
Prior service credit	(511		)	(839		)
Total reclassification adjustment associated with affiliate's pension and postretirement benefit plans	(271		)	(117		)
Other comprehensive income (loss)	4,946			(2,858		)
Total comprehensive income	$	5,692		$	1,271

	Nine months ended   September 30,
($ in thousands)	2017			2016
Net income	$	13,054		$	24,911
OTHER COMPREHENSIVE INCOME (LOSS)
Unrealized holding gains (losses) on investment securities, net of deferred income tax expense of $12,632 and $11,145	23,460			20,698
Reclassification adjustment for net realized investment gains included in net income, net of income tax expense of $(2,368) and $(1,613)	(4,399		)	(2,995		)
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income, net of deferred income tax expense of $(439) and $(327):
Net actuarial loss	719			1,271
Prior service credit	(1,535		)	(1,878		)
Total reclassification adjustment associated with affiliate's pension and postretirement benefit plans	(816		)	(607		)
Other comprehensive income (loss)	18,245			17,096
Total comprehensive income	$	31,299		$	42,007

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

7

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

($ in thousands, except per share amounts)	Common stock			Additional paid-in capital			Accumulated other comprehensive income		Retained earnings			Total stockholders' equity
Balance at December 31, 2016	$	21,223		$	119,054		$	46,081	$	366,984		$	553,342
Issuance of common stock through stock plans	225			5,328								5,553
Repurchase of common stock	(68		)	(1,790		)						(1,858		)
Increase resulting from stock-based compensation expense				48								48
Other comprehensive income							18,245					18,245
Net income									13,054			13,054
Dividends paid to public stockholders ($0.63 per share)									(5,906		)	(5,906		)
Dividends paid to affiliate ($0.63 per share)									(7,416		)	(7,416		)
Balance at September 30, 2017	$	21,380		$	122,640		$	64,326	$	366,716		$	575,062

($ in thousands, except per share amounts)	Common stock			Additional paid-in capital			Accumulated other comprehensive income		Retained earnings			Total stockholders' equity
Balance at December 31, 2015	$	20,781		$	108,747		$	58,433	$	336,977		$	524,938
Issuance of common stock through stock plans	321			7,294								7,615
Repurchase of common stock	(17		)	(366		)						(383		)
Increase resulting from stock-based compensation expense				49								49
Other comprehensive income							17,096					17,096
Net income									24,911			24,911
Dividends paid to public stockholders ($0.57 per share)									(5,107		)	(5,107		)
Dividends paid to affiliate ($0.57 per share)									(6,710		)	(6,710		)
Balance at September 30, 2016	$	21,085		$	115,724		$	75,529	$	350,071		$	562,409

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

8

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended   September 30,
($ in thousands)	2017			2016
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	13,054		$	24,911
Adjustments to reconcile net income to net cash provided by operating activities:
Losses and settlement expenses (affiliated $35,368 and $24,292)	35,929			21,791
Unearned premiums (affiliated $37,373 and $32,902)	37,558			33,465
Other policyholders' funds due to affiliate	(3,221		)	3,088
Amounts due to/from affiliate to settle inter-company transaction balances	(15,432		)	(2,383		)
Net pension and postretirement benefits due from affiliate	(638		)	(317		)
Reinsurance receivables due from affiliate	(4,753		)	1,646
Prepaid reinsurance premiums due from affiliate	(6,450		)	(5,025		)
Commissions payable (affiliated $(2,309) and $(3,682))	(2,318		)	(3,743		)
Deferred policy acquisition costs (affiliated $(3,176) and $(3,785))	(3,171		)	(3,900		)
Accrued investment income	(913		)	(1,354		)
Current income tax	(6,209		)	1,891
Deferred income tax	257			(2,340		)
Net realized investment gains	(2,166		)	643
Other, net (affiliated $(1,545) and $(451))	8,596			6,769
Total adjustments to reconcile net income to net cash provided by operating activities	37,069			50,231
Net cash provided by operating activities	50,123			75,142
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturity securities available-for-sale	(174,579		)	(338,659		)
Disposals of fixed maturity securities available-for-sale	121,463			282,787
Purchases of equity securities available-for-sale	(43,868		)	(45,632		)
Disposals of equity securities available-for-sale	49,595			40,525
Purchases of other long-term investments	(12,231		)	(5,920		)
Disposals of other long-term investments	1,304			480
Net (purchases) disposals of short-term investments	14,415			(4,012		)
Net receipts under reverse repurchase agreements	3,500			—
Net cash used in investing activities	(40,401		)	(70,431		)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock through affiliate’s stock plans	5,553			7,615
Repurchase of common stock	(1,858		)	(383		)
Dividends paid to stockholders (affiliated $(7,416) and $(6,710))	(13,322		)	(11,817		)
Net cash used in financing activities	(9,627		)	(4,585		)
NET INCREASE IN CASH	95			126
Cash at the beginning of the year	307			224
Cash at the end of the quarter	$	402		$	350

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

9

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

EMC Insurance Group Inc., a majority owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance and reinsurance.  The Company writes property and casualty insurance in both commercial and personal lines of insurance, with a focus on medium-sized commercial accounts.  The term “Company” is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.

The accompanying unaudited consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  The Company has evaluated all subsequent events through the date the financial statements were issued.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the interim financial statements have been included.  The results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year.  The consolidated balance sheet at December 31, 2016 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements.

In reading these financial statements, reference should be made to the Company’s 2016 Form 10-K or the 2016 Annual Report to Stockholders for more detailed footnote information.

2. TRANSACTIONS WITH AFFILIATES

An inter-company reinsurance program is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. This reinsurance program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. The reinsurance program consists of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty was effective from January 1, 2017 through June 30, 2017, and had a retention of $20.0 million and a limit of $24.0 million. The total cost of this treaty was approximately $6.0 million. The second treaty is effective from July 1, 2017 through December 31, 2017, and has a retention of $15.0 million and a limit of $12.0 million. The total cost of this treaty is approximately $1.4 million. Losses and settlement expenses ceded to Employers Mutual under the 2017 program totaled $3.0 million and $19.0 million for the three and nine months ended September 30, 2017, respectively, compared to $3.5 million and $5.1 million ceded during the three and nine months ended September 30, 2016, respectively. In both years the ceded amounts are applicable to the treaties that covered the first half of each year. The terms of these treaties were the same in 2016 with the exception of the costs, which were $6.3 million during the first half of 2016 and $1.5 million during the second half of 2016. All catastrophe and storm losses assumed by the property and casualty insurance subsidiaries (net of applicable reinsurance recoveries from external reinsurance protections purchased by the pool participants) are subject to the terms of these treaties, and there is no co-participation provision.

An inter-company reinsurance program is also in place between the Company's reinsurance subsidiary and Employers Mutual. The reinsurance program consists of two treaties. The first is a per occurrence catastrophe excess of loss treaty with a retention of $10.0 million, a limit of $10.0 million, 20 percent co-participation, and no reinstatement. The total cost of this treaty is approximately $1.7 million. The second is an annual aggregate catastrophe excess of loss treaty with a retention of $20.0 million, a limit of $100.0 million, and 20 percent co-participation. The total cost of this treaty is approximately $3.2 million. Any losses recovered under the per occurrence treaty inure to the benefit of the aggregate treaty, and only catastrophic events with total losses greater than $500,000 are subject to the terms of the aggregate treaty. Recoveries totaled $9.0 million during the three and nine months ended September 30, 2017, all under the annual aggregate treaty. The terms of these treaties were the same in 2016 with the exception of the costs, which were $2.0 million for the per occurrence treaty and $3.2 million for the annual aggregate treaty. No recoveries were made under these treaties during the same periods of 2016.

The reinsurance subsidiary purchases additional reinsurance protection in peak exposure territories from external parties in which coverage is triggered when losses experienced by the insurance industry from a catastrophic event exceed a specified threshold. Any reinsurance recoveries received from external parties reduces the amount of losses ceded to Employers Mutual under the inter-company reinsurance program. No recoveries have been made from external parties in 2017 or 2016.

10

3. REINSURANCE

The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, for the three and nine months ended September 30, 2017 and 2016 is presented below.  The classification of the assumed and ceded reinsurance amounts between affiliates and nonaffiliates is based on the participants in the underlying reinsurance agreements, and is intended to provide an understanding of the actual source of the reinsurance activities.  This presentation differs from the classifications used in the consolidated financial statements, where all amounts flowing through the pooling and quota share agreements and inter-company reinsurance programs with Employers Mutual are reported as “affiliated” balances.

	Three months ended September 30, 2017
($ in thousands)	Property and casualty insurance			Reinsurance			Total
Premiums written
Direct	$	122,665		$	—		$	122,665
Assumed from nonaffiliates	1,333			38,955			40,288
Assumed from affiliates	153,900			—			153,900
Ceded to nonaffiliates	(10,532		)	(1,220		)	(11,752		)
Ceded to affiliates	(123,355		)	(1,212		)	(124,567		)
Net premiums written	$	144,011		$	36,523		$	180,534
Premiums earned
Direct	$	96,547		$	—		$	96,547
Assumed from nonaffiliates	1,225			38,463			39,688
Assumed from affiliates	128,325			—			128,325
Ceded to nonaffiliates	(8,388		)	(2,533		)	(10,921		)
Ceded to affiliates	(97,237		)	(1,212		)	(98,449		)
Net premiums earned	$	120,472		$	34,718		$	155,190
Losses and settlement expenses incurred
Direct	$	62,745		$	—		$	62,745
Assumed from nonaffiliates	961			57,268			58,229
Assumed from affiliates	81,047			277			81,324
Ceded to nonaffiliates	(4,435		)	(3,039		)	(7,474		)
Ceded to affiliates	(66,279		)	(8,969		)	(75,248		)
Net losses and settlement expenses incurred	$	74,039		$	45,537		$	119,576

11

	Three months ended September 30, 2016
($ in thousands)	Property and casualty insurance			Reinsurance			Total
Premiums written
Direct	$	119,849		$	—		$	119,849
Assumed from nonaffiliates	1,221			39,592			40,813
Assumed from affiliates	146,289			—			146,289
Ceded to nonaffiliates	(7,841		)	(983		)	(8,824		)
Ceded to affiliates	(120,614		)	(1,270		)	(121,884		)
Net premiums written	$	138,904		$	37,339		$	176,243
Premiums earned
Direct	$	96,730		$	—		$	96,730
Assumed from nonaffiliates	1,170			39,394			40,564
Assumed from affiliates	122,058			—			122,058
Ceded to nonaffiliates	(6,091		)	(2,315		)	(8,406		)
Ceded to affiliates	(97,495		)	(1,270		)	(98,765		)
Net premiums earned	$	116,372		$	35,809		$	152,181
Losses and settlement expenses incurred
Direct	$	59,831		$	—		$	59,831
Assumed from nonaffiliates	793			27,206			27,999
Assumed from affiliates	85,196			280			85,476
Ceded to nonaffiliates	(895		)	(944		)	(1,839		)
Ceded to affiliates	(63,282		)	(12		)	(63,294		)
Net losses and settlement expenses incurred	$	81,643		$	26,530		$	108,173

12

	Nine months ended September 30, 2017
($ in thousands)	Property and casualty insurance			Reinsurance			Total
Premiums written
Direct	$	312,809		$	—		$	312,809
Assumed from nonaffiliates	3,542			108,056			111,598
Assumed from affiliates	415,426			—			415,426
Ceded to nonaffiliates	(27,109		)	(9,074		)	(36,183		)
Ceded to affiliates	(319,459		)	(3,637		)	(323,096		)
Net premiums written	$	385,209		$	95,345		$	480,554
Premiums earned
Direct	$	287,821		$	—		$	287,821
Assumed from nonaffiliates	3,370			110,563			113,933
Assumed from affiliates	375,601			—			375,601
Ceded to nonaffiliates	(22,014		)	(7,719		)	(29,733		)
Ceded to affiliates	(294,471		)	(3,637		)	(298,108		)
Net premiums earned	$	350,307		$	99,207		$	449,514
Losses and settlement expenses incurred
Direct	$	198,317		$	—		$	198,317
Assumed from nonaffiliates	2,406			104,685			107,091
Assumed from affiliates	258,169			942			259,111
Ceded to nonaffiliates	(9,400		)	(4,626		)	(14,026		)
Ceded to affiliates	(218,425		)	(8,979		)	(227,404		)
Net losses and settlement expenses incurred	$	231,067		$	92,022		$	323,089

13

	Nine months ended September 30, 2016
($ in thousands)	Property and casualty insurance			Reinsurance			Total
Premiums written
Direct	$	311,542		$	—		$	311,542
Assumed from nonaffiliates	3,430			111,378			114,808
Assumed from affiliates	393,418			—			393,418
Ceded to nonaffiliates	(19,069		)	(8,814		)	(27,883		)
Ceded to affiliates	(318,617		)	(3,810		)	(322,427		)
Net premiums written	$	370,704		$	98,754		$	469,458
Premiums earned
Direct	$	284,281		$	—		$	284,281
Assumed from nonaffiliates	3,332			111,790			115,122
Assumed from affiliates	359,985			—			359,985
Ceded to nonaffiliates	(17,653		)	(5,205		)	(22,858		)
Ceded to affiliates	(291,356		)	(3,810		)	(295,166		)
Net premiums earned	$	338,589		$	102,775		$	441,364
Losses and settlement expenses incurred
Direct	$	167,827		$	—		$	167,827
Assumed from nonaffiliates	2,298			71,787			74,085
Assumed from affiliates	232,472			1,033			233,505
Ceded to nonaffiliates	(4,498		)	(2,336		)	(6,834		)
Ceded to affiliates	(172,892		)	411			(172,481		)
Net losses and settlement expenses incurred	$	225,207		$	70,895		$	296,102

Individual lines in the above tables are defined as follows:

• “Direct” represents business produced by the property and casualty insurance subsidiaries.

• “Assumed from nonaffiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of involuntary business assumed by the pool participants pursuant to state law. For the reinsurance subsidiary, this line represents the reinsurance business assumed through the quota share agreement (including “fronting” activities initiated by Employers Mutual) and the business assumed outside the quota share agreement.

