UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2001
----------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------------ ---------------------
Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- --------------------------------------- -------------------
(Address of principal executive office) (Zip Code)
(515) 280-2902
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at May 1, 2001
----- --------------------------
Common stock, $1.00 par value 11,309,349
Total pages 19
------
1
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2001 2000
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $57,824,139 and $70,975,728) ... $ 55,951,584 $ 70,202,394
Securities available-for-sale, at fair value
(amortized cost $289,989,612 and
$279,770,031) .............................. 297,794,625 284,400,891
Equity securities available-for-sale, at fair
value (cost $29,447,177 and $28,742,915) ..... 33,260,250 34,720,458
Short-term investments, at cost ................ 37,308,204 23,388,027
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $44,809,854 and $48,599,702) ... 41,299,328 45,509,199
Securities available-for-sale, at fair value
(amortized cost $12,509,522 and $9,679,449) 12,882,166 9,755,774
------------ ------------
Total investments ..................... 478,496,157 467,976,743
Cash ............................................. 1,331,106 490,226
Accrued investment income ........................ 6,211,858 7,345,363
Accounts receivable (net of allowance for
uncollectible accounts of $633,000 and $633,000) 147,358 274,014
Income taxes recoverable ......................... - 735,911
Reinsurance receivables .......................... 11,433,152 11,925,355
Deferred policy acquisition costs ................ 18,393,149 15,636,753
Deferred income taxes ............................ 15,071,445 15,445,251
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,515,349
and $2,481,721 ................................. 1,042,471 1,076,099
Prepaid reinsurance premiums ..................... 2,643,820 1,945,099
Indebtedness of related party .................... 13,794,665 17,684,094
Securities lending collateral .................... 59,736,716 60,254,637
Other assets ..................................... 341,838 770,552
------------ ------------
Total assets .......................... $608,643,735 $601,560,097
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
2
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2001 2000
------------ ------------
(Unaudited)
LIABILITIES
Losses and settlement expenses ................... $290,165,596 $286,489,028
Unearned premiums ................................ 89,831,837 87,562,837
Other policyholders' funds ....................... 838,308 728,653
Income taxes payable ............................. 701,740 -
Postretirement benefits .......................... 7,155,648 6,848,512
Deferred income .................................. 63,057 78,212
Securities lending ............................... 59,736,716 60,254,637
Other liabilities ................................ 10,378,170 11,204,902
------------ ------------
Total liabilities ......................... 458,871,072 453,166,781
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,306,625
shares in 2001 and 11,294,220 shares in 2000 ... 11,306,625 11,294,220
Additional paid-in capital ....................... 65,681,741 65,546,963
Accumulated other comprehensive income ........... 7,913,882 7,051,920
Retained earnings ................................ 64,870,415 64,500,213
------------ ------------
Total stockholders' equity ................ 149,772,663 148,393,316
------------ ------------
Total liabilities and stockholders' equity $608,643,735 $601,560,097
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
3
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended
March 31,
------------------------
2001 2000
----------- -----------
REVENUES:
Premiums earned .................................. $60,093,881 $53,427,335
Investment income, net ........................... 7,368,195 6,947,416
Realized investment gains ........................ 587,076 164,385
Other income ..................................... 245,854 605,490
----------- -----------
68,295,006 61,144,626
----------- -----------
LOSSES AND EXPENSES:
Losses and settlement expenses ................... 47,294,321 41,766,260
Dividends to policyholders ....................... 590,339 274,386
Amortization of deferred policy acquisition costs 12,420,179 11,969,362
Other underwriting expenses ...................... 4,960,864 4,723,387
Other expenses ................................... 351,476 407,557
----------- -----------
65,617,179 59,140,952
----------- -----------
Income before income tax expense ........... 2,677,827 2,003,674
----------- -----------
INCOME TAX EXPENSE (BENEFIT):
Current .......................................... 671,861 101,785
Deferred ......................................... (59,187) 284,719
----------- -----------
612,674 386,504
----------- -----------
Net income ................................. $ 2,065,153 $ 1,617,170
=========== ===========
Net income per common share - basic and diluted .... $ .18 $ .14
=========== ===========
Dividends per common share ......................... $ .15 $ .15
=========== ===========
Average number of shares outstanding - basic and
diluted .......................................... 11,298,575 11,266,820
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
4
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended
March 31,
------------------------
2001 2000
----------- -----------
Net income ......................................... $ 2,065,153 $ 1,617,170
----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding gains arising during the
