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 SEPTEMBER 30, 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 October 31, 2001
----- -------------------------------
Common stock, $1.00 par value 11,321,772
Total pages 24
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2001 2000
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $40,957,484 and $70,975,728) ... $ 38,512,092 $ 70,202,394
Securities available-for-sale, at fair value
(amortized cost $342,705,091 and
$279,770,031) .............................. 353,478,961 284,400,891
Equity securities available-for-sale, at fair
value (cost $28,624,602 and $28,742,915) ..... 30,265,989 34,720,458
Short-term investments, at cost ................ 27,793,406 23,388,027
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $45,728,525 and $48,599,702) ... 41,428,271 45,509,199
Securities available-for-sale, at fair value
(amortized cost $16,755,600 and $9,679,499) 18,012,703 9,755,774
------------ ------------
Total investments ..................... 509,491,422 467,976,743
Cash ............................................. 762,479 490,226
Accrued investment income ........................ 7,082,322 7,345,363
Accounts receivable (net of allowance for
uncollectible accounts of $574,702 and $633,000) 313,417 274,014
Income taxes recoverable ......................... 1,070,614 735,911
Reinsurance receivables .......................... 14,221,011 11,925,355
Deferred policy acquisition costs ................ 22,104,578 15,636,753
Deferred income taxes ............................ 16,557,532 15,445,251
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,582,606
and $2,481,721 ................................. 975,214 1,076,099
Prepaid reinsurance premiums ..................... 3,542,300 1,945,099
Indebtedness of related party .................... 8,239,605 17,684,094
Securities lending collateral .................... 65,851,335 60,254,637
Other assets ..................................... 330,238 770,552
------------ ------------
Total assets .......................... $650,542,067 $601,560,097
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2001 2000
------------ ------------
(Unaudited)
LIABILITIES
Losses and settlement expenses ................... $307,100,099 $286,489,028
Unearned premiums ................................ 105,211,919 87,562,837
Other policyholders' funds ....................... 365,725 728,653
Postretirement benefits .......................... 7,667,430 6,848,512
Deferred income .................................. 38,353 78,212
Securities lending obligation .................... 65,851,335 60,254,637
Other liabilities ................................ 19,517,474 11,204,902
------------ ------------
Total liabilities ......................... 505,752,335 453,166,781
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,321,497
shares in 2001 and 11,294,220 shares in 2000 ... 11,321,497 11,294,220
Additional paid-in capital ....................... 65,877,563 65,546,963
Accumulated other comprehensive income ........... 9,023,753 7,051,920
Retained earnings ................................ 58,566,919 64,500,213
------------ ------------
Total stockholders' equity ................ 144,789,732 148,393,316
------------ ------------
Total liabilities and stockholders' equity $650,542,067 $601,560,097
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
2001 2000 2001 2000
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$69,138,856 $58,617,746 $192,548,093 $167,177,512
Investment income, net ... 7,932,760 7,328,513 23,082,657 21,508,240
Realized investment
(losses) gains ......... (39,421) 574,984 562,317 904,237
Other income ............. 148,046 271,664 590,002 1,264,630
----------- ----------- ------------ ------------
77,180,241 66,792,907 216,783,069 190,854,619
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 57,796,154 46,971,850 162,802,872 135,845,029
Dividends to policyholders 471,493 630,354 1,060,241 1,147,760
Amortization of deferred
policy acquisition costs 13,932,628 12,561,548 39,864,489 36,759,123
Other underwriting
expenses ............... 5,573,609 4,852,337 15,248,838 12,846,085
Other expenses ........... 173,266 347,890 921,473 1,117,982
----------- ----------- ------------ ------------
77,947,150 65,363,979 219,897,913 187,715,979
----------- ----------- ------------ ------------
(Loss) income before
income tax (benefit)
expense .............. (766,909) 1,428,928 (3,114,844) 3,138,640
----------- ----------- ------------ ------------
INCOME TAX (BENEFIT)
EXPENSE:
Current ................ (8,480) 574,237 (142,528) 682,711
Deferred ............... (694,901) (349,525) (2,128,076) (561,305)
----------- ----------- ------------ ------------
(703,381) 224,712 (2,270,604) 121,406
----------- ----------- ------------ ------------
Net (loss) income ..$ (63,528)$ 1,204,216 $ (844,240)$ 3,017,234