• “Assumed from affiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of all the pool members’ direct business.  The amounts reported under the caption “Losses and settlement expenses incurred” also include claim-related services provided by Employers Mutual that are allocated to the property and casualty insurance subsidiaries and the reinsurance subsidiary.

• “Ceded to nonaffiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of 1) the amounts ceded to nonaffiliated reinsurance companies in accordance with the terms of the reinsurance agreements providing protection to the pool and each of its participants, and 2) the amounts ceded on a mandatory basis to state organizations in connection with various programs.  For the reinsurance subsidiary, this line includes 1) reinsurance business that is ceded to other insurance companies in connection with “fronting” activities initiated by Employers Mutual, and 2) amounts ceded to purchase additional reinsurance protection in peak exposure territories from external parties.

• “Ceded to affiliates” for the property and casualty insurance subsidiaries represents the cession of their direct business to Employers Mutual under the terms of the pooling agreement and amounts ceded to Employers Mutual under the terms of the inter-company reinsurance program.  For the reinsurance subsidiary this line represents amounts ceded to Employers Mutual under the terms of the inter-company reinsurance program.

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4. LIABILITY FOR LOSSES AND SETTLEMENT EXPENSES

The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the Company.  Amounts presented are on a net basis, with a reconciliation of beginning and ending reserves to the gross amounts presented in the consolidated financial statements.

	Nine months ended September 30,
($ in thousands)	2017			2016
Gross reserves at beginning of year	$	690,532		$	678,774
Re-valuation due to foreign currency exchange rates	(1,913		)	(2,475		)
Less ceded reserves at beginning of year	20,664			23,477
Net reserves at beginning of year	671,781			657,772
Incurred losses and settlement expenses related to:
Current year	340,706			325,211
Prior years	(17,617		)	(29,109		)
Total incurred losses and settlement expenses	323,089			296,102
Paid losses and settlement expenses related to:
Current year	120,053			112,283
Prior years	173,986			161,888
Total paid losses and settlement expenses	294,039			274,171
Net reserves at end of period	700,831			679,703
Plus ceded reserves at end of period	25,348			21,983
Re-valuation due to foreign currency exchange rates	282			(1,121		)
Gross reserves at end of period	$	726,461		$	700,565

There is an inherent amount of uncertainty involved in the establishment of insurance liabilities.  This uncertainty is greatest in the current and more recent accident years because a smaller percentage of the expected ultimate claims have been reported, adjusted and settled compared to more mature accident years.  For this reason, carried reserves for these accident years reflect prudently conservative assumptions.  As the carried reserves for these accident years run off, the overall expectation is that, more often than not, favorable development will occur.  However, there is also the possibility that the ultimate settlement of liabilities associated with these accident years will show adverse development, and such adverse development could be substantial.

Changes in reserve estimates are reflected in net income in the year such changes are recorded.  Following is an analysis of the reserve development the Company experienced during the nine months ended September 30, 2017 and 2016.  Care should be exercised when attempting to analyze the financial impact of the reported development amounts because, as noted above, the overall expectation is that, more often than not, favorable development will occur as the prior accident years’ reserves run off.

15

2017 Development

For the property and casualty insurance segment, the September 30, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $15.6 million from the estimate at December 31, 2016.  This decrease represents 3.2 percent of the December 31, 2016 gross carried reserves and is primarily attributed to reductions in prior year ultimate loss ratios for every line of business except commercial auto liability. The other liability line of business was the largest contributor to favorable development. The ultimate loss ratios for this line were decreased slightly for most accident years from 2003 through 2016 due to declines in expected ultimate claim frequency and/or severity. Due to increases in projected ultimate claim frequency and severity, the ultimate loss ratios in the commercial auto line of business were increased for accident years 2013 through 2016, producing adverse reserve development for that line of business. Included in the development amount is adverse development experienced in the other liability line of business stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure associated with a former insured, and a slight strengthening of remaining reserves.

For the reinsurance segment, the September 30, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $2.1 million from the estimate at December 31, 2016.  This decrease represents 1.0 percent of the December 31, 2016 gross carried reserves and is primarily attributed to prior year reserve releases in the per risk excess, property/casualty global excess and property/casualty global pro rata contract types.

2016 Development

During the third quarter of 2016, management implemented a new reserving methodology for the determination of direct bulk reserves in the property and casualty insurance segment. The new methodology, which is referred to as the accident year ultimate estimate approach, better conforms to industry practices and provides increased transparency of the drivers of the property and casualty insurance segment's performance. In connection with this change in reserving methodology, there was a reallocation of incurred but not reported (IBNR) loss and allocated settlement expense reserves from prior accident years to the current accident year in multiple lines of business. This change resulted in the movement of approximately $5.6 million of reserves from prior accident years to the current accident year that is reported as favorable development; however, this development is "mechanical in nature", and did not have an impact on earnings because the total amount of carried reserves did not change.

For the property and casualty insurance segment, the September 30, 2016 estimate of loss and settlement expense reserves for accident years 2015 and prior decreased $22.2 million from the estimate at December 31, 2015.  Excluding the $5.6 million of "mechanical" favorable development that resulted from the change in reserving methodology noted above, the implied amount of favorable development that had an impact on earnings was approximately $16.6 million. This decrease represented 3.5 percent of the December 31, 2015 gross carried reserves and was primarily attributed to better than expected outcomes for all lines of business except commercial auto liability, commercial property and homeowners (workers' compensation and other liability lines of business were the largest contributors to favorable development). As noted above, the change in bulk reserving methodology implemented on September 30, 2016 resulted in the movement of a significant amount of settlement expense reserves to loss reserves, and a reallocation of reserves between current and prior accident years. Other liability accounted for most of the favorable development on settlement expense reserves.

For the reinsurance segment, the September 30, 2016 estimate of loss and settlement expense reserves for accident years 2015 and prior decreased $6.9 million from the estimate at December 31, 2015.  This decrease represented 3.5 percent of the December 31, 2015 gross carried reserves, with slightly less than half of the favorable development coming from the Mutual Reinsurance Bureau underwriting association (MRB), which included a decrease in bulk reserves.

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5. SEGMENT INFORMATION

The Company’s operations consist of a property and casualty insurance segment and a reinsurance segment.  The property and casualty insurance segment writes both commercial and personal lines of insurance, with a focus on medium-sized commercial accounts.  The reinsurance segment provides reinsurance for other insurers and reinsurers.  The segments are managed separately due to differences in the insurance products sold and the business environments in which they operate. Management evaluates the performance of its insurance segments using financial measurements based on Statutory Accounting Principles (SAP) instead of GAAP. Such measures include premiums written, premiums earned, statutory underwriting profit (loss), and investment results, as well as loss and loss adjustment expense ratios, trade underwriting expense ratios, and combined ratios.

Summarized financial information for the Company’s segments is as follows:

Three months ended September 30, 2017	Property and casualty insurance			Reinsurance			Parent company			Consolidated
($ in thousands)
Premiums earned	$	120,472		$	34,718		$	—		$	155,190
Underwriting profit (loss):
SAP underwriting profit (loss)	1,927			(18,364		)	—			(16,437		)
GAAP adjustments	5,860			194			—			6,054
GAAP underwriting profit (loss)	7,787			(18,170		)	—			(10,383		)
Net investment income	8,252			3,237			12			11,501
Net realized investment gains (losses)	(108		)	(486		)	—			(594		)
Other income (loss)	179			(358		)	—			(179		)
Interest expense	84			—			—			84
Other expenses	170			—			531			701
Income (loss) before income tax expense (benefit)	$	15,856		$	(15,777	)	$	(519	)	$	(440	)

Three months ended September 30, 2016	Property and casualty insurance			Reinsurance			Parent company			Consolidated
($ in thousands)
Premiums earned	$	116,372		$	35,809		$	—		$	152,181
Underwriting profit (loss):
SAP underwriting profit (loss)	(8,081		)	689			—			(7,392		)
GAAP adjustments	2,970			35			—			3,005
GAAP underwriting profit (loss)	(5,111		)	724			—			(4,387		)
Net investment income	8,185			3,285			4			11,474
Net realized investment gains (losses)	(799		)	(393		)	—			(1,192		)
Other income (loss)	172			(257		)	—			(85		)
Interest expense	84			—			—			84
Other expenses	190			—			489			679
Income (loss) before income tax expense (benefit)	$	2,173		$	3,359		$	(485	)	$	5,047

17

Nine months ended September 30, 2017	Property and casualty insurance			Reinsurance			Parent company			Consolidated
($ in thousands)
Premiums earned	$	350,307		$	99,207		$	—		$	449,514
Underwriting profit (loss):
SAP underwriting profit (loss)	(9,559		)	(14,899		)	—			(24,458		)
GAAP adjustments	8,135			(942		)	—			7,193
GAAP underwriting profit (loss)	(1,424		)	(15,841		)	—			(17,265		)
Net investment income	24,225			9,421			33			33,679
Net realized investment gains (losses)	3,033			(867		)	—			2,166
Other income (loss)	623			(1,457		)	—			(834		)
Interest expense	253			—			—			253
Other expenses	580			—			1,684			2,264
Income (loss) before income tax expense (benefit)	$	25,624		$	(8,744	)	$	(1,651	)	$	15,229
Assets	$	1,185,269		$	481,951		$	575,365		$	2,242,585
Eliminations	—			—			(568,814		)	(568,814		)
Reclassifications	(2,772		)	—			(161		)	(2,933		)
Total assets	$	1,182,497		$	481,951		$	6,390		$	1,670,838

Nine months ended September 30, 2016	Property and casualty insurance			Reinsurance			Parent company			Consolidated
($ in thousands)
Premiums earned	$	338,589		$	102,775		$	—		$	441,364
Underwriting profit (loss):
SAP underwriting profit (loss)	(8,904		)	7,777			—			(1,127		)
GAAP adjustments	3,026			(803		)	—			2,223
GAAP underwriting profit (loss)	(5,878		)	6,974			—			1,096
Net investment income	25,524			10,350			9			35,883
Net realized investment gains (losses)	(627		)	(16		)	—			(643		)
Other income (loss)	466			(485		)	—			(19		)
Interest expense	253			—			—			253
Other expenses	558			—			1,495			2,053
Income (loss) before income tax expense (benefit)	$	18,674		$	16,823		$	(1,486	)	$	34,011
Year ended December 31, 2016
Assets	$	1,122,037		$	455,493		$	554,164		$	2,131,694
Eliminations	—			—			(540,249		)	(540,249		)
Reclassifications	—			(1,932		)	(700		)	(2,632		)
Total assets	$	1,122,037		$	453,561		$	13,215		$	1,588,813

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The following table displays the premiums earned for the property and casualty insurance segment and the reinsurance segment for the three and nine months ended September 30, 2017 and 2016, by line of insurance.

	Three months ended September 30,				Nine months ended September 30,
($ in thousands)	2017		2016		2017		2016
Property and casualty insurance segment
Commercial lines:
Automobile	$	30,229	$	28,113	$	87,275	$	82,449
Property	27,980		27,471		79,551		77,292
Workers' compensation	25,373		24,536		75,419		71,272
Other liability	24,996		24,277		73,378		72,086
Other	2,203		2,102		6,509		6,246
Total commercial lines	110,781		106,499		322,132		309,345
Personal lines	9,691		9,873		28,175		29,244
Total property and casualty insurance	$	120,472	$	116,372	$	350,307	$	338,589
Reinsurance segment
Pro rata reinsurance	$	10,730	$	15,066	$	33,181	$	44,175
Excess of loss reinsurance	23,988		20,743		66,026		58,600
Total reinsurance	$	34,718	$	35,809	$	99,207	$	102,775
Consolidated	$	155,190	$	152,181	$	449,514	$	441,364

6. INCOME TAXES

The actual income tax expense (benefit) for the three and nine months ended September 30, 2017 and 2016 differed from the “expected” income tax expense (benefit) for those periods (computed by applying the United States federal corporate tax rate of 35 percent to income (loss) before income tax) as follows:

	Three months ended   September 30,						Nine months ended   September 30,
($ in thousands)	2017			2016			2017			2016
Computed "expected" income tax expense (benefit)	$	(154	)	$	1,767		$	5,330		$	11,904
Increases (decreases) in tax resulting from:
Tax-exempt interest income	(656		)	(709		)	(2,122		)	(2,101		)
Dividends received deduction	(294		)	(336		)	(948		)	(1,110		)
Proration of tax-exempt interest and dividends received deduction	142			157			460			482
Other, net	(224		)	39			(545		)	(75		)
Total income tax expense (benefit)	$	(1,186	)	$	918		$	2,175		$	9,100

The Company had no provision for uncertain income tax positions at September 30, 2017 or December 31, 2016.  The Company recognized no interest expense or other penalties related to U.S. federal or state income taxes during the three or nine months ended September 30, 2017 or 2016.  It is the Company’s accounting policy to reflect income tax penalties as other expense, and interest as interest expense.

The Company files a U.S. federal income tax return, along with various state income tax returns.  The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2014.  

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7. EMPLOYEE RETIREMENT PLANS

The components of net periodic benefit cost (income) for Employers Mutual’s pension and postretirement benefit plans is as follows:

	Three months ended   September 30,						Nine months ended   September 30,
($ in thousands)	2017			2016			2017			2016
Pension plans:
Service cost	$	3,783		$	3,639		$	11,351		$	10,824
Interest cost	2,798			2,551			8,393			7,620
Expected return on plan assets	(5,192		)	(4,841		)	(15,574		)	(14,521		)
Amortization of net actuarial loss	911			1,111			2,732			3,233
Amortization of prior service cost	5			9			15			24
Net periodic pension benefit cost	$	2,305		$	2,469		$	6,917		$	7,180
Postretirement benefit plans:
Service cost	$	341		$	319		$	1,022		$	955
Interest cost	570			553			1,710			1,661
Expected return on plan assets	(1,077		)	(1,056		)	(3,233		)	(3,168		)
Amortization of net actuarial loss	342			374			1,028			1,121
Amortization of prior service credit	(2,788		)	(2,835		)	(8,365		)	(8,504		)
Net periodic postretirement benefit income	$	(2,612	)	$	(2,645	)	$	(7,838	)	$	(7,935	)

Net periodic pension benefit cost allocated to the Company amounted to $692,000 and $1.1 million for the three months and $2.1 million and $2.5 million for the nine months ended September 30, 2017 and 2016, respectively.  Net periodic postretirement benefit income allocated to the Company amounted to $736,000 and $937,000 for the three months and $2.2 million and $2.4 million for the nine months ended September 30, 2017 and 2016, respectively.

