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 Registered Public Accounting Firm. 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, 2003, 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 Registered Public Accounting Firm
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, 2003 and 2002, and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2003. 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 audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (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 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, 2003 and 2002 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in conformity with U.S
generally accepted accounting principles.
/s/Ernst & Young LLP
February 27, 2004
Des Moines, Iowa
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2003 2002
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $21,167,655 and $61,639,037) .... $ 19,423,013 $ 55,033,675
Securities available-for-sale, at fair value
(amortized cost $382,326,388 and
$459,844,928) ............................... 405,758,798 485,855,966
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $32,686,769 and $0) ............ 30,422,335 -
Securities available-for-sale, at fair value
(amortized cost $117,184,150 and $0) ....... 118,026,960 -
Equity securities available-for-sale, at fair
value (cost $38,998,075 and $38,444,030) ..... 49,008,498 34,596,985
Other long-term investments, at cost ........... 4,758,019 3,057,000
Short-term investments, at cost ................ 63,568,064 29,650,230
------------ ------------
Total investments .......................... 690,965,687 608,193,856
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ..................... 15,861,754 11,582,136
Prepaid reinsurance premiums ................ 3,297,228 2,442,899
Intangible asset, defined benefit
retirement plan ........................... 1,016,492 1,411,716
Other assets ................................ 1,857,284 1,331,816
Cash ............................................. (14,069,102) (119,097)
Accrued investment income ........................ 7,821,652 9,179,555
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $7,297) ....... 379,423 772,944
Income taxes recoverable ......................... - 213,504
Deferred policy acquisition costs ................ 26,737,784 24,926,861
Deferred income taxes ............................ 10,345,429 13,986,172
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................... 941,586 941,586
Securities lending collateral .................... 154,556,758 -
------------ ------------
Total assets .............................. $899,711,975 $674,863,948
============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2003 2002
------------ ------------
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses ............. $367,923,881 $331,226,753
Unearned premiums .......................... 124,832,607 115,746,814
Other policyholders' funds ................. 1,390,594 1,035,622
Surplus notes payable ...................... 36,000,000 36,000,000
Indebtedness to related party .............. 2,175,118 3,304,539
Employee retirement plans .................. 9,965,600 10,014,349
Other liabilities .......................... 19,336,366 19,767,507
Income taxes payable ............................. 2,780,500 -
Securities lending obligation .................... 154,556,758 -
------------ ------------
Total liabilities ........................ 718,961,424 517,095,584
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value,
authorized 20,000,000 shares;
issued and outstanding, 11,501,065 shares
in 2003 and 11,399,050 shares in 2002 .......... 11,501,065 11,399,050
Additional paid-in capital ....................... 69,113,228 67,270,591
Accumulated other comprehensive income ........... 22,285,668 14,218,330
Retained earnings ................................ 77,850,590 64,880,393
------------ ------------
Total stockholders' equity ................. 180,750,551 157,768,364
------------ ------------
Total liabilities and stockholders' equity $899,711,975 $674,863,948
============ ============
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 gains (losses) and income tax expense (benefit), are the
result of related party transactions with Employers Mutual.