=========== =========== ============ ============
Net (loss) income per
common share -
basic and diluted ........$ (.01)$ .11 $ (.07)$ .27
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .45 $ .45
=========== =========== ============ ============
Average number of common
shares outstanding -
basic and diluted ........ 11,316,708 11,290,979 11,308,273 11,281,968
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
Net (loss) income .......... $ (63,528)$ 1,204,216 $ (844,240)$ 3,017,234
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding
gains arising during the
period, before deferred
income tax expense ..... 2,872,383 4,639,391 3,539,740 7,427,043
Deferred income tax
expense ................ 976,612 1,180,658 1,203,516 1,292,604
----------- ----------- ----------- -----------
1,895,771 3,458,733 2,336,224 6,134,439
----------- ----------- ----------- -----------
Reclassification
adjustment for (losses)
gains included in net
income, before income
tax (benefit) expense .. 39,421 (574,984) (552,108) (904,237)
Income tax (benefit)
expense ................ (13,403) 195,495 187,717 307,441
----------- ----------- ----------- -----------
26,018 (379,489) (364,391) (596,796)
----------- ----------- ----------- -----------
Other comprehensive
income ........... 1,921,789 3,079,244 1,971,833 5,537,643
----------- ----------- ----------- -----------
Total comprehensive
income ........... $ 1,858,261 $ 4,283,460 $ 1,127,593 $ 8,554,877
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
--------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ............................. $ (844,240) $ 3,017,234
------------ ------------
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Losses and settlement expenses ............ 20,611,071 8,633,767
Unearned premiums ......................... 17,649,082 13,450,936
Other policyholders' funds ................ (362,928) (333,774)
Deferred policy acquisition costs ......... (6,467,825) (2,962,913)
Indebtedness of related party ............. (2,733,753) (5,301,811)
Accrued investment income ................. 263,041 617,507
Accrued income taxes:
Current ................................. (334,703) 695,750
Deferred ................................ (2,128,080) (561,304)
Realized investment gains ................. (562,317) (904,237)
Postretirement benefits ................... 818,918 690,678
Reinsurance receivables ................... (2,295,656) (1,676,494)
Prepaid reinsurance premiums .............. (1,597,201) (1,171,964)
Amortization of deferred income ........... (39,859) (63,542)
Other, net ................................ 8,546,944 1,778,802
------------ ------------
31,366,734 12,891,401
Cash provided by the property and casualty
insurance subsidiaries' change in
recording the full-term premium amount
on policies billed on an installment
basis (note 2) .......................... 12,178,242 -
------------ ------------
Net cash provided by
operating activities ................ $ 42,700,736 $ 15,908,635
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Nine months ended
September 30,
--------------------------
2001 2000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of fixed maturity securities
held-to-maturity ............................ $ 35,808,699 $ 8,442,086
Purchases of fixed maturity securities
available-for-sale .......................... (95,881,016) (39,542,271)
Disposals of fixed maturity securities
available-for-sale .......................... 26,112,612 16,882,174
Purchases of equity securities
available-for-sale .......................... (19,489,793) (16,781,588)
Disposals of equity securities
available-for-sale .......................... 20,157,569 17,150,692
Net (purchases) sales of short-term investments (4,405,377) 3,716,072
------------ ------------
Net cash used in investing activities ....... (37,697,306) (10,132,835)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 357,877 234,572
Dividends paid to stockholders ................ (5,089,054) (5,077,358)
------------ ------------
Net cash used in financing activities ..... (4,731,177) (4,842,786)
------------ ------------
NET INCREASE IN CASH ............................ 272,253 933,014
Cash at beginning of year ....................... 490,226 1,508,678
------------ ------------
Cash at end of quarter .......................... $ 762,479 $ 2,441,692
============ ============
Income taxes paid (recovered) ................... $ 191,684 $ (13,122)
Interest (received) paid ........................ $ (79,232) $ 12,587
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
1. BASIS OF PRESENTATION
The results of operations for the interim periods reported are not
necessarily indicative of the results to be expected for the year. The
information reflects all adjustments (which include only normal recurring
adjustments) that 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.
