FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. EXHIBIT 13(c)
- ------------------------------------------- -------------
Management's Responsibility for Financial Reporting
The management of EMC Insurance Group Inc. and Subsidiaries is
responsible for the preparation, integrity and objectivity of the accompanying
financial statements, as well as other financial information in this report.
The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and include amounts that
are based on management's estimates and judgments where necessary.
The Company's financial statements have been audited by Ernst & Young
LLP, independent certified public accountants. Management has made available
to Ernst & Young LLP all of the Company's financial records and related data,
as well as the minutes of the stockholders' and directors' meetings.
Furthermore, management believes that all representations made to Ernst &
Young LLP during its audit were valid and appropriate. Their report appears
elsewhere in this annual report.
Management of the Company has established and continues to maintain a
system of internal controls that are designed to provide assurance as to the
integrity and reliability of the financial statements, the protection of
assets from unauthorized use or disposition, and the prevention and detection
of fraudulent financial reporting. The system of internal controls provides
for appropriate division of responsibility. Certain aspects of these systems
and controls are tested periodically by the Company's internal auditors.
Management considers the recommendations of its internal auditors and the
independent auditors concerning the Company's internal controls and takes the
necessary actions that are cost-effective in the circumstances to respond
appropriately to the recommendations presented. Management believes that as
of December 31, 2002, the Company's system of internal controls was adequate
to accomplish the above objectives.
The Audit Committee of the Board of Directors, composed solely of outside
directors, met during the year with management and the independent auditors to
review and discuss audit findings and other financial and accounting matters.
The independent auditors and the internal auditors have free access to the
Audit Committee, with and without management present, to discuss the results
of their audit work.
/s/ Bruce G. Kelley /s/ Mark E. Reese
- ----------------------- -----------------------
Bruce G. Kelley Mark E. Reese
President and Vice President and
Chief Executive Officer Chief Financial Officer
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
EMC Insurance Group Inc.
We have audited the accompanying consolidated balance sheets of EMC
Insurance Group Inc. and Subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows of EMC Insurance Group Inc. and
Subsidiaries for the year ended December 31, 2000 were audited by other
auditors whose report dated February 27, 2001 expressed an unqualified opinion
on those statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the 2002 and 2001 financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of EMC Insurance Group Inc. and Subsidiaries at December 31, 2002 and 2001 and
the consolidated results of their operations and their cash flows for the
years then ended, in conformity with accounting principles generally accepted
in the United States.
/s/Ernst & Young LLP
February 25, 2003
Des Moines, Iowa
Report of KPMG LLP, Independent Auditors
The Board of Directors and Stockholders
EMC Insurance Group Inc.:
We have audited the accompanying consolidated statements of income,
comprehensive income, stockholders' equity and cash flows of EMC Insurance
Group Inc. and Subsidiaries for the year ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally
accepted in The United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of EMC Insurance Group Inc. and Subsidiaries for the year ended December
31, 2000, in conformity with accounting principles generally accepted in The
United States of America.
/s/ KPMG LLP
Des Moines, Iowa
February 27, 2001
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2002 2001
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $61,639,037 and $35,502,755) ..... $ 55,033,675 $ 33,572,602
Securities available-for-sale, at fair value
(amortized cost $459,844,928 and $384,410,393) 485,855,966 390,214,177
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $0 and $35,962,133) ............. - 32,505,305
Securities available-for-sale, at fair value
(amortized cost $0 and $27,325,968) ......... - 28,436,008
Equity securities available-for-sale, at fair
value (cost $38,444,030 and $28,686,321) ...... 34,596,985 33,322,767
Other long-term investments, at cost ............ 3,057,000 -
Short-term investments, at cost ................. 29,650,230 17,724,458
------------ ------------
Total investments ........................... 608,193,856 535,775,317
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 11,582,136 14,501,336
Prepaid reinsurance premiums ................. 2,442,899 2,275,231
Intangible asset, defined benefit
retirement plan ............................ 1,411,716 -
Other assets ................................. 1,331,816 1,170,655
Cash .............................................. (119,097) 558,073
Accrued investment income ......................... 9,179,555 8,659,008
Accounts receivable (net of allowance for
uncollectible accounts of $7,297 and $573,502) .. 772,944 1,081,024
Income taxes recoverable .......................... 213,504 100,614
Deferred policy acquisition costs ................. 24,926,861 21,363,528
Deferred income taxes ............................. 13,986,172 18,328,807
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 .................... 941,586 941,586
Securities lending collateral ..................... - 66,809,518
------------ ------------
Total assets ............................... $674,863,948 $671,564,697
============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2002 2001
------------ ------------
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses .............. $331,226,753 $314,518,588
Unearned premiums ........................... 115,746,814 99,382,176
Other policyholders' funds .................. 1,035,622 472,952
Surplus notes payable ....................... 36,000,000 25,000,000
Indebtedness to related party ............... 3,304,539 2,684,418
Employee retirement plans ................... 10,014,349 6,967,484
Other liabilities ........................... 19,767,507 15,271,938
Securities lending obligation ..................... - 66,809,518
------------ ------------
Total liabilities ......................... 517,095,584 531,107,074
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value,
authorized 20,000,000 shares;
issued and outstanding, 11,399,050 shares
in 2002 and 11,329,987 shares in 2001 ........... 11,399,050 11,329,987
Additional paid-in capital ........................ 67,270,591 66,013,203
Accumulated other comprehensive income ............ 14,218,330 7,507,672
Retained earnings ................................. 64,880,393 55,606,761
------------ ------------
Total stockholders' equity .................. 157,768,364 140,457,623
------------ ------------
Total liabilities and stockholders' equity .. $674,863,948 $671,564,697
============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
All balances presented below, with the exception of investment income,
realized investment (losses) gains and income tax expense (benefit), are the
result of related party transactions with Employers Mutual.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
REVENUES
Premiums earned .................... $297,043,033 $265,279,858 $231,458,442
Investment income, net ............. 32,778,133 30,969,630 29,006,316
Realized investment (losses) gains (3,159,201) 800,582 1,557,870
Other income ....................... 865,819 774,169 1,473,113
------------ ------------ ------------
327,527,784 297,824,239 263,495,741
------------ ------------ ------------
LOSSES AND EXPENSES
Losses and settlement expenses ..... 207,057,856 221,918,750 189,521,674
Dividends to policyholders ......... 2,977,154 1,823,970 1,632,961
Amortization of deferred
policy acquisition costs ......... 65,727,016 55,687,015 51,288,479
Other underwriting expenses ........ 26,928,972 22,739,913 18,479,492
Interest expense ................... 1,638,716 11,055 -
Other expenses ..................... 1,306,034 1,185,415 1,508,523
------------ ------------ ------------
305,635,748 303,366,118 262,431,129
------------ ------------ ------------
Income (loss) before income
tax expense (benefit) ...... 21,892,036 (5,541,879) 1,064,612
------------ ------------ ------------
INCOME TAX EXPENSE (BENEFIT)
Current .......................... 5,061,093 (142,405) (307,677)
Deferred ......................... 729,205 (3,293,342) (956,742)
5,790,298 (3,435,747) (1,264,419)
------------ ------------ ------------
Net income (loss) ............ $ 16,101,738 $ (2,106,132) $ 2,329,031
============ ============ ============
Net income (loss) per common share
- basic and diluted .............. $ 1.42 $ (.19) $ .21
============ ============ ============
Average number of shares outstanding
- basic and diluted .............. 11,375,779 11,312,063 11,284,885
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Net income (loss) .................. $ 16,101,738 $ (2,106,132) $ 2,329,031
------------ ------------ ------------
OTHER COMPREHENSIVE INCOME
Unrealized holding gains
arising during the period,
before deferred income tax
expense ........................ 7,454,522 1,645,082 15,872,363
Deferred income tax expense ...... 2,609,079 682,629 4,164,014
------------ ------------ ------------
4,845,443 962,453 11,708,349
------------ ------------ ------------
Reclassification adjustment for
losses (gains) included in net
income (loss), before income
tax (benefit) expense .......... 3,159,201 (779,540) (1,562,372)
Income tax (benefit) expense ..... (1,105,720) 272,839 531,206
------------ ------------ ------------
2,053,481 (506,701) (1,031,166)
------------ ------------ ------------
Adjustment for minimum pension
liability ...................... (289,639) - -
Deferred income tax benefit ...... (101,373) - -
------------ ------------ ------------
(188,266) - -
------------ ------------ ------------
Other comprehensive income ... 6,710,658 455,752 10,677,183
------------ ------------ ------------
Total comprehensive income
(loss) ..................... $ 22,812,396 $ (1,650,380) $ 13,006,214
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Year ended December 31,
------------ ------------ ------------
2002 2001 2000
------------ ------------ ------------
COMMON STOCK
Beginning of year .................. $ 11,329,987 $ 11,294,220 $ 11,265,232
Issuance of common stock through
stock option plans ............... 69,063 35,767 28,988