Year ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
REVENUES
Premiums earned .................... $330,622,810 $297,043,033 $265,279,858
Investment income, net ............. 29,702,461 32,778,133 30,969,630
Realized investment gains (losses) 1,169,698 (3,159,201) 800,582
Other income ....................... 862,070 865,819 774,169
------------ ------------ ------------
362,357,039 327,527,784 297,824,239
------------ ------------ ------------
LOSSES AND EXPENSES
Losses and settlement expenses ..... 226,504,550 207,057,856 221,918,750
Dividends to policyholders ......... 3,011,433 2,977,154 1,823,970
Amortization of deferred
policy acquisition costs ......... 71,959,232 65,727,016 55,687,015
Other underwriting expenses ........ 29,924,942 26,928,972 22,739,913
Interest expense ................... 1,320,266 1,638,716 11,055
Other expenses ..................... 1,654,320 1,306,034 1,185,415
------------ ------------ ------------
334,374,743 305,635,748 303,366,118
------------ ------------ ------------
Income (loss) before income
tax expense (benefit) ...... 27,982,296 21,892,036 (5,541,879)
------------ ------------ ------------
INCOME TAX EXPENSE (BENEFIT)
Current .......................... 8,336,381 5,061,093 (142,405)
Deferred ......................... (703,208) 729,205 (3,293,342)
------------ ------------ ------------
7,633,173 5,790,298 (3,435,747)
------------ ------------ ------------
Net income (loss) ............ $ 20,349,123 $ 16,101,738 $ (2,106,132)
============ ============ ============
Net income (loss) per common share
- basic and diluted .............. $ 1.78 $ 1.42 $ (.19)
============ ============ ============
Average number of shares outstanding
- basic and diluted .............. 11,453,324 11,375,779 11,312,063
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Net income (loss) .................. $ 20,349,123 $ 16,101,738 $ (2,106,132)
------------ ------------ ------------
OTHER COMPREHENSIVE INCOME
Unrealized holding gains
arising during the period,
before deferred income tax
expense ........................ 13,290,568 7,454,522 1,645,082
Deferred income tax expense ...... 4,651,699 2,609,079 682,629
------------ ------------ ------------
8,638,869 4,845,443 962,453
------------ ------------ ------------
Reclassification adjustment for
(gains) losses included in net
income (loss), before income
tax expense (benefit) .......... (1,168,918) 3,159,201 (779,540)
Income tax expense (benefit) ..... 409,121 (1,105,720) 272,839
------------ ------------ ------------
(759,797) 2,053,481 (506,701)
------------ ------------ ------------
Adjustment for minimum pension
liability associated with
Employers Mutual's pension plan 289,639 (289,639) -
Deferred income tax expense
(benefit) ...................... 101,373 (101,373) -
------------ ------------ ------------
188,266 (188,266) -
------------ ------------ ------------
Other comprehensive income ... 8,067,338 6,710,658 455,752
------------ ------------ ------------
Total comprehensive income
(loss) ..................... $ 28,416,461 $ 22,812,396 $ (1,650,380)
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Year ended December 31,
--------------------------------------
2003 2002 2001
------------ ------------ ------------
COMMON STOCK
Beginning of year .................. $ 11,399,050 $ 11,329,987 $ 11,294,220
Issuance of common stock through
Employers Mutual's stock option
plans ............................ 102,015 69,063 35,767
------------ ------------ ------------
End of year ........................ 11,501,065 11,399,050 11,329,987
------------ ------------ ------------
ADDITIONAL PAID-IN CAPITAL
Beginning of year .................. 67,270,591 66,013,203 65,546,963
Issuance of common stock through
Employers Mutual's stock option
plans ............................ 1,842,637 1,257,388 466,240
------------ ------------ ------------
End of year ........................ 69,113,228 67,270,591 66,013,203
------------ ------------ ------------
ACCUMULATED OTHER COMPREHENSIVE
INCOME
Beginning of year .................. 14,218,330 7,507,672 7,051,920
Unrealized gains on
available-for-sale securities .... 7,879,072 6,898,924 455,752
Minimum pension liability associated
with Employers Mutual's pension
plan ............................. 188,266 (188,266) -
------------ ------------ ------------
End of year ........................ 22,285,668 14,218,330 7,507,672
------------ ------------ ------------
RETAINED EARNINGS
Beginning of year .................. 64,880,393 55,606,761 64,500,213
Net income (loss) .................. 20,349,123 16,101,738 (2,106,132)
Dividends paid to stockholders
($.60 per share in 2003, 2002 and
2001) ............................ (1,350,736) (1,405,064) (1,511,382)
Dividends paid to Employers Mutual
($.60 per share in 2003, 2002 and
2001) ............................ (5,522,994) (5,423,042) (5,275,938)
Dividends to Employers Mutual
(reimbursement for non-GAAP