2. INSTALLMENT BASIS PREMIUMS
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. As a
result, on January 1, 2001 written premiums and unearned premiums increased
$13,884,423, assets increased $12,178,242 and the Company incurred $1,706,181
of commission expense. This change did not affect earned premiums on the
consolidated statements of income for the three and nine months ended
September 30, 2001 and the operating results for those periods were not
materially affected as the commission expense was offset by an increase in
deferred policy acquisition costs. For comparative purposes, the December 31,
2000 consolidated balance sheet has been restated to conform to the
presentation utilized in the 2001 consolidated balance sheet. This change had
no effect on the previously reported stockholders' equity as of December 31,
2000.
3. WORLD TRADE CENTER
On September 11, 2001 a terrorist attack was made on the World Trade
Center in New York. The Company's estimated pretax losses as a result of this
atrocious event totaled $1,617,500. The majority of the Company's exposure to
the World Trade Center came from the reinsurance business assumed by the
Company's reinsurance subsidiary from Employers Mutual Casualty Company
(Employers Mutual). Under the quota share agreement in place between the
Company's reinsurance subsidiary and Employers Mutual, the Company's losses
from this event were capped at $1,500,000. The remainder ($117,500) is from
direct business written by the Company's property and casualty insurance
subsidiaries.
4. 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
environment in which they operate.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
Summarized financial information for the Company's segments is as
follows:
Property
Three months ended and casualty Parent
September 30, 2001 insurance Reinsurance Company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 51,637,788 $ 17,501,068 $ 69,138,856
Underwriting loss .... (6,358,566) (2,276,462) (8,635,028)
Net investment income 5,793,272 2,094,020 $ 45,468 7,932,760
Realized loss ........ (35,210) (4,211) - (39,421)
Other income ......... 136,547 11,499 - 148,046
Other expense ........ (100,587) - (72,679) (173,266)
------------ ------------ ------------ ------------
Loss before income
tax benefit ........ $ (564,544) $ (175,154) $ (27,211) $ (766,909)
============ ============ ============ ============
Property
Three months ended and casualty Parent
September 30, 2000 insurance Reinsurance Company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 47,111,895 $ 11,505,851 $ 58,617,746
Underwriting loss .... (4,062,684) (2,335,659) (6,398,343)
Net investment income 5,289,832 1,948,483 $ 90,198 7,328,513
Realized gains ....... 489,144 85,840 - 574,984
Other income ......... 252,695 18,969 - 271,664
Other expense ........ (276,040) - (71,850) (347,890)
------------ ------------ ------------ ------------
Income (loss) before
income tax (benefit)
expense ............ $ 1,692,947 $ (282,367) $ 18,348 $ 1,428,928
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
Property
Nine months ended and casualty Parent
September 30, 2001 insurance Reinsurance Company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $150,458,463 $ 42,089,630 $192,548,093
Underwriting loss .... (20,206,176) (6,222,171) (26,428,347)
Net investment income 16,737,370 6,190,239 $ 155,048 23,082,657
Realized gains
(losses) ........... 576,633 (14,316) - 562,317
Other income ......... 550,143 39,859 - 590,002
Other expense ........ (536,953) - (384,520) (921,473)
------------ ------------ ------------ ------------
Loss before income
tax benefit ........ $ (2,878,983) $ (6,389) $ (229,472) $ (3,114,844)
============ ============ ============ ============
Property
Nine months ended and casualty Parent
September 30, 2000 insurance Reinsurance Company Consolidated
- -------------------- ------------ ------------ ------------ ------------
Premiums earned ...... $136,178,624 $ 30,998,888 $167,177,512
Underwriting loss .... (14,357,663) (5,062,822) (19,420,485)
Net investment income 15,353,947 5,894,769 $ 259,524 21,508,240
Realized gains ....... 830,292 73,945 - 904,237
Other income ......... 1,201,088 63,542 - 1,264,630
Other expense ........ (811,796) - (306,186) (1,117,982)
------------ ------------ ------------ ------------
Income (loss) before
income tax (benefit)
expense ............ $ 2,215,868 $ 969,434 $ (46,662) $ 3,138,640
============ ============ ============ ============
5. INCOME TAXES
The actual income tax (benefit) expense for the three months and nine
months ended September 30, 2001 and 2000 differed from the "expected" tax
(benefit) expense for those periods (computed by applying the United States
federal corporate tax rate of 34 percent to (loss) income before income tax
(benefit) expense) as follows:
Three months ended Nine months ended
September 30, September 30,
--------------------- ------------------------
2001 2000 2001 2000