------------ ------------ ------------
End of year ........................ 11,399,050 11,329,987 11,294,220
------------ ------------ ------------
ADDITIONAL PAID-IN CAPITAL
Beginning of year .................. 66,013,203 65,546,963 65,333,686
Issuance of common stock through
stock option plans ............... 1,257,388 466,240 213,277
------------ ------------ ------------
End of year ........................ 67,270,591 66,013,203 65,546,963
------------ ------------ ------------
ACCUMULATED OTHER COMPREHENSIVE
INCOME
Beginning of year .................. 7,507,672 7,051,920 (3,625,263)
Minimum pension liability .......... (188,266) - -
Unrealized gains on
available-for-sale securities .... 6,898,924 455,752 10,677,183
------------ ------------ ------------
End of year ........................ 14,218,330 7,507,672 7,051,920
------------ ------------ ------------
RETAINED EARNINGS
Beginning of year .................. 55,606,761 64,500,213 68,942,622
Net income (loss) .................. 16,101,738 (2,106,132) 2,329,031
Cash dividends on common stock
($.60 per share in 2002, 2001 and
2000) ............................ (6,828,106) (6,787,320) (6,771,440)
------------ ------------ ------------
End of year ........................ 64,880,393 55,606,761 64,500,213
------------ ------------ ------------
Total stockholders' equity ....... $157,768,364 $140,457,623 $148,393,316
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................... $16,101,738 $(2,106,132) $ 2,329,031
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Balances resulting from related
party transactions with
Employers Mutual:
Losses and settlement
expenses .................. 16,708,165 28,029,560 19,975,004
Unearned premiums ........... 16,364,638 13,822,959 8,687,285
Other policyholders' funds .. 562,670 (255,701) (364,601)
Indebtedness of related party 620,121 6,484,089 (7,686,230)
Employee retirement plans ... 2,475,961 118,972 80,293
Reinsurance receivables ..... 2,919,200 (2,575,981) (795,990)
Prepaid reinsurance premiums (167,668) (330,132) (664,535)
Amortization of deferred
income .................... - (78,212) (80,619)
Deferred policy acquisition costs (3,563,333) (5,726,775) (2,017,561)
Accrued investment income ....... (520,547) (1,313,645) (458,424)
Accrued income taxes:
Current ....................... (112,890) 635,297 801,089
Deferred ...................... 729,205 (3,293,342) (956,742)
Realized investment losses
(gains) ....................... 3,159,201 (800,582) (1,557,870)
Accounts receivable ............. 308,084 (807,010) 3,019,523
Other, net ...................... 2,988,881 3,403,024 1,209,447
----------- ----------- -----------
42,471,688 37,312,521 19,190,069
Balances resulting from related
party transactions with
Employers Mutual:
Cash provided by the property
and casualty insurance
subsidiaries' change in
recording of full-term
premium amount on policies
billed on an installment
basis ....................... - 11,880,803 -
----------- ----------- -----------
Net cash provided by
operating activities .... $58,573,426 $47,087,192 $21,519,100
----------- ----------- -----------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity
securities held-to-maturity .... $ 11,074,685 $ 49,692,313 $ 11,529,551
Purchases of fixed maturity
securities available-for-sale .. (231,511,754) (166,403,259) (52,060,772)
Disposals of fixed maturity
securities available-for-sale .. 180,717,143 44,693,688 27,499,407
Purchases of equity securities
available-for-sale ............. (43,930,432) (26,769,001) (23,203,788)
Disposals of equity securities
available-for-sale ............. 33,884,190 27,388,659 23,451,046
Purchase of other long-term
investments .................... (4,057,004) - -
Disposals of other long-term
investments .................... 1,000,004 - -
Net (purchases) sales of
short-term investments ......... (11,925,773) 5,663,568 (3,223,821)
------------ ------------ ------------
Net cash used in investing
activities ............. (64,748,941) (65,734,032) (16,008,377)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related
party transactions with
Employers Mutual:
Issuance of common stock ..... 1,326,451 502,007 242,265
Dividends paid to
Employers Mutual ........... (5,423,042) (5,275,938) (5,013,592)
Issuance of surplus notes .... 11,000,000 25,000,000 -
Dividends paid to stockholders ... (1,405,064) (1,511,382) (1,757,848)
------------ ------------ ------------
Net cash provided (used) in
financing activities .... 5,498,345 18,714,687 (6,529,175)
------------ ------------ ------------
Net (decrease) increase in cash .... (677,170) 67,847 (1,018,452)
Cash at beginning of year .......... 558,073 490,226 1,508,678
------------ ------------ ------------
Cash at end of year ................ $ (119,097) $ 558,073 $ 490,226
============ ============ ============
Income taxes paid (recovered) ...... $ 4,755,010 $ (778,316) $ (1,108,766)
Interest paid (received) ........... $ 19,232 $ (79,232) $ (23,722)
See accompanying Notes to Consolidated Financial Statements
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
EMC Insurance Group Inc., a 79.9 percent owned subsidiary of Employers
Mutual Casualty Company (Employers Mutual), is an insurance holding company
with operations in property and casualty insurance and reinsurance. Both
commercial and personal lines of insurance are written, with a focus on
medium-sized commercial accounts. About one-half of the premiums written are
in Iowa and contiguous states. The term "Company" is used interchangeably to
describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance
Group Inc. and its subsidiaries.
The Company's subsidiaries include EMCASCO Insurance Company, Illinois
EMCASCO Insurance Company, Dakota Fire Insurance Company, Farm and City
Insurance Company, EMC Reinsurance Company and EMC Underwriters, LLC.
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States (GAAP), which
differ in some respects from those followed in reports to insurance regulatory
authorities. All significant inter-company balances and transactions have
been eliminated.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
differ from those estimates.
Property and Casualty Insurance and Reinsurance Operations
Property and casualty insurance premiums are recognized as revenue
ratably over the terms of the respective policies. Unearned premiums are
calculated on the daily pro rata method. Both domestic and foreign assumed
reinsurance premiums are recognized as revenues ratably over the terms of the
contract period. Amounts paid as ceded reinsurance premiums are reported as
prepaid reinsurance premiums and amortized over the remaining contract period
in proportion to the amount of reinsurance protection provided. Reinsurance
reinstatement premiums are recognized in the same period as the loss event
that gave rise to the reinstatement premiums.
Certain costs of acquiring new business, principally commissions, premium
taxes and other underwriting expenses that vary with and are directly related
to the production of business have been deferred. Such deferred costs are
being amortized as premium revenue is recognized. The method followed in
computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value, which gives effect to the premium
to be earned, related investment income, losses and settlement expenses and
certain other costs expected to be incurred as the premium is earned.
Certain commercial lines of business, primarily workers' compensation,
are eligible for policyholder dividends in accordance with provisions of the
underlying insurance policies. Net written premiums subject to policyholder
dividends represented approximately 49 percent of the Company's total net
written premiums in 2002. Policyholder dividends are accrued over the terms
of the underlying policies.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Liabilities for losses are based upon case-basis estimates of reported
losses, estimates of unreported losses based upon prior experience adjusted
for current trends, and estimates of losses expected to be paid under assumed
reinsurance contracts. Liabilities for settlement expenses are provided by
estimating expenses expected to be incurred in settling the claims provided
for in the loss reserves. Changes in estimates are reflected in current
operating results (see note 4).
Ceded reinsurance amounts with nonaffiliated reinsurers relating to
reinsurance receivables for paid and unpaid losses and settlement expenses and
prepaid reinsurance are reported on the balance sheet on a gross basis.
Amounts ceded to Employers Mutual relating to the affiliated reinsurance
pooling agreement (see note 2) have not been grossed up because the contracts
provide that receivables and payables may be offset upon settlement.
The liabilities for losses and settlement expenses are considered
adequate to cover the ultimate net cost of losses and claims incurred to date.
Since the provisions are necessarily based on estimates, the ultimate
liability may be more or less than such provisions.
Investments
Securities classified as held-to-maturity are purchased with the intent
and ability to be held to maturity and are carried at amortized cost.
Unrealized holding gains and losses on securities held-to-maturity are not
reflected in the financial statements. All other securities have been
classified as securities available-for-sale and are carried at fair value,
with unrealized holding gains and losses reported as accumulated other
comprehensive income in stockholders' equity, net of deferred income taxes.
Other long-term investments represent minor ownership interests in limited
partnerships and limited liability companies and are carried at cost. Short-
term investments represent money market funds and are carried at cost.
The Company's carrying value for investments is reduced to its estimated
realizable value if a decline in the fair value is deemed "other than
temporary." Such reductions in carrying value are recognized as realized
losses and are charged to income. Premiums and discounts on debt securities
are amortized over the life of the security as an adjustment to yield using
the effective interest method. Realized gains and losses on disposition of
investments are included in net income. The cost of investments sold is
determined on the specific identification method using the highest cost basis
first. Included in investments at December 31, 2002 and 2001 are securities
on deposit with various regulatory authorities as required by law amounting to
$12,648,887 and $12,448,310, respectively.
The Company participates in a securities lending program whereby certain
fixed maturity securities from the investment portfolio are loaned to other
institutions for a short period of time. The Company requires initial
collateral equal to 102 percent of the market value of the loaned securities.