The Company’s share of Employers Mutual’s remaining 2017 planned contribution to the pension plan, if made, will be approximately $2.7 million. No contributions will be made to the Voluntary Employee Beneficiary Association (VEBA) trust in 2017.

8. STOCK-BASED COMPENSATION

On May 26, 2017, the Company registered 150,000 shares of the Company's common stock for use in the EMC Insurance Group Inc. 2017 Non-Employee Director Stock Plan (the "2017 Director Plan"). The 2017 Director Plan provides for the awarding of non-qualified stock options, restricted stock, restricted stock units and other stock-based awards to non-employee directors of the Company. During the first nine months of 2017, 2,000 shares of restricted stock were granted to non-employee directors of the Company. Employers Mutual also has several stock plans which utilize the common stock of the Company. Employers Mutual can provide the common stock required under its plans by: 1) using shares of common stock that it currently owns; 2) purchasing common stock in the open market; or 3) directly purchasing common stock from the Company at the current fair value. A portion of the compensation expense recognized by Employers Mutual (as the requisite service period for granted options and restricted stock awards/units is rendered) is allocated to the Company’s property and casualty insurance subsidiaries though their participation in the pooling agreement.

During the first quarter of 2017, Employers Mutual began issuing restricted stock units rather than restricted stock awards. In connection with this change, Employers Mutual will now acquire stock to fulfill its obligations to the recipients of the restricted stock units on the date they vest, rather than on the grant date of the awards.

Because of this change, an account Employers Mutual established to hold previously granted restricted stock awards until they vest will contain excess shares of the Company's stock stemming from forfeitures and surrenders. During the first nine months of 2017, the Company repurchased 67,974 shares of stock from this unvested restricted stock account at an average cost of $27.34.

20

During the first nine months of 2017, 116,288 restricted stock units were granted to eligible employees of Employers Mutual. Under the stock plans, 85,192 shares of restricted stock vested, and 163,658 options were exercised at a weighted average exercise price of $14.76. The Company recognized compensation expense from these plans of $296,000 ($192,000 net of tax) and $218,000 ($142,000 net of tax) for the three months and $508,000 ($330,000 net of tax) and $542,000 ($353,000 net of tax) for the nine months ended September 30, 2017 and 2016, respectively.  

9. DISCLOSURES ABOUT THE FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values of the Company’s financial instruments as of September 30, 2017 and December 31, 2016 are summarized in the tables below.

September 30, 2017	Carrying amounts		Estimated fair values
($ in thousands)
Assets:
Fixed maturity securities available-for-sale:
U.S. treasury	$	8,164	$	8,164
U.S. government-sponsored agencies	255,619		255,619
Obligations of states and political subdivisions	336,638		336,638
Commercial mortgage-backed	65,810		65,810
Residential mortgage-backed	103,666		103,666
Other asset-backed	24,967		24,967
Corporate	463,476		463,476
Total fixed maturity securities available-for-sale	1,258,340		1,258,340
Equity securities available-for-sale:
Common stocks:
Financial services	40,738		40,738
Information technology	36,684		36,684
Healthcare	30,730		30,730
Consumer staples	15,044		15,044
Consumer discretionary	21,605		21,605
Energy	17,196		17,196
Industrials	28,315		28,315
Other	16,787		16,787
Non-redeemable preferred stocks	24,620		24,620
Total equity securities available-for-sale	231,719		231,719
Short-term investments	25,255		25,255
Liabilities:
Surplus notes	25,000		11,512

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December 31, 2016	Carrying amounts		Estimated fair values
($ in thousands)
Assets:
Fixed maturity securities available-for-sale:
U.S. treasury	$	7,830	$	7,830
U.S. government-sponsored agencies	239,197		239,197
Obligations of states and political subdivisions	335,757		335,757
Commercial mortgage-backed	37,572		37,572
Residential mortgage-backed	96,434		96,434
Other asset-backed	26,393		26,393
Corporate	456,516		456,516
Total fixed maturity securities available-for-sale	1,199,699		1,199,699
Equity securities available-for-sale:
Common stocks:
Financial services	35,122		35,122
Information technology	30,542		30,542
Healthcare	24,707		24,707
Consumer staples	19,100		19,100
Consumer discretionary	22,321		22,321
Energy	19,071		19,071
Industrials	24,245		24,245
Other	18,384		18,384
Non-redeemable preferred stocks	20,347		20,347
Total equity securities available-for-sale	213,839		213,839
Short-term investments	39,670		39,670
Liabilities:
Surplus notes	25,000		11,228

The estimated fair values of fixed maturity and equity securities is based on quoted market prices, where available.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security.

Short-term investments generally include money market funds, U.S. Treasury bills and commercial paper.  Short-term investments are carried at fair value, which approximates cost, due to the highly liquid nature of the securities.   Short-term securities are classified as Level 1 fair value measurements when the fair values can be validated by recent trades.  When recent trades are not available, fair value is deemed to be the cost basis and the securities are classified as Level 2 fair value measurements.

The estimated fair value of the surplus notes is derived by discounting future expected cash flows at a rate deemed appropriate.  The discount rate was set at the average of current yields-to-maturity on several insurance company surplus notes that are traded in observable markets, adjusted upward by 50 basis points to reflect illiquidity and perceived risk premium differences. Other assumptions include a 25-year term (the surplus notes have no stated maturity date) and an interest rate that continues at the current 1.35 percent interest rate. The rate is typically adjusted every five years (next review due in 2018) and is based upon the then-current Federal Home Loan Bank borrowing rate for 5-year funds available to Employers Mutual.

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Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The following fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value.

Level 1 -	Unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.
Level 2 -	Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Level 3 -	Prices or valuation techniques that require significant unobservable inputs because observable inputs are not available.  The unobservable inputs may reflect the Company’s own judgments about the assumptions that market participants would use.

The Company uses an independent pricing source to obtain the estimated fair values of a majority of its securities, subject to an internal validation.  The fair values are based on quoted market prices, where available.  This is typically the case for equity securities and money market funds, which are accordingly classified as Level 1 fair value measurements.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security.  Fixed maturity securities, non-redeemable preferred stocks and various short-term investments in the Company’s portfolio may not trade on a daily basis; however, observable inputs are utilized in their valuations, and these securities are therefore classified as Level 2 fair value measurements.  Following is a brief description of the various pricing techniques used by the independent pricing source for different asset classes.

• U.S. Treasury securities (including bonds, notes, and bills) are priced according to a number of live data sources, including active market makers and inter-dealer brokers.  Prices from these sources are reviewed based on the sources’ historical accuracy for individual issues and maturity ranges.

• U.S. government-sponsored agencies and corporate securities (including fixed-rate corporate bonds and medium-term notes) are priced by determining a bullet (non-call) spread scale for each issuer for maturities going out to forty years.  These spreads represent credit risk and are obtained from the new issue market, secondary trading, and dealer quotes.  An option adjusted spread model is incorporated to adjust spreads of issues that have early redemption features.  The final spread is then added to the U.S. Treasury curve.

• Obligations of states and political subdivisions are priced by tracking and analyzing actively quoted issues and reported trades, material event notices and benchmark yields.  Municipal bonds with similar characteristics are grouped together into market sectors, and internal yield curves are constructed daily for these sectors.  Individual bond evaluations are extrapolated from these sectors, with the ability to make individual spread adjustments for attributes such as discounts, premiums, alternative minimum tax, and/or whether or not the bond is callable.

• Mortgage-backed and asset-backed securities are first reviewed for the appropriate pricing speed (if prepayable), spread, yield and volatility.  The securities are priced with models using spreads and other information solicited from market buy- and sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts.  To determine a tranche’s price, first the benchmark yield is determined and adjusted for collateral performance, tranche level attributes and market conditions.  Then the cash flow for each tranche is generated (using consensus prepayment speed assumptions including, as appropriate, a prepayment projection based on historical statistics of the underlying collateral).  The tranche-level yield is used to discount the cash flows and generate the price.  Depending on the characteristics of the tranche, a volatility-driven, multi-dimensional single cash flow stream model or an option-adjusted spread model may be used.  When cash flows or other security structure or market information is not available, broker quotes may be used.

On a quarterly basis, the Company receives from its independent pricing service a list of fixed maturity securities, if any, that were priced solely from broker quotes.  For these securities, fair value may be determined using the broker quotes, or by the Company using similar pricing techniques as the Company’s independent pricing service.  Depending on the level of observable inputs, these securities would be classified as Level 2 or Level 3 fair value measurements.   At September 30, 2017 and December 31, 2016, the Company had no securities priced solely from broker quotes.

23

A small number of the Company’s securities are not priced by the independent pricing service.  Two of these are equity securities that are reported as Level 3 fair value measurements since no observable inputs are used in their valuations.  The largest of these equity security holdings is in a privately placed non-redeemable convertible preferred stock investment in a start-up technology company that Employers Mutual is working closely with in its data analytics activities. This security is carried at its acquisition cost, which is presumed to approximate fair value. The other equity security, a much smaller holding, continues to be reported at the fair value obtained from the Securities Valuation Office (SVO) of the National Association of Insurance Commissioners (NAIC).  The SVO establishes a per share price for this security based on an annual review of that company’s financial statements, typically performed during the second quarter.  The other securities not priced by the Company’s independent pricing service consist of eight fixed maturity securities (nine at December 31, 2016). Two of these fixed maturity securities, classified as Level 3 fair value measurements, are corporate securities that convey premium tax benefits and are not publicly traded. The fair values for these securities are based on discounted cash flow analyses. The other fixed maturity securities are classified as Level 2 fair value measurements.  The fair values for these fixed maturity securities were obtained from either the SVO, the Company's investment custodian, or the Company's investment department using similar pricing techniques as the Company’s independent pricing service.

24

Presented in the tables below are the estimated fair values of the Company’s financial instruments as of September 30, 2017 and December 31, 2016.

September 30, 2017			Fair value measurements using
($ in thousands)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial instruments reported at fair value on recurring basis:
Assets:
Fixed maturity securities available-for-sale:
U.S. treasury	$	8,164	$	—	$	8,164	$	—
U.S. government-sponsored agencies	255,619		—		255,619		—
Obligations of states and political subdivisions	336,638		—		336,638		—
Commercial mortgage-backed	65,810		—		65,810		—
Residential mortgage-backed	103,666		—		103,666		—
Other asset-backed	24,967		—		24,967		—
Corporate	463,476		—		462,762		714
Total fixed maturity securities available-for-sale	1,258,340		—		1,257,626		714
Equity securities available-for-sale:
Common stocks:
Financial services	40,738		40,735		—		3
Information technology	36,684		36,684		—		—
Healthcare	30,730		30,730		—		—
Consumer staples	15,044		15,044		—		—
Consumer discretionary	21,605		21,605		—		—
Energy	17,196		17,196		—		—
Industrials	28,315		28,315		—		—
Other	16,787		16,787		—		—
Non-redeemable preferred stocks	24,620		9,822		12,798		2,000
Total equity securities available-for-sale	231,719		216,918		12,798		2,003
Short-term investments	25,255		25,255		—		—
Financial instruments not reported at fair value:
Liabilities:
Surplus notes	11,512		—		—		11,512

25

December 31, 2016			Fair value measurements using
($ in thousands)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial instruments reported at fair value on recurring basis:
Assets:
Fixed maturity securities available-for-sale:
U.S. treasury	$	7,830	$	—	$	7,830	$	—
U.S. government-sponsored agencies	239,197		—		239,197		—
Obligations of states and political subdivisions	335,757		—		335,757		—
Commercial mortgage-backed	37,572		—		37,572		—
Residential mortgage-backed	96,434		—		96,434		—
Other asset-backed	26,393		—		26,393		—
Corporate	456,516		—		455,534		982
Total fixed maturity securities available-for-sale	1,199,699		—		1,198,717		982
Equity securities available-for-sale:
Common stocks:
Financial services	35,122		35,119		—		3
Information technology	30,542		30,542		—		—
Healthcare	24,707		24,707		—		—
Consumer staples	19,100		19,100		—		—
Consumer discretionary	22,321		22,321		—		—
Energy	19,071		19,071		—		—
Industrials	24,245		24,245		—		—
Other	18,384		18,384		—		—
Non-redeemable preferred stocks	20,347		11,074		7,273		2,000
Total equity securities available-for-sale	213,839		204,563		7,273		2,003
Short-term investments	39,670		39,670		—		—
Financial instruments not reported at fair value:
Liabilities:
Surplus notes	11,228		—		—		11,228

26

Presented in the table below is a reconciliation of the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2017 and 2016.  Any unrealized gains or losses on these securities are recognized in other comprehensive income (loss).  Any gains or losses from settlements, disposals or impairments of these securities are reported as realized investment gains or losses in net income.

($ in thousands)	Fair value measurements using significant unobservable (Level 3) inputs
Three months ended September 30, 2017	Fixed maturity securities available-for-sale, corporate			Equity securities available-for-sale, financial services		Equity securities available-for-sale, non-redeemable preferred stocks		Total
Beginning balance	$	840		$	3	$	2,000	$	2,843
Settlements	(125		)	—		—		(125		)
Unrealized gains (losses) included in other comprehensive income (loss)	(1		)	—		—		(1		)
Balance at September 30, 2017	$	714		$	3	$	2,000	$	2,717
Nine months ended September 30, 2017
Beginning balance	$	982		$	3	$	2,000	$	2,985
Settlements	(265		)	—		—		(265		)
Unrealized gains (losses) included in other comprehensive income (loss)	(3		)	—		—		(3		)
Balance at September 30, 2017	$	714		$	3	$	2,000	$	2,717

($ in thousands)	Fair value measurements using significant unobservable (Level 3) inputs
Three months ended September 30, 2016	Fixed maturity securities available-for-sale, corporate			Equity securities available-for-sale, financial services		Equity securities available-for-sale, non-redeemable preferred stocks		Total
Beginning balance	$	1,191		$	3	$	—	$	1,194
Settlements	(117		)	—		—		(117		)
Unrealized gains (losses) included in other comprehensive income (loss)	(4		)	—		—		(4		)
Balance at September 30, 2016	$	1,070		$	3	$	—	$	1,073
Nine months ended September 30, 2016
Beginning balance	$	1,329		$	3	$	—	$	1,332
Settlements	(262		)	—		—		(262		)
Unrealized gains (losses) included in other comprehensive income (loss)	3			—		—		3
Balance at September 30, 2016	$	1,070		$	3	$	—	$	1,073

There were no transfers into or out of Levels 1 or 2 during the nine months ended September 30, 2017 or 2016.  It is the Company’s policy to recognize transfers between levels at the beginning of the reporting period.

