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 JUNE 30, 2002
-------------
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 July 31, 2002
----- ----------------------------
Common stock, $1.00 par value 11,389,734
Total pages 27
-----
PART I. FINANCIAL INFORMATION
- ------- ---------------------
ITEM 1. FINANCIAL STATEMENTS
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
------------ ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $29,166,513 and $35,502,755) ... $ 27,165,985 $ 33,572,602
Securities available-for-sale, at fair value
(amortized cost $387,761,595 and
$384,410,393) .............................. 397,356,547 390,214,177
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $37,056,801 and $35,962,133) ... 33,453,528 32,505,305
Securities available-for-sale, at fair value
(amortized cost $23,922,880 and $27,325,968) 24,489,880 28,436,008
Equity securities available-for-sale, at fair
value (cost $38,601,739 and $28,686,321) ..... 40,301,948 33,322,767
Other long-term investments, at fair value ..... 2,200,229 -
Short-term investments, at cost ................ 31,488,569 17,724,458
------------ ------------
Total investments ..................... 556,456,686 535,775,317
Cash ............................................. 112,552 558,073
Indebtedness of related party .................... 6,833,387 -
Accrued investment income ........................ 9,061,224 8,659,008
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $573,502) ..... 982,327 1,081,024
Income taxes recoverable ......................... - 100,614
Reinsurance receivables .......................... 11,430,840 14,501,336
Deferred policy acquisition costs ................ 23,514,675 21,363,528
Deferred income taxes ............................ 19,013,189 18,328,807
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Prepaid reinsurance premiums ..................... 3,108,326 2,275,231
Securities lending collateral .................... 63,691,867 66,809,518
Other assets ..................................... 2,028,444 1,170,655
------------ ------------
Total assets .......................... $697,175,103 $671,564,697
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
------------ ------------
(Unaudited)
LIABILITIES
Losses and settlement expenses ................... $320,706,875 $314,518,588
Unearned premiums ................................ 109,993,212 99,382,176
Other policyholders' funds ....................... 1,086,608 472,952
Surplus notes payable (note 5) ................... 36,000,000 25,000,000
Indebtedness to related party .................... - 2,684,418
Income taxes payable ............................. 456,983 -
Postretirement benefits .......................... 7,281,409 6,967,484
Securities lending ............................... 63,691,867 66,809,518
Other liabilities ................................ 12,898,544 15,271,938
------------ ------------
Total liabilities ......................... 552,115,498 531,107,074
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,389,529
shares in 2002 and 11,329,987 shares in 2001 ... 11,389,529 11,329,987
Additional paid-in capital ....................... 67,128,602 66,013,203
Accumulated other comprehensive income ........... 7,710,404 7,507,672
Retained earnings ................................ 58,831,070 55,606,761
------------ ------------
Total stockholders' equity ................ 145,059,605 140,457,623
------------ ------------
Total liabilities and stockholders' equity $697,175,103 $671,564,697
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------- -------------------------
2002 2001 2002 2001
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$73,348,688 $63,315,356 $141,858,080 $123,409,237
Investment income, net ... 8,346,315 7,781,702 16,605,026 15,149,897
Realized investment
(losses) gains ......... (3,372,379) 14,662 (3,100,460) 601,738
Other income ............. 260,163 196,102 377,275 441,956
----------- ----------- ------------ ------------
78,582,787 71,307,822 155,739,921 139,602,828
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 51,215,844 57,712,397 99,766,852 105,006,718
Dividends to policyholders 783,385 (1,591) 1,752,618 588,748
Amortization of deferred
policy acquisition costs 16,345,669 13,511,682 31,489,662 25,931,861
Other underwriting
expenses ............... 6,073,752 4,714,365 12,506,956 9,675,229
Interest expense ......... 340,075 - 671,719 -
Other expenses ........... 305,759 396,731 563,488 748,207
----------- ----------- ------------ ------------
75,064,484 76,333,584 146,751,295 141,950,763
----------- ----------- ------------ ------------
Income (loss) before
income tax expense
(benefit) ............ 3,518,303 (5,025,762) 8,988,626 (2,347,935)
----------- ----------- ------------ ------------
INCOME TAX EXPENSE
(BENEFIT):
Current ................ 2,337,022 (805,909) 3,147,607 (134,048)
Deferred ............... (1,763,405) (1,373,988) (793,544) (1,433,175)
----------- ----------- ------------ ------------
573,617 (2,179,897) 2,354,063 (1,567,223)
----------- ----------- ------------ ------------
Net income (loss) ..$ 2,944,686 $(2,845,865)$ 6,634,563 $ (780,712)