--------- --------- ----------- -----------
Computed "expected" tax
(benefit) expense .......... $(260,749) $ 485,836 $(1,059,047) $ 1,067,138
Increases (decreases) in tax
resulting from:
Tax-exempt interest
income ................ (361,910) (406,821) (1,108,768) (1,293,208)
Proration of tax-exempt
interest and dividends
received deduction .... 41,451 46,500 125,021 150,885
Other, net .............. (122,173) 99,197 (227,810) 196,591
--------- --------- ----------- -----------
Income tax (benefit)
expense ........... $(703,381) $ 224,712 $(2,270,604) $ 121,406
========= ========= =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
6. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities", effective for fiscal years
beginning after June 15, 1999. In June 1999, the FASB issued SFAS No.137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS No. 133 until fiscal years beginning after June 15, 2000. In June 2000,
the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities - an amendment of FASB Statement No. 133".
SFAS No. 138 addresses a limited number of Statement No. 133 implementation
issues, and is effective for 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 these
statements did not have any effect on the operating results of the Company.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142 "Goodwill and Other Intangible Assets". SFAS No. 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and establishes specific criteria for the recognition of
intangible assets separately from goodwill. SFAS No. 142 addresses accounting
for intangible assets, eliminates the amortization of goodwill and provides
specific steps for testing the impairment of goodwill. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001; however, the
amortization provisions apply to goodwill and intangible assets acquired after
June 30, 2001. The Company is currently reviewing these statements to
determine what impact, if any, they will have on the operating results of the
Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which is effective for fiscal
years beginning after December 15, 2001. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of". SFAS No. 144 requires that one accounting model be
used for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions. Adoption of this statement
will not have any effect on the operating results of the Company.
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 79 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
78.1 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. Employers Mutual and all of its subsidiaries (including the
Company) and an affiliate, are referred to as the "EMC Insurance Companies."
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
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to inter-company balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not
necessarily indicative of the results to be expected for the year. The
information reflects all adjustments (which include only normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and nine months ended September
30, 2001 and 2000 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2001 2000 2001 2000
-------- -------- -------- --------
Premiums earned ..................... $ 69,139 $ 58,618 $192,548 $167,178
Losses and settlement expenses ...... 57,796 46,972 162,803 135,845
Acquisition and other expenses ...... 19,978 18,044 56,174 50,753
-------- -------- -------- --------
Underwriting loss ................... (8,635) (6,398) (26,429) (19,420)
Net investment income ............... 7,933 7,328 23,083 21,508
Other (loss) income ................. (25) (76) (331) 147
-------- -------- -------- --------
Operating (loss) income before
income tax (benefit) expense ...... (727) 854 (3,677) 2,235
Realized investment (losses) gains .. (40) 575 562 904
-------- -------- -------- --------
(Loss) income before income tax
(benefit) expense ................. (767) 1,429 (3,115) 3,139
Income tax (benefit) expense ........ (703) 225 (2,271) 122
-------- -------- -------- --------
Net (loss) income ................... $ (64)$ 1,204 $ (844)$ 3,017
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 57,669 $ 48,053 $163,043 $140,080
Increase (decrease) in provision
for insured events of prior
years ......................... 127 (1,081) (240) (4,235)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 57,796 $ 46,972 $162,803 $135,845
======== ======== ======== ========
Catastrophe and storm losses ........ $ 6,788 $ 2,252 $ 19,373 $ 7,683
======== ======== ======== ========
Operating results before income taxes declined significantly for both the
three months and nine months ended September 30, 2001 as compared to the same
periods in 2000. These declines are primarily attributed to an unusually
large increase in catastrophe and storm losses, including $1,618,000 of losses
associated with the World Trade Center terrorist attack. The majority of the
Company's exposure to the World Trade Center catastrophe came from the