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10. INVESTMENTS

Investments of the Company’s insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments that may be made by insurance companies.  In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages.  The Company believes that it is in compliance with these laws.

The amortized cost and estimated fair value of securities available-for-sale as of September 30, 2017 and December 31, 2016 are as follows.  All securities are classified as available-for-sale and are carried at fair value.

September 30, 2017	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair values
($ in thousands)
Securities available-for-sale:
Fixed maturity securities:
U.S. treasury	$	8,109	$	57	$	2	$	8,164
U.S. government-sponsored agencies	262,050		237		6,668		255,619
Obligations of states and political subdivisions	318,016		18,954		332		336,638
Commercial mortgage-backed	66,138		583		911		65,810
Residential mortgage-backed	104,620		2,593		3,547		103,666
Other asset-backed	24,501		756		290		24,967
Corporate	450,338		14,001		863		463,476
Total fixed maturity securities	1,233,772		37,181		12,613		1,258,340
Equity securities:
Common stocks:
Financial services	28,130		12,679		71		40,738
Information technology	19,772		16,912		—		36,684
Healthcare	18,417		12,457		144		30,730
Consumer staples	10,258		4,794		8		15,044
Consumer discretionary	12,224		9,464		83		21,605
Energy	13,273		4,692		769		17,196
Industrials	13,209		15,138		32		28,315
Other	12,114		4,704		31		16,787
Non-redeemable preferred stocks	23,031		1,591		2		24,620
Total equity securities	150,428		82,431		1,140		231,719
Total securities available-for-sale	$	1,384,200	$	119,612	$	13,753	$	1,490,059

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December 31, 2016	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair values
($ in thousands)
Securities available-for-sale:
Fixed maturity securities:
U.S. treasury	$	7,841	$	—	$	11	$	7,830
U.S. government-sponsored agencies	249,495		311		10,609		239,197
Obligations of states and political subdivisions	319,663		17,034		940		335,757
Commercial mortgage-backed	37,964		741		1,133		37,572
Residential mortgage-backed	102,307		1,435		7,308		96,434
Other asset-backed	26,592		732		931		26,393
Corporate	445,663		12,232		1,379		456,516
Total fixed maturity securities	1,189,525		32,485		22,311		1,199,699
Equity securities:
Common stocks:
Financial services	22,922		12,410		210		35,122
Information technology	19,832		10,739		29		30,542
Healthcare	16,092		8,700		85		24,707
Consumer staples	13,438		5,787		125		19,100
Consumer discretionary	14,812		7,672		163		22,321
Energy	14,276		4,873		78		19,071
Industrials	13,005		11,258		18		24,245
Other	13,071		5,345		32		18,384
Non-redeemable preferred stocks	20,031		483		167		20,347
Total equity securities	147,479		67,267		907		213,839
Total securities available-for-sale	$	1,337,004	$	99,752	$	23,218	$	1,413,538

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The following tables set forth the estimated fair values and gross unrealized losses associated with investment securities that were in an unrealized loss position as of September 30, 2017 and December 31, 2016, listed by length of time the securities were consistently in an unrealized loss position.

September 30, 2017	Less than twelve months				Twelve months or longer				Total
($ in thousands)	Fair values		Unrealized losses		Fair values		Unrealized losses		Fair values		Unrealized losses
Fixed maturity securities:
U.S. treasury	$	248	$	2	$	—	$	—	$	248	$	2
U.S. government-sponsored agencies	104,235		1,695		125,982		4,973		230,217		6,668
Obligations of states and political subdivisions	—		—		14,372		332		14,372		332
Commercial mortgage-backed	26,070		133		15,653		778		41,723		911
Residential mortgage-backed	19,872		431		21,155		3,116		41,027		3,547
Other asset-backed	5,211		39		8,809		251		14,020		290
Corporate	9,056		67		15,956		796		25,012		863
Total fixed maturity securities	164,692		2,367		201,927		10,246		366,619		12,613
Equity securities:
Common stocks:
Financial services	2,964		71		—		—		2,964		71
Healthcare	1,594		144		—		—		1,594		144
Consumer staples	159		8		—		—		159		8
Consumer discretionary	1,023		79		99		4		1,122		83
Energy	4,323		769		—		—		4,323		769
Industrials	309		32		—		—		309		32
Other	894		31		—		—		894		31
Non-redeemable preferred stocks	—		—		1,998		2		1,998		2
Total equity securities	11,266		1,134		2,097		6		13,363		1,140
Total temporarily impaired securities	$	175,958	$	3,501	$	204,024	$	10,252	$	379,982	$	13,753

30

December 31, 2016	Less than twelve months				Twelve months or longer				Total
($ in thousands)	Fair values		Unrealized losses		Fair values		Unrealized losses		Fair values		Unrealized losses
Fixed maturity securities:
U.S. treasury	$	7,830	$	11	$	—	$	—	$	7,830	$	11
U.S. government-sponsored agencies	202,900		10,609		—		—		202,900		10,609
Obligations of states and political subdivisions	43,777		940		—		—		43,777		940
Commercial mortgage-backed	21,695		1,133		—		—		21,695		1,133
Residential mortgage-backed	26,217		1,232		23,625		6,076		49,842		7,308
Other asset-backed	19,091		931		—		—		19,091		931
Corporate	82,657		1,273		8,625		106		91,282		1,379
Total fixed maturity securities	404,167		16,129		32,250		6,182		436,417		22,311
Equity securities:
Common stocks:
Financial services	1,462		12		908		198		2,370		210
Information technology	1,947		29		—		—		1,947		29
Healthcare	3,585		85		—		—		3,585		85
Consumer staples	2,427		125		—		—		2,427		125
Consumer discretionary	1,637		163		—		—		1,637		163
Energy	1,621		33		1,188		45		2,809		78
Industrials	779		18		—		—		779		18
Other	1,472		32		—		—		1,472		32
Non-redeemable preferred stocks	3,356		44		1,877		123		5,233		167
Total equity securities	18,286		541		3,973		366		22,259		907
Total temporarily impaired securities	$	422,453	$	16,670	$	36,223	$	6,548	$	458,676	$	23,218

Most of the fixed maturity securities that are in an unrealized loss position are considered investment grade by credit rating agencies. Because management does not intend to sell these securities, does not believe it will be required to sell these securities before recovery, and believes it will collect the amounts due on these securities, it was determined that these securities were not “other-than-temporarily” impaired at September 30, 2017.

No individual equity security accounted for a material amount of unrealized losses. Because the Company has the ability and intent to hold these securities for a reasonable amount of time to allow for recovery, it was determined that these securities were not “other-than-temporarily” impaired at September 30, 2017.

All of the Company’s preferred stock holdings that are in an unrealized loss position are perpetual preferred stocks.  The Company evaluates these perpetual preferred stocks with unrealized losses for “other-than-temporary” impairment similar to fixed maturity securities since they have debt-like characteristics such as periodic cash flows in the form of dividends and call features, are rated by rating agencies and are priced like other long-term callable fixed maturity securities.  There was no evidence of any credit deterioration in the issuers of the preferred stocks and the Company does not intend to sell these securities before recovery, nor does it believe it will be required to sell these securities before recovery; therefore, it was determined that these securities were not “other-than-temporarily” impaired at September 30, 2017.

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The amortized cost and estimated fair values of fixed maturity securities at September 30, 2017, by contractual maturity, are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

($ in thousands)	Amortized cost		Estimated fair values
Securities available-for-sale:
Due in one year or less	$	51,964	$	52,464
Due after one year through five years	167,769		173,934
Due after five years through ten years	378,169		387,220
Due after ten years	462,916		473,065
Securities not due at a single maturity date	172,954		171,657
Totals	$	1,233,772	$	1,258,340

A summary of realized investment gains and (losses) is as follows:

	Three months ended September 30,						Nine months ended September 30,
($ in thousands)	2017			2016			2017			2016
Fixed maturity securities available-for-sale:
Gross realized investment gains	$	29		$	261		$	408		$	1,935
Gross realized investment losses	(230		)	(218		)	(2,316		)	(517		)
Equity securities available-for-sale:
Gross realized investment gains	1,396			1,001			10,669			5,849
Gross realized investment losses	(435		)	(50		)	(906		)	(1,683		)
"Other-than-temporary" impairments	(355		)	(275		)	(1,088		)	(976		)
Other long-term investments, net	(999		)	(1,911		)	(4,601		)	(5,251		)
Totals	$	(594	)	$	(1,192	)	$	2,166		$	(643	)

Gains and losses realized on the disposition of investments are included in net income.  The cost of investments sold is determined on the specific identification method using the highest cost basis first.  The Company did not have any outstanding cumulative credit losses on fixed maturity securities that have been recognized in earnings from “other-than-temporary” impairments during any of the reported periods. The amounts reported as “other-than-temporary” impairments on equity securities do not include any individually significant items. The net realized investment losses recognized on other long-term investments primarily represent changes in the carrying value of a limited partnership that is used solely to support an equity tail-risk hedging strategy.

11. CONTINGENT LIABILITIES

The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business.  The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations.  The companies involved have established reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings.

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The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions.  The Company’s share of case loss reserves eliminated by the purchase of those annuities was $110,000 at December 31, 2016.  The Company had a contingent liability for the aggregate guaranteed amount of the annuities of $183,000 at December 31, 2016 should the issuers of those annuities fail to perform.  Although management is not able to verify the amount, the Company would likely have a similar contingent liability at September 30, 2017.  The probability of a material loss due to failure of performance by the issuers of these annuities is considered remote.

12. STOCK REPURCHASE PROGRAM

On November 3, 2011, the Company’s Board of Directors authorized a $15.0 million stock repurchase program.  This program does not have an expiration date.  The timing and terms of the purchases are determined by management based on board approved parameters and market conditions, and are conducted in accordance with the applicable rules of the Securities and Exchange Commission.  Common stock repurchased under this program will be retired by the Company.  During the first nine months of 2016, the Company repurchased 17,300 shares under this program at an average cost of $22.14.

13. ACCUMULATED OTHER COMPREHENSIVE INCOME

The Company has available-for-sale securities and receives an allocation of the actuarial losses and net prior service credits associated with Employers Mutual’s pension and postretirement benefit plans, both of which generate accumulated other comprehensive income (loss) amounts.  The following table reconciles, by component, the beginning and ending balances of accumulated other comprehensive income, net of tax.

	Accumulated other comprehensive income by component
	Unrealized gains (losses) on available-for- sale securities			Unrecognized pension and postretirement benefit obligations
($ in thousands)				Net actuarial loss			Prior service credit			Total			Total
Balance at December 31, 2016	$	49,748		$	(16,299	)	$	12,632		$	(3,667	)	$	46,081
Other comprehensive income before reclassifications	23,460			—			—			—			23,460
Amounts reclassified from accumulated other comprehensive income	(4,399		)	719			(1,535		)	(816		)	(5,215		)
Other comprehensive income (loss)	19,061			719			(1,535		)	(816		)	18,245
Balance at September 30, 2017	$	68,809		$	(15,580	)	$	11,097		$	(4,483	)	$	64,326

	Accumulated other comprehensive income by component
	Unrealized gains (losses) on available-for- sale securities			Unrecognized pension and postretirement benefit obligations
($ in thousands)				Net actuarial loss			Prior service credit			Total			Total
Balance at December 31, 2015	$	60,369		$	(17,306	)	$	15,370		$	(1,936	)	$	58,433
Other comprehensive income before reclassifications	20,698			—			—			—			20,698
Amounts reclassified from accumulated other comprehensive income	(2,995		)	1,271			(1,878		)	(607		)	(3,602		)
Other comprehensive income (loss)	17,703			1,271			(1,878		)	(607		)	17,096
Balance at September 30, 2016	$	78,072		$	(16,035	)	$	13,492		$	(2,543	)	$	75,529

33

The following tables display amounts reclassified out of accumulated other comprehensive income and into net income during the three and nine months ended September 30, 2017 and 2016, respectively.

($ in thousands)	Amounts reclassified from accumulated other comprehensive income
Accumulated other comprehensive income components	Three months ended   September 30, 2017			Nine months ended   September 30, 2017			Affected line item in the consolidated statements of income
Unrealized gains on investments:
Reclassification adjustment for net realized investment gains included in net income	$	405		$	6,767		Net realized investment gains (losses), excluding impairment losses on securities available-for-sale
Deferred income tax expense	(141		)	(2,368		)	Total income tax expense (benefit)
Net reclassification adjustment	264			4,399			Net income
Unrecognized pension and postretirement benefit obligations:
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income:
Net actuarial loss	(370		)	(1,107		)	(1)
Prior service credit	787			2,362			(1)
Total before tax	417			1,255
Deferred income tax expense	(146		)	(439		)
Net reclassification adjustment	271			816
Total reclassification adjustment	$	535		$	5,215

(1) These reclassified components of accumulated other comprehensive income are included in the computation of net periodic pension and postretirement benefit income (see note 7, Employee Retirement Plans, for additional details).

34

($ in thousands)	Amounts reclassified from accumulated other comprehensive income
Accumulated other comprehensive income components	Three months ended September 30, 2016			Nine months ended September 30, 2016			Affected line item in the consolidated statements of income
Unrealized gains on investments:
Reclassification adjustment for net realized investment gains included in net income	$	718		$	4,608		Net realized investment gains (losses), excluding impairment losses on securities available-for-sale
Deferred income tax expense	(252		)	(1,613		)	Total income tax expense (benefit)
Net reclassification adjustment	466			2,995			Net income
Unrecognized pension and postretirement benefit obligations:
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income:
Net actuarial loss	(1,112		)	(1,956		)	(1)
Prior service credit	1,291			2,890			(1)
Total before tax	179			934
Deferred income tax expense	(62		)	(327		)
Net reclassification adjustment	117			607
Total reclassification adjustment	$	583		$	3,602

(1) These reclassified components of accumulated other comprehensive income are included in the computation of net periodic pension and postretirement benefit income (see note 7, Employee Retirement Plans, for additional details).

14. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED

In May 2014, the Financial Accounting Standards Board (FASB) updated its guidance related to the Revenue from Contracts with Customers Topic 606 of the Accounting Standards Codification^TM (Codification or ASC).  The objective of this update (and other related following updates) is to improve the reporting of revenue by providing a more robust framework for addressing revenue issues, and improved disclosure requirements. Current revenue recognition guidance in U.S. GAAP is comprised of broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes result in different accounting for economically similar transactions. This guidance is to be applied retrospectively to annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted as of the original effective date (annual and interim reporting periods beginning after December 15, 2016).  The Company will adopt this guidance during the first quarter of 2018. Since premium revenue from insurance contracts is excluded, the Company has only minimal revenue items that are covered by this guidance. The largest revenue item, outside of premium income, is commission income on excess and surplus lines business marketed by EMC Underwriters, LLC, which is included in "Other income" in the consolidated statements of income. Applying this new revenue recognition guidance to commission income produces no material difference compared to that recognized under current practices, as the commission income is typically recognized in full at the time the policy is issued, which is when substantially all of the performance obligation is performed. This guidance will have no impact on the consolidated financial condition or operating results of the Company.

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In January 2016, the FASB updated its guidance related to the Financial Instruments-Overall Subtopic 825-10 of the ASC.  The objective of this update is to enhance the reporting model for financial instruments to provide financial statement users with more decision-useful information. The major change in reporting from this update that will impact the Company is a requirement that equity investments (excluding those accounted for under the equity method of accounting or those that are consolidated) be measured at fair value, with changes in fair value recognized in net income. While all of the Company's equity investments are already measured at fair value (with the exception of those that are consolidated and those that are accounted for under the equity method of accounting), the Company currently classifies all of its investments in equity securities as available-for-sale, and as such, the changes in fair value are currently recognized in other comprehensive income rather than net income. This guidance is to be applied to annual and interim reporting periods beginning after December 15, 2017, with recognition of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.  Early adoption is not permitted. The Company will adopt this guidance during the first quarter of 2018. Adoption is not expected to impact consolidated stockholders' equity, but is expected to introduce a material amount of volatility to the Company's consolidated net income.

In February 2016, the FASB issued updated guidance in Leases Topic 842 of the ASC, which supersedes the guidance in Leases Topic 840 of the ASC. The objective of this update is to increase transparency and comparability among organizations by requiring recognition of lease assets and lease liabilities on the balance sheet, and disclosure of key information about leasing arrangements. This guidance is effective for interim and annual periods beginning after December 15, 2018, and is to be applied using a modified retrospective approach. Early adoption is permitted. The Company will adopt this guidance during the first quarter of 2019. Management continues to research this guidance, which thus far has lead management to a preliminary determination that lease costs allocated to the Company through the pooling and quota share agreements can not be attributed to a specified asset, and therefore do not meet the definition of a leased asset contained in the guidance. As a result, adoption of this guidance is not expected to have a material impact on the Company's consolidated financial condition or net income.

In June 2016, the FASB issued updated guidance in Financial Instruments-Credit Losses Topic 326 of the ASC. The objective of this update is to provide information about expected credit losses on financial instruments and other commitments to extend credit. Specifically, this updated guidance replaces the current incurred loss impairment methodology which delays recognition of a loss until it is probable a loss has been incurred, with a methodology that reflects expected credit losses considering a broader range of reasonable and supportable information. This guidance covers financial assets that are not accounted for at fair value through net income, thus will not be applicable to the Company's equity investments upon implementation of the updated guidance described above for the Financial Instruments-Overall Subtopic 825-10. This guidance is effective for interim and annual periods beginning after December 15, 2019, and is to be applied with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (modified-retrospective approach). Early adoption is permitted, but only to fiscal years beginning after December 15, 2018. The Company will adopt this guidance during the first quarter of 2020. The Company is currently evaluating the impact this guidance will have on the Company's consolidated financial condition and net income.

In March 2017, the FASB issued updated guidance in Compensation-Retirement Benefits Topic 715 of the ASC. The objective of this update is to improve the presentation of net periodic pension and postretirement benefit costs by disaggregating the components of these expenses (disclosing the service cost component separately from the other components) for income statement reporting. Also included in this update is a prohibition against including components of the net periodic pension and postretirement benefit costs, other than the service cost component, in any capitalized assets. This guidance is effective for interim and annual periods beginning after December 15, 2017. The portion of the guidance related to the income statement display of net periodic pension and postretirement benefit costs is to be applied retrospectively, while the prohibition against including these costs, other than the service cost component, in capitalized assets is to be applied prospectively. Early adoption is permitted. The Company will adopt this guidance during the first quarter of 2018. Adoption will not impact consolidated stockholders' equity initially; however, the prohibition against including components of the net periodic pension and postretirement benefit costs, other than the service cost component, in capitalized assets is expected to result in a relatively small change in the deferred policy acquisition cost asset starting March 31, 2018, which is expected to have an immaterial impact, net of tax, on consolidated stockholders' equity and net income from that which would otherwise have been reported.

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EMC INSURANCE GROUP INC. AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Unaudited)

The term “Company” is used below interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.  The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included under Item 1 of this Form 10-Q, and the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2016 Form 10-K.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides issuers the opportunity to make cautionary statements regarding forward-looking statements.  Accordingly, any forward-looking statement contained in this report is based on management’s current beliefs, assumptions and expectations of the Company’s future performance, taking all information currently available into account.  These beliefs, assumptions and expectations can change as the result of many possible events or factors, not all of which are known to management.  If a change occurs, the Company’s business, financial condition, liquidity, results of operations, plans and objectives may vary materially from those expressed in the forward-looking statements.  The risks and uncertainties that may affect the actual results of the Company include, but are not limited to, the following:

• catastrophic events and the occurrence of significant severe weather conditions;

• the adequacy of loss and settlement expense reserves;

• state and federal legislation and regulations;

• changes in the property and casualty insurance industry, interest rates or the performance of financial markets and the general economy;

• rating agency actions;

• “other-than-temporary” investment impairment losses; and

• other risks and uncertainties inherent to the Company’s business, including those discussed under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K.

Management intends to identify forward-looking statements when using the words “believe”, “expect”, “anticipate”, “estimate”, “project”, “may”, “intend”, “likely” or similar expressions.  Undue reliance should not be placed on these forward-looking statements. The Company disclaims any obligation to update such statements or to announce publicly the results of any revisions that it may make to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

COMPANY OVERVIEW

The Company, a majority owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations that consist of a property and casualty insurance segment and a reinsurance segment. Management evaluates the performance of its insurance segments based upon underwriting profit (loss), which is calculated as premiums earned, less loss and settlement expenses and acquisition and other expenses. Additional information is presented in note 5 "Segment Information" of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q.

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Property and casualty insurance operations are conducted through three subsidiaries and represent the most significant segment of the Company’s business, totaling 78 percent of consolidated premiums earned during the first nine months of 2017.  The property and casualty insurance operations are integrated with the property and casualty insurance operations of Employers Mutual through participation in a reinsurance pooling agreement.  Because the Company conducts its property and casualty insurance operations together with Employers Mutual through the reinsurance pooling agreement, the Company shares the same business philosophy, management, employees and facilities as Employers Mutual and offers the same types of insurance products.

Reinsurance operations are conducted through EMC Reinsurance Company and accounted for 22 percent of consolidated premiums earned during the first nine months of 2017.  The principal business activity of EMC Reinsurance Company is to assume, through a quota share reinsurance agreement, 100 percent of Employers Mutual’s assumed reinsurance business, subject to certain exceptions.

An inter-company reinsurance program, consisting of two semi-annual aggregate catastrophe excess of loss treaties, is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. The program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. An inter-company reinsurance program is also in place between the Company's reinsurance subsidiary and Employers Mutual. This program also consists of two treaties, one being a per occurrence catastrophe excess of loss treaty and the other an annual aggregate catastrophe excess of loss treaty. The terms of all of these treaties are the same as 2016, with the exception of the costs. For detailed information regarding the inter-company reinsurance programs, see note 2 of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accounting policies and estimates considered by management to be critically important in the preparation and understanding of the Company’s financial statements and related disclosures are presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2016 Form 10-K.

During the third quarter of 2016, management implemented a new reserving methodology for the determination of direct bulk reserves in the property and casualty insurance segment. The new methodology, which is referred to as the accident year ultimate estimate approach, better conforms to industry practices and provides increased transparency of the drivers of the property and casualty insurance segment's performance. Although the reserves carried at September 30, 2016 were calculated under the new reserving methodology, the explicit drivers of development on prior years' reserves for the three and nine months ended September 30, 2016 could not be identified because the reserves carried at December 31, 2015 were calculated under the prior reserving methodology, and the implicit accident year ultimate assumptions underlying that methodology were not known.

The implementation of the new reserving methodology did not have a material impact on total carried reserves for the property and casualty insurance segment at September 30, 2016; however, approximately $5.6 million of incurred but not reported (IBNR) loss reserves and settlement expense reserves were reallocated from prior accident years to the current accident year in multiple lines of business. This reduction in prior accident years' reserves was reported as favorable development; however, this development was "mechanical" in nature, and did not have any impact on earnings because the total amount of carried reserves did not change as a result of this reallocation.

NON-GAAP INFORMATION

The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP). Management uses certain non-GAAP financial measures for evaluating the Company’s performance. These measures are considered non-GAAP financial measures under applicable Securities and Exchange Commission (SEC) rules because they are not displayed as separate line items in the consolidated financial statements or are not required to be disclosed in the notes to financial statements or, in some cases, include or exclude certain items not ordinarily included or excluded in the most comparable GAAP financial measure. The Company’s calculation of non-GAAP financial measures may differ from similar measures used by other companies, so investors should exercise caution when comparing the Company’s non-GAAP financial measures to the measures used by other companies. In this report, a non-GAAP financial measure known as the "underlying loss and settlement expense ratio" is utilized in describing the Company's results of operations with respect to the property and casualty insurance segment. The most directly comparable GAAP financial measure is reconciled to this non-GAAP financial measure under "Results of Operations" below.

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RESULTS OF OPERATIONS

Results of operations by segment and on a consolidated basis for the three and nine months ended September 30, 2017 and 2016 are as follows:

	Three months ended September 30,						Nine months ended September 30,
($ in thousands)	2017			2016			2017			2016
Property and casualty insurance
Premiums earned	$	120,472		$	116,372		$	350,307		$	338,589
Losses and settlement expenses	74,039			81,643			231,067			225,207
Acquisition and other expenses	38,646			39,840			120,664			119,260
Underwriting profit (loss)	$	7,787		$	(5,111	)	$	(1,424	)	$	(5,878	)
GAAP ratios:
Loss and settlement expense ratio	61.5		%	70.2		%	66.0		%	66.5		%
Acquisition expense ratio	32.0		%	34.2		%	34.4		%	35.2		%
Combined ratio	93.5		%	104.4		%	100.4		%	101.7		%
Reconciliation of loss and settlement expense ratio to underlying loss and settlement expense ratio1:
Loss and settlement expense ratio	61.5		%	70.2		%	66.0		%	66.5		%
Catastrophe and storm losses	(8.2		)%	(12.7		)%	(8.5		)%	(10.3		)%
Favorable development on prior years' reserves	5.2		%	5.9		%	4.4		%	4.9		%
Underlying loss and settlement expense ratio	58.5		%	63.4		%	61.9		%	61.1		%
Favorable development on prior years' reserves2	$	(6,242	)	$	(6,850	)	$	(15,555	)	$	(16,637	)
Catastrophe and storm losses	$	9,922		$	14,787		$	29,922		$	34,787

¹ Property and casualty insurance segment's underlying loss and settlement expense ratio: The loss and settlement expense ratio is the ratio (expressed as a percentage) of losses and settlement expenses incurred to premiums earned, which management uses as a measure of underwriting profitability of the Company’s property and casualty insurance business. The underlying loss and settlement expense ratio is a non-GAAP financial measure which represents the loss and settlement expense ratio, excluding the impact of catastrophe and storm losses and development on prior years’ reserves. Management uses this ratio as an indicator of the property and casualty insurance segment’s underwriting discipline and performance for the current accident year. Management believes this ratio is useful for investors to understand the property and casualty insurance segment’s periodic earnings and variability of earnings caused by the unpredictable nature (i.e., the timing and amount) of catastrophe and storm losses and development on prior years’ reserves. While this measure is consistent with measures utilized by investors and analysts to evaluate performance, it is not intended as a substitute for the GAAP financial measure of loss and settlement expense ratio.

² During the third quarter of 2016, management implemented a new reserving methodology for the determination of direct bulk reserves in the property and casualty insurance segment. The new methodology, which is referred to as the accident year ultimate estimate approach, better conforms to industry practices and provides increased transparency of the drivers of the property and casualty insurance segment's performance. In connection with this change in reserving methodology, there was a reallocation of IBNR loss reserves and allocated settlement expense reserves from prior accident years to the current accident year in multiple lines of business. This change resulted in the movement of approximately $5.6 million of reserves from prior accident years to the current accident year that was reported as favorable development; however, this development is "mechanical in nature", and did not have an impact on earnings because the total amount of carried reserves did not change. This "mechanical" favorable development has been excluded from the amounts presented for 2016.