period, before deferred income tax expense ..... 1,882,869 4,178,243
Deferred income tax expense ...................... 640,175 188,013
----------- -----------
1,242,694 3,990,230
----------- -----------
Reclassification adjustment for gains included
in net income, before income tax expense ....... (576,867) (164,385)
Income tax expense................................ 196,135 55,891
----------- -----------
(380,732) (108,494)
----------- -----------
Other comprehensive income .................. 861,962 3,881,736
----------- -----------
Total comprehensive income ..................$ 2,927,115 $ 5,498,906
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
5
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended
March 31,
--------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 2,065,153 $ 1,617,170
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 3,676,568 (466,398)
Unearned premiums ......................... 2,269,000 1,786,507
Other policyholders' funds ................ 109,655 (175,516)
Deferred policy acquisition costs ......... (2,756,396) (419,355)
Indebtedness to related party ............. 3,889,429 5,985,894
Accrued investment income ................. 1,133,505 603,784
Accrued income taxes:
Current ................................. 735,911 664,999
Deferred ................................ (70,234) 284,719
Realized investment gains ................. (587,076) (164,385)
Postretirement benefits ................... 307,136 230,226
Reinsurance receivables ................... 492,203 189,262
Prepaid reinsurance premiums .............. (698,721) (278,868)
Amortization of deferred income ........... (15,155) (23,471)
Other, net ................................ 385,195 (366,173)
------------ ------------
8,871,020 7,851,225
------------ ------------
Net cash provided by
operating activities .............. $ 10,936,173 $ 9,468,395
------------ ------------
6
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Three months ended
March 31,
--------------------------
2001 2000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of fixed maturity securities
held-to-maturity ............................ 18,478,565 1,097,506
Purchases of fixed maturity securities
available-for-sale .......................... (21,072,400) (14,573,157)
Disposals of fixed maturity securities
available-for-sale .......................... 8,078,537 1,326,393
Purchases of equity securities
available-for-sale .......................... (7,601,123) (4,744,432)
Disposals of equity securities
available-for-sale .......................... 7,489,073 4,684,057
Net (purchases) sales of short-term investments (13,920,177) 4,895,490
------------ ------------
Net cash used in investing activities ..... (8,547,525) (7,314,143)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 147,183 155,197
Dividends paid to stockholders ................ (1,694,951) (1,690,043)
------------ ------------
Net cash used in financing activities ..... (1,547,768) (1,534,846)
------------ ------------
NET INCREASE IN CASH ............................ 840,880 619,406
Cash at beginning of year ....................... 490,226 1,508,678
------------ ------------
Cash at end of quarter .......................... $ 1,331,106 $ 2,128,084
============ ============
Income taxes recovered .......................... $ (754,745) $ (563,214)
Interest (received) paid ........................ $ (91,529) $ 154,292
See accompanying Notes to Interim Consolidated Financial Statements.
7
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2001
Note 1
- ------
The results of operations for the interim periods reported are not necessarily
indicative of results to be expected for the year. The information reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
Certain amounts previously reported in prior years' consolidated financial
statements have been reclassified to conform to current year presentation.
In reading these financial statements, reference should be made to the
Company's 2000 Form 10-K or the 2000 Annual Report to Shareholders for more
detailed footnote information.
Note 2
- ------
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. In June 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of Effective Date of
FASB Statement No. 133", which defers the effective date of SFAS 133 until
fiscal years beginning after June 15, 2000. Currently, the Company's
investment strategy does not include investments in derivative instruments or
hedging activities. Therefore, adoption of this statement did not have any
effect on the operating results of the Company.
Note 3
- ------
Effective January 1, 2001, the Company began recording the full-term premium
amount due on policies that are billed on an installment basis. Previously,
such amounts were recorded as each installment became due. This resulted in an
increase to "Indebtedness of related party" and "Unearned premiums" of
$13,884,423 on the consolidated balance sheet as of March 31, 2001. This
change did not affect earned premiums on the consolidated statements of income
nor have a material effect on the operating results of the Company for the
three months ended March 31, 2001. Corresponding amounts in the December 31,
2000 consolidated balance sheet have been reclassified to conform to the
presentation utilized in the 2001 consolidated balance sheet. These changes
had no effect on previously reported stockholders' equity as of December 31,
2000.
8
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Unaudited)
OVERVIEW
EMC Insurance Group Inc., an approximately 77 percent-owned subsidiary of
Employers Mutual Casualty Company (Employers Mutual), is an insurance holding
company with operations in property and casualty insurance and reinsurance.