=========== =========== ============ ============
Net income (loss) per common
share - basic and diluted $ .26 $ (.25)$ .58 $ (.07)
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,374,729 11,309,536 11,357,957 11,304,055
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income (loss) .......... $ 2,944,686 $(2,845,865)$ 6,634,563 $ (780,712)
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding
gains (losses) arising
during the period,
before deferred income
tax expense (benefit) .. 3,776,003 (1,215,512) (2,779,679) 667,357
Deferred income tax
expense (benefit) ...... 1,321,601 (413,271) (972,891) 226,904
----------- ----------- ----------- -----------
2,454,402 (802,241) (1,806,788) 440,453
----------- ----------- ----------- -----------
Reclassification
adjustment for losses
(gains) included in net
income (loss), before
income tax (benefit)
expense ................ 3,363,489 (14,662) 3,091,570 (591,529)
Income tax (benefit)
expense ................ (1,177,222) 4,985 (1,082,050) 201,120
----------- ----------- ----------- -----------
2,186,267 (9,677) 2,009,520 (390,409)
----------- ----------- ----------- -----------
Other comprehensive
income (loss) .... 4,640,669 (811,918) 202,732 50,044
----------- ----------- ----------- -----------
Total comprehensive
income (loss) .... $ 7,585,355 $(3,657,783)$ 6,837,295 $ (730,668)
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
--------------------------
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................. $ 6,634,563 $ (780,712)
------------ ------------
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Losses and settlement expenses ............ 6,188,287 12,350,535
Unearned premiums ......................... 10,611,036 11,160,324
Other policyholders' funds ................ 613,656 (363,036)
Deferred policy acquisition costs ......... (2,151,147) (4,315,999)
Indebtedness of related party ............. (9,517,805) 3,578,784
Accrued investment income ................. (402,216) (659,383)
Accrued income taxes:
Current ................................. 557,597 (325,913)
Deferred ................................ (793,544) (1,433,175)
Realized investment losses (gains) ........ 3,100,460 (601,738)
Postretirement benefits ................... 313,925 561,242
Reinsurance receivables ................... 3,070,496 (917,863)
Prepaid reinsurance premiums .............. (833,095) (1,691,584)
Amortization of deferred income ........... - (28,360)
Other, net ................................ (3,359,982) 2,959,840
------------ ------------
7,397,668 20,273,674
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) .......................... - 11,880,803
------------ ------------
Net cash provided by
operating activities ................ $ 14,032,231 $ 31,373,765
============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Six months ended
June 30,
--------------------------
2002 2001
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of fixed maturity securities
held-to-maturity ............................ $ 5,474,136 $ 22,463,927
Purchases of fixed maturity securities
available-for-sale .......................... (114,264,640) (58,685,145)
Disposals of fixed maturity securities
available-for-sale .......................... 111,323,992 14,220,276
Purchases of equity securities
available-for-sale .......................... (25,850,242) (14,036,612)
Disposals of equity securities
available-for-sale .......................... 16,038,657 14,339,309
Purchase of other long-term investments ....... (2,644,445) -
Disposals of other long-term investments ...... 444,216 -
Net purchases of short-term investments ....... (13,764,113) (5,262,276)
------------ ------------
Net cash used in investing activities ....... (23,242,439) (26,960,521)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 1,174,941 234,178
Dividends paid to stockholders ................ (3,410,254) (3,391,380)
Issuance of surplus note (note 5) ............. 11,000,000 -
------------ ------------
Net cash provided (used) in financing
activities .............................. 8,764,687 (3,157,202)
------------ ------------
NET (DECREASE) INCREASE IN CASH ................. (445,521) 1,256,042
Cash at beginning of year ....................... 558,073 490,226
------------ ------------
Cash at end of quarter .......................... $ 112,552 $ 1,746,268
============ ============
Income taxes paid ............................... $ 2,590,010 $ 191,988
Interest paid (received) ........................ $ 19,232 $ (88,519)
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2002
1. BASIS OF PRESENTATION
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 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 2001 Form 10-K or the 2001 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 $11,880,803 and the Company incurred $1,706,181
of commission expense and $297,439 of premium tax expense. These expenses
were offset by a $3,054,573 increase in deferred policy acquisition costs,
resulting in $1,050,953 of non-recurring income that was amortized into
operations on a quarterly basis.
