As mentioned in the overview of this discussion, we expect our premium revenue growth rate to remain at modest levels of growth over the next year. The personal lines property and casualty insurance business, in which 88% of total premium revenue is derived, has historically been cyclical in nature with periods of intense price competition among insurers followed by periods of increased pricing flexibility. Due to the increase in hurricane activity over the last year, we feel that we are entering a period of increased price flexibility in the coastal market that we serve. Unfortunately, due to regulatory hurdles in developing rates and submitting to various state regulatory agencies, we are unable to adjust the rates we charge as rapidly as reinsurance companies can adjust the rates we pay for catastrophe reinsurance. Because of the inherent lag time in getting rate adjustments submitted and approved, we will experience an increase in cost for reinsurance this year that we will be unable to fully recover through increased pricing of our products.
Revenues from leasing operations are generated by the Company’s 50% owned subsidiary, Mobile Attic, Inc. Mobile Attic’s revenues are generated from the rental of portable storage containers for industrial and household consumers through its dealer network as well as the sale of franchises and storage units to franchisees through its wholly-owned subsidiary Mobile Attic Franchising Company. In the first quarter of 2006 total revenues from leasing operations were down 24.8% to $453,000 compared to $602,000 the same quarter last year. The decrease is attributable to a decrease in franchise fee revenue. Five new franchises were added in the first quarter of 2005 compared to only two new franchises in the first quarter of 2006.
Net investment income increased 6.8% to $1,165,000 in the first quarter of 2006 compared to $1,091,000 in the first quarter of 2005. The increase in investment income is primarily attributable to the increase in short term interest rates experienced over the last year.
Realized capital gains were up for the quarter due to the disposal of a significant common stock portfolio holding during the quarter. Realized capital gains are subject to significant fluctuations from quarter to quarter and year to year depending on prevailing market conditions and changes in investment mix.
Other income decreased 9.1% compared to last year. Other income is primarily composed of insurance related fees. The decrease was primarily due to a decrease in fees associated with the automobile lines of business.
Policyholder benefits and settlement expenses increased $2,567,000 and had the most significant adverse impact on first quarter earnings. As a percentage of premium revenue, policyholder benefits and settlement expenses were 73.7% in the first quarter of 2006 compared to 59.4% in the first quarter of 2005. As discussed in the overview at the opening of this management discussion and analysis, an increase in claims activity in the property and casualty subsidiaries was the primary factor contributing to this increase in benefits and settlement expenses. Claims and adjustment expenses incurred in the property/casualty subsidiaries totaled 71% of premium revenue for the first quarter of 2006 compared to 55% of premium revenue for the first quarter of 2005. The property and casualty combined ratio was 106% for the quarter compared to 89.5% for the first quarter of 2005.
Two primary factors contributed to the increase in policyholder benefits and settlement expenses:
contributing to a $740,000 increase in incurred claims and adding six percentage points to the property and casualty combined ratio. This increase in fire losses was primarily attributable to fire related losses on policies in force less than six months. Claims are customarily higher on new business than on business that has been in force for a number of years. We have incurred spikes in fire related claims in the past which have led to more stringent underwriting guidelines in significantly impacted territories. We are currently evaluating the impact of the first quarter increase in fire related claims activity and will make adjustments in underwriting guidelines where appropriate.
2. | Storm and tornado related claims increased $781,000 in the first quarter of 2006 compared to the same period last year. An increase in the frequency of early springtime tornadoes in Arkansas, North Alabama, North Mississippi and Tennessee was the primary contributor to the increase in storm related claims. Also, the average severity of these storms increased in 2006 to $3,112 per occurrence compared to an average per occurrence of $2,661 in 2005. The higher volume of tornadoes as opposed to straight line winds and hail appears to be the primary contributor to the increase in the average storm claim. |
The remaining increase in claims was due to several less individually significant items the most notable of which included an increase in automobile claims of over $150,000, and increase in incurred losses in the mobile homeowners program of $110,000 and an increase in NSIC claims reserve estimate of $458,000.