The collateral is invested by the lending agent, in accordance with the
Company's guidelines, and generates fee income for the Company that is
recognized ratably over the time period the security is on loan. The
securities on loan to others are segregated from the other invested assets on
the Company's balance sheet. In accordance with the relevant accounting
literature, the collateral held by the Company is accounted for as a secured
borrowing and is recorded as an asset on the Company's balance sheet with a
corresponding liability reflecting the Company's obligation to return this
collateral upon the return of the loaned securities. The securities lending
program was temporarily suspended at December 31, 2002 to eliminate financial
ratio concerns expressed by certain regulatory authorities.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Income Taxes
The Company files a consolidated Federal income tax return with its
subsidiaries. Consolidated income taxes/benefits are allocated among the
entities based upon separate tax liabilities. The Company expects to become
an 80 percent owned subsidiary of Employers Mutual in 2003. At that time the
Company will begin filing a consolidated tax return with Employers Mutual and
its subsidiaries.
Deferred income taxes are provided for temporary differences between the
tax basis of assets and liabilities and the reported amounts of those assets
and liabilities for financial reporting purposes. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Income tax expense provisions increase or decrease in
the same period in which a change in tax rates is enacted. A valuation
allowance is established to reduce deferred tax assets to their net realizable
value if it is "more likely than not" that a tax benefit will not be realized.
Stock Based Compensation
The Company has no stock based compensation plans of its own; however,
Employers Mutual has several stock plans that utilize the common stock of the
Company. The Company receives the current fair value for any shares issued
under these plans. Under the terms of the pooling agreement (see note 2),
stock option expense is allocated to the Company as determined on a statutory
basis of accounting; however, for these GAAP basis financial statements the
Company accounts for the stock option plans using the intrinsic value method
of accounting as prescribed by Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Under the provisions of APB 25, no compensation expense is recognized from the
operation of Employers Mutual's stock option plans since the exercise price of
the options is equal to the fair value of the stock on the date of grant.
Prior to 2002, the Company had concluded that it was not subject to the
accounting requirements of APB 25 since it receives the current fair value for
any common stock issued under Employers Mutual's stock option plans. As a
result, the Company was recognizing as compensation expense its pool
participation share of the stock option expense recorded by Employers Mutual
for these plans. During 2002, the Company concluded that it is subject to the
accounting requirements of APB 25 and, accordingly, should not be recognizing
compensation expense from Employers Mutual's stock option plans as discussed
above. Accordingly, during 2002 the Company reversed the accrual for stock
option expense allocated to it by Employers Mutual, resulting in $349,273 of
pre-tax income. Pre-tax compensation expense recognized in the Company's
financial statements for the years 2001 and 2000 amounted to $354,703 and
$66,943, respectively. Since these amounts are not material, the financial
statements for those years have not been restated.
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which is effective for
fiscal years ending after December 15, 2002. SFAS 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation, and the effect of the method used on
reported results. The Company has adopted the disclosure requirements of SFAS
148 and elected to continue to follow the recognition and measurement
principles of APB 25.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table illustrates the effect on net income (loss) and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS 123 to Employers Mutual's stock option plans:
2002 2001 2000
----------- ----------- ----------
Net income (loss), as reported $16,101,738 $(2,106,132) $2,329,031
Add: Compensation expense
recognized in net income (loss) - 230,557 44,182
Deduct: Total stock-based
employee compensation expense
determined under fair value
method for all awards, net of
related tax effects .......... 18,992 16,287 14,410
----------- ----------- ----------
Pro forma net income (loss) .... $16,082,746 $(1,891,862) $2,358,803
=========== =========== ==========
Net income (loss) per share:
Basic and diluted - As reported $1.42 $(0.19) $0.21
Basic and diluted - Pro forma $1.41 $(0.17) $0.21
The weighted average fair value of options granted amounted to $3.28,
$1.59 and $.83 for 2002, 2001 and 2000, respectively. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-
pricing model with the following weighted-average assumptions used for the
grants:
2002 2001 2000
------ ------ ------
Dividend yield .......................... 3.28% 5.22% 6.49%
Expected volatility ..................... .218 .215 .159
Risk-free interest rate ................. 4.37% 4.78% 6.14%
Expected life (years) ................... 5 5 5
Net Income (loss) Per Share - Basic and Diluted
The Company's basic and diluted net income (loss) per share are computed
by dividing net income (loss) by the weighted average number of common shares
outstanding during each year. As previously noted, the Company receives the
current fair value for any shares issued under Employers Mutual's stock plans.
As a result, the Company had no potential common shares outstanding during
2002, 2001 and 2000 that would have been dilutive to net income (loss) per
share.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Goodwill
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets." SFAS 142 eliminated the amortization of
goodwill, which represents the excess of cost over the fair value of net
assets acquired subsidiaries, and provides specific steps for testing the
impairment of goodwill. The initial adoption of SFAS 142 did not have an
impact on the operating results of the Company. The annual impairment test
was completed inthe fourth quarter of 2002 and goodwill was not deemed to be
impaired.
Prior to January 1, 2002, goodwill was being amortized on a straight-line
basis over 25 years. The Company reviewed the recoverability of the
unamortized balance of goodwill on a periodic basis using projected cash
flows. Goodwill amortization expense amounted to approximately $135,000
($87,000 after tax) per year. 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.
Reclassifications
Certain amounts previously reported in prior years' consolidated
financial statements have been reclassified to conform to current year
presentation.
2. AFFILIATION AND TRANSACTIONS WITH AFFILIATES
Property and Casualty Insurance Subsidiaries
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. 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 pooling agreement is continuous, but may be amended or
terminated at the end of any calendar year as to any one or more parties.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Reinsurance Subsidiary
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 investment
and income tax activities of the reinsurance subsidiary are not subject to the
quota share agreement.
Premiums assumed by the reinsurance subsidiary from Employers Mutual
amounted to $76,203,278, $66,287,442 and $47,530,111 in 2002, 2001 and 2000,
respectively. It is customary in the reinsurance business for the assuming
company to compensate the ceding company for the acquisition expenses incurred
in the generation of the business. Commissions paid by the reinsurance
subsidiary to Employers Mutual amounted to $18,117,058, $15,892,684 and
$10,795,106 in 2002, 2001 and 2000, respectively.
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. Total override commission paid to Employers Mutual amounted to
$3,429,148, $2,982,935 and $2,138,855 in 2002, 2001 and 2000, respectively.
Employers Mutual retained losses and settlement expenses under this agreement
totaling $1,186,598 in 2002, $14,442,561 in 2001 and $373,847 in 2000. 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 and amounted to $3,247,969, $2,495,794 and $2,122,248
in 2002, 2001 and 2000, respectively.
Services Provided by Employers Mutual
Employers Mutual provides various services to all of its subsidiaries and
affiliates. Such services include data processing, claims, financial,
actuarial, auditing, marketing and underwriting. Employers Mutual allocates a
portion of the cost of these services to the subsidiaries that do not
participate in the pooling agreement based upon a number of criteria,
including usage and number of transactions. The remaining costs are charged
to the pooling agreement and each pool participant shares in the total cost in
accordance with its pool participation percentage. Costs allocated to the
Company by Employers Mutual for services provided to the holding company and
its subsidiaries that do not participate in the pooling agreement amounted to
$1,765,179, $2,040,822 and $1,674,704 in 2002, 2001 and 2000, respectively.
Costs allocated to the Company through the operation of the pooling agreement
amounted to $56,897,066, $51,041,812 and $46,796,784 in 2002, 2001 and 2000,
respectively.
Investment expenses are based on actual expenses incurred by the Company
plus an allocation of other investment expenses incurred by Employers Mutual,
which is based on a weighted average of total invested assets and number of
investment transactions. Investment expenses allocated to the Company by
Employers Mutual amounted to $559,136, $494,142 and $462,068 in 2002, 2001 and
2000, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. REINSURANCE
The parties to the pooling agreement cede insurance business to other
insurers in the ordinary course of business for the purpose of limiting their
maximum loss exposure through diversification of their risks. In its
consolidated financial statements, the Company treats risks to the extent they
are reinsured as though they were risks for which the Company is not liable.
Insurance ceded by the pool participants does not relieve their primary
liability as the originating insurers. Employers Mutual evaluates the
financial condition of the reinsurers of the parties to the pooling agreement
and monitors concentrations of credit risk arising from similar geographic
regions, activities or economic characteristics of the reinsurers to minimize
exposure to significant losses from reinsurer insolvencies.
As of December 31, 2002, reinsurance ceded to two nonaffiliated
reinsurers aggregated $5,800,768, which represents a significant portion of
the total prepaid reinsurance premiums and reinsurance receivables for losses
and settlement expenses. These amounts reflect the property and casualty
insurance subsidiaries' pool participation percentage of amounts ceded by
Employers Mutual to these organizations in connection with its role as
"service carrier". Under these arrangements, Employers Mutual writes business
for these organizations on a direct basis and then cedes 100 percent of this
business to these organizations. Credit risk associated with these amounts is
minimal, as all companies participating in these organizations are responsible
for the liabilities of such organizations on a pro rata basis.