3. 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.
Property
Three months ended and casualty Parent
June 30, 2002 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 55,367,753 $ 17,980,935 $ 73,348,688
Underwriting loss .... (607,379) (462,583) (1,069,962)
Net investment income 6,027,417 2,279,541 $ 39,357 8,346,315
Realized investment
(losses) gains ..... (2,305,356) (1,072,336) 5,313 (3,372,379)
Other income ......... 260,163 - - 260,163
Interest expense ..... (335,328) (4,747) - (340,075)
Other expense ........ (179,429) - (126,330) (305,759)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 2,860,088 $ 739,875 $ (81,660) $ 3,518,303
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2002
Property
Three months ended and casualty Parent
June 30, 2001 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 50,409,654 $ 12,905,702 $ 63,315,356
Underwriting loss .... (10,500,231) (2,121,266) (12,621,497)
Net investment income 5,628,345 2,098,200 $ 55,157 7,781,702
Realized investment
gains (losses) ..... 14,663 (1) - 14,662
Other income ......... 182,897 13,205 - 196,102
Other expense ........ (233,183) - (163,548) (396,731)
------------ ------------ ------------ ------------
Loss before income
tax benefit ........ $ (4,907,509) $ (9,862) $ (108,391) $ (5,025,762)
============ ============ ============ ============
Property
Six months ended and casualty Parent
June 30, 2002 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $107,811,323 $ 34,046,757 $141,858,080
Underwriting loss .... (1,797,381) (1,860,627) (3,658,008)
Net investment income 12,035,034 4,498,920 $ 71,072 16,605,026
Realized investment
(losses) gains ..... (2,056,396) (1,049,377) 5,313 (3,100,460)
Other income ......... 377,275 - - 377,275
Interest expense ..... (666,972) (4,747) - (671,719)
Other expense ........ (330,657) - (232,831) (563,488)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) .......... $ 7,560,903 $ 1,584,169 $ (156,446) $ 8,988,626
============ ============ ============ ============
Property
Six months ended and casualty Parent
June 30, 2001 insurance Reinsurance company Consolidated
- --------------- ------------ ------------ ------------ ------------
Premiums earned ...... $ 98,820,675 $ 24,588,562 $123,409,237
Underwriting loss .... (13,847,610) (3,945,709) (17,793,319)
Net investment income 10,944,098 4,096,219 $ 109,580 15,149,897
Realized investment
gains (losses) ..... 611,843 (10,105) - 601,738
Other income ......... 413,596 28,360 - 441,956
Other expense ........ (436,366) - (311,841) (748,207)
------------ ------------ ------------ ------------
(Loss) income before
income tax benefit) $ (2,314,439) $ 168,765 $ (202,261) $ (2,347,935)
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
June 30, 2002
4. INCOME TAXES
The actual income tax expense (benefit) for the three and six months
ended June 30, 2002 and 2001 differed from the "expected" tax expense
(benefit) for those periods (computed by applying the United States federal
corporate tax rate of 35 percent for 2002 and 34 percent for 2001 to income
(loss) before income tax expense (benefit)) as follows:
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Computed "expected" tax
expense (benefit) ...... $ 1,231 406 $(1,708,759) $ 3,146,019 $ (798,298)
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (360,715) (372,024) (725,169) (746,858)
Proration of
tax-exempt interest
and dividends
received deduction 41,677 41,685 82,817 83,570
Other, net ........... (338,751) (140,799) (149,604) (105,637)
----------- ----------- ----------- -----------
Income tax expense
(benefit) ...... $ 573,617 $(2,179,897) $ 2,354,063 $(1,567,223)
=========== =========== =========== ===========
5. SURPLUS NOTE
On June 27, 2002, EMC Reinsurance Company, a subsidiary of the Company,
issued a surplus note in the amount of $11,000,000 to Employers Mutual
Casualty Company. The surplus note bears an annual interest rate of 5.25
percent and does not have a maturity date. Payment of interest and repayment
of principal can only be repaid out of EMC Reinsurance Company's statutory
surplus earnings and is subject to approval by the State of Iowa Insurance
Commissioner. The surplus note is subordinate and junior in right of payment
to all obligations or liabilities of EMC Reinsurance Company.
6. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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. Other than the requirement to eliminate the
amortization of the Company's carried goodwill, adoption of these statements
did not have an impact on the operating results of the Company.
Goodwill amortization expense amounted to approximately $34,000 and
$67,000 for the three and six months ended June 31, 2001, respectively and
$135,000 for the twelve months ended December 31, 2001. On an after tax
basis, these amounts totaled approximately $22,000, $44,000 and $87,000,
respectively. Due to the immaterial amounts involved, the Company has not
presented prior year net income or earnings per share information that has
been adjusted to exclude this expense.
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
did 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., a 79.4 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 76.0
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. The aggregate
participation of the Company's property and casualty insurance subsidiaries is
23.5 percent. 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 reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The
information reflects all adjustments that are, in the opinion of management,
necessary for a fair statement of the results for the interim periods.
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and six months ended June 30, 2002
and 2001 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 73,349 $ 63,315 $141,858 $123,409
Losses and settlement expenses ...... 51,216 57,713 99,767 105,007
Acquisition and other expenses ...... 23,202 18,225 45,749 36,196
-------- -------- -------- --------
Underwriting loss ................... (1,069) (12,623) (3,658) (17,794)
Net investment income ............... 8,346 7,782 16,605 15,150
Interest expense .................... (340) - (672) -
Other expense ....................... (46) (200) (186) (306)
-------- -------- -------- --------
Operating income (loss) before
income tax expense (benefit) ...... 6,891 (5,041) 12,089 (2,950)
Realized investment (losses) gains .. (3,372) 15 (3,100) 602
-------- -------- -------- --------
Income (loss) before income tax
expense (benefit) ................. 3,519 (5,026) 8,989 (2,348)
Income tax expense (benefit) ........ 574 (2,180) 2,354 (1,567)
-------- -------- -------- --------
Net income (loss) ................... $ 2,945 $ (2,846) $ 6,635 $ (781)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 52,796 $ 58,807 $102,498 $105,374
Decrease in provision for
insured events of prior years (1,580) (1,094) (2,731) (367)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 51,216 $ 57,713 $ 99,767 $105,007
======== ======== ======== ========
Catastrophe and storm losses ........ $ 3,936 $ 11,714 $ 4,819 $ 12,585
======== ======== ======== ========
Operating results before income taxes improved substantially for both the
three months and six months ended June 30, 2002 compared to the same periods
in 2001. These improved operating results reflect previous rate increases,
disciplined underwriting and a significant decline in catastrophe and storm
losses from the storm plagued second quarter of 2001.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Premium rate increases continued to grow progressively larger during the
first half of 2002 and management expects additional increases to be
implemented during the remainder of the year. Based on current projections,
premium rates could approach adequate levels in most lines of business by
year-end for the first time in nearly a decade. 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 underwriting profitability through ongoing
initiatives for existing accounts and agencies, which include the careful
evaluation and selection of business with a reasonable expectation of
profitability. New business is generally being limited to that which fits
within the Company's core competencies and that can be priced adequately.
Effective January 1, 2001, the Company began recording the full-term
written premium and related commission expense at the inception of insurance
policies that are billed on an installment basis. Previously, such amounts
were recorded as each installment became due. As a result, written premiums
and unearned premiums increased $13,884,000, invested assets increased
$11,881,000 and the Company incurred $1,706,000 of commission expense and
$297,000 of premium tax expense. These expenses were offset by a $3,054,000
increase in deferred policy acquisition costs, resulting in $1,051,000 of non-
recurring income that was amortized into operations on a quarterly basis
during 2001.