reinsurance business assumed by the Company's reinsurance subsidiary from
Employers Mutual. Under the quota share agreement in place between the
Company's reinsurance subsidiary and Employers Mutual, the Company's losses
from this atrocious event were capped at $1,500,000. The remainder ($118,000)
is from direct business written by the Company's property and casualty
insurance subsidiaries.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
In addition to the large increase in catastrophe and storm losses, the
Company's operating performance for the first nine months of 2001 continued to
be hampered by the inadequate premium rate levels that persist in the
insurance marketplace. After bottoming out in 1998, premium rate levels have
shown moderate, but steady, improvement over the last three years. During
2000 and the first nine months of 2001, implemented premium rate increases
have been growing progressively larger and this trend is expected to intensify
through 2002 as a result of the terrorist attack on the World Trade Center;
however, it will take time for premium rates to return to adequate levels.
The improvement that has been achieved in premium rate adequacy over the last
three years 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 improving profitability through
focused underwriting programs and by reducing discretionary rate credits.
Premiums earned increased 17.9 percent for the three months and 15.2
percent for the nine months ended September 30, 2001 from the same periods in
2000. Both the property and casualty insurance segment and the reinsurance
segment achieved significant growth in 2001 through a combination of
implemented rate increases and increased exposures. Applications for
insurance coverage have continued at high levels during the first nine months
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 new and renewal business at more adequate levels.
Losses and settlement expenses increased 23.0 percent for the three
months and 19.8 percent for the nine months ended September 30, 2001 from the
same periods in 2000. These increases are primarily attributed to the
unusually large amount of catastrophe and storm losses experienced in 2001.
In addition to the large increase in catastrophe and storm losses, the Company
has experienced a substantial decline in the amount of benefit realized from
the favorable development of prior years' reserves. The Company has
historically experienced favorable development in its reserves and its
reserving practices have not 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 10.7 percent for both the three
months and nine months ended September 30, 2001 from the same periods in 2000.
These increases are primarily attributed to the higher premium levels of 2001,
but were limited by a decline in contingent commission expense and a lower
commission rate on reinstatement premiums recorded during the third quarter of
2001.
Net investment income increased 8.3 percent for the three months and 7.3
percent for the nine months ended September 30, 2001 from the same periods in
2000. These increases are primarily attributed to a higher average invested
balance in fixed-maturity securities. The Company experienced a significant
amount of call activity on its fixed-maturity securities during the first nine
months of 2001 due to the decline in interest rates. Proceeds from this call
activity have been reinvested at current interest rates, which will have a
negative impact on future investment income.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Realized investment gains declined for both the three months and nine
months ended September 30, 2001 from the same periods in 2000. The amounts
reported for 2000 include gains that were realized in connection with the
change in the Company's asset allocation from tax-exempt securities to taxable
securities.
The Company reported an income tax benefit for both the three months and
nine months ended September 30, 2001 compared to income tax expense for the
same periods in 2000. This change in tax status primarily reflects the
decline in pre-tax operating results experienced in 2001.
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. As a
result, on January 1, 2001 written premiums and unearned premiums increased
$13,884,423, assets increased $12,178,242 and the Company incurred $1,706,181
of commission expense. This change did not affect earned premiums on the
consolidated statements of income for the three and nine months ended
September 30, 2001 and the operating results for those periods were not
materially affected as the commission expense was offset by an increase in
deferred policy acquisition costs. For comparative purposes, the December 31,
2000 consolidated balance sheet has been restated to conform to the
presentation utilized in the 2001 consolidated balance sheet. This change had
no effect on the previously reported stockholders' equity as of December 31,
2000.