expenses) ........................ (505,196) - -
------------ ------------ ------------
End of year ........................ 77,850,590 64,880,393 55,606,761
------------ ------------ ------------
Total stockholders' equity ....... $180,750,551 $157,768,364 $140,457,623
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................... $20,349,123 $16,101,738 $(2,106,132)
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 .................. 36,697,128 16,708,165 28,029,560
Unearned premiums ........... 9,085,793 16,364,638 13,822,959
Other policyholders' funds .. 354,972 562,670 (255,701)
Indebtedness of related party (1,129,421) 620,121 6,484,089
Employee retirement plans ... 636,114 774,079 1,180,566
Reinsurance receivables ..... (4,279,618) 2,919,200 (2,575,981)
Prepaid reinsurance premiums (854,329) (167,668) (330,132)
Amortization of deferred
income .................... - - (78,212)
Commission payable .......... 2,470,516 2,732,425 285,221
Interest payable ............ (1,003,066) 1,641,205 (967)
Prepaid assets .............. (87,676) 27,894 (113,264)
Deferred policy acquisition costs (1,810,923) (3,563,333) (5,726,775)
Accrued investment income ....... 1,357,903 (520,547) (1,313,645)
Accrued income taxes:
Current ....................... 2,994,004 (112,890) 635,297
Deferred ...................... (703,208) 729,205 (3,293,342)
Realized investment (gains)
losses ........................ (1,169,698) 3,159,201 (800,582)
Accounts receivable ............. 393,521 308,080 (807,010)
Other, net ...................... (206,551) (1,717,779) 2,170,440
----------- ----------- -----------
42,745,461 40,464,666 37,312,521
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 .... $63,094,584 $56,566,404 $47,087,192
----------- ----------- -----------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Year ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity
securities held-to-maturity .... $ 5,293,717 $ 11,074,685 $ 49,692,313
Purchases of fixed maturity
securities available-for-sale .. (791,156,969) (229,504,732) (166,403,259)
Disposals of fixed maturity
securities available-for-sale .. 753,004,136 180,717,143 44,693,688
Purchases of equity securities
available-for-sale ............. (34,283,972) (43,930,432) (26,769,001)
Disposals of equity securities
available-for-sale ............. 31,151,627 33,884,190 27,388,659
Purchase of other long-term
investments .................... (2,040,000) (4,057,004) -
Disposals of other long-term
investments .................... 338,981 1,000,004 -
Net (purchases) sales of
short-term investments ......... (33,917,835) (11,925,773) 5,663,568
------------ ------------ ------------
Net cash used in investing
activities ............. (71,610,315) (62,741,919) (65,734,032)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related
party transactions with
Employers Mutual:
Issuance of common stock ..... 1,944,652 1,326,451 502,007
Dividends paid to
Employers Mutual ........... (5,522,994) (5,423,042) (5,275,938)
Dividends to Employers Mutual
(reimbursement for non-GAAP
expense) ................... (505,196) - -
Issuance of surplus notes .... - 11,000,000 25,000,000
Dividends paid to stockholders ... (1,350,736) (1,405,064) (1,511,382)
------------ ------------ ------------
Net cash (used) provided in
financing activities .... (5,434,274) 5,498,345 18,714,687
------------ ------------ ------------
Net (decrease) increase in cash .... (13,950,005) (677,170) 67,847
Cash at beginning of year .......... (119,097) 558,073 490,226
------------ ------------ ------------
Cash at end of year ................ $(14,069,102) $ (119,097) $ 558,073
============ ============ ============
Income taxes paid (recovered) ...... $ 5,400,010 $ 4,755,010 $ (778,316)
Interest paid (received) ........... $ 615,709 $ 19,232 $ (79,232)
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., an 80.9 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 47 percent of the Company's total net
written premiums in 2003. 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.
Based on current information, the liabilities for losses and settlement
expenses are considered to be adequate. 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, which
approximates fair value.
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, 2003 and 2002 are securities
on deposit with various regulatory authorities as required by law amounting to
$12,960,435 and $12,648,887, 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
Effective April 1, 2003, the Company was included in Employers Mutual's
consolidated tax return due to the fact that Employers Mutual attained 80
percent ownership of the Company at the end of March. The Company will file a
short-period tax return with its subsidiaries for the period January 1, 2003
through March 31, 2003. Consolidated income taxes/benefits are allocated
among the entities based upon separate tax liabilities.