Premiums earned increased 15.8 percent for the three months and 14.9
percent for the six months ended June 30, 2002 from the same periods in 2001,
primarily due to implemented rate increases. In addition to the implemented
rate increases, the reinsurance segment expanded its premium volume by
increasing its participation in a reinsurance pool and its exposure on a
marine syndicate account. Despite rising premium rates, retention levels have
remained fairly constant, evidence of the movement of the insurance industry
towards more adequate rate levels. 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 decreased 11.3 percent for the three
months and 5.0 percent for the six months ended June 30, 2002 from the same
periods in 2001, primarily due to a significant decline in catastrophe and
storm losses from the unusually large amount experienced during the second
quarter of 2001. Other factors contributing to the decline in losses and
settlement expenses include the implementation of tighter underwriting
standards, a decline in large losses and an increase in the amount of
favorable development experienced on prior years' reserves.
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 27.3 percent for the three
months and 26.4 percent for the six months ended June 30, 2002 compared to the
same periods in 2001. These increases are primarily attributed to increases
in both commission and contingent commission expense, which reflects the
growth in premium volume during 2002 as well as improved underwriting results.
Acquisition and other expenses were also impacted by an increase in the
expense for policyholder dividends and higher employee benefit costs.
Included in the acquisition and other expenses amount for the first half of
2001 is approximately $67,000 of goodwill amortization expense. In accordance
with Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", which became effective January 1, 2002, the Company's
carried goodwill is no longer subject to amortization and must instead be
tested for impairment on a periodic basis.
Net investment income increased 7.2 percent for the three months and 9.6
percent for the six months ended June 30, 2002 from the same periods in 2001.
These increases are primarily attributed to a higher average invested balance
in fixed maturity securities, which resulted from the issuance of $25,000,000
of surplus notes in December 2001. During 2001, the Company experienced a
significant amount of call activity on its portfolio of fixed maturity
securities due to the large decline in interest rates. Proceeds from this
call activity, and from maturing securities, were reinvested at lower current
interest rates, which had a negative impact on 2002 investment income.
On June 27, 2002, the Company's reinsurance subsidiary issued $11,000,000
of surplus notes with an interest rate of 5.25 percent to Employers Mutual.
These surplus notes were issued in response to capital adequacy concerns
raised by certain rating agencies because the surplus position of the
reinsurance subsidiary had declined over the last three years due to
unfavorable operating results and the payment of dividends to the parent
company. It should be noted that surplus notes are considered to be a
component of surplus for statutory reporting purposes because the notes have
no maturity date and all payments of interest and principal must be approved
in advance by the insurance commissioner of the state of domicile of the
issuing insurance company; however, under generally accepted accounting
principals, surplus notes are considered to be debt and are reported as a
liability in the Company's financial statements.
The Company incurred $672,000 of interest expense on surplus notes during
the first half of 2002. This interest expense did not have a material impact
on operating results as the proceeds of the surplus notes were invested in
government agencies and corporate bonds and earned a similar amount of
interest income.
The realized investment losses of the second quarter of 2002 reflect an
"other than temporary" security impairment write down of the Company's
investment in MCI Communications Corporation corporate bonds totaling
$3,821,000. MCI Communications Corporation is owned by WorldCom Inc., whose
corporate bonds were downgraded to junk status in May when it reported the
detection of accounting irregularities. The MCI bonds are supported by the
assets of MCI; however, the magnitude of the WorldCom collapse has cast doubt
on the prospect of collecting the entire principal and interest payments due
the Company. As a result, the Company has determined that the recent decline
in market value of the MCI bonds is "other than temporary."
Income tax expense increased for both the three months and six months
ended June 30, 2002 from the same periods in 2001. These increases primarily
reflect the improvement in pre-tax operating results experienced in 2002.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and six months ended June 30, 2002
and 2001 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 55,368 $ 50,409 $107,811 $ 98,820
Losses and settlement expenses ...... 38,871 46,499 75,090 83,621
Acquisition and other expenses ...... 17,103 14,411 34,518 29,047
-------- -------- -------- --------
Underwriting loss ................... (606) (10,501) (1,797) (13,848)
Net investment income ............... 6,027 5,628 12,035 10,944
Interest expense .................... (335) - (667) -
Other income (expense) .............. 80 (49) 47 (22)
-------- -------- -------- --------
Operating income (loss) before
income taxes ...................... $ 5,166 $ (4,922) $ 9,618 $ (2,926)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 40,075 $ 48,711 $ 78,778 $ 88,341
Decrease in provision for
insured events of prior years.. (1,204) (2,212) (3,688) (4,720)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 38,871 $ 46,499 $ 75,090 $ 83,621
======== ======== ======== ========
Catastrophe and storm losses ........ $ 3,513 $ 10,187 $ 4,172 $ 11,004
======== ======== ======== ========
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 9.8 percent for the three months and 9.1
percent for the six months ended June 30, 2002 from the same periods in 2001.