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	Three months ended September 30,
	2017						2016
($ in thousands)	Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio		Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio
Property and casualty insurance
Commercial lines:
Automobile	$	30,229	$	24,293	80.4	%	$	28,113	$	26,274	93.5	%
Property	27,980		15,803		56.5	%	27,471		17,227		62.7	%
Workers' compensation	25,373		11,386		44.9	%	24,536		13,510		55.1	%
Other liability	24,996		15,802		63.2	%	24,277		14,179		58.4	%
Other	2,203		447		20.3	%	2,102		705		33.6	%
Total commercial lines	110,781		67,731		61.1	%	106,499		71,895		67.5	%
Personal lines	9,691		6,308		65.1	%	9,873		9,748		98.7	%
Total property and casualty insurance	$	120,472	$	74,039	61.5	%	$	116,372	$	81,643	70.2	%

	Nine months ended September 30,
	2017						2016
($ in thousands)	Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio		Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio
Property and casualty insurance
Commercial lines:
Automobile	$	87,275	$	74,926	85.8	%	$	82,449	$	69,763	84.6	%
Property	79,551		51,291		64.5	%	77,292		52,687		68.2	%
Workers' compensation	75,419		41,451		55.0	%	71,272		39,680		55.7	%
Other liability	73,378		40,833		55.6	%	72,086		38,045		52.8	%
Other	6,509		777		11.9	%	6,246		648		10.4	%
Total commercial lines	322,132		209,278		65.0	%	309,345		200,823		64.9	%
Personal lines	28,175		21,789		77.3	%	29,244		24,384		83.4	%
Total property and casualty insurance	$	350,307	$	231,067	66.0	%	$	338,589	$	225,207	66.5	%

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	Three months ended September 30,						Nine months ended September 30,
($ in thousands)	2017			2016			2017			2016
Reinsurance
Premiums earned	$	34,718		$	35,809		$	99,207		$	102,775
Losses and settlement expenses	45,537			26,530			92,022			70,895
Acquisition and other expenses	7,351			8,555			23,026			24,906
Underwriting profit (loss)	$	(18,170	)	$	724		$	(15,841	)	$	6,974
GAAP ratios:
Loss and settlement expense ratio	131.2		%	74.1		%	92.8		%	69.0		%
Acquisition expense ratio	21.1		%	23.9		%	23.2		%	24.2		%
Combined ratio	152.3		%	98.0		%	116.0		%	93.2		%
(Favorable) unfavorable development on prior years' reserves	$	1,822		$	(796	)	$	(2,062	)	$	(6,880	)
Catastrophe and storm losses	$	19,499		$	2,266		$	27,996		$	10,747

	Three months ended September 30,
	2017						2016
($ in thousands)	Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio		Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio
Reinsurance
Pro rata reinsurance	$	10,730	$	10,159	94.7	%	$	15,066	$	10,235	67.9	%
Excess of loss reinsurance	23,988		35,378		147.5	%	20,743		16,295		78.6	%
Total reinsurance	$	34,718	$	45,537	131.2	%	$	35,809	$	26,530	74.1	%

	Nine months ended September 30,
	2017						2016
($ in thousands)	Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio		Premiums earned		Losses and settlement expenses		Loss and settlement expense ratio
Reinsurance
Pro rata reinsurance	$	33,181	$	23,979	72.3	%	$	44,175	$	26,367	59.7	%
Excess of loss reinsurance	66,026		68,043		103.1	%	58,600		44,528		76.0	%
Total reinsurance	$	99,207	$	92,022	92.8	%	$	102,775	$	70,895	69.0	%

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	Three months ended September 30,						Nine months ended September 30,
($ in thousands, except per share amounts)	2017			2016			2017			2016
Consolidated
REVENUES
Premiums earned	$	155,190		$	152,181		$	449,514		$	441,364
Net investment income	11,501			11,474			33,679			35,883
Realized investment gains (losses)	(594		)	(1,192		)	2,166			(643		)
Other losses	(179		)	(85		)	(834		)	(19		)
	165,918			162,378			484,525			476,585
LOSSES AND EXPENSES
Losses and settlement expenses	119,576			108,173			323,089			296,102
Acquisition and other expenses	45,997			48,395			143,690			144,166
Interest expense	84			84			253			253
Other expense	701			679			2,264			2,053
	166,358			157,331			469,296			442,574
Income (loss) before income tax expense (benefit)	(440		)	5,047			15,229			34,011
Income tax expense (benefit)	(1,186		)	918			2,175			9,100
Net income	$	746		$	4,129		$	13,054		$	24,911
Net income per share	$	0.03		$	0.20		$	0.61		$	1.19
GAAP ratios:
Loss and settlement expense ratio	77.1		%	71.1		%	71.9		%	67.1		%
Acquisition expense ratio	29.6		%	31.8		%	31.9		%	32.7		%
Combined ratio	106.7		%	102.9		%	103.8		%	99.8		%
Favorable development on prior years' reserves2	$	(4,420	)	$	(7,646	)	$	(17,617	)	$	(23,517	)
Catastrophe and storm losses	$	29,421		$	17,053		$	57,918		$	45,534

Net income declined to $746,000 ($0.03 per share) and $13.1 million ($0.61 per share) for the three and nine months ended September 30, 2017 from $4.1 million ($0.20 per share) and $24.9 million ($1.19 per share) during the same periods in 2016.  These declines are primarily due to a record amount of third quarter catastrophe and storm losses incurred by the reinsurance segment. Management currently estimates that the reinsurance segment's ultimate gross losses from Hurricanes Harvey, Irma and Maria will be approximately $9.0 million, $7.5 million and $3.0 million, respectively, and that losses from two Mexico earthquakes will be approximately $1.5 million. These estimates are before factoring in recoveries under the annual aggregate catastrophe excess of loss treaty with Employers Mutual. The property and casualty insurance segment was much less impacted by these events, with Hurricanes Harvey and Irma producing combined losses of less than $1.0 million. A decline in favorable development on prior years' reserves in the reinsurance segment also contributed to the decline in underwriting results for both the three and nine month periods of 2017.

Because the $20.0 million retention amount in the annual aggregate treaty has been filled, the reinsurance subsidiary will only retain 20 percent of any fourth quarter catastrophe or storm events with losses greater than $500,000, up to the $100.0 million limit of coverage. The property and casualty insurance segment has $5.1 million of retention remaining in its July 1 through December 31 aggregate catastrophe excess of loss treaty with Employers Mutual, meaning that catastrophe and storm losses will be capped at $5.1 million in the fourth quarter, unless the $12.0 million limit of protection is exceeded. The property and casualty insurance segment was further into the $15.0 million retention amount at September 30, 2016; therefore, fourth quarter 2016 catastrophe and storm losses were capped at $512,000.

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Premium income

Premiums earned increased 2.0 percent and 1.8 percent to $155.2 million and $449.5 million for the three and nine months ended September 30, 2017 from $152.2 million and $441.4 million for the same periods in 2016.  Rate levels for both segments continue to be constrained by a high level of competition, especially for quality accounts with good loss experience. Average rate level increases continue to be slightly positive in the property and casualty insurance segment, while rate levels in the reinsurance segment stabilized somewhat during the January 1, 2017 renewal season, when approximately 70 percent of the business renews, after several years of declines.

Premiums earned in the property and casualty insurance segment increased 3.5 percent and 3.5 percent to $120.5 million and $350.3 million for the three and nine months ended September 30, 2017 from $116.4 million and $338.6 million for the same periods in 2016.  These increases are primarily attributed to growth in insured exposures, and to a lesser extent higher policy counts and small rate level increases on renewal business. New business premium (representing 15 percent of the pool participants’ direct premiums written) was approximately 12 percent higher than in the first nine months of 2016. Commercial lines new business continues to be in the desired range of growth, and accounted for most of the increase in total new business premium. Personal lines new business premium was up significantly, but is measured against a relatively small amount of new business premium in the first nine months of 2016. While management continues to seek growth in most territories, it is particularly focused on achieving growth outside of the core Midwest market, which will help diversify the pool participants' book of business geographically, while staying consistent with the industry and line of business mix of the existing book of business. Renewal business premium increased approximately four percent during the first nine months of 2017. After factoring in the continued implementation of some mandatory rate reductions on workers' compensation business in a few states, the overall rate change on renewal business was positive, but less than one percent. Rate levels are expected to be mixed during the remainder of 2017, with the largest rate increases expected in the commercial auto line of business. Rate decreases are expected in the workers' compensation and general liability lines of business, and rates on most other lines of business are expected to be flat or increase slightly. The overall policy retention rate remained strong during the first nine months of 2017 at 85.8 percent (commercial lines at 87.0 percent and personal lines at 83.5 percent). These retention rates approximate those reported at the end of 2016.

Premiums earned in the reinsurance segment decreased 3.0 percent and 3.5 percent to $34.7 million and $99.2 million for the three and nine months ended September 30, 2017 from $35.8 million and $102.8 million for the same periods in 2016. These decreases reflect MRB's withdrawal from non-standard automobile business, and declines in some casualty business that converted from a pro rata structure in 2016 to an excess of loss structure in 2017. The addition of some new business and growth on some existing accounts partially offset these declines in premium. The assumed reinsurance market continues to experience pricing pressure due to the influx of nontraditional capital and, prior to the third quarter of 2017, the lack of major catastrophic events. Pricing declines did moderate somewhat during the January 1, 2017 renewal season, as rate levels on excess of loss reinsurance business were largely unchanged, which was an improvement from the declines experienced on the January 1, 2016 renewals. There was a moderate deterioration in the pricing of catastrophe reinsurance for the industry at the mid-year renewal cycle; however, the majority of the reinsurance segment's business (approximately 70 percent) renewed at January 1, 2017, and as a result this reduction in pricing is expected to have a limited impact on 2017 premiums. Management expects rate levels to increase slightly on certain lines of business during the January 1, 2018 renewal season due to the high level of catastrophe losses experienced by the industry in the third quarter of 2017.

Losses and settlement expenses

Losses and settlement expenses increased 10.5 percent and 9.1 percent to $119.6 million and $323.1 million for the three and nine months ended September 30, 2017 from $108.2 million and $296.1 million for the same periods in 2016.  The loss and settlement expense ratio increased to 77.1 percent and 71.9 percent for the three and nine months ended September 30, 2017 from 71.1 percent and 67.1 percent for the same periods in 2016.  The record amount of catastrophe and storm losses experienced by the reinsurance segment during the third quarter of 2017 is largely responsible for the increase in the ratio for the three months ended September 30, 2017, and accounts for approximately half of the increase in the ratio for the nine months ended September 30, 2017. A decline in favorable development on prior years' reserves accounts for most of the remaining increase in the ratio for the nine months ended; whereas its impact on the ratio for the three months ended was offset by an improvement in the property and casualty insurance segment's underlying loss and settlement expense ratio. The actuarial analysis of the Company’s carried reserves at September 30, 2017 indicates that they are in the upper half of the range of reasonable reserves.

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The loss and settlement expense ratio for the property and casualty insurance segment decreased to 61.5 percent and 66.0 percent for the three and nine months ended September 30, 2017 from 70.2 percent and 66.5 percent for the same periods in 2016.  Lower catastrophe and storm losses produced the decline in the ratio for the nine months ended, and accounted for approximately half of the decline in the ratio for the third quarter. A lower underlying loss and settlement expense ratio contributed the remainder of the decline in the ratio for the third quarter. Catastrophe and storm losses, net of the amounts ceded to Employers Mutual under the inter-company reinsurance program, accounted for 8.2 and 8.5 percentage points of the loss and settlement expense ratio for the three and nine months ended September 30, 2017, respectively, compared to 12.7 and 10.3 percentage points during the same periods in 2016. The underlying loss and settlement expense ratio has become more consistent during 2017. The underlying loss and settlement expense ratio of 61.9 percent for the nine months ended September 30, 2017, is the result of steadily improving results during 2017, from 65.3 percent for the first quarter, to 62.1 percent for the second quarter, and to 58.5 percent for the third quarter. The decline in the third quarter primarily reflects reductions in the current accident year ultimate loss and settlement expense ratio projections in the personal auto liability, workers' compensation and commercial property lines of business. The commercial auto and personal lines of business, which posted loss and settlement expense ratios of 85.8 percent and 77.3 percent, respectively, for the nine months ended September 30, 2017, continue to underperform; though the ratios for both lines improved somewhat from the previous year. Management continues to devote a significant amount of time and effort to the initiatives that have been undertaken to improve the performance of these lines of business.

Favorable development on the property and casualty insurance segment's prior years' reserves totaled $6.2 million and $6.8 million for the three months and $15.6 million and $16.6 million for the nine months ended September 30, 2017 and 2016, respectively. Included in the development amount reported for the first nine months of 2017 is $4.5 million of adverse development experienced in the other liability line of business stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure associated with a former insured. Under the new reserving methodology implemented in the third quarter of 2016, development on prior accident years' reserves is determined primarily by changes in the prior accident years' ultimate loss and settlement expense ratios implemented by management. Changes in the assumptions underlying the ultimate ratios previously established for accident years 2015 and prior are difficult to quantify as the implied ultimate ratios under the previous methodology were based on implicit, rather than explicit, actuarial assumptions. Therefore, comparison of 2017 third quarter and year-to-date development amounts to the 2016 development amounts provides little meaningful information, as the prior accident year reserve allocation method lacked explicit frequency and severity assumptions. The explicit drivers of development on prior years' reserves are identifiable beginning in 2017. See note 4 of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q for further discussion of the sources of development on prior years' reserves.

The property and casualty insurance subsidiaries ceded $3.0 million and $19.0 million of catastrophe and storm losses to Employers Mutual under the 2017 inter-company reinsurance program during the three and nine months ended September 30, 2017, compared to $3.5 million and $5.1 million during the same periods in 2016. In both years, the ceded amounts are applicable to the treaties that covered the first half of each year. Taking the loss recoveries received and the premiums paid to Employers Mutual into consideration, the inter-company reinsurance program with Employers Mutual reduced the catastrophe and storm loss ratios by 2.1 and 2.4 percentage points for the three months and 4.1 and 0.1 percentage points for the nine months ended September 30, 2017 and 2016, respectively. The terms of the inter-company reinsurance program, including the pricing of the coverage, are reviewed annually by the Inter-Company Committees of the boards of directors of the Company and Employers Mutual.