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three years ended December 31, 2002 is
presented below.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Premiums written
Direct ......................... $235,596,547 $272,027,823 $249,896,499
Assumed from nonaffiliates ..... 3,985,370 1,898,509 1,220,442
Assumed from affiliates
(note 11) .................... 320,940,551 299,990,245 244,762,032
Ceded to nonaffiliates ......... (11,089,041) (11,189,227) (8,347,822)
Ceded to affiliates ............ (235,596,547) (272,027,823) (249,896,499)
------------ ------------ ------------
Net premiums written ......... $313,836,880 $290,699,527 $237,634,652
============ ============ ============
Premiums earned
Direct ......................... $241,939,466 $255,764,274 $245,078,165
Assumed from nonaffiliates ..... 3,501,616 1,786,132 1,194,835
Assumed from affiliates ........ 304,462,790 274,352,821 237,946,894
Ceded to nonaffiliates ......... (10,921,373) (10,859,095) (7,683,287)
Ceded to affiliates ............ (241,939,466) (255,764,274) (245,078,165)
------------ ------------ ------------
Net premiums earned .......... $297,043,033 $265,279,858 $231,458,442
============ ============ ============
Losses and settlement expenses
incurred
Direct ......................... $165,218,514 $221,314,633 $208,604,970
Assumed from nonaffiliates ..... 2,876,808 1,336,824 400,360
Assumed from affiliates ........ 206,614,356 227,650,959 194,017,734
Ceded to nonaffiliates ......... (2,433,308) (7,069,033) (4,896,420)
Ceded to affiliates ............ (165,218,514) (221,314,633) (208,604,970)
------------ ------------ ------------
Net losses and settlement
expenses incurred .......... $207,057,856 $221,918,750 $189,521,674
============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
4. LIABILITY FOR LOSSES AND SETTLEMENT EXPENSES
The following table sets forth a reconciliation of beginning and ending
reserves for losses and settlement expenses of the Company. Amounts presented
are on a net basis, with a reconciliation of beginning and ending reserves to
the gross amounts presented in the consolidated financial statements.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Gross reserves at beginning of year $314,518,588 $286,489,028 $266,514,024
Ceded reserves at beginning of year (11,848,597) (11,224,797) (10,260,815)
------------ ------------ ------------
Net reserves at beginning of year .. 302,669,991 275,264,231 256,253,209
------------ ------------ ------------
Incurred losses and
settlement expenses
Provision for insured events
of the current year ............ 200,059,798 216,752,003 191,425,036
Increase (decrease) in provision
for insured events of prior
years .......................... 6,998,058 5,166,747 (1,903,362)
------------ ------------ ------------
Total incurred losses and
settlement expenses ...... 207,057,856 221,918,750 189,521,674
------------ ------------ ------------
Payments
Losses and settlement expenses
attributable to insured events
of the current year ............ 81,124,276 94,983,112 82,912,082
Losses and settlement expenses
attributable to insured events
of prior years ................. 107,744,442 99,529,878 87,598,570
------------ ------------ ------------
Total payments ............. 188,868,718 194,512,990 170,510,652
------------ ------------ ------------
Net reserves at end of year ........ 320,859,129 302,669,991 275,264,231
Ceded reserves at end of year ...... 10,367,624 11,848,597 11,224,797
------------ ------------ ------------
Gross reserves at end of year ...... $331,226,753 $314,518,588 $286,489,028
============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Underwriting results of the Company are significantly influenced by
estimates of loss and settlement expense reserves. Changes in reserve
estimates are reflected in operating results in the year such changes are
recorded. The Company experienced adverse development on prior years'
reserves in both the property and casualty insurance segment and the
reinsurance segment during 2002, which contributed to the increase in losses
and settlement expenses. For the property and casualty insurance segment, the
December 31, 2002 estimate of loss and settlement expense reserves for
accident years 2001 and prior increased $4,645,194 from the estimate at
December 31, 2001. This increase represents 2.1% of the December 31, 2001
carried reserves and is primarily attributable to three sources: direct IBNR
reserves, involuntary pools and contingent salary plan reserves. With regard
to direct IBNR reserves, the methodology utilized to establish these reserves
assumes consistency in claims reporting patterns. However, in recent years
emerged IBNR losses have increased as a percentage of earned premiums. As a
result of these actuarial indications, the Company strengthened direct IBNR
reserves by $3,564,000 in 2002, $1,697,000 of which was allocated to accident
years 2001 and prior. In addition, the Company established $2,068,705 of
additional IBNR asbestos reserves at December 31, 2002 based on the results of
a recently completed study of the Company's asbestos exposures, all of which
was allocated to accident years 2001 and prior. As previously noted, the
Company books the reserves reported by the management of the involuntary pools
and in 2002 these bookings resulted in modest upward development of $353,000.
Finally, Employers Mutual implemented a contingent salary plan in 2002 and
$376,000 of the reserve established for this plan at December 31, 2002 was
allocated to settlement expenses for accident years 2001 and prior.
For the reinsurance segment, the December 31, 2002 estimate of loss and
settlement expense reserves for accident years 2001 and prior increased
$2,352,864 from the estimate at December 31, 2001. This increase represents
2.6% of the December 31, 2001 carried reserves. Virtually all of the increase
arose from the MRB pool, for which the Company books the reserves established
and reported by the pool. The carried MRB reserves at December 31, 2001 were
above the midpoint of the actuarial range of estimates. However, reported
losses and settlement expenses during pool year 2002 exceeded by approximately
$1,249,792 the amounts predicted by the actuarial analysis. In addition,
management of the MRB pool increased the IBNR reserves for prior years by
$345,800. Finally, the losses and settlement expenses reported during January
2002 exceeded by $762,000 the IBNR reserve established at December 31, 2001 to
cover the one-month reporting lag.
The Company has historically experienced favorable development in its
reserves and its reserving practices have not changed; however, the amount of
development experienced will fluctuate from year to year as individual claims
are settled and new information becomes available on open claims.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS
The Company has exposure to asbestos and environmental related claims
associated with the insurance business written by the parties to the pooling
agreement and the reinsurance business assumed from Employers Mutual by the
reinsurance subsidiary. These exposures are not considered to be significant.
Asbestos and environmental losses paid by the Company have averaged only
$219,000 per year over the past five years. During 2002, the Company re-
evaluated the estimated ultimate losses for direct asbestos and environmental
exposures. Based on this re-evaluation, the Company reallocated $752,000 of
bulk IBNR reserves and $324,303 of settlement expense reserves to these
exposures. In addition, the Company took a proactive approach to evaluate the
adequacy of its asbestos reserves and commissioned a "ground-up" study to
better quantify its exposure to asbestos liabilities. This study concluded
that the Company's exposure for direct asbestos claims ranged from $1,000,000
to $5,100,000, with a point estimate of $3,000,000. Based on this study, the
Company elected to increase the IBNR reserves carried for direct asbestos
exposures by $2,068,705 at December 31, 2002, to $2,985,402. The study and
its results assume no improvement in the current asbestos litigation
environment; however, federal legislation currently being considered could
reduce the ultimate losses from asbestos litigation below the levels currently
being projected for the industry. Reserves for asbestos and environmental
related claims for direct insurance and assumed reinsurance business totaled
$5,526,943 and $2,565,515 at December 31, 2002 and 2001, respectively.
Estimating loss and settlement expense reserves for asbestos and
environmental claims is very difficult due to the many uncertainties
surrounding these types of claims. These uncertainties exist because the
assignment of responsibility varies widely by state and claims often emerge
long after the policy has expired, which makes assignment of damages to the
appropriate party and to the time period covered by a particular policy
difficult. In establishing reserves for these types of claims, management
monitors the relevant facts concerning each claim, the current status of the
legal environment, the social and political conditions, and the claim history
and trends within the Company and the industry.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
6. STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The Company's insurance subsidiaries are required to file financial
statements with state regulatory authorities. The accounting principles used
to prepare these statutory financial statements follow prescribed or permitted
accounting practices that differ from GAAP. Prescribed statutory accounting
principles include state laws, regulations and general administrative rules
issued by the state of domicile as well as a variety of publications and
manuals of the National Association of Insurance Commissioners (NAIC).
Permitted accounting practices encompass all accounting practices not
prescribed, but allowed by the state of domicile. The Company's insurance
subsidiaries had no permitted accounting practices during 2002, 2001 and 2000.
Statutory surplus of the Company's insurance subsidiaries was
$140,323,534 and $128,735,605 at December 31, 2002 and 2001, respectively.
Statutory net income (loss) of the Company's insurance subsidiaries was
$13,729,028, ($8,289,542) and ($1,599,085) for 2002, 2001 and 2000,
respectively.
The NAIC utilizes a risk-based capital model to help state regulators
assess the capital adequacy of insurance companies and identify insurers that
are in, or are perceived as approaching, financial difficulty. This model
establishes minimum capital needs based on the risks applicable to the
operations of the individual insurer. The risk-based capital requirements for
property and casualty insurance companies measure three major areas of risk:
asset risk, credit risk and underwriting risk. Companies having less
statutory surplus than required by the risk-based capital requirements are
subject to varying degrees of regulatory scrutiny and intervention, depending
on the severity of the inadequacy. At December 31, 2002, the Company's
insurance subsidiaries had total adjusted statutory capital of $140,323,534,
which is well in excess of the minimum risk-based capital requirement of
$35,865,587.