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 and quota share agreements
(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 statutory-basis stock option expense allocated to
it 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 year 2001 amounted to
$354,703. Since this amount is not material, the financial statements for
2001 were not restated.
The Company's insurance subsidiaries reimburse Employers Mutual for their
share of the statutory-basis compensation expense associated with stock option
exercises under the terms of the pooling and quota share agreements.
Beginning in 2003, the statutory-basis compensation expense that is paid by
the Company's subsidiaries to Employers Mutual ($505,196 in 2003) is being
reclassified as a dividend payment to Employers Mutual in these GAAP-basis
financial statements. Since the corresponding amounts for 2002 and 2001 were
not material, the financial statements for such years were not restated.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 was effective for
fiscal years ending after December 15, 2002. SFAS 148 amended 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 amended 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 adopted the disclosure requirements of SFAS 148
and elected to continue to follow the recognition and measurement principles
of APB 25.
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if the Company had applied the fair value
recognition provisions of SFAS 123 to Employers Mutual's stock option plans:
2003 2002 2001
----------- ----------- -----------
Net income (loss), as reported $20,349,123 $16,101,738 $(2,106,132)
Add (deduct):
Stock-based compensation
expense reported in net
income (loss) .............. - - 230,557
Stock-based compensation
expense determined under the
fair value method for all
awards, net of related
tax effects ................ (25,383) (18,992) (16,287)
----------- ----------- -----------
Pro forma net income (loss) .... $20,323,740 $16,082,746 $(1,891,862)
=========== =========== ===========
Net income (loss) per share:
Basic and diluted -
As reported ................ $1.78 $1.42 $(0.19)
Basic and diluted -
Pro forma .................. $1.77 $1.41 $(0.17)
The weighted average fair value of options granted amounted to $2.93,
$3.28 and $1.59 for 2003, 2002 and 2001, 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:
2003 2002 2001
------ ------ ------
Dividend yield .......................... 3.56% 3.28% 5.22%
Expected volatility ..................... .247 .218 .215
Risk-free interest rate ................. 2.99% 4.37% 4.78%
Expected life (years) ................... 5.35 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
2003, 2002 and 2001 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 of 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 in the fourth quarter of 2003 and 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 2001 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. Effective December
31, 2003, the pooling agreement was amended to provide that Employers Mutual
will make up any shortfall or difference resulting from an error in its
systems and/or computational processes that would otherwise result in the
required restatement of the pool participants' financial statements. The
investment and income tax activities of the pool participants are not subject
to the pooling agreement.
On January 22, 2004, the Company announced that Farm and City Insurance
Company, its wholly-owned subsidiary, would discontinue writing nonstandard
risk automobile insurance and institute non-renewal procedures on all existing
business. Farm and City will continue to participate in the pooling agreement
even though it will no longer write any direct business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
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 $90,057,773, $76,203,278 and $66,287,442 in 2003, 2002 and 2001,
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 $18,936,008, $18,117,058 and
$15,892,684 in 2003, 2002 and 2001, 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
$4,052,600, $3,429,148 and $2,982,935 in 2003, 2002 and 2001, respectively.
Employers Mutual retained losses and settlement expenses under this agreement
totaling $2,747,334 in 2003, $1,186,598 in 2002 and $14,442,561 in 2001. 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 $3,802,878, $3,247,969 and $2,495,794
in 2003, 2002 and 2001, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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
$2,097,057, $1,765,287 and $2,040,822 in 2003, 2002 and 2001, respectively.
Costs allocated to the Company through the operation of the pooling agreement
amounted to $63,293,517, $56,897,066 and $51,041,812 in 2003, 2002 and 2001,
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 $699,954, $559,136 and $494,142 in 2003, 2002 and
2001, respectively.
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, 2003, reinsurance ceded to two nonaffiliated
reinsurers aggregated $7,043,728, 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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three years ended December 31, 2003 is
presented below.