Property and casualty insurance is the most significant segment, representing
80.6 percent of consolidated premiums earned. For purposes of this discussion,
the term "Company" is used interchangeably to describe EMC Insurance Group Inc.
(Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. Operations of the pool
give rise to inter-company balances with Employers Mutual, which are settled on
a quarterly basis. The investment and income tax activities of the pool
participants are not subject to the pooling agreement.
The purpose of the pooling agreement is to spread the risk of an exposure
insured by any of the pool participants among all the companies. The pooling
agreement produces a more uniform and stable underwriting result from year to
year for all companies in the pool than might be experienced individually. In
addition, each company benefits from the capacity of the entire pool, rather
than being limited to policy exposures of a size commensurate with its own
assets, and from the wide range of policy forms, lines of insurance written,
rate filings and commission plans offered by each of the companies. A single
set of reinsurance treaties is maintained for the protection of all companies
in the pool.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related losses
and settlement expenses of this business, subject to a maximum loss of
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility or
pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to inter-company balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The information
reflects all adjustments which are, in the opinion of management, necessary for
a fair statement of the results for the interim periods.
9
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months ended March 31, 2001 and 2000 are
as follows:
($ in thousands) 2001 2000
-------- --------
Premiums earned .......................... $ 60,094 $ 53,427
Losses and settlement expenses ........... 47,294 41,766
Acquisition and other expenses ........... 17,971 16,967
-------- --------
Underwriting loss ........................ (5,171) (5,306)
Net investment income .................... 7,368 6,948
Other (expense) income ................... (106) 198
-------- --------
Operating income before income tax expense 2,091 1,840
Realized investment gains ................ 587 164
-------- --------
Income before income tax expense ......... 2,678 2,004
Income tax expense ....................... 613 387
-------- --------
Net income ............................... $ 2,065 $ 1,617
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 46,567 $ 43,351
Increase (decrease) in provision for
insured events of prior years ........ 727 (1,585)
-------- --------
Total losses and settlement expenses $ 47,294 $ 41,766
======== ========
Catastrophe and storm losses ............. $ 871 $ 876
======== ========
Operating results before income taxes improved moderately for the first
three months of 2001 compared to the same period in 2000. This improvement is
attributable to the property and casualty insurance segment, which benefited
from an increase in overall premium rate adequacy and a decline in loss
frequency. Operating results for the reinsurance segment declined for the
first three months of 2001, but remained profitable. Inadequate premium rates,
the result of several years of intense rate competition within the insurance
industry, continue to be the primary factor impeding the Company's performance.
Premium rate levels have improved during the last two years and this
improvement continued during the first three months of 2001 as implemented rate
increases grew progressively larger. This trend of increasing premium rate
levels is expected to continue through the remainder of 2001, but it will take
time for these rate increases to be fully reflected in earned premiums. The
improvement that has been achieved in premium rate adequacy will have a
positive impact on future operating results, but the unpredictable nature of
catastrophe and storm losses will remain. In the meantime, management
continues to work toward improved profitability through re-underwriting
programs for both the existing book of business and the agency force and by
controlling the usage of discretionary rate credits.
10
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premium income increased 12.5 percent for the three months ended March 31,
2001 from the same period in 2000 as both the property and casualty insurance
segment and the reinsurance segment achieved significant growth. Applications
for insurance coverage continued at high levels during the first quarter of
2001 due to the fact that some of the Company's competitors have withdrawn from
certain markets or implemented large rate increases. The Company continues to
be selective in the insurance risks that it accepts and has been able to price
both the new and renewal business at more adequate levels.
Losses and settlement expenses increased 13.2 percent for the three months
ended March 31, 2001 from the same period in 2000. This increase is attributed
to growth in the exposure base of both the property and casualty insurance
segment and the reinsurance segment and adverse development on prior years'
reserves. The Company has historically experienced favorable development in
its reserves and reserving practices have not been changed; however, the amount
of favorable development experienced will fluctuate from quarter to quarter and
from year to year as individual claims are settled.
Acquisition and other expenses increased 5.9 percent for the three months
ended March 31, 2001 from the same period in 2000. This increase reflects the
higher production achieved during the first quarter of 2001, but was limited by
a reduction in commission and profit sharing expenses.
Net investment income increased 6.0 percent for the three months ended
March 31, 2001 from the same period in 2000. This increase is primarily
attributable to a higher average invested balance in bonds. Also contributing
to the increase was approximately $142,000 of interest expense incurred during
the first quarter of 2000 associated with premium refunds mandated by the State
of North Carolina.