A.M. Best announced on July 10, 2001 that their rating of the EMC
Insurance Companies, which includes the Company's property and casualty
insurance subsidiaries, was changed from "A" (Excellent) to "A-" (Excellent).
This rating action reflects A.M. Best's perception of the EMC Insurance
Companies underwriting performance and operating losses over the past three
years. Despite this rating action, A.M. Best stated that the EMC Insurance
Companies' Excellent rating reflects its strong capitalization, conservative
operating strategies and local-market presence. Management does not believe
that the new rating will have a material impact on the Company's operations.
The September 11, 2001 terrorist attack on the World Trade Center will
have a significant impact on the operating results of insurance industry in
2001, but the repercussions of this atrocious event will last well beyond
2001. Limitations of coverage, exclusions for terrorist activities and
significant increases in pricing are anticipated for reinsurance policies that
renew in January 2002. In order for the Company to continue to provide
insurance in the absence of terrorism reinsurance, a federal government
reinsurance program for terrorist acts will need to be enacted as a backstop.
The Company will not be immune to these factors and will likely face
significantly higher costs and increased retentions when it renews its
reinsurance program for 2002; however, the Company should benefit from the
increased pricing that is expected to occur in the property and casualty
insurance industry due to the anticipated increase in reinsurance rates.
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 and nine months ended September
30, 2001 and 2000 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2001 2000 2001 2000
-------- -------- -------- --------
Premiums earned ..................... $ 51,638 $ 47,112 $150,458 $136,179
Losses and settlement expenses ...... 42,972 37,124 126,593 108,935
Acquisition and other expenses ...... 15,025 14,050 44,072 41,601
-------- -------- -------- --------
Underwriting loss ................... (6,359) (4,062) (20,207) (14,357)
Net investment income ............... 5,794 5,290 16,738 15,354
Other income (expense) .............. 35 (24) 13 389
-------- -------- -------- --------
Operating (loss) income
before income taxes ............... $ (530)$ 1,204 $ (3,456)$ 1,386
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 42,532 $ 37,203 $130,873 $114,671
Increase (decrease) in provision
for insured events of prior
years ......................... 440 (79) (4,280) (5,736)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 42,972 $ 37,124 $126,593 $108,935
======== ======== ======== ========
Catastrophe and storm losses ........ $ 3,808 $ 2,233 $ 14,812 $ 7,062
======== ======== ======== ========
Premiums earned increased 9.6 percent for the three months and 10.5
percent for the nine months ended September 30, 2001 from the same periods in
2000. These increases are primarily attributable to rate increases that have
been implemented during the last two years and an increase in the exposure
base of the commercial lines of business. Premium rate levels for property
and casualty insurance continued to improve during the third quarter of 2001
as rate increases ranging from six to thirteen percent were implemented in
most lines of business. Premium rate increases have grown progressively
larger during the first nine months of 2001 and this trend is expected to
intensify through 2002 as a result of the terrorist attack on the World Trade
Center; however, it will take time for premium rates to return to adequate
levels. Premium income for the first nine months of 2000 reflects
approximately $239,000 of premium refunds mandated by the State of North
Carolina.
Losses and settlement expenses increased 15.8 percent for the three
months and 16.2 percent for the nine months ended September 30, 2001 from the
same periods in 2000. These increases are primarily the result of an
unusually large amount of catastrophe and storm losses that were experienced
during the second and third quarters of 2001. Excluding the affect of
catastrophe and storm losses, overall loss experience for 2001 has been
negatively impacted by an increase in both large losses and loss severity, but
benefited from a decline in loss frequency. The benefit realized from the
favorable development of prior years' reserves declined for both the third
quarter and the first nine months of 2001.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Acquisition and other expenses increased 6.9 percent for the three months
and 5.9 percent for the nine months ended September 30, 2001 from the same
periods in 2000. These increases are primarily related to the growth in
premium income reported for these periods.