Retained earnings of the Company's insurance subsidiaries available for
distribution as dividends are limited by law to the statutory unassigned
surplus of each of the subsidiaries as of the previous December 31, as
determined in accordance with accounting practices prescribed by insurance
regulatory authorities of the state of domicile of each subsidiary. Subject
to this limitation, the maximum dividend that may be paid within a 12 month
period without prior approval of the insurance regulatory authorities is
restricted to the greater of 10 percent of statutory surplus as regards
policyholders as of the preceding December 31, or net income of the preceding
calendar year on a statutory basis. At December 31, 2002, $16,784,451 was
available for distribution to the Company in 2003 without prior approval.
In 1998, the NAIC adopted a comprehensive Codification of Statutory
Accounting Principles (Codification) to replace the Accounting Practices and
Procedures Manual as the NAIC's primary guidance on statutory accounting.
Codification is intended to provide a consistent and comprehensive basis of
statutory accounting for all insurance companies and became effective in most
states, including the states of domicile of the Company's insurance
subsidiaries, on January 1, 2001. The adoption of Codification resulted in
changes to the accounting practices that the Company's insurance subsidiaries
use to prepare their statutory financial statements. One of the more
significant changes was the recording of deferred income taxes. As a result
of the adoption of Codification, the statutory surplus of the Company's
insurance subsidiaries increased by approximately $9,110,000 on January 1,
2001.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. 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. The accounting policies of the segments
are described in note 1, Summary of Significant Accounting Policies.
Summarized financial information for the Company's segments is as
follows:
Property
Year ended and casualty Parent
December 31, 2002 insurance Reinsurance company Consolidated
- ----------------- ------------ ------------ ------------ ------------
Premiums earned ......... $225,013,076 $ 72,029,957 $ - $297,043,033
Underwriting loss ....... (3,621,656) (2,026,309) - (5,647,965)
Net investment income ... 23,517,163 9,147,127 113,843 32,778,133
Realized (losses) gains (2,154,246) (1,010,268) 5,313 (3,159,201)
Interest expense ........ (1,345,153) (293,563) - (1,638,716)
Other income ............ 865,819 - - 865,819
Other expenses .......... (869,346) - (436,688) (1,306,034)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) ........... $ 16,392,581 $ 5,816,987 $ (317,532)$ 21,892,036
============ ============ ============ ============
Assets .................. $490,583,702 $181,401,782 $158,010,734 $829,996,218
Eliminations ............ - - (154,552,425)(154,552,425)
Reclassifications ....... - (579,845) - (579,845)
------------ ------------ ------------ ------------
Net assets ......... $490,583,702 $180,821,937 $ 3,458,309 $674,863,948
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Property
Year ended and casualty Parent
December 31, 2001 insurance Reinsurance company Consolidated
- ----------------- ------------ ------------ ------------ ------------
Premiums earned ......... $203,392,845 $ 61,887,013 $ - $265,279,858
Underwriting loss ....... (26,828,133) (10,061,657) - (36,889,790)
Net investment income ... 22,457,799 8,317,505 194,326 30,969,630
Realized gains .......... 681,349 119,233 - 800,582
Interest expense ........ (11,055) - - (11,055)
Other income ............ 695,957 78,212 - 774,169
Other expenses .......... (746,728) - (438,687) (1,185,415)
------------ ------------ ------------ ------------
Loss before income
tax benefit ......... $ (3,750,811)$ (1,546,707)$ (244,361)$ (5,541,879)
============ ============ ============ ============
Assets .................. $514,376,179 $157,360,388 $140,659,584 $812,396,151
Eliminations ............ - - (137,738,931)(137,738,931)
Reclassifications........ - (3,092,523) - (3,092,523)
------------ ------------ ------------ ------------
Net assets ......... $514,376,179 $154,267,865 $ 2,920,653 $671,564,697
============ ============ ============ ============
Year ended
December 31, 2000
- -----------------
Premiums earned ......... $184,985,620 $ 46,472,822 $ - $231,458,442
Underwriting loss ....... (22,280,746) (7,183,418) - (29,464,164)
Net investment income ... 20,787,679 7,873,040 345,597 29,006,316
Realized gains .......... 1,242,233 315,101 536 1,557,870
Other income ............ 1,392,494 80,619 - 1,473,113
Other expenses .......... (1,106,996) - (401,527) (1,508,523)
------------ ------------ ------------ ------------
Income (loss) before
income tax (benefit)
expense ............. $ 34,664 $ 1,085,342 $ (55,394)$ 1,064,612
============ ============ ============ ============
8. INVESTMENTS
Investments of the Company's insurance subsidiaries are subject to the
insurance laws of the state of their incorporation. These laws prescribe the
kind, quality and concentration of investments that may be made by insurance
companies. In general, these laws permit investments, within specified limits
and subject to certain qualifications, in federal, state and municipal
obligations, corporate bonds, preferred and common stocks and real estate
mortgages. The Company believes that it is in compliance with these laws.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The amortized cost and estimated fair value of securities
held-to-maturity and available-for-sale as of December 31, 2002 and 2001 are
as follows. The estimated fair value is based on quoted market prices, where
available, or on values obtained from independent pricing services.
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ------------ ------------
December 31, 2002
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 49,956,691 $ 6,190,424 $ - $ 56,147,115
Mortgage-backed
securities ........... 5,076,984 414,938 - 5,491,922
------------ ----------- ----------- ------------
Total securities
held-to-maturity $ 55,033,675 $ 6,605,362 $ - $ 61,639,037
============ =========== =========== ============
Securities available-for-
sale:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $110,033,485 $ 1,354,496 $ (6,934)$111,381,047
Obligations of states
and political
subdivisions ......... 81,425,249 5,706,479 (15,640) 87,116,088
Mortgage-backed
securities ........... 12,594,103 1,047,853 - 13,641,956
Debt securities issued
by foreign governments 6,483,656 1,104,054 - 7,587,710
Public utilities ....... 46,979,003 2,431,362 (303,457) 49,106,908
Corporate securities ... 202,329,432 18,388,758 (3,695,933) 217,022,257
------------ ----------- ----------- ------------
Total fixed maturity
securities ....... 459,844,928 30,033,002 (4,021,964) 485,855,966
------------ ----------- ----------- ------------
Equity securities:
Common stocks .......... 37,944,030 1,472,034 (5,277,079) 34,138,985
Non-redeemable
preferred stocks ..... 500,000 - (42,000) 458,000
------------ ----------- ----------- ------------
Total equity
securities ....... 38,444,030 1,472,034 (5,319,079) 34,596,985
------------ ----------- ----------- ------------
Total securities
available-for-sale $498,288,958 $31,505,036 $(9,341,043)$520,452,951
============ =========== =========== ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
------------ ----------- ----------- ------------
December 31, 2001
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 57,443,480 $ 4,938,670 $ - $ 62,382,150
Mortgage-backed
securities ........... 8,634,427 448,311 - 9,082,738
------------ ----------- ----------- ------------
Total securities
held-to-maturity $ 66,077,907 $ 5,386,981 $ - $ 71,464,888
============ =========== =========== ============
Securities available-for-
Sale:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 53,080,155 $ 171,555 $ (80,651)$ 53,171,059
Obligations of states
and political
subdivisions ......... 77,746,658 2,528,902 (510,260) 79,765,300
Mortgage-backed
securities ........... 24,993,733 1,234,960 - 26,228,693
Debt securities issued
by foreign governments 6,481,973 662,892 - 7,144,865
Public utilities ....... 59,510,559 578,124 (1,182,696) 58,905,987
Corporate securities ... 189,923,283 5,741,902 (2,230,904) 193,434,281
------------ ----------- ----------- ------------
Total fixed maturity
securities ....... 411,736,361 10,918,335 (4,004,511) 418,650,185
------------ ----------- ----------- ------------
Equity securities:
Common stocks .......... 27,689,811 6,190,284 (1,492,393) 32,387,702
Non-redeemable
preferred stocks ..... 996,510 6,055 (67,500) 935,065
------------ ----------- ----------- ------------
Total equity
securities ....... 28,686,321 6,196,339 (1,559,893) 33,322,767
------------ ----------- ----------- ------------
Total securities
available-for-sale $440,422,682 $17,114,674 $(5,564,404)$451,972,952
============ =========== =========== ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The amortized cost and estimated fair value of fixed maturity securities
at December 31, 2002, by contractual maturity, are shown below. Expected
maturities may differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
Estimated
Amortized fair
cost value
------------ ------------
Securities held-to-maturity:
Due in one year or less ................... $ - $ -
Due after one year through five years ..... 43,973,773 49,782,810
Due after five years through ten years .... 4,985,531 5,313,205
Due after ten years ....................... 997,387 1,051,100
Mortgage-backed securities ................ 5,076,984 5,491,922
------------ ------------
Totals ................................ $ 55,033,675 $ 61,639,037
============ ============
Securities available-for-sale:
Due in one year or less ................... $ 55,668,261 $ 55,717,130
Due after one year through five years ..... 24,992,053 26,572,980
Due after five years through ten years .... 105,727,344 116,605,900
Due after ten years ....................... 260,863,167 273,318,000
Mortgage-backed securities ................ 12,594,103 13,641,956
------------ ------------
Totals ................................ $459,844,928 $485,855,966
============ ============
The mortgage-backed securities shown in the above table include
$17,059,099 of securities issued by government corporations and agencies and
$611,988 of collateralized mortgage obligations (CMOs). CMOs are securities
backed by mortgages on real estate, which come due at various times. The
Company has attempted to minimize the prepayment risks associated with
mortgage-backed securities by not investing in "principal only" and "interest
only" CMOs. The CMOs that the Company has invested in are designed to reduce
the risk of prepayment by providing predictable principal payment schedules
within a designated range of prepayments. Investment yields may vary from
those anticipated due to changes in prepayment patterns of the underlying
collateral.