These increases are primarily attributable to rate increases that were
implemented during the last two years. Premium rate increases continued to
grow progressively larger during the first half of 2002 and management expects
additional increases to be implemented during the remainder of the year.
Based on current projections, premium rates could approach adequate levels by
year-end in most lines of business. It should be noted, however, that it
takes a considerable amount of time for implemented rate increases to have a
noticeable impact on underwriting results due to the timing of policy renewals
and the fact that premiums are earned ratably over the terms of the underlying
policies.
Losses and settlement expenses decreased 16.4 percent for the three
months and 10.2 percent for the six months ended June 30, 2002 as compared to
the same periods in 2001. The primary factor contributing to this improvement
was a significant decline in catastrophe and storm losses from the unusually
large amount experienced during the storm plagued second quarter of 2001.
Other factors contributing to the improvement include tighter underwriting
standards and a decline in large losses. Loss frequency also declined during
the first half of 2002, continuing a trend that began in 2000, but the impact
on operating results was partially offset by an increase in loss severity.
Acquisition and other expenses increased 18.7 percent for the three
months and 18.8 percent for the six months ended June 30, 2002 as compared to
the same periods in 2001. These increases are primarily related to the growth
in premium income noted above, but also reflect an increase in policyholder
dividends, the discontinuation of an assigned risk program during 2001 that
produced commission income and higher employee benefit costs.
Underwriting results for the three months and six months ended June 30,
2002 improved substantially in comparison to the same periods in 2001. This
improvement reflects an increase in overall premium rate adequacy due to rate
increases that were implemented during the last two years and tighter
underwriting standards, as well as a significant decline in catastrophe and
storm losses from the storm-plagued second quarter of 2001. The improvements
that have been achieved in premium rate adequacy will continue to have an
increasingly positive impact on future operating results, but the
unpredictable nature of catastrophe and storm losses will remain. Meanwhile,
ongoing initiatives for existing accounts and agencies include the careful
evaluation and selection of business with a reasonable expectation of
profitability. New business is generally being limited to that which fits
within our core competencies and can be priced adequately.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
(Unaudited)
Reinsurance
Operating results for the three months and six months ended June 30, 2002
and 2001 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Premiums earned ..................... $ 17,981 $ 12,906 $ 34,047 $ 24,589
Losses and settlement expenses ...... 12,345 11,214 24,677 21,386
Acquisition and other expenses ...... 6,099 3,814 11,231 7,149
-------- -------- -------- --------
Underwriting loss ................... (463) (2,122) (1,861) (3,946)
Net investment income ............... 2,280 2,099 4,499 4,097
Interest expense .................... (5) - (5) -
Other income ........................ - 13 - 28
-------- -------- -------- --------
Operating income (loss) before
income taxes ...................... $ 1,812 $ (10) $ 2,633 $ 179
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 12,721 $ 10,096 $ 23,720 $ 17,033
(Decrease) increase in
provision for insured events
of prior years ................ (376) 1,118 957 4,353
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 12,345 $ 11,214 $ 24,677 $ 21,386
======== ======== ======== ========
Catastrophe losses .................. $ 423 $ 1,527 $ 647 $ 1,581
======== ======== ======== ========
Premium income increased 39.9 percent for the three months and 38.5
percent for the six months ended June 30, 2002 from the same periods in 2001.
These large increases are attributed to rate increases implemented during the
January 2002 renewal season, increased participation in a reinsurance pool and
growth in a marine syndicate account. Sizable rate increases were placed on
excess of loss contracts during the January 2002 renewal season and both
excess of loss and pro-rata contracts have benefited from industry-wide rate
increases being implemented at the primary company level. These rate
increases have been realized in conjunction with a moderate decline in the
related exposure base due to increased retention levels on many contracts and
coverage exclusions for terrorist activities on most contracts. Premium
income for the six months ended June 30, 2002 reflects a reduction of
approximately $550,000 in the estimated amount of assumed reinstatement
premiums associated with the World Trade Center catastrophe.