Year ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Premiums written
Direct ......................... $220,741,419 $235,596,547 $272,027,823
Assumed from nonaffiliates ..... 3,816,789 3,985,370 1,898,509
Assumed from affiliates
(note 11) .................... 351,641,368 320,940,551 299,990,245
Ceded to nonaffiliates ......... (15,808,709) (11,089,041) (11,189,227)
Ceded to affiliates ............ (220,741,419) (235,596,547) (272,027,823)
------------ ------------ ------------
Net premiums written ......... $339,649,448 $313,836,880 $290,699,527
============ ============ ============
Premiums earned
Direct ......................... $221,662,098 $241,939,466 $255,764,274
Assumed from nonaffiliates ..... 3,629,346 3,501,616 1,786,132
Assumed from affiliates ........ 341,947,846 304,462,790 274,352,821
Ceded to nonaffiliates ......... (14,954,382) (10,921,373) (10,859,095)
Ceded to affiliates ............ (221,662,098) (241,939,466) (255,764,274)
------------ ------------ ------------
Net premiums earned .......... $330,622,810 $297,043,033 $265,279,858
============ ============ ============
Losses and settlement expenses
incurred
Direct ......................... $157,500,290 $165,218,514 $221,314,633
Assumed from nonaffiliates ..... 3,270,406 2,876,808 1,336,824
Assumed from affiliates ........ 233,823,801 206,614,356 227,650,959
Ceded to nonaffiliates ......... (10,589,657) (2,433,308) (7,069,033)
Ceded to affiliates ............ (157,500,290) (165,218,514) (221,314,633)
------------ ------------ ------------
Net losses and settlement
expenses incurred .......... $226,504,550 $207,057,856 $221,918,750
============ ============ ============
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,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Gross reserves at beginning of year $331,226,753 $314,518,588 $286,489,028
Ceded reserves at beginning of year (10,367,624) (11,848,597) (11,224,797)
------------ ------------ ------------
Net reserves at beginning of year .. 320,859,129 302,669,991 275,264,231
------------ ------------ ------------
Incurred losses and
settlement expenses
Provision for insured events
of the current year ............ 219,028,236 200,059,798 216,752,003
Increase in provision for
insured events of prior years .. 7,476,314 6,998,058 5,166,747
------------ ------------ ------------
Total incurred losses and
settlement expenses ...... 226,504,550 207,057,856 221,918,750
------------ ------------ ------------
Payments
Losses and settlement expenses
attributable to insured events
of the current year ............ 86,072,127 81,124,276 94,983,112
Losses and settlement expenses
attributable to insured events
of prior years ................. 108,175,065 107,744,442 99,529,878
------------ ------------ ------------
Total payments ............. 194,247,192 188,868,718 194,512,990
------------ ------------ ------------
Net reserves at end of year ........ 353,116,487 320,859,129 302,669,991
Ceded reserves at end of year ...... 14,807,394 10,367,624 11,848,597
------------ ------------ ------------
Gross reserves at end of year ...... $367,923,881 $331,226,753 $314,518,588
============ ============ ============
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 the property and casualty insurance segment during 2003, while the
reinsurance segment experienced favorable development. For the property and
casualty insurance segment, the December 31, 2003 estimate of loss and
settlement expense reserves for accident years 2002 and prior increased
$9,014,984 from the estimate at December 31, 2002. This increase represents
3.9 percent of the December 31, 2002 carried reserves and is attributed to a
combination of bulk reserve strengthening, development on case reserves of
previously reported claims and newly reported claims in excess of carried
incurred but not reported (IBNR) reserves. Included in the reserve
strengthening actions taken during 2003 was an increase of approximately
$6,055,000 in formula IBNR reserves, an increase of approximately $3,245,000
in settlement expense reserves and a $3,525,000 bulk reserve established for
the workers' compensation line of business. The remaining adverse development
of approximately $4,521,000 came from case reserve development and IBNR claim
emergence.