A summary of realized investment gains and losses is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ---------- ----------
Fixed maturity securities
held-to-maturity: (1)
Gross realized investment gains ... $ - $ 21,042 $ 536
Gross realized investment losses .. - - (5,038)
Fixed maturity securities
available-for-sale: (2)
Gross realized investment gains ... 960,705 235,515 1,074,068
Gross realized investment losses .. (3,831,374) (19,039) (7,237)
Equity securities
available-for-sale:
Gross realized investment gains ... 4,654,622 4,050,256 3,911,717
Gross realized investment losses .. (4,943,154) (3,487,192) (3,416,176)
----------- ---------- ----------
Totals .......................... $(3,159,201) $ 800,582 $1,557,870
=========== ========== ==========
(1) Investment gains and losses realized on fixed maturity securities
held-to-maturity are the result of calls and prepayments.
(2) Investment losses realized on fixed maturity securities available-
for-sale for the year ended December 31, 2002 include "other than temporary"
security impairment write-downs totaling $3,821,466.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2000, the Company sold approximately $14,000,000 of investments in
tax-exempt fixed maturity securities available-for-sale and reinvested the
proceeds into taxable fixed maturity securities available-for-sale that pay a
higher interest rate. This change in asset allocation was implemented to
increase the Company's after-tax rate of return on its investment portfolio.
Realized investment gains from the disposal of these tax-exempt fixed maturity
securities amounted to $531,352.
A summary of net investment income is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Interest on fixed maturities .......... $31,909,946 $29,507,515 $27,857,760
Dividends on equity securities ........ 605,079 551,066 494,941
Interest on short-term investments .... 690,046 1,425,167 1,114,717
Interest on long-term investments ..... 103,763 - -
Fees from securities lending .......... 120,489 132,905 96,709
----------- ----------- -----------
Total investment income ........... 33,429,323 31,616,653 29,564,127
Investment expenses ................... (651,190) (647,023) (557,811)
----------- ----------- -----------
Net investment income ............. $32,778,133 $30,969,630 $29,006,316
=========== =========== ===========
A summary of net changes in unrealized holding gains (losses) on
securities available-for-sale is as follows:
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Fixed maturity securities ......... $ 19,097,214 $ 2,206,640 $ 12,246,089
Applicable deferred income tax
expense ......................... 6,684,025 819,396 4,163,670
------------ ------------ ------------
Total fixed maturity securities 12,413,189 1,387,244 8,082,419
------------ ------------ ------------
Equity securities ................. (8,483,491) (1,341,098) 2,063,902
Applicable deferred income tax
(benefit) expense ............... (2,969,226) (409,606) 701,728
------------ ------------ ------------
Total equity securities ....... (5,514,265) (931,492) 1,362,174
------------ ------------ ------------
Deferred income tax valuation
allowance ....................... - - (1,232,590)
------------ ------------ ------------
Total available-for-sale
securities .................. $ 6,898,924 $ 455,752 $ 10,677,183
============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. INCOME TAXES
Temporary differences between the consolidated financial statement
carrying amount and tax basis of assets and liabilities that give rise to
significant portions of the deferred income tax asset at December 31, 2002
and 2001 are as follows:
Year ended December 31,
-------------------------
2002 2001
----------- -----------
Loss reserve discounting .......................... $15,730,089 $15,487,210
Unearned premium reserve limitation ............... 7,993,385 6,520,646
Postretirement benefits ........................... 2,364,160 2,187,059
Other policyholders' funds payable ................ 362,468 165,533
Net operating loss carry forward .................. - 3,481,087
Minimum tax credit ................................ 1,730,815 2,158,360
Impairment losses on investments .................. 1,337,513 -
Other, net ........................................ 1,789,128 457,464
----------- -----------
Total deferred income tax asset ............. 31,307,558 30,457,359
----------- -----------
Deferred policy acquisition costs ................. (8,724,401) (7,477,235)
Net unrealized holding gains ...................... (7,757,397) (4,042,595)
Other, net ........................................ (839,588) (608,722)
----------- -----------
Total deferred income tax liability ......... (17,321,386) (12,128,552)
----------- -----------
Net deferred income tax asset ............. $13,986,172 $18,328,807
=========== ===========
Based upon anticipated future taxable income and consideration of all
other available evidence, management believes that it is "more likely than
not" that the Company's net deferred income tax asset will be realized.
The actual income tax expense (benefit) for the years ended December 31,
2002, 2001 and 2000 differed from the "expected" tax expense (benefit) for
those years (computed by applying the United States federal corporate tax rate
of 35 percent (34 percent for 2000) to income (loss) before income tax expense
(benefit)) as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Computed "expected" tax expense
(benefit) ........................... $ 7,662,213 $(1,939,658) $ 361,968
Increases (decreases) in
tax resulting from:
Tax-exempt interest income ........ (1,441,502) (1,509,839) (1,673,566)
Change in accrual of prior year
taxes ........................... - - (470,000)
Other, net ........................ (430,413) 13,750 517,179
----------- ----------- -----------
Income tax expense (benefit)..... $ 5,790,298 $(3,435,747) $(1,264,419)
=========== =========== ===========
Comprehensive income tax expense (benefit) included in the consolidated
financial statements for the years ended December 31, 2002, 2001 and 2000 is
as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Income tax expense (benefit) on:
Operations .......................... $ 5,790,298 $(3,435,747) $(1,264,419)
Unrealized holding gains (losses) on
revaluation of securities
available-for-sale ................ 3,714,799 409,790 3,632,808
Minimum pension liability ........... (101,373) - -
----------- ----------- -----------
Comprehensive income tax
expense (benefit) ............. $ 9,403,724 $(3,025,957) $ 2,368,389
=========== =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. SURPLUS NOTES
On June 27, 2002, the Company's reinsurance subsidiary issued a surplus
note in the amount of $11,000,000 to Employers Mutual. 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 the
reinsurance subsidiary's statutory surplus earnings and is subject to approval
by the Iowa Insurance Commissioner. The surplus note is subordinate and
junior in right of payment to all obligations or liabilities of the
reinsurance subsidiary. Interest expense on this surplus note amounted to
$293,563 for 2002.
On December 28, 2001, three of the Company's property and casualty
insurance subsidiaries issued surplus notes totaling $25,000,000 to Employers
Mutual. The surplus notes bear an annual interest rate of 5.38 percent and do
not have a maturity date. Payment of interest and repayment of principal can
only be repaid out of the issuing company's statutory surplus earnings and is
subject to approval by the Insurance Commissioner of the issuing company's
state of domicile. The surplus notes are subordinate and junior in right of
payment to all obligations or liabilities of the issuing company. Interest
expense on these surplus notes amounted to $1,345,153 for 2002 and $11,055 for
2001.
11. INSTALLMENT BASIS PREMIUMS
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 $13,884,423, invested 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. EMPLOYEE RETIREMENT PLANS
Employers Mutual has various benefit plans, including a defined benefit
retirement plan and two postretirement benefit plans. Although the Company
has no employees of its own, under the terms of the pooling agreement as
described in note 2, the Company is responsible for its pool participation
share of Employers Mutual's benefit plan expenses and related benefit plan
prepaid assets and liabilities. Accordingly, the Company's consolidated
balance sheets reflect such benefit plan assets and liabilities, including a
minimum pension liability at December 31, 2002.
Employers Mutual's defined benefit retirement plan covers substantially
all of its employees. The plan is funded by employer contributions and
provides benefits under two different formulas, depending on an employee's age
and date of service. Benefits generally vest after five years of service.
It is Employers Mutual's policy to fund pension costs according to regulations
provided under the Internal Revenue Code. Assets held in the plan are a mix
of equity, debt and guaranteed interest securities and real estate funds.
Employers Mutual also offers postretirement benefit plans, which provide
certain health care and life insurance benefits for retired employees.
Substantially all of its employees may become eligible for those benefits if
they reach normal retirement age and have attained the required length of
service while working for Employers Mutual or its subsidiaries. The health
care postretirement plan requires contributions from participants and contains
certain cost sharing provisions such as coinsurance and deductibles. The life
insurance plan is noncontributory. The benefits provided under both plans are
subject to change.