The loss and settlement expense ratio for the reinsurance segment increased to 131.2 percent and 92.8 percent for the three and nine months ended September 30, 2017 from 74.1 percent and 69.0 percent for the same periods in 2016. These increases reflect $19.5 million of catastrophe and storm losses incurred during the third quarter of 2017. Catastrophe and storm losses accounted for 56.2 and 28.2 percentage points of the loss and settlement expense ratios for the three and nine months ended September 30, 2017, respectively, compared to 6.3 and 10.5 percentage points during the same periods in 2016. Gross losses from Hurricanes Harvey, Irma and Maria are currently estimated to be approximately $9.0 million, $7.5 million and $3.0 million, respectively, and losses from two Mexico earthquakes are estimated at approximately $1.5 million. During the third quarter of 2017, the reinsurance subsidiary retained $15.8 million of catastrophe and storm losses to fill the $20.0 million retention amount in the annual aggregate catastrophe excess of loss treaty with Employers Mutual, and an additional $2.2 million of catastrophe and storm losses representing its 20 percent co-participation on $11.2 million of losses above the retention amount. A total of $9.0 million was recovered from Employers Mutual under the aggregate treaty. Taking the loss recoveries received and the premiums paid to Employers Mutual into consideration, the inter-company reinsurance program with Employers Mutual reduced the catastrophe and storm loss ratios by 20.4 and 5.4 percentage points for the three months and nine months ended September 30, 2017, respectively. The terms of the inter-company reinsurance program, including the pricing of the coverage, are reviewed annually by the Inter-Company Committees of the boards of directors of the Company and Employers Mutual.

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The reinsurance subsidiary accrued $1.3 million of estimated reinstatement premiums expected to be received as a result of the hurricane losses. None of the catastrophic events occurring during the third quarter of 2017 have resulted in recoveries under the reinsurance subsidiary's per occurrence catastrophe excess of loss treaty, as losses stemming from these events are all currently below the $10.0 million retention amount. In addition, no recoveries have occurred under the additional reinsurance protection purchased by the reinsurance subsidiary because total estimated losses experienced by the insurance industry for these events currently do not exceed the specified thresholds to trigger coverage. Aside from catastrophe and storm losses, the remaining increases in the reinsurance segment's loss and settlement expense ratios for the three and nine months ended is due to a decline in favorable development on prior years' reserves, including adverse development during the third quarter of 2017. See note 4 of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q for further discussion of the sources of development on prior years' reserves.

Acquisition and other expenses

Acquisition and other expenses decreased 5.0 percent and 0.3 percent to $46.0 million and $143.7 million for the three and nine months ended September 30, 2017 from $48.4 million and $144.2 million for the same periods in 2016.  The acquisition expense ratio decreased to 29.6 percent and 31.9 percent for the three and nine months ended September 30, 2017 from 31.8 percent and 32.7 percent for the same periods in 2016.  Both segments contributed to the decreases in these ratios.

The acquisition expense ratio for the property and casualty insurance segment decreased to 32.0 percent and 34.4 percent for the three and nine months ended September 30, 2017 from 34.2 percent and 35.2 percent for the same periods in 2016. These decreases are primarily due to lower policyholder dividend expense, largely from a couple of the pool participants' safety dividend groups. Partially offsetting these decreases are higher salary expenses, an increase in costs associated with data analytics initiatives, and an increase in agents' contingent commissions.

The acquisition expense ratio for the reinsurance segment decreased to 21.1 percent and 23.2 percent for the three and nine months ended September 30, 2017 from 23.9 percent and 24.2 percent for the same periods in 2016. These decreases reflect the accumulation of several expense declines, including salaries (inclusive of bonuses), legal, and contingent commissions.

Investment results

Net investment income remained flat at $11.5 million for the three months ended September 30, 2017 and 2016, but decreased 6.1 percent to $33.7 million for the nine months ended September 30, 2017 from $35.9 million for the same period in 2016. The decrease for the nine months ended primarily reflects a lower book yield in the fixed maturity portfolio and a decline in dividend income. Current interest rate levels remain below the average book yield of the fixed maturity portfolio, and will therefore likely continue to limit future growth in net investment income. The average coupon rate on the fixed maturity portfolio, excluding interest-only securities, has remained relatively steady over the past year, coming in at 3.8 percent at September 30, 2017 and December 31, 2016, up slightly from 3.7 percent at September 30, 2016.  The effective duration of the fixed maturity portfolio, excluding interest-only securities, decreased to 4.9 at September 30, 2017 from 5.2 at December 31, 2016. The Company’s equity portfolio produced dividend income of $1.4 million and $4.5 million during the three and nine months ended September 30, 2017, respectively, compared to $1.6 million and $5.4 million during the same periods in 2016.

The Company had net realized investment losses of $594,000 and $1.2 million during the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017, the Company had net realized investment gains of $2.2 million compared to losses of $643,000 during the same period in 2016. The reported amounts include losses of $999,000 and $4.6 million generated during the three and nine months ended September 30, 2017 from declines in the carrying value of a limited partnership that the Company invests in to help protect the equity portfolio from a sudden and significant decline in value (an equity tail-risk hedging strategy). Losses on this limited partnership amounted to $1.9 million and $5.3 million, respectively, during the same periods in 2016. The Company recognized "other-than-temporary" impairment losses of $355,000 and $1.1 million during the three and nine months ended September 30, 2017, compared to $275,000 and $976,000 during the same periods in 2016. These impairment losses were recognized on securities held in the Company's equity portfolio.

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Other losses

Included in other losses are foreign currency exchange losses recognized on the reinsurance segment’s foreign currency denominated reinsurance business.  The reinsurance segment had foreign currency exchange losses of $357,000 and $1.5 million during the three and nine months ended September 30, 2017, compared to losses of $317,000 and $545,000 during the same periods in 2016.

Income tax

Income tax expense (benefit) decreased 229.2 percent and 76.1 percent to a $1.2 million benefit and $2.2 million expense for the three and nine months ended September 30, 2017 from expenses of $918,000 and $9.1 million for the same periods in 2016. The effective tax rates for the three and nine months ended September 30, 2017 were 269.5 percent and 14.3 percent, compared to 18.2 percent and 26.8 percent for the same periods in 2016. The primary contributors to the differences between these effective tax rates and the United States federal corporate tax rate of 35 percent are tax-exempt interest income earned and the dividends received deduction.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet cash obligations.  The Company had positive cash flows from operations of $50.1 million and $75.1 million during the first nine months of 2017 and 2016, respectively. The Company typically generates substantial positive cash flows from operations because cash from premium payments is generally received in advance of cash payments made to settle claims.  These positive cash flows provide the foundation of the Company’s asset/liability management program and are the primary driver of the Company’s liquidity.  The Company invests in high quality, liquid securities to match the anticipated payments of losses and settlement expenses of the underlying insurance policies.  Because the timing of the losses is uncertain, the majority of the portfolio is maintained in short to intermediate maturity securities that can be easily liquidated or that generate adequate cash flow to meet liabilities.

The Company is a holding company whose principal asset is its investment in its property and casualty insurance subsidiaries and its reinsurance subsidiary (“insurance subsidiaries”).  As a holding company, the Company is dependent upon cash dividends from its insurance subsidiaries to meet all its obligations, including cash dividends to stockholders and the funding of the Company’s stock repurchase program.  State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval.  The maximum amount of dividends that the insurance subsidiaries can pay to the Company in 2017 without prior regulatory approval is approximately $52.7 million.  The Company received $3.8 million and $3.6 million of dividends from its insurance subsidiaries and paid cash dividends to its stockholders totaling $13.3 million and $11.8 million during the first nine months of 2017 and 2016, respectively.

The Company’s insurance subsidiaries must maintain adequate liquidity to ensure that their cash obligations are met; however, because of the property and casualty insurance subsidiaries’ participation in the pooling agreement and the reinsurance subsidiary’s participation in the quota share agreement, they do not have the daily liquidity concerns normally associated with an insurance company.  This is because under the terms of the pooling and quota share agreements, Employers Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the Company’s reinsurance subsidiary, and then settles inter-company balances generated by these transactions with the participating companies on a monthly (pool participants) or quarterly (reinsurance subsidiary) basis.

At the insurance subsidiary level, the primary sources of cash are premium income, investment income and proceeds from called or matured investments.  The principal outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends, interest and principal payments on debt, and investment purchases.  Cash outflows vary because of uncertainties regarding settlement dates for unpaid losses and the potential for large losses, either individually or in the aggregate.  Accordingly, the insurance subsidiaries maintain investment and reinsurance programs intended to provide adequate funds to pay claims without forced sales of investments.  The insurance subsidiaries also have the ability to borrow funds on a short-term basis (180 days) from Employers Mutual and its subsidiaries and affiliate under an Inter-Company Loan Agreement. In addition, Employers Mutual maintains access to a line of credit with the Federal Home Loan Bank that could be used to provide the insurance subsidiaries additional liquidity if needed.

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The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid investments to ensure the availability of funds to pay claims and expenses.  A variety of maturities are maintained in the Company’s investment portfolio to assure adequate liquidity.  The maturity structure of the fixed maturity portfolio is also established by the relative attractiveness of yields on short, intermediate and long-term securities.  The Company does not invest in non-investment grade debt securities.  Any non-investment grade securities held by the Company are the result of rating downgrades subsequent to their purchase.

The Company invests for the long term and generally purchases fixed maturity securities with the intent to hold them to maturity.  Despite this intent, the Company currently classifies fixed maturity securities as available-for-sale to provide flexibility in the management of its investment portfolio.  At September 30, 2017 and December 31, 2016, the Company had net unrealized holding gains, net of deferred taxes, on its fixed maturity securities available-for-sale of $16.0 million and $6.6 million, respectively.  The fluctuation in the fair value of these investments is primarily due to changes in the interest rate environment during this time period, but also reflects fluctuations in risk premium spreads over U.S. Treasuries.  Since the Company intends to hold fixed maturity securities to maturity, such fluctuations in the fair value of these investments are not expected to have a material impact on the operations of the Company, as forced liquidations of investments are not anticipated. The Company closely monitors the bond market and makes appropriate adjustments in its portfolio as conditions warrant.

The majority of the Company’s assets are invested in fixed maturity securities.  These investments provide a substantial amount of investment income that supplements underwriting results and contributes to net earnings.  As these investments mature, or are called, the proceeds are reinvested at current interest rates, which may be higher or lower than those now being earned; therefore, more or less investment income may be available to contribute to net earnings.  Due to the prolonged low interest rate environment, proceeds from calls and maturities in recent years have been reinvested at lower yields, which has had a negative impact on investment income.

The Company held $14.5 million and $12.5 million in minority ownership interests in limited partnerships and limited liability companies at September 30, 2017 and December 31, 2016, respectively.  During the first nine months of 2017 and 2016, the Company invested $5.8 million and $4.9 million, respectively, in a limited partnership that is designed to help protect the Company from a sudden and significant decline in the value of its equity portfolio. During the fourth quarter of 2016, the Company's reinsurance subsidiary invested approximately $6.6 million in a limited liability company as an investment that conveys renewable energy tax credits. After reductions for the utilization of tax credits and a $209,000 impairment loss during the fourth quarter of 2016, the carrying value of this investment was approximately $1.1 million and $2.0 million at September 30, 2017 and December 31, 2016, respectively. These investments are included in "other long-term investments" in the Company's financial statements, with the limited partnership carried under the equity method of accounting.

The Company participates in reverse repurchase arrangements, involving the purchase of investment securities from third-party sellers with the agreement that the purchased securities be sold back to the third-party sellers for agreed-upon prices at specified future dates. The third-party sellers are required to pledge collateral with a value greater than the amount of cash received in the transactions. In accordance with GAAP, the investment securities purchased under the reverse repurchase agreements are not reflected in the Company's consolidated balance sheets, but instead a receivable is recorded for the principal amount lent. The Company's receivable under reverse repurchase agreements was $16.5 million and $20.0 million at September 30, 2017 and December 31, 2016, respectively.

The Company’s cash balance was $402,000 and $307,000 at September 30, 2017 and December 31, 2016, respectively.

During the first nine months of 2017, Employers Mutual made no contributions to its qualified pension plan or postretirement benefit plans.  The Company’s share of Employers Mutual’s 2017 planned contribution to its pension plan, if made, will be approximately $2.7 million. No contributions will be made to the postretirement benefit plans in 2017.

During the first nine months of 2016, Employers Mutual made no contributions to its qualified pension plan or postretirement benefit plans.  The Company reimbursed Employers Mutual $2.7 million for its share of the total 2016 pension contribution (no contributions were made to the postretirement benefit plans during 2016).

Capital Resources

Capital resources consist of stockholders’ equity and debt, representing funds deployed or available to be deployed to support business operations.  For the Company’s insurance subsidiaries, capital resources are required to support premium writings.  Regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to its statutory surplus should not exceed three to one.  On an annualized basis, all of the Company’s property and casualty insurance subsidiaries were well under this guideline at September 30, 2017.

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The Company’s insurance subsidiaries are required to maintain a certain minimum level of surplus on a statutory basis, and are subject to regulations under which the payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities.  The Company’s insurance subsidiaries are also subject to annual Risk Based Capital (RBC) requirements that may further impact their ability to pay dividends.  RBC requirements attempt to measure minimum statutory capital needs based upon the risks in a company’s mix of products and investment portfolio.  At December 31, 2016, the Company’s insurance subsidiaries had total adjusted statutory capital of $526.8 million, which is well in excess of the minimum risk-based capital requirement of $87.3 million.