For the reinsurance segment, the December 31, 2003 estimate of loss and
settlement expense reserves for accident years 2002 and prior decreased
$1,538,670 from the estimate at December 31, 2002. This decrease represents
1.5 percent of the December 31, 2002 carried reserves. This decrease is
primarily from the 2002 accident year on the Home Office Reinsurance Assumed
Department (HORAD) book of business, which has experienced very low reported
loss activity. The favorable development was partially offset by $326,000 of
asbestos reserve strengthening.
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
$233,000 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 diligently evaluated the adequacy of its
asbestos reserves by commissioning 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 the results of this study, the
Company elected to increase the IBNR and settlement expense reserves carried
for direct asbestos exposures by $2,068,705 at December 31, 2002, to
$2,985,402. The study's results for asbestos exposures on assumed reinsurance
business were received during 2003, and the Company elected to increase its
IBNR reserves carried for assumed asbestos exposures by $326,000 to the
study's point estimate. The study and its results assume no improvement in
the current asbestos litigation environment; however, continued efforts for
federal legislation could reduce the ultimate loss projections for asbestos
litigation below the levels currently projected for the industry. Reserves
for asbestos and environmental related claims for direct insurance and assumed
reinsurance business totaled $5,584,196 and $5,526,943 at December 31, 2003
and 2002, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2003, the Company was presented with several hundred additional
lawsuits filed against three former policyholders representing approximately
40,500 claims related to exposure to asbestos or asbestos containing products.
The Company has denied coverage on one of the the former policyholders,
representing approximately 10,000 claims, because of express asbestos
exclusion language contained in the policy. Minimal expense payments have
been made to date on the lawsuits related to the other two former
policyholders and no payments have been made for either defense or indemnity.
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.
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 2003, 2002 and 2001.
Statutory surplus of the Company's insurance subsidiaries was
$170,232,871 and $140,323,534 at December 31, 2003 and 2002, respectively.
Statutory net income (loss) of the Company's insurance subsidiaries was
$16,700,374, $13,729,028 and ($8,289,542) for 2003, 2002 and 2001,
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, 2003, the Company's
insurance subsidiaries had total adjusted statutory capital of $170,232,871,
which is well in excess of the minimum risk-based capital requirement of
$39,609,015.
<Page>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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, 2003, $22,244,303 was
available for distribution to the Company in 2004 without prior approval.
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, 2003 insurance Reinsurance company Consolidated
- ----------------- ------------ ------------ ------------ --------------
Premiums earned ....... $241,237,313 $ 89,385,497 $ - $ 330,622,810
Underwriting (loss)
gain ................ (7,493,703) 6,716,356 - (777,347)
Net investment income 20,724,017 8,948,076 30,368 29,702,461
Realized gains (losses) 1,312,252 (142,554) - 1,169,698
Interest expense ...... (919,362) (400,904) - (1,320,266)
Other income .......... 862,070 - - 862,070
Other expenses ........ (1,044,757) - (609,563) (1,654,320)
------------ ------------ ------------ --------------
Income (loss) before
income tax expense
(benefit) ......... $ 13,440,517 $ 15,120,974 $ (579,195)$ 27,982,296
============ ============ ============ ==============
Assets ................ $639,366,058 $256,579,831 $180,961,286 $1,076,907,175
Eliminations .......... - - (176,087,397) (176,087,397)
Reclassifications ..... (896,043) - (211,760) (1,107,803)
------------ ------------ ------------ --------------
Net assets ....... $638,470,015 $256,579,831 $ 4,662,129 $ 899,711,975
============ ============ ============ ==============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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
============ ============ ============ ============
Year ended
December 31, 2001
- -----------------
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)
============ ============ ============ ============
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, 2003 and 2002 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, 2003
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 47,547,267 $ 3,780,331 $ - $ 51,327,598
Mortgage-backed
securities ........... 2,298,081 228,745 - 2,526,826
------------ ----------- ----------- ------------
Total securities
held-to-maturity $ 49,845,348 $ 4,009,076 $ - $ 53,854,424
============ =========== =========== ============
Securities available-for-