Income tax expense increased 58.4 percent for the three months ended March
31, 2001 from the same period in 2000. This increase is attributable to the
improvement in pre-tax income for the first three months of 2001 and a decline
in the amount of tax-exempt interest income earned, which totaled $1,102,000 in
2001 compared to $1,305,000 in 2000.
Effective January 1, 2001, the Company began recording the full-term
premium amount due on policies that are billed on an installment basis.
Previously, such amounts were recorded as each installment became due. This
resulted in an increase to "Indebtedness of related party" and "Unearned
premiums" of $13,884,000 on the consolidated balance sheet as of March 31,
2001. This change did not affect earned premiums on the consolidated
statements of income nor have a material effect on the operating results of
the Company for the three months ended March 31, 2001. Corresponding amounts
in the December 31, 2000 consolidated balance sheet have been reclassified to
conform to the presentation utilized in the 2001 consolidated balance sheet.
Such changes had no effect on previously reported stockholders' equity as of
December 31, 2000.
11
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months ended March 31, 2001 and 2000 are
as follows:
($ in thousands) 2001 2000
-------- --------
Premiums earned .......................... $ 48,411 $ 44,007
Losses and settlement expenses ........... 37,122 33,700
Acquisition and other expenses ........... 14,636 14,101
-------- --------
Underwriting loss ........................ (3,347) (3,794)
Net investment income .................... 5,316 4,889
Other income ............................. 27 277
-------- --------
Operating income before income taxes ..... $ 1,996 $ 1,372
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 39,630 $ 37,019
Decrease in provision for insured
events of prior years ................ (2,508) (3,319)
-------- --------
Total losses and settlement expenses $ 37,122 $ 33,700
======== ========
Catastrophe and storm losses ............. $ 817 $ 667
======== ========
Premiums earned increased 10.0 percent for the three months ended
March 31, 2001 from the same period in 2000. This increase is primarily
attributable to an increase in the exposure base of the commercial lines of
business and rate increases that have been implemented during the last two
years. Premium rate levels for property and casualty insurance continued to
improve during the first quarter of 2001 as moderate single-digit to larger
double-digit rate increases were implemented in most lines of business. This
trend of increasing premium rate levels is expected to continue through the
remainder of 2001. Premium income for the first three months of 2000 reflects
approximately $239,000 of premium refunds mandated by the State of North
Carolina.
Losses and settlement expenses increased 10.2 percent for the three months
ended March 31, 2001 from the same period in 2000, primarily as a result of the
increase in exposure base noted above. Loss frequency declined during the
first three months of 2001, continuing the trend that began in 2000, but the
impact on operating results was partially offset by an increase in loss
severity. The benefit realized from the development of prior years' reserves
declined for the first three months of 2001 while catastrophe and storm losses
increased slightly due to winter storms.
Acquisition and other expenses increased 3.8 percent for the three months
ended March 31, 2001 from the same period in 2000. This increase is
significantly less than the growth in premium income due to the fact that a
significant portion of the growth in premium income occurred in the workers'
compensation line of business, which has a lower commission rate.
12
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Other income decreased 90.3 percent for the three months ended March 31,
2001 from the same period in 2000. This decrease is primarily the result of a
decline in operating income of the excess and surplus lines insurance agency
due to the discontinuation of a long-haul trucking program.
Underwriting results for the property and casualty insurance segment
improved for the first quarter of 2001, but remained unprofitable due to
inadequate premium rate levels. Premium rate levels have improved over the
last two years and this trend is expected to continue through the remainder
of 2001; however, it will take time for these rates increases to be fully
reflected in earned premiums. The improvement that has been achieved in
premium rate adequacy will have a positive impact on future underwriting
results, but the unpredictable nature of catastrophe and storm losses will
remain. In the meantime, management continues to work toward improved
profitability through re-underwriting programs for both the existing book of
business and the agency force and by controlling the usage of discretionary
rate credits.