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 10.1 percent for the three
months and 15.4 percent for the six months ended June 30, 2002 from the same
periods in 2001. These increases are primarily attributed to the growth in
premiums noted above, but were limited by a decline in the amount of adverse
development experienced on prior years' reserves, decreased levels of
catastrophe losses and a decline in casualty losses. The majority of the
adverse development reported for 2001 came from a reinsurance pool that the
reinsurance subsidiary participates in that experienced a high level of
construction defect claims on an account that was discontinued on December 31,
1999.
Acquisition and other expenses increased 59.9 percent for the three
months and 57.1 percent for the six months ended June 30, 2002 from the same
periods in 2001. These increases are primarily due to increases in both
commission and contingent commission expenses. The increase in commission
expense is attributed to the significant growth in premium volume experienced
during the 2002, and includes approximately $379,000 of expense incurred in
connection with the increased participation in the reinsurance pool. The
increase in contingent commission expense is associated with good loss
experience on certain reinsurance contracts.
The improvement in the underwriting results of the reinsurance segment
for the three and six months ended June 30, 2002 is primarily attributed to a
substantial decline in the amount of adverse development experienced on prior
years' reserves, lower catastrophe losses and a decline in casualty losses.
Although the reinsurance subsidiary was able to implement significant rate
increases in 2002, the methodology utilized to establish loss and settlement
expense reserves has limited the impact of these rate increases on the
underwriting results of 2002. For a significant portion of the reinsurance
book of business, loss and settlement expense reserves for the latest policy
year are established by a formula-based process that produces a break-even
result. This procedure is utilized until sufficient data is available to more
formally project anticipated losses and settlement expenses. Reported
reinsurance results are analyzed throughout the year and modifications are
made to the formula-based reserves when appropriate. It is anticipated that
the rate increases implemented during 2002 will mitigate the need to establish
loss and settlement reserves in excess of the formula-based amounts, as has
been required during the last several years. Such adjustments to the formula-
based reserves totaled $2,400,000 in the first half of 2001 and $6,400,000 for
the year ended December 31, 2001. In addition to pricing its reinsurance
premiums at more adequate rates, Employers Mutual continues to work toward
improving profitability on the assumed book of business by accepting larger
shares of coverage on desirable programs, utilizing relationships with
reinsurance intermediaries and monitoring exposures.
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 loss before income taxes totaled $87,000 and $162,000 for the
three months and six months ended June 30, 2002 compared to losses of $109,000
and $203,000 for the same periods in 2001. The operating results of the
Company were positively impacted by a decline in operating expenses for both
the three months and six months ended June 30, 2002 over the same periods in
2001. However, this improvement was partially offset by a decline in interest
income, the Company's primary source of revenue.
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 gain on fixed maturity securities
available-for-sale of $6,605,000 at June 30, 2002 compared to $4,494,000 at
December 31, 2001. 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, interest and principal payments on debt 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 $14,032,231
during the first half of 2002 compared to $31,373,765 for the same period in
2001. The amount for 2001 includes $11,880,803 received from Employers Mutual
in connection with a change in the recording of written premiums and
commissions on policies billed on an installment basis.
Employers Mutual reinvested 25 percent of its dividends in additional
shares of the Company's common stock during the first half of 2002. Prior to
2002, Employers Mutual was reinvesting 100 percent of its dividends in
additional shares of the Company's common stock. As a result of this dividend
reinvestment activity, the Company expects to become an 80 percent owned
subsidiary of Employers Mutual within the next 12 months. At that time the
Company will begin filing a consolidated tax return with Employers Mutual and
its subsidiaries.
NEW ACCOUNTING PRONOUNCEMENTS
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. Other than the requirement to eliminate the future
amortization of the Company's carried goodwill, which has amounted to $135,000
per year, adoption of these statements did not have an impact 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
did not have any effect on the operating results of the Company.