Employers Mutual maintains two Voluntary Employee Beneficiary Association
(VEBA) trusts, which accumulate funds for the payment of postretirement health
care and life insurance benefits. Contributions to the VEBA trusts are used
to fund the accumulated postretirement benefit obligation, as well as pay
current year benefits. Assets held in the VEBA trusts are primarily invested
in life insurance products purchased from Employers Modern Life Company, a
subsidiary of Employers Mutual.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table sets forth the funded status of the Employers Mutual
defined benefit retirement plan and postretirement benefit plans as of
December 31, 2002 and 2001, based upon a measurement date of November 1, 2002
and 2001, respectively:
Defined benefit plan Postretirement plans
------------------------- --------------------------
2002 2001 2002 2001
------------ ----------- ------------ ------------
Change in projected
benefit obligation:
Benefit obligation at
beginning of year ...$ 98,008,250 $88,601,838 $ 46,759,000 $ 34,715,000
Service cost .......... 5,299,831 4,885,731 2,964,000 2,299,000
Interest cost ......... 6,576,584 6,640,491 3,223,000 2,644,000
Actuarial loss ........ 6,769,141 5,242,814 14,954,000 8,406,000
Benefits paid ......... (4,960,786) (8,069,721) (1,591,000) (1,305,000)
Amendments ............ 97,049 707,097 - -
------------ ----------- ------------ ------------
Projected benefit
obligation at end
of year ......... 111,790,069 98,008,250 66,309,000 46,759,000
------------ ----------- ------------ ------------
Change in plan assets:
Fair value of plan
assets at beginning
of year ............. 83,408,910 95,116,686 5,937,000 3,353,000
Actual return on plan
assets .............. (1,240,498) (3,638,055) 326,000 214,000
Employer contributions 4,990,740 - 8,065,000 3,675,000
Benefits paid ......... (4,960,786) (8,069,721) (1,591,000) (1,305,000)
------------ ----------- ------------ ------------
Fair value of plan
assets at end
of year ......... 82,198,366 83,408,910 12,737,000 5,937,000
------------ ----------- ------------ ------------
Funded status ......... (29,591,703) (14,599,340) (53,572,000) (40,822,000)
Unrecognized net
actuarial loss ...... 21,963,572 7,209,026 21,438,000 6,442,000
Unrecognized prior
service costs ....... 4,899,114 5,586,284 - 535,000
Employer contributions - - - 4,090,000
------------ ----------- ------------ ------------
Net amount
recognized ......$ (2,729,017) $(1,804,030) $(32,134,000) $(29,755,000)
============ =========== ============ ============
Amounts recognized in
the statement of
financial position
consist of:
Accrued benefit
liability ....... $(8,633,268) $(1,804,030) $(32,134,000) $(29,755,000)
Intangible asset .. 4,899,114 - - -
Accumulated other
comprehensive
income .......... 1,005,137 - - -
----------- ----------- ------------ ------------
Net amount
recognized .. $(2,729,017) $(1,804,030) $(32,134,000) $(29,755,000)
=========== =========== ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The components of net periodic pension cost for the Employers Mutual
defined benefit retirement plan is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Service cost .......................... $ 5,299,831 $ 4,885,731 $ 4,599,973
Interest cost ......................... 6,576,584 6,640,491 6,097,377
Expected return on plan assets ........ (6,744,907) (7,836,882) (7,436,949)
Recognized net actuarial gain ......... - - (164,619)
Amortization of initial net asset ..... - - (755,787)
Amortization of prior service costs ... 784,219 781,043 563,914
----------- ----------- -----------
Net periodic pension benefit cost ... $ 5,915,727 $ 4,470,383 $ 2,903,909
=========== =========== ===========
The weighted average discount rate used to measure the projected benefit
obligation was 6.50 percent for 2002, 7.00 for 2001 and 7.75 percent for 2000.
The assumed long-term rate of return on plan assets was 8.00 percent for 2002
and 8.50 percent for 2001 and 2000. The rate of increase in future
compensation levels used in measuring the projected benefit obligation was
5.93 percent in 2002 and 5.96 percent in 2001 and 2000.
Pension liabilities reflected in the Company's financial statements
totaled $2,487,560 (including $1,701,355 of additional minimum liability) in
2002 and $570,096 in 2001. At December 31, 2002, the Company's financial
statements also reflect an intangible asset associated with the pension plan
of $1,411,716. The $289,639 difference between the additional minimum
liability and the intangible asset is reflected as other comprehensive loss in
the Company's stockholders' equity. Pension expense allocated to the Company
amounted to $1,406,306, $1,060,259 and $691,007 in 2002, 2001 and 2000,
respectively.
The components of net periodic postretirement benefit cost for the
Employers Mutual postretirement benefit plans is as follows:
Year ended December 31,
--------------------------------------
2002 2001 2000
------------ ------------ ------------
Service cost ......................... $ 2,964,000 $ 2,299,000 $ 2,066,000
Interest cost ........................ 3,223,000 2,644,000 2,396,000
Expected return on assets ............ (518,000) (318,000) (140,000)
Amortization of net loss (gain) ...... 150,000 (1,000) (16,000)
Amortization of prior service costs .. 535,000 571,000 571,000
------------ ------------ ------------
Net periodic postretirement benefit
cost ............................. $ 6,354,000 $ 5,195,000 $ 4,877,000
============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The assumed weighted average annual rate of increase in the per capita
cost of covered health care benefits (i.e. the health care cost trend rate)
for 2002 is 12.00 percent, and is assumed to decrease gradually to 5.00
percent in 2009 and remain at that level thereafter. The health care cost
trend rate assumption has a significant effect on the amounts reported. For
example, a one-percentage-point increase in the assumed health care cost trend
rate for each future year would increase the accumulated postretirement
benefit obligation as of December 31, 2002 by $11,362,000 and the aggregate of
the service and interest cost components of net periodic postretirement
benefit cost for the year ended December 31, 2002 by $1,254,000. A one-
percentage-point decrease in the assumed health care cost trend rate for each
future year would decrease the accumulated postretirement benefit obligation
as of December 31, 2002 by $9,014,000 and the aggregate of the service and
interest cost components of net periodic postretirement benefit cost for the
year ended December 31, 2002 by $977,000. The weighted average discount rate
used in determining the accumulated postretirement benefit obligation was 6.50
percent in 2002, 7.00 percent 2001 and 7.75 percent for 2000. The assumed
long-term rate of return on plan assets was 5.00 percent in 2002 and 6.00
percent for 2001 and 2000.
Postretirement benefit liabilities reflected in the Company's financial
statements totaled $7,526,789 in 2002 and $6,967,484 in 2001. Net periodic
postretirement benefit cost allocated to the Company for the years ended
December 31, 2002, 2001 and 2000 was $1,486,724, $1,214,255 and $1,138,231,
respectively.
The Company participates in several other retirement plans sponsored by
Employers Mutual, including a 401(k) Plan, an Executive Non Qualified Excess
Plan, an Excess Retirement Benefit Agreement and a Supplemental Executive
Retirement Plan. The Company's share of expenses for these plans amounted to
$703,555, $379,988 and $404,400 in 2002, 2001 and 2000, respectively.
13. STOCK PLANS
Stock Based Compensation
The Company has no stock based compensation plans of its own; however,
Employers Mutual has several stock plans which utilize the common stock of the
Company. Employers Mutual can provide the common stock required under its
plans by: 1) using shares of common stock that it currently owns; 2)
purchasing common stock on the open market; or 3) directly purchasing common
stock from the Company at the current fair value. Employers Mutual has
historically purchased common stock from the Company for use in its incentive
stock option plans and its non-employee director stock purchase plan.
Employers Mutual generally purchases common stock on the open market to
fulfill its obligations under its employee stock purchase plan.
Incentive Stock Option Plans
Employers Mutual maintains two separate stock option plans for the
benefit of officers and key employees of Employers Mutual and its
subsidiaries. A total of 600,000 shares have been reserved for the 1982
Employers Mutual Casualty Company Incentive Stock Option Plan (1982 Plan) and
a total of 500,000 shares of the Company's common stock were initially
reserved for issuance under the 1993 Employers Mutual Casualty Company
Incentive Stock Option Plan (1993 Plan). Effective January 30, 1998, an
additional 500,000 shares were registered under the 1993 Plan.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
There is a ten year time limit for granting options under the plans.
Options can no longer be granted under the 1982 Plan and the time period for
granting options under the 1993 Plan expired on December 31, 2002. Options
granted under the plans have a vesting period of two, three, four or five
years with options becoming exercisable in equal annual cumulative increments.
The Senior Executive Compensation and Stock Option Committee (the
"Committee") of Employers Mutual's Board of Directors (the "Board") is the
administrator of the plans. Option prices are determined by the Committee but
cannot be less than the fair value of the stock on the date of grant.