The Company’s total cash and invested assets at September 30, 2017 and December 31, 2016 are summarized as follows:

	September 30, 2017
($ in thousands)	Amortized cost		Fair value		Percent of total fair value		Carrying value
Fixed maturity securities available-for-sale	$	1,233,772	$	1,258,340	82.3	%	$	1,258,340
Equity securities available-for-sale	150,428		231,719		15.1	%	231,719
Cash	402		402		—	%	402
Short-term investments	25,255		25,255		1.7	%	25,255
Other long-term investments	14,471		14,471		0.9	%	14,471
	$	1,424,328	$	1,530,187	100.0	%	$	1,530,187

	December 31, 2016
($ in thousands)	Amortized cost		Fair value		Percent of total fair value		Carrying value
Fixed maturity securities available-for-sale	$	1,189,525	$	1,199,699	81.8	%	$	1,199,699
Equity securities available-for-sale	147,479		213,839		14.6	%	213,839
Cash	307		307		—	%	307
Short-term investments	39,670		39,670		2.7	%	39,670
Other long-term investments	12,506		12,506		0.9	%	12,506
	$	1,389,487	$	1,466,021	100.0	%	$	1,466,021

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The amortized cost and estimated fair value of fixed maturity and equity securities at September 30, 2017 were as follows:

($ in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair values
Securities available-for-sale:
Fixed maturity securities:
U.S. treasury	$	8,109	$	57	$	2	$	8,164
U.S. government-sponsored agencies	262,050		237		6,668		255,619
Obligations of states and political subdivisions	318,016		18,954		332		336,638
Commercial mortgage-backed	66,138		583		911		65,810
Residential mortgage-backed	104,620		2,593		3,547		103,666
Other asset-backed	24,501		756		290		24,967
Corporate	450,338		14,001		863		463,476
Total fixed maturity securities	1,233,772		37,181		12,613		1,258,340
Equity securities:
Common stocks:
Financial services	28,130		12,679		71		40,738
Information technology	19,772		16,912		—		36,684
Healthcare	18,417		12,457		144		30,730
Consumer staples	10,258		4,794		8		15,044
Consumer discretionary	12,224		9,464		83		21,605
Energy	13,273		4,692		769		17,196
Industrials	13,209		15,138		32		28,315
Other	12,114		4,704		31		16,787
Non-redeemable preferred stocks	23,031		1,591		2		24,620
Total equity securities	150,428		82,431		1,140		231,719
Total securities available-for-sale	$	1,384,200	$	119,612	$	13,753	$	1,490,059

The Company’s property and casualty insurance subsidiaries have $25.0 million of surplus notes issued to Employers Mutual.  The interest rate on the surplus notes is 1.35 percent.  Reviews of the interest rate are conducted by the Inter-Company Committees of the boards of directors of the Company and Employers Mutual every five years, with the next review due in 2018.  Payments of interest and repayments of principal can only be made out of the applicable subsidiary’s statutory surplus and are subject to prior approval by the insurance commissioner of the respective states of domicile.  The surplus notes are subordinate and junior in right of payment to all obligations or liabilities of the applicable insurance subsidiaries.  Total interest expense incurred on these surplus notes was $253,000 during the first nine months of 2017 and 2016.  During the first quarter of 2017, the Company’s property and casualty insurance subsidiaries paid Employers Mutual for the interest that had been accrued on the surplus notes during 2016.

As of September 30, 2017, the Company had no material commitments for capital expenditures.

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Off-Balance Sheet Arrangements

Employers Mutual collects from agents, policyholders and ceding companies all written premiums associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the reinsurance subsidiary. Employers Mutual also collects from its reinsurers all losses and settlement expenses recoverable under the reinsurance contracts protecting the pool participants and, starting in 2016, the reinsurance subsidiary, as well as the fronting business ceded to the reinsurance subsidiary. Employers Mutual settles with the pool participants (monthly) and the reinsurance subsidiary (quarterly) the premiums written from these insurance policies and the paid losses and settlement expenses recoverable under the external reinsurance contracts, providing full credit for the premiums written and the paid losses and settlement expenses recoverable under the external reinsurance contracts generated during the period (not just the collected portion). Due to this arrangement, and since a significant portion of the premium balances are collected over the course of the underlying coverage periods, Employers Mutual carries a substantial receivable balance for insurance and reinsurance premiums in process of collection and, to a lesser extent, paid losses and settlement expenses recoverable from the external reinsurance companies.  Any of these receivable amounts that are ultimately deemed to be uncollectible are charged-off by Employers Mutual and the expense is charged to the reinsurance subsidiary or allocated to the pool members on the basis of pool participation.  As a result, the Company has off-balance sheet arrangements with an unconsolidated entity that results in credit-risk exposures (Employers Mutual’s insurance and reinsurance premium receivable balances, and paid loss and settlement expense recoverable amounts) that are not reflected in the Company’s financial statements.  The average annual expense for such charge-offs allocated to the Company over the past ten years is $362,000. Based on this historical data, this credit-risk exposure is not considered to be material to the Company’s results of operations or financial position and, accordingly, no loss contingency liability has been recorded.

Investment Impairments and Considerations

The Company recorded $355,000 and $1.1 million of "other-than-temporary" investment impairment losses during the three and nine months ended September 30, 2017, respectively, compared to $275,000 and $976,000 during the same periods in 2016. The impairment losses were recognized on securities held in the Company's equity portfolio.

At September 30, 2017, the Company had unrealized losses on available-for-sale securities as presented in the following table. The estimated fair value is based on quoted market prices, where available.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security.  None of these securities are considered to be in concentrations by either security type or industry.  The Company uses several factors to determine whether the carrying value of an individual security has been “other-than-temporarily” impaired.  Such factors include, but are not limited to, the security’s value and performance in the context of the overall markets, length of time and extent the security’s fair value has been below carrying value, key corporate events and, for fixed maturity securities, the amount of collateral available. Based on these factors, the absence of management’s intent to sell these securities prior to recovery or maturity, and the fact that management does not anticipate that it will be forced to sell these securities prior to recovery or maturity, it was determined that the carrying value of these securities were not “other-than-temporarily” impaired at September 30, 2017.  Risks and uncertainties inherent in the methodology utilized in this evaluation process include interest rate risk, equity price risk, and the overall performance of the economy, all of which have the potential to adversely affect the value of the Company’s investments. Should a determination be made at some point in the future that these unrealized losses are “other-than-temporary”, the Company’s earnings would be reduced by approximately $8.9 million, net of tax; however, the Company’s financial position would not be affected because unrealized losses on available-for-sale securities are reflected in the Company’s financial statements as a component of stockholders’ equity, net of deferred taxes.

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Following is a schedule of the length of time securities have continuously been in an unrealized loss position as of September 30, 2017.

	Less than twelve months				Twelve months or longer				Total
($ in thousands)	Fair values		Unrealized losses		Fair values		Unrealized losses		Fair values		Unrealized losses
Fixed maturity securities:
U.S. treasury	$	248	$	2	$	—	$	—	$	248	$	2
U.S. government-sponsored agencies	104,235		1,695		125,982		4,973		230,217		6,668
Obligations of states and political subdivisions	—		—		14,372		332		14,372		332
Commercial mortgage-backed	26,070		133		15,653		778		41,723		911
Residential mortgage-backed	19,872		431		21,155		3,116		41,027		3,547
Other asset-backed	5,211		39		8,809		251		14,020		290
Corporate	9,056		67		15,956		796		25,012		863
Total fixed maturity securities	164,692		2,367		201,927		10,246		366,619		12,613
Equity securities:
Common stocks:
Financial services	2,964		71		—		—		2,964		71
Healthcare	1,594		144		—		—		1,594		144
Consumer staples	159		8		—		—		159		8
Consumer discretionary	1,023		79		99		4		1,122		83
Energy	4,323		769		—		—		4,323		769
Industrials	309		32		—		—		309		32
Other	894		31		—		—		894		31
Non-redeemable preferred stocks	—		—		1,998		2		1,998		2
Total equity securities	11,266		1,134		2,097		6		13,363		1,140
Total temporarily impaired securities	$	175,958	$	3,501	$	204,024	$	10,252	$	379,982	$	13,753

The Company does not purchase non-investment grade fixed maturity securities.  Any non-investment grade fixed maturity securities held are the result of rating downgrades that occurred subsequent to their purchase.  At September 30, 2017, the Company held $2.9 million of non-investment grade fixed maturity securities in a net unrealized gain position of $44,000.

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Following is a schedule of gross realized losses recognized in the first nine months of 2017.  The schedule is aged according to the length of time the underlying securities were in an unrealized loss position.  

	Realized losses from sales						"Other-than- temporary" impairment losses		Total gross realized losses
($ in thousands)	Book value		Sales price		Gross realized losses
Fixed maturity securities:
Three months or less	$	—	$	—	$	—	$	—	$	—
Over three months to six months	2,330		2,086		244		—		244
Over six months to nine months	2,993		2,938		55		—		55
Over nine months to twelve months	5,044		4,684		360		—		360
Over twelve months	24,880		23,223		1,657		—		1,657
Subtotal, fixed maturity securities	35,247		32,931		2,316		—		2,316
Equity securities:
Three months or less	8,540		7,884		656		—		656
Over three months to six months	2,233		2,000		233		733		966
Over six months to nine months	129		112		17		—		17
Over nine months to twelve months	—		—		—		—		—
Over twelve months	—		—		—		355		355
Subtotal, equity securities	10,902		9,996		906		1,088		1,994
Total realized losses	$	46,149	$	42,927	$	3,222	$	1,088	$	4,310

LEASES, COMMITMENTS AND CONTINGENT LIABILITIES

One of the Company’s property and casualty insurance subsidiaries leases office facilities in Bismarck, North Dakota with lease terms expiring in 2024.  Employers Mutual has entered into various leases for branch and service office facilities with lease terms expiring through 2026.  All of these lease costs are included as expenses under the pooling agreement.  The Company’s contractual obligations as of September 30, 2017 did not change materially from those presented in the Company’s 2016 Form 10-K.

The participants in the pooling agreement are subject to guaranty fund assessments by states in which they write business.  Guaranty fund assessments are used by states to pay policyholder liabilities of insolvent insurers domiciled in those states.  Many states allow assessments to be recovered through premium tax offsets.  The Company has accrued estimated guaranty fund assessments of $827,000 and $851,000 as of September 30, 2017 and December 31, 2016, respectively. Premium tax offsets of $990,000 and $1.0 million, which are related to prior guarantee fund payments and current assessments, have been accrued as of September 30, 2017 and December 31, 2016, respectively.  The guaranty fund assessments are expected to be paid over the next two years and the premium tax offsets are expected to be realized within ten years of the payments.  The participants in the pooling agreement are also subject to second-injury fund assessments, which are designed to encourage employers to employ workers with pre-existing disabilities.  The Company had accrued estimated second-injury fund assessments of $2.0 million and $1.9 million as of September 30, 2017 and December 31, 2016, respectively.  The second-injury fund assessment accruals are based on projected loss payments.  The periods over which the assessments will be paid is not known.

The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions.  Based on information provided by the life insurance companies on an annual basis, the Company’s share of case loss reserves eliminated by the purchase of those annuities was $110,000 at December 31, 2016.  The Company had a contingent liability for the aggregate guaranteed amount of the annuities of $183,000 at December 31, 2016 should the issuers of those annuities fail to perform. Although management is not able to verify the amount, the Company would likely have a similar contingent liability at September 30, 2017.  The probability of a material loss due to failure of performance by the issuers of these annuities is considered remote.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The main objectives in managing the Company’s investment portfolios are to maximize after-tax investment return while minimizing risk, in order to provide maximum support for the underwriting operations.  Investment strategies are developed based upon many factors including the economic environment, business cycle, regulatory requirements, fluctuations in interest rates, underwriting results and consideration of other market risks.  Investment decisions are centrally managed by investment professionals and are supervised by the investment committees of the respective boards of directors for each of the Company’s subsidiaries.

Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments, and is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded.  The market risks of the financial instruments owned by the Company relate to the investment portfolio, which exposes the Company to interest rate (inclusive of credit spreads) and equity price risk and, to a lesser extent, credit quality and prepayment risk. Monitoring systems and analytical tools are in place to assess each of these elements of market risk; however, there can be no assurance that future changes in interest rates, creditworthiness of issuers, prepayment activity, liquidity available in the market and other general market conditions will not have a material adverse impact on the Company’s results of operations, liquidity or financial position.

Two categories of influences on market risk exist as it relates to financial instruments.  First are systematic aspects, which relate to the investing environment and are out of the control of the investment manager.  Second are non-systematic aspects, which relate to the construction of the investment portfolio through investment policies and decisions, and are under the direct control of the investment manager.  The Company is committed to controlling non-systematic risk through sound investment policies and diversification.

Further analysis of the components of the Company’s market risk (including interest rate risk, equity price risk, credit quality risk, and prepayment risk) can be found in the Company’s 2016 Form 10-K.

ITEM 4. CONTROLS AND PROCEDURES

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely making known to them material information relating to the Company and the Company’s consolidated subsidiaries required to be disclosed in the Company’s reports filed or submitted under the Exchange Act.

There were no changes in the Company’s internal control over financial reporting that occurred during the third quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding purchases of equity securities by the Company and affiliated purchasers for the three months ended September 30, 2017:

Period	(a) Total number of shares (or units) purchased1	(b) Average price paid per share (or unit)		(c) Total number of shares (or units) purchased as part of publicly announced plans or programs2	(d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs ($ in thousands)2,3
7/1/2017 - 7/31/2017	97	$	27.97	—	$	19,108
8/1/2017 - 8/31/2017	31	27.66		—	19,108
9/1/2017 - 9/30/2017	4,833	27.74		—	19,108
Total	4,961	$	27.74	—

¹ Included in this column are 1,345 shares purchased in the open market to fulfill the Company's obligations under its dividend reinvestment and common stock purchase plan, and 3,616 shares purchased from the account established by Employers Mutual to hold previously granted restricted stock awards until they vest, as these shares were excess shares stemming from forfeitures and surrenders.

² On November 3, 2011, the Company’s Board of Directors authorized a $15.0 million stock repurchase program.  This program does not have an expiration date.  A total of $14.6 million remains available in this plan for the purchase of additional shares.

³ On May 12, 2005, the Company announced that its parent company, Employers Mutual, had initiated a $15.0 million stock purchase program under which Employers Mutual may purchase shares of the Company’s common stock in the open market.  This purchase program does not have an expiration date; however, this program has been dormant while the Company’s repurchase programs have been in effect.  A total of $4.5 million remains in this program.

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ITEM 6. EXHIBITS

Exhibit number	Item
31.1*	Certification of President, Chief Executive Officer and Treasurer as required by Section 302 of the Sarbanes-Oxley Act of 2002
31.2*	Certification of Senior Vice President and Chief Financial Officer as required by Section 302 of the Sarbanes-Oxley Act of 2002
32.1*	Certification of President, Chief Executive Officer and Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*	Certification of Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS**	XBRL Instance Document
101.SCH**	XBRL Taxonomy Extension Schema Document
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB**	XBRL Taxonomy Extension Label Linkbase Document
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document

*	Filed herewith
**	Furnished, not filed

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EMC INSURANCE GROUP INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 8, 2017.

EMC INSURANCE GROUP INC.

Registrant

/s/ Bruce G. Kelley

Bruce G. Kelley

President, Chief Executive Officer, Treasurer and Director

(Principal Executive Officer)

/s/ Mark E. Reese

Mark E. Reese

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

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