Underwriting results for the three months and nine months ended September
30, 2001 declined from the same periods in 2000, primarily due to a
significant increase in catastrophe and storm losses. In addition,
underwriting results continue to be hampered by inadequate premium rate
levels. Premium rate levels continued to grow progressively larger during the
third quarter of 2001 and future increases are expected to intensify through
2002 as a result of the terrorist attack on the World Trade Center; however,
it will take time for premium rates to return to adequate levels. 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. Management continues to work toward
improving profitability through focused underwriting programs and by
controlling the usage of discretionary rate credits.
Reinsurance
Operating results for the three months and nine months ended September
30, 2001 and 2000 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 2001 2000 2001 2000
-------- -------- -------- --------
Premiums earned ..................... $ 17,501 $ 11,506 $ 42,090 $ 30,999
Losses and settlement expenses ...... 14,824 9,848 36,210 26,910
Acquisition and other expenses ...... 4,953 3,994 12,102 9,152
-------- -------- -------- --------
Underwriting loss ................... (2,276) (2,336) (6,222) (5,063)
Net investment income ............... 2,093 1,949 6,190 5,895
Other income ........................ 12 19 40 64
-------- -------- -------- --------
Operating (loss) income before
income taxes ...................... $ (171)$ (368) $ 8 $ 896
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 15,137 $ 10,850 $ 32,170 $ 25,409
(Decrease) increase in
provision for insured events
of prior years ................ (313) (1,002) 4,040 1,501
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 14,824 $ 9,848 $ 36,210 $ 26,910
======== ======== ======== ========
Catastrophe and storm losses ........ $ 2,980 $ 19 $ 4,561 $ 621
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premiums earned increased 52.1 percent for the three months and 35.8
percent for the nine months ended September 30, 2001 from the same periods in
2000. These increases reflect the addition of a new marine syndicate account,
the addition of new contracts, growth in the exposure base of existing
contracts and modest rate increases. In addition, the increase in premiums
earned also reflects approximately $2,001,000 of reinstatement premiums
associated with the World Trade Center catastrophe. Industry premium rates
have continued to show moderate improvement during the first nine months of
2001 and management anticipates that more aggressive rate increases will be
placed on all classes of assumed reinsurance business in the upcoming January
2002 renewal season. These expected rate increases are consistent with the
movement of the reinsurance industry towards more adequate rate levels,
particularly in light of the recent terrorist attacks.
Losses and settlement expenses increased 50.5 percent for the three
months and 34.6 percent for the nine months ended September 30, 2001 from the
same periods in 2000. These increases are primarily attributed to a
substantial increase in catastrophe and storm losses, but also reflect the
increase in exposure base noted above. The reinsurance subsidiary incurred
significant catastrophe and storm losses in the second and third quarters of
2001, primarily from Midwest wind and hail storms, flood losses from tropical
storm Allison and losses associated with the September 11, 2001 terrorist
attack on the World Trade Center. Under the quota share agreement in place
between the reinsurance subsidiary and Employers Mutual, the reinsurance
subsidiary's losses from the World Trade Center were capped at $1,500,000.
The reinsurance subsidiary's results for 2001 have also been negatively
impacted by significant levels of adverse development on prior years' reserves
and by increased loss activity from construction defect claims and winter
storm losses.
Acquisition and other expenses increased 24.0 percent for the three
months and 32.2 percent for the nine months ended September 30, 2001 from the
same periods in 2000. These increases primarily reflect the large increase in
premium income experienced during 2001; however, the increase for the three
months ended September 30, 2001 was limited by a decline in contingent
commission expense. It should also be noted that the reinstatement premiums
recognized during the third quarter of 2001 carried a five percent commission
rate, which resulted in the recognition of approximately $100,000 of
commission expense. Commission rates on reinstatement premiums are much lower
than the rates imposed on the base premium.
Underwriting results improved marginally for the three months but
declined for the nine months ended September 30, 2001 compared to the same
periods in 2000. Significantly higher catastrophe and storm losses, increased
adverse development on prior years' reserves and increased loss activity on
certain accounts are the primary contributors to the decline in 2001 results.
Although moderate rate increases were implemented during the 2001 renewal
season, premium rate levels are still considered to be inadequate.