During 2002, 65,900 options were granted under the 1993 Plan to eligible
participants at a price of $18.30 and 98,864 options were exercised under the
plans at prices ranging from $14.32 to $22.66. A summary of the activity
under Employers Mutual's incentive stock option plans for 2002, 2001 and 2000
is as follows:
2002 2001 2000
------------------ ------------------ -----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- ------- --------
Outstanding,
beginning of year 723,378 $10.84 809,882 $10.71 595,255 $11.22
Granted ............. 65,900 18.30 10,700 11.38 265,775 9.25
Exercised ........... (98,864) 10.26 (85,377) 9.58 (47,748) 8.94
Expired ............. (11,657) 10.88 (11,827) 11.28 (3,400) 10.75
------- ------- -------
Outstanding,
end of year ....... 678,757 11.65 723,378 10.84 809,882 10.71
======= ======= =======
Exercisable,
end of year ....... 404,807 $11.35 407,108 $11.18 390,447 $10.82
======= ======= =======
December 31, 2002
----------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------- ---------------------
Weighted-
Weighted- average Weighted-
average remaining average
Range of option Number exercise contractual Number exercise
exercise prices outstanding price life exercisable price
- ---------------- ----------- -------- ----------- ----------- ---------
$ 8.81 - $10.00 340,496 $ 9.36 5.41 185,306 $ 9.45
11.38 - 12.69 145,613 12.38 5.26 109,333 12.38
13.25 - 18.30 192,648 15.16 5.30 110,168 13.51
------- -------
678,757 11.65 5.35 404,807 11.35
======= =======
Employee Stock Purchase Plan
A total of 500,000 shares of the Company's common stock have been
reserved for issuance under the Employers Mutual Casualty Company 1993
Employee Stock Purchase Plan. Any employee who is employed by Employers
Mutual or its subsidiaries on the first day of the month immediately preceding
any option period is eligible to participate in the plan. Participants pay 85
percent of the fair market value of the stock purchased, which is fully vested
on the date purchased. The plan is administered by the Board of Employers
Mutual and the Board has the right to amend or terminate the plan at any time;
however, no such amendment or termination shall adversely affect the rights
and privileges of participants with unexercised options. Expenses allocated
to the Company in connection with this plan totaled $6,817, $6,889 and $12,749
in 2002, 2001 and 2000, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2002, a total of 11,716 options were exercised at prices of $14.95
and $15.10. Activity under the plan was as follows:
Year ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Shares available for purchase,
beginning of year ...................... 313,755 327,489 352,354
Shares purchased under plan .............. (11,716) (13,734) (24,865)
------- ------- -------
Shares available for purchase, end of year 302,039 313,755 327,489
======= ======= =======
Non-Employee Director Stock Purchase Plan
A total of 200,000 shares of the Company's common stock have been
reserved for issuance under the Employers Mutual Casualty Company Non-Employee
Director Stock Purchase Plan. All non-employee directors of Employers Mutual
and its subsidiaries who are not serving on the "Disinterested Director
Committee" of the Board as of the beginning of the option period are eligible
to participate in the plan. Each eligible director can purchase shares of
common stock at 75 percent of the fair value of the stock in an amount equal
to a minimum of 25 percent to a maximum of 100 percent of their annual cash
retainer. The plan will continue through the option period for options
granted at the 2002 annual meetings. The plan is administered by the
Disinterested Director Committee of the Board. The Board may amend or
terminate the plan at any time; however, no such amendment or termination
shall adversely affect the rights and privileges of participants with
unexercised options. During 2002, a total of 1,961 options were exercised at
a price of $12.24. Expenses allocated to the Company in connection with this
plan totaled $0, $5,819 and $5,916 in 2002, 2001 and 2000, respectively.
Activity under the plan was as follows:
Year ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Shares available for purchase,
beginning of year ...................... 143,158 143,158 152,190
Shares purchased under plan .............. (1,961) - (9,032)
------- ------- -------
Shares available for purchase, end of year 141,197 143,158 143,158
======= ======= =======
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Dividend Reinvestment Plan
The Company maintains a dividend reinvestment and common stock purchase
plan which provides stockholders with the option of reinvesting cash dividends
in additional shares of the Company's common stock. Participants may also
purchase additional shares of common stock without incurring broker
commissions by making optional cash contributions to the plan and may sell
shares of common stock through the plan. Since the third quarter of 1998, all
shares of common stock issued under the plan have been purchased in the open
market through the Company's transfer agent. On September 15, 2000, an
additional 1,000,000 shares of stock were registered for issuance under the
dividend reinvestment plan. Employers Mutual participated in the Dividend
Reinvestment Plan during 2002 by reinvesting 25 percent of its dividends in
additional shares of the Company's common stock. Prior to 2002, Employers
Mutual was reinvesting 100 percent of its dividends in additional shares of
the Company's common stock. Employers Mutual increased its dividend
reinvestment percentage to 50 percent in the first quarter of 2003 and expects
to surpass the 80 percent ownership threshold of the Company in 2003.
Employers Mutual has indicated that it may continue to participate in the
dividend reinvestment plan in the future; however, its reinvestment percentage
will likely be reduced to a level necessary to maintain the 80 percent
ownership threshold. Activity under the plan was as follows:
Year ended December 31,
-------------------------------
2002 2001 2000
------- ------- ---------
Shares available for purchase,
beginning of year .................. 501,230 880,679 399,629
Additional shares registered ......... - - 1,000,000
Shares purchased under plan .......... (84,331) (379,449) (518,950)
------- ------- ---------
Shares available for purchase,
end of year ........................ 416,899 501,230 880,679
======= ======= =========
Range of purchase prices ............. $15.38 $11.50 $ 7.50
to to to
$21.99 $17.25 $12.66
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash, indebtedness to related party and accounts
receivable approximate fair value because of the short maturity of these
instruments.
The estimated fair value for fixed maturities, equity securities and
short-term investments is based on quoted market prices, where available, or
on values obtained from independent pricing services (see note 8).
The carrying value of the surplus notes approximates their estimated fair
value since their interest rates approximate current interest rates for
comparable surplus notes.
Other long-term investments, consisting primarily of holdings in limited
partnerships and limited liability companies, are valued by the various fund
managers. In management's opinion, these values reflect fair value at
December 31, 2002.
The estimated fair value of the Company's financial instruments is
summarized below.
Carrying Estimated
amount fair value
------------ ------------
December 31, 2002
- -----------------
Assets:
Fixed maturity securities:
Held-to-maturity ............................ $ 55,033,675 $ 61,639,037
Available-for-sale .......................... 485,855,966 485,855,966
Equity securities available-for-sale .......... 34,596,985 34,596,985
Short-term investments ........................ 29,650,230 29,650,230
Other long-term investments ................... 3,057,000 3,057,000
Liabilities:
Surplus notes ................................. 36,000,000 36,000,000
December 31, 2001
- -----------------
Assets:
Fixed maturity securities:
Held-to-maturity ............................ $ 33,572,602 $ 35,502,755
Available-for-sale .......................... 390,214,177 390,214,177
Fixed maturity securities on loan:
Held-to-maturity ............................ 32,505,305 35,962,133
Available-for-sale .......................... 28,436,008 28,436,008
Equity securities available-for-sale .......... 33,322,767 33,322,767
Short-term investments ........................ 17,724,458 17,724,458
Liabilities:
Surplus notes ................................. 25,000,000 25,000,000
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
15. CONTINGENT LIABILITIES
The Company and Employers Mutual and its other subsidiaries are parties
to numerous lawsuits arising in the normal course of the insurance business.
The Company believes that the resolution of these lawsuits will not have a
material adverse effect on its financial condition or its results of
operations. The companies involved have reserves which are believed adequate
to cover any potential liabilities arising out of all such pending or
threatened proceedings.
The members of the pooling agreement have purchased annuities to fund
future payments that are fixed pursuant to specific claim settlement
provisions. The Company, under the current terms of the pooling agreement, is
contingently liable for 23.5 percent of these annuities (see note 2). The
Company is contingently liable to various claimants in the amount of $646,772
in the event that the issuing company would be unable to fulfill its
obligations.
16. UNAUDITED INTERIM FINANCIAL INFORMATION
Three months ended,
-----------------------------------------------------
March 31 June 30 September 30 December 31
----------- ----------- ------------ -----------
2002
- ----
Total revenues ........ $77,157,134 $78,582,787 $81,763,105 $90,024,758
=========== =========== =========== ===========
Income before income
tax expense ......... $ 5,470,323 $ 3,518,303 $ 5,971,780 $ 6,931,630
Income tax expense .... 1,780,446 573,617 1,670,595 1,765,640
----------- ----------- ----------- -----------
Net income ....... $ 3,689,877 $ 2,944,686 $ 4,301,185 $ 5,165,990
=========== =========== =========== ===========
Net income per share
- basic and diluted* $ .33 $ .26 $ .38 $ .45
=========== =========== =========== ===========
2001
- ----
Total revenues ........ $68,295,006 $71,307,822 $77,180,241 $81,041,170
=========== =========== =========== ===========
Income (loss) before
income tax expense
(benefit) ........... $ 2,677,827 $(5,025,762) $ (766,909) $(2,427,035)
Income tax expense
(benefit) ........... 612,674 (2,179,897) (703,381) (1,165,143)
----------- ----------- ----------- -----------
Net income (loss) $ 2,065,153 $(2,845,865) $ (63,528) $(1,261,892)
=========== =========== =========== ===========
Net income (loss) per
share
- basic and diluted* $ .18 $ (.25) $ (.01) $ (.11)
=========== =========== =========== ===========
2000
- ----
Total revenues ........ $61,144,637 $62,917,075 $66,792,907 $72,641,122
=========== =========== =========== ===========
Income (loss) before
income tax expense
(benefit) ........... $ 2,003,674 $ (293,962) $ 1,428,928 $(2,074,028)
Income tax expense
(benefit) ........... 386,504 (489,810) 224,712 (1,385,825)
----------- ----------- ----------- -----------
Net income (loss) $ 1,617,170 $ 195,848 $ 1,204,216 $ (688,203)
=========== =========== =========== ===========
Net income (loss) per
share
- basic and diluted* $ .14 $ .02 $ .11 $ (.06)
=========== =========== =========== ===========
* Since the weighted average shares for the quarters are calculated
independent of the weighted average shares for the year, quarterly net income
(loss) per share may not total to annual net income (loss) per share.