Policy acquisition costs:
Policy acquisition costs are down $48,000 compared to last year. Policy acquisition costs are directly related to the production of earned premium and as a percentage of premiums earned, policy acquisition costs are down primarily due to a reduction in commission rates on an automobile program operated by a general agent in Alabama and Mississippi.
General insurance expenses:
General expenses as a percent of earned premium were 16.2% in the first quarter of 2006 compared to 14.3% in the first quarter of 2005. The most significant item contributing to this increase was a $75,000 guaranty fund assessment incurred during the quarter.
Taxes, licenses, and fees:
Taxes, licenses and fees are 4.5% of premium revenue in the first quarter of 2006 compared to 4.01% in the first quarter of last year, an increase of $107,000. The most significant item contributing to this increase was non-deductible fees incurred in association with a periodic examination of insurance subsidiaries conducted by the Alabama Department of Insurance.
Interest Expense:
Interest expense increased $184,000 in the first quarter of 2006 compared to last year due to increased interest cost associated with the issuance of $9.2 million in trust preferred securities. The issuance was completed in December of 2005.
Summary:
The Company has a net loss for the 2006 first quarter of $141,000 compared to net income of $1,292,000 for the first quarter of 2005. As discussed under the caption “Policyholder benefits and settlement expenses” earlier in this report, a significant increase in claims incurred in the property and casualty subsidiaries was the primary factor contributing to the decline in earnings.
Investments:
Investments at March 31, 2006 were down $793,000 compared to December 31, 2005. Increased claims activity
14
hampered our ability to increase investments during the quarter as cash flow produced by premium revenue was primarily used to pay claims.
The Company considers any fixed income investment with a Standard & Poor’s rating of BB+ or lower to be below investment grade (Commonly referred to as “Junk Bonds”). At March 31, 2006 less than 1% of the Company’s investment portfolio was invested in fixed income investments rated below investment grade. The Company currently has no bonds in the investment portfolio in default.
The Company monitors its level of investments in debt and equity securities held in issuers of below investment grade debt securities. Management believes the level of such investments is not significant to the Company’s financial condition.
Income taxes:
Due to the low level of income before taxes for the first quarter of 2006, income taxes are not comparable to prior periods. Income taxes were most significantly impacted by an increase in unearned premium during the quarter, 20% of which is currently taxable under the federal internal revenue code. Deferred income taxes did not change materially during the quarter but deferred income tax also exceeded earnings due to the low level of earnings for the quarter.
Liquidity and capital resources:
At March 31, 2006, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $42,824,000 down $732,000 compared to December 31, 2005. The decrease reflects a net loss of $141,000, a decrease in accumulated unrealized investment gains of $48,000, and dividends paid of $543,000.
The Company has $11.9 million in notes from local banks which management intends to repay over the next five years. The Company also has $9.3 million in trust preferred securities which were issued in December of 2005. These securities currently have a fixed interest rate of 8.83% and a final maturity of December 15, 2035.
The Company had $3,093,000 in cash and cash equivalents at March 31, 2006. Net cash provided by operating activities totaled $1,876,000 in the first quarter of 2006. The increase in cash from operations was primarily attributable to recoveries from reinsurance companies of losses incurred during the 2005 hurricane season.
The liquidity requirements of the Company are primarily met by funds provided from operations of the life insurance and property/casualty subsidiaries. The Company receives funds from its subsidiaries consisting of dividends, payments for federal income taxes, and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used to pay stockholder dividends, corporate interest, corporate administrative expenses, federal income taxes, and for funding investments in subsidiaries.
The Company’s subsidiaries require cash in order to fund policy acquisition costs, claims, other policy benefits, interest expense, general expenses, and dividends to the Company. Premium and investment income, as well as maturities, calls, and sales of invested assets, provide the primary sources of cash for both subsidiaries. A significant portion of the Company’s investment portfolio consists of readily marketable securities, which can be sold for cash.