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. The upcoming January 2002 renewal
season is expected to produce more aggressive rate increases for the
reinsurance industry, which should benefit the reinsurance subsidiary's future
operating results. In addition to rate increases, Employers Mutual is working
towards 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Parent Company
Operating results before income taxes totaled ($26,000) and ($229,000)
for the three months and nine months ended September 30, 2001 compared to
$18,000 and ($47,000) for the same periods in 2000. The decline in operating
results is due to the combination of a reduction in investment income that has
resulted from a decline in the invested asset balance, and an increase in
expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of the 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.
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
Despite this intent, the Company has historically classified a portion of its
fixed maturity investments as available-for-sale securities to provide
flexibility in the management of the portfolio. Since the third quarter of
1999, all newly acquired fixed maturity investments have been classified as
available-for-sale securities to provide increased management flexibility.
The Company had an unrealized holding loss on fixed maturity securities
available-for-sale of $7,940,000 at September 30, 2001 compared to an
unrealized holding gain of $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 investment
income that supplements underwriting results and contributes to net earnings.
As these investments mature, or are called, 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.
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The Company generated positive cash flows from operations of $42,700,736
during the first nine months of 2001 as compared to $15,908,635 for the same
period of 2000. The amount for 2001 includes $12,178,242 received from
Employers Mutual in connection with the change in recording the full-term
premium amount on policies billed on an installment basis.
Employers Mutual continued to reinvest 100 percent of its dividends in
additional shares of the Company's common stock during the first nine months
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.
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 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. In June 2000, the
FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities - an amendment of FASB Statement No. 133". SFAS
No. 138 addresses a limited number of Statement No. 133 implementation issues,
and is effective for 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.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations", and
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and establishes specific criteria for the recognition of
intangible assets separately from goodwill. SFAS No. 142 addresses accounting
for intangible assets, eliminates the amortization of goodwill and provides
specific steps for testing the impairment of goodwill. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001, however, the
amortization provisions apply to goodwill and intangible assets acquired after
June 30, 2001. The Company is currently reviewing these statements to
determine what impact, if any, they will have on the operating results of the
Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which is effective for fiscal
years beginning after December 15, 2001. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of". SFAS No. 144 requires that one accounting model be
used for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions. Adoption of this statement
will not have any effect on the operating results of the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
SUBSEQUENT EVENTS
In October 2001, the Pennsylvania Department of Insurance ordered the
liquidation of Reliance Insurance Company (Reliance). The Reliance insolvency
is the single largest property and casualty insolvency in the history of the
United States. It is anticipated that various state guaranty funds, which pay
policyholder losses of insolvent insurance companies, will begin levying
assessments in the fourth quarter of 2001 against the insurance companies
writing business in these states. The Company expects to record pretax
expense of approximately $500,000 in the fourth quarter of 2001 related
to these assessments.
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; rating agency actions; and other risks and
uncertainties inherent in the Company's business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------- ----------------------------------------------------------
(Unaudited)
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.
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 September
30, 2001 would result in a corresponding pre-tax decrease in the fair value of
the fixed maturity portfolios of approximately $24,935,000 or 5.1 percent. In
addition, a hypothetical one percent decrease in interest rates at September
30, 2001 would result in a corresponding decrease in pre-tax income over the
next twelve months of approximately $1,036,000, 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
September 30, 2001 was 5.22 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 September 30, 2001 would result in a
corresponding pre-tax decrease in the fair value of the Company's equity
portfolio of approximately $2,381,000.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At September 30, 2001 the portfolio of long-
term fixed maturity securities consists of 12.0 percent U.S. Treasury, 5.2
percent government agency, 8.5 percent mortgage-backed, 16.9 percent
municipal, and 57.4 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) in default. The bond has a book
value of $1,400,000 and is being carried at its market value of $1,190,000.
It is unknown at this time what portion of the bond balance, if any, will be
collectible.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, CONTINUED
- ------- ---------------------------------------------------------------------
(Unaudited)
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 September 30, 2001 the effective duration of the mortgage-
backed securities is 2.3 years with an average life and current yield of 3.2
years and 7.2 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.
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 September 30, 2001.
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: November 14, 2001