sale:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $170,445,955 $ 703,239 $ - $171,149,194
Obligations of states
and political
subdivisions ......... 140,694,351 6,381,069 (300,188) 146,775,232
Mortgage-backed
securities ........... 19,311,455 1,967,145 - 21,278,600
Public utilities ....... 20,171,434 1,714,421 (86,518) 21,799,337
Corporate securities ... 148,887,343 14,194,708 (298,656) 162,783,395
------------ ----------- ----------- ------------
Total fixed maturity
securities ....... 499,510,538 24,960,582 (685,362) 523,785,758
------------ ----------- ----------- ------------
Equity securities:
Common stocks .......... 38,498,075 10,188,751 (206,828) 48,479,998
Non-redeemable
preferred stocks ..... 500,000 28,500 - 528,500
------------ ----------- ----------- ------------
Total equity
securities ....... 38,998,075 10,217,251 (206,828) 49,008,498
------------ ----------- ----------- ------------
Total securities
available-for-sale $538,508,613 $35,177,833 $ (892,190)$572,794,256
============ =========== =========== ============
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, 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 ........... 21,054,770 2,426,541 - 23,481,311
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 ... 193,868,765 17,010,070 (3,695,933) 207,182,902
------------ ----------- ----------- ------------
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
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
reached a consensus on certain disclosures required by EITF Issue 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments," which is effective for fiscal years ending after December 15,
2003. EITF Issue 03-1 requires certain quantitative and qualitative
disclosures for debt and equity securities classified as available-for-sale or
held-to-maturity that are impaired at the balance sheet date but have not been
recognized as other-than-temporary impairments. The Company's adoption of
this EITF, which only requires additional disclosures, did not have any effect
on the operating results of the Company.
The following table sets forth the estimated fair value and unrealized
losses of securities in an unrealized loss position as of December 31, 2003
listed by length of time the securities have been in an unrealized loss
position.
Less than twelve Twelve months or
months or longer Total
-------------------- ------------------- --------------------
Description of Fair Unrealized Fair Unrealized Fair Unrealized
securities value losses value losses value losses
-------------------- ------------------- --------------------
Obligations of
states and
political
subdivisions $22,800,627 $300,188 $ - $ - $22,800,627 $300,188
Public
utilities 2,487,500 86,518 - - 2,487,500 86,518
Corporate
Securities 11,519,158 129,669 5,679,227 168,987 17,198,385 298,656
----------- -------- ---------- -------- ----------- --------
Subtotal, debt
securities 36,807,285 516,375 5,679,227 168,987 42,486,512 685,362
----------- -------- ---------- -------- ----------- --------
Common stock 2,040,512 76,659 1,134,251 130,169 3,174,763 206,828
----------- -------- ---------- -------- ----------- --------
Total
temporarily
impaired
securities $38,847,797 $593,034 $6,813,478 $299,156 $45,661,275 $892,190
=========== ======== ========== ======== =========== ========
The Company uses several factors to determine whether the carrying value
of an individual security has been other-than-temporarily impaired. Such
factors include, but are not limited to, the security's value and performance
in the context of the overall markets, length of time and extent the
security's fair value has been below carrying value, key corporate events and
collateralization of fixed maturity securities. Based on these factors, and
the Company's ability and intent to hold the fixed maturity securities until
maturity, it was determined that the carrying value of these securities was
not other-than-temporarily impaired at December 31, 2003.
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, 2003, 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 ................... $ 16,997,445 $ 17,822,500
Due after one year through five years ..... 27,063,720 29,841,985
Due after five years through ten years .... 2,488,435 2,647,213
Due after ten years ....................... 997,667 1,015,900
Mortgage-backed securities ................ 2,298,081 2,526,826
------------ ------------
Totals ................................ $ 49,845,348 $ 53,854,424
============ ============
Securities available-for-sale:
Due in one year or less ................... $106,453,766 $106,485,455
Due after one year through five years ..... 31,350,344 34,042,389
Due after five years through ten years .... 97,852,171 106,724,729
Due after ten years ....................... 244,542,802 255,254,585
Mortgage-backed securities ................ 19,311,455 21,278,600
------------ ------------
Totals ................................ $499,510,538 $523,785,758
============ ============
The mortgage-backed securities shown in the above table include
$12,557,063 of securities issued by government corporations and agencies.