Reinsurance
Operating results for the three months ended March 31, 2001 and 2000 are
as follows:
($ in thousands) 2001 2000
-------- --------
Premiums earned ............................ $ 11,683 $ 9,420
Losses and settlement expenses ............. 10,172 8,066
Acquisition and other expenses ............. 3,335 2,866
-------- --------
Underwriting loss .......................... (1,824) (1,512)
Net investment income ...................... 1,998 1,987
Other income ............................... 15 23
-------- --------
Operating income before income taxes ....... $ 189 $ 498
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ....... $ 6,937 $ 6,332
Increase in provision for insured
events of prior years .................. 3,235 1,734
-------- --------
Total losses and settlement expenses $ 10,172 $ 8,066
======== ========
Catastrophe losses ......................... $ 54 $ 209
======== ========
Premium income increased 24.0 percent for the three months ended March 31,
2001 from the same period in 2000. This large increase reflects $500,000 of
"earned but not reported" premium associated with the addition of a new marine
syndicate account, substantial growth in the exposure base of existing
contracts, the addition of several new contracts and modest rate increases.
Due to the time lag in reporting on certain foreign reinsurance contracts,
estimated amounts of premium income and related losses and expenses are booked
on a quarterly basis. These estimates are adjusted when the reported amounts
deviate from the estimates. Industry premium rates improved during 2000 and
the reinsurance subsidiary was successful in obtaining moderate rate increases
on many of its reinsurance contracts during the January renewal season, when
the majority of its reinsurance contracts renew. Industry premium rates
continued to show moderate improvement during the first quarter of 2001 and
this trend is expected to continue through the remainder of 2001.
13
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Losses and settlement expenses increased 26.1 percent for the three months
ended March 31, 2001 from the same period in 2000. This increase is attributed
to the increase in exposure base noted above as well as a significant increase
in adverse development on prior years' reserves, primarily from a reinsurance
pool in which the reinsurance subsidiary participates. Results for the first
quarter of 2001 also reflect increased loss activity from construction defect
claims and winter storms.
Acquisition and other expenses increased 16.4 percent for the three months
ended March 31, 2001 as compared to the same period in 2000. This increase
reflects the growth in premium income achieved in the first three months of
2001, but was limited by a decline in profit sharing expenses associate with
the poor loss performance of the reinsurance pool noted above.
Underwriting results declined in 2001 as the reinsurance segment
experienced a significant increase in adverse development on prior years'
reserves and increased loss activity on certain accounts. Industry premium
rate levels improved during 2000 and the reinsurance subsidiary was able to
implement moderate rate increases during the January 2001 renewal season;
however, premium rate levels are still considered to be inadequate and the
excess capacity that led to the reduction in premium rate levels continues to
exist. Underwriting results for the remainder of 2001 will benefit from the
recent rate increases, but it is unknown whether the trend of increased loss
frequency and severity will continue. Employers Mutual continues to work
toward improving profitability on the assumed book of business by accepting a
larger share of coverage on desirable programs, strengthening its relationships
with reinsurance intermediaries and monitoring premium growth.
Parent Company
The parent company reported an operating loss before income taxes of
$94,000 for the three months ended March 31, 2001 compared to an operating loss
of $30,000 for the same period in 2000. The decrease in the 2001 operating
results is due to higher operating expenses and, to a lesser extent, a decline
in investment income.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of its investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds to
meet claims and expenses. The remainder of the investment portfolio, excluding
investments in equity securities, is invested in securities with maturities
that approximate the anticipated liabilities of the insurance issued.
14
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
The Company has previously classified a portion of its investments in fixed
maturity securities, primarily bonds issued by municipalities and corporations,
as available-for-sale securities to provide flexibility in the management of
the portfolio. Beginning in the third quarter of 1999, all newly acquired
securities are being classified as available-for-sale to provide increased
management flexibility. The Company had an unrealized holding gain on fixed
maturity securities available-for-sale of $5,397,000 at March 31, 2001 compared
to $3,107,000 at December 31, 2000. The fluctuation in the market value of
these investments is primarily due to changes in the interest rate environment
during this time period. Since the Company does not actively trade in the bond
market, 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 investment policy as
changing conditions warrant.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of income which
supplements underwriting results and contributes to net earnings. As these
investments mature, the proceeds will be reinvested at current 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 depending on
the interest rate level.
The Company participates in a securities lending program whereby certain
fixed maturity securities from the investment portfolio are loaned to other
institutions for short periods of time. The Company receives a fee for each
security loaned out under this program and requires initial collateral,
primarily cash, equal to 102 percent of the market value of the loaned
securities.
During 1999 and 2000 the Company sold approximately $55,000,000 and
$14,000,000, respectively, of investments in tax-exempt fixed maturity
securities and reinvested the proceeds in taxable fixed maturity securities.
This change in asset allocation is not expected to have a material impact on
the operations of the Company, as forced liquidations of investments are not
anticipated.