SUBSEQUENT EVENTS
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act
of 2002. The legislation creates new standards for corporate governance, the
auditing and financial reporting process and conflicts of interest and will
impact a number of parties, including issuers, directors, officers, employees,
attorneys, auditors and investment banks. Most of the new standards are
subject to the rule making authority of the Securities and Exchange Commission
(SEC) and must be adopted within 30 to 270 days of the date the legislation
was enacted. A few of the new standards became effective immediately upon the
enactment of the legislation, including a requirement that the Chief Executive
Officer and the Chief Financial Officer of an issuer certify that the
information contained in periodic reports filed with the SEC that contain
financial statements "fully complies" with SEC requirements and that the
information contained in the periodic reports "fairly presents, in all
material respects, the financial condition and results of operations of the
issuer." This certification has been filed as an exhibit to this periodic
report.
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; terrorist activities and federal solutions
to make available insurance coverage for acts of terrorism; timely collection
of amounts due under ceded reinsurance contracts; 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 June 30,
2002 would result in a corresponding pre-tax decrease in the fair value of the
fixed maturity portfolios of approximately $27,924,000 or 5.3 percent. In
addition, a hypothetical one percent decrease in interest rates at June 30,
2002 would result in a corresponding decrease in pre-tax income over the next
twelve months of approximately $1,020,000, 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
June 30, 2002 was 4.96 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 June 30, 2002 would result in a
corresponding pretax decrease in the fair value of the Company's equity
portfolio of approximately $3,467,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, CONTINUED
- ------- ---------------------------------------------------------------------
(Unaudited)
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At June 30, 2002 the portfolio of long-term
fixed maturity securities consists of 8.1 percent U.S. Treasury, 10.0 percent
government agency, 4.9 percent mortgage-backed, 15.0 percent municipal, and
62.0 percent corporate securities. At December 31, 2001 the portfolio of
long-term fixed maturity securities consisted of 8.3 percent U.S. Treasury,
7.3 percent government agency, 6.8 percent mortgage-backed, 15.7 percent
municipal, and 61.9 percent corporate securities. At June 30, 2002 the
Company had one bond (MCI Communications Corporation) considered to be "other
than temporarily" impaired, resulting in the recognition of a realized loss of
$3,821,466 for the write down of the bonds from their aggregate book value of
$5,603,966 to their aggregate fair value of $1,782,500. At June 30, 2002 the
Company also had two bonds considered to be below investment grade. The
Company's investment in United Airlines' bonds had a book value of $1,963,754,
a fair value of $1,660,000, and an unrealized loss of $303,754 (before tax) at
June 30, 2002. These bonds are securitized with the airline's planes. The
Company's investment in US West Communications' bonds had a book value of
$4,629,389, a fair value of $3,854,675, and an unrealized loss of $774,714
(before tax) at June 30, 2002. These bonds are being closely monitored for
further developments, but are not currently considered to be "other than
temporarily" impaired.
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 June 30, 2002 the effective duration of the mortgage-backed
securities is 2.0 years with an average life and current yield of 3.6 years
and 7.2 percent, respectively. At December 31, 2001 the effective duration of
the mortgage-backed securities was 2.6 years with an average life and current
yield of 4.6 years and 7.3 percent, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ----------------------------------------------------
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 21, 2002
(b) The following seven persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter III Elwin H. Creese
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
----------------------- ---------- --------
George C. Carpenter III 10,901,505 14,071
Elwin H. Creese 10,902,435 13,141
David J. Fisher 10,902,521 13,055
Bruce G. Kelley 10,872,423 43,153
George W. Kochheiser 10,901,023 14,553
Raymond A. Michel 10,900,505 15,071
Fredrick A. Schiek 10,903,793 11,783
2. Proposal to approve the 2003 Employers Mutual Casualty Company
Incentive Stock Option Plan
For 10,837,446 Against 66,220 Withheld 11,910
---------- ------ ------
3. Proposal to ratify the appointment of Ernst & Young LLP as
the independent auditors of the Company:
For 10,900,054 Against 10,227 Withheld 5,295
---------- ------ -----
The total number of qualified shares voted by proxy
was: 10,915,576
(d) None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibit 99. Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) No Form 8-K was filed by the registrant during the
quarter ended June 30, 2002.
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
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Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
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Mark Reese
Vice President and
Chief Financial Officer
Date: August 14, 2002