The Company’s business is concentrated primarily in the Southeastern United States. Accordingly, unusually severe storms or other disasters in the Southeastern United States might have a more significant effect on the Company than on a more geographically diversified insurance company. Unusually severe storms, other natural disasters and other events could have an adverse impact on the Company’s financial condition and operating results. However, the Company maintains a catastrophe reinsurance program to limit the effect of such catastrophic events on the Company’s financial condition.
15
Item 3. Market Risk Disclosures
The Company’s primary objectives in managing its investment portfolio are to maximize investment income and total investment returns while minimizing overall credit risk. Investment strategies are developed based on many factors including changes in interest rates, overall market conditions, underwriting results, regulatory requirements, and tax position. Investment decisions are made by management and reviewed by the Board of Directors. Market risk represents the potential for loss due to adverse changes in fair value of securities. The three potential risks related to the Company’s fixed maturity portfolio are interest rate risk, prepayment risk, and default risk. The primary risk related to the Company’s equity portfolio is equity price risk. There have been no material changes to the Company’s market risk for the three months ended March 31, 2006. For further information reference is made to the Company’s Form 10-K for the year ended December 31, 2005.
Item 4. Controls and Procedures
Company management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation.
16
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Please refer to Note 7 to the financial statements. |
Item 1A.Risk Factors
There has been no material change in risk factors previously disclosed under Item 1A. of the |
Company’s annual report for 2005 on Form 10-K. | |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
11. Computation of Earnings Per Share Filed Herewith, See Note 3 to Consolidated Financial Statements
31.1 | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2 | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1 | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2 | Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
b. Reports on Form 8-K during the quarter ended March 31, 2006
Date of Report | | Date Filed | | Description | |
| | | | | | | | | |
January 20, 2006 | | January 20, 2006 | | Press release, dated January 20, 2006, issued by The National Security Group, Inc. |
February 28, 2006 | | February 28, 2006 | | Press release, dated February 28, 2006, issued by The National Security Group, Inc. |
| | | | | | | | | |
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned duly authorized officer, on its behalf and in the capacity indicated.
The National Security Group, Inc.
/s/ Brian R. McLeod | | /s/ William L. Brunson, Jr. |
Brian R. McLeod | | William L. Brunson, Jr. |
President and Chief Executive Officer | | Treasurer and Chief Financial Officer |
Dated: May 12, 2006
18
Exhibit 31.1
CERTIFICATION
I, William L. Brunson, Jr. certify that:
1. | I have reviewed this quarterly report on Form 10-Q of The National Security Group, Inc.; |
| | |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| | |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| | |
4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| | |
| | |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| | |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| | |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| | |
5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| | |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| | |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: May 12, 2006
|
|
|
|
/s/ William L. Brunson, Jr. Chief Executive Officer |
19
Exhibit 31.2
CERTIFICATION
I, Brian R. McLeod, certify that:
1. | I have reviewed this quarterly report on Form 10-Q of The National Security Group, Inc.; |
| | |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| | |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| | |
4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
| | |
| | |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| | |
| (b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| | |
| (c) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| | |
5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| | |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| | |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: May 12, 2006
|
|
|
|
/s/ Brian R. McLeod, CPA Chief Financial Officer |
20
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1 Certification of Chief Executive Officer
Pursuant to 18 U.S.C. § 1350, the undersigned officer of the National Security Group, Inc. (the “Company”), hereby certifies, to such officer’s knowledge, that the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the Securities Exchange Act of 1934 and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
| | | | |
| | |
Date: May 12, 2006 | | | | |
| | | | |
| | | | Name:/s/ William L. Brunson, Jr. Title: Chief Executive Officer |
21
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2 Certification of Chief Financial Officer
Pursuant to 18 U.S.C. § 1350, the undersigned officer of The National Security Group, Inc. (the “Company”), hereby certifies, to such officer’s knowledge, that the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15 (d), as applicable, of the Securities Exchange Act of 1934 and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
| | | | |
| | |
Date: May 12. 2006 | | | | |
| | | | |
| | | | Name:/s/ Brian R. McLeod, CPA Title: Chief Financial Officer |
22