The major ongoing sources of the Company's liquidity are insurance premium
income, investment income and cash provided from maturing or liquidated
investments. The principal outflows of cash are payments of claims,
commissions, premium taxes, operating expenses, income taxes, dividends and
investment purchases.
The Company generated positive cash flows from operations of $10,936,173
during the first quarter of 2001 as compared to $9,468,395 for the same period
of 2000.
Employers Mutual continued to reinvest 100 percent of its dividends in
additional shares of the Company's common stock during the first quarter of
2001. It is not known whether, or for how long, Employers Mutual will continue
to participate in the Company's dividend reinvestment plan, or whether it will
change its level of participation in the plan.
15
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 133, "Accounting for
Derivative Instruments and Hedging Activities", effective for fiscal years
beginning afterJune 15, 1999. In June 1999, the FASB issued SFAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS 133 until fiscal years beginning after June 15, 2000. Currently, the
Company's investment strategy does not include investments in derivative
instruments or hedging activities. Therefore, adoption of this statement did
not have any effect on the operating results of the Company.
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 expectations and actual results of the Company may differ
materially from such expectations. 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; state and federal legislation and regulations; changes in the
demand for, pricing of, or supply of insurance or reinsurance; changes in
interest rates and the performance of financial markets; the adequacy of loss
and settlement expense reserves, including asbestos and environmental claims;
and other risks and uncertainties inherent in the Company's business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective board 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. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate 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.
16
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK,
- ------- -----------------------------------------------------------
CONTINUED
---------
(Unaudited)
Interest rate risk includes the price sensitivity of a fixed maturity
security to changes in interest rates and the affect on future earnings from
short-term investments and maturing long-term investments, given a change in
interest rates. The following analysis illustrates the sensitivity of the
Company's financial instruments to selected changes in market rates and prices.
A hypothetical one percent increase in interest rates as of March 31, 2001
would result in a corresponding pre-tax decrease in the fair value of the fixed
maturity portfolios of approximately $22,942,000 or 5.0 percent. In addition,
a hypothetical one percent decrease in interest rates at March 31, 2001 would
result in a corresponding decrease in pre-tax income over the next twelve
months of approximately $1,014,000, assuming the current maturity and
prepayment patterns. The Company monitors interest rate risk through the
analysis of interest rate simulations, and adjusts the average duration of its
fixed maturity portfolio by investing in either longer or shorter term
instruments given the results of interest rate simulations and judgments of
cash flow needs. The effective duration of the fixed maturity portfolio at
March 31, 2001 was 4.88 years.
The valuation of the Company's marketable equity portfolios is subject to
equity price risk. In general, equities have more year-to-year price
variability than bonds. However, returns from equity securities over longer
time frames have been consistently higher. The Company invests in a
diversified portfolio of readily marketable equity securities. A hypothetical
10 percent decrease in the S&P 500 as of March 31, 2001 would result in a
corresponding pre-tax decrease in the fair value of the Company's equity
portfolio of approximately $2,916,000.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At March 31, 2001 the portfolio of long-term
fixed maturity securities consists of 12.3 percent U.S. Treasury, 8.1 percent
government agency, 11.1 percent mortgage-backed, 18.5 percent municipal, and
50.0 percent corporate securities. At December 31, 2000 the portfolio of long-
term fixed maturity securities consisted of 12.5 percent U.S. Treasury, 12.2
percent government agency, 12.3 percent mortgage-backed, 19.1 percent
municipal, and 43.9 percent corporate securities. The Company had one bond
(Southern California Edison) below investment grade. The bond has a book
value of $1,400,000 and is being carried at its market value of $1,134,000.
It is unknown at this time what portion of the bond balance, if any, will be
collectible.
Prepayment risk refers to the changes in prepayment patterns that can
either shorten or lengthen the expected timing of the principal repayments and
thus the average life and the effective yield of a security. Such risk exists
primarily within the portfolio of mortgage-backed securities. The prepayment
risk analysis is monitored regularly through the analysis of interest rate
simulations. At March 31, 2001 the effective duration of the mortgage-backed
securities is 2.7 years with an average life and current yield of 6.3 years and
7.4 percent, respectively. At December 31, 2000 the effective duration of the
mortgage-backed securities was 3.9 years with an average life and current yield
of 5.4 years and 7.4 percent, respectively.
17
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) None.
(b) No Form 8-K was filed by the registrant during the
quarter ended March 31, 2001.
18
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.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: May 14, 2001
19