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,
--------------------------------------
2003 2002 2001
----------- ----------- ----------
Fixed maturity securities
held-to-maturity: (1)
Gross realized investment gains .. $ 781 $ - $ 21,042
Gross realized investment losses - - -
Fixed maturity securities
available-for-sale: (2)
Gross realized investment gains .. 8,624,525 960,705 235,515
Gross realized investment losses (4,877,307) (3,831,374) (19,039)
Equity securities
available-for-sale: (3)
Gross realized investment gains .. 2,885,412 4,654,622 4,050,256
Gross realized investment losses (5,463,713) (4,943,154) (3,487,192)
----------- ----------- ----------
Totals ......................... $ 1,169,698 $(3,159,201) $ 800,582
=========== =========== ==========
(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
impairment write-downs totaling $3,821,466.
(3) Investment losses realized on equity securities for the year ended
December 31, 2003 include other-than-temporary impairment write-downs totaling
$1,566,985. All of the impaired equity securities were sold during 2003
generating gross realized gains of $619,069 and gross realized losses of
$47,558.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
A summary of net investment income is as follows:
Year ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
Interest on fixed maturities .......... $29,027,370 $31,909,946 $29,507,515
Dividends on equity securities ........ 587,723 605,079 551,066
Interest on short-term investments .... 440,902 690,046 1,425,167
Interest on long-term investments ..... 371,340 103,763 -
Fees from securities lending .......... 92,671 120,489 132,905
----------- ----------- -----------
Total investment income ........... 30,520,006 33,429,323 31,616,653
Investment expenses ................... (817,545) (651,190) (647,023)
----------- ----------- -----------
Net investment income ............. $29,702,461 $32,778,133 $30,969,630
=========== =========== ===========
A summary of net changes in unrealized holding gains (losses) on
securities available-for-sale is as follows:
Year ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Fixed maturity securities ......... $ (1,735,818) $ 19,097,214 $ 2,206,640
Applicable deferred income tax
(benefit) expense ............... (607,536) 6,684,025 819,396
------------ ------------ ------------
Total fixed maturity securities (1,128,282) 12,413,189 1,387,244
------------ ------------ ------------
Equity securities ................. 13,857,468 (8,483,491) (1,341,098)
Applicable deferred income tax
expense (benefit) ............... 4,850,114 (2,969,226) (409,606)
------------ ------------ ------------
Total equity securities ....... 9,007,354 (5,514,265) (931,492)
------------ ------------ ------------
Total available-for-sale
securities .................. $ 7,879,072 $ 6,898,924 $ 455,752
============ ============ ============
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, 2003
and 2002 are as follows:
Year ended December 31,
-------------------------
2003 2002
----------- -----------
Loss reserve discounting .......................... $17,036,591 $15,730,089
Unearned premium reserve limitation ............... 8,592,924 7,993,385
Postretirement benefits ........................... 2,671,261 2,364,160
Other policyholders' funds payable ................ 486,708 362,468
Minimum tax credits ............................... 954,954 1,730,815
Other-than-temporary impairment losses on
investments ..................................... 1,337,513 1,337,513
Other, net ........................................ 1,311,318 1,789,128
----------- -----------
Total deferred income tax asset ............. 32,391,269 31,307,558
----------- -----------
Deferred policy acquisition costs ................. (9,358,224) (8,724,401)
Net unrealized holding gains ...................... (11,999,975) (7,757,397)
Other, net ........................................ (687,641) (839,588)
----------- -----------
Total deferred income tax liability ......... (22,045,840) (17,321,386)
----------- -----------
Net deferred income tax asset ............. $10,345,429 $13,986,172
=========== ===========
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The actual income tax expense (benefit) for the years ended December 31,
2003, 2002 and 2001 differed from the "expected" tax expense (benefit) for
those years (computed by applying the United States federal corporate tax rate
of 35 percent to income (loss) before income tax expense (benefit)) as
follows:
Year ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
Computed "expected" tax expense
(benefit) ........................... $ 9,793,804 $ 7,662,213 $(1,939,658)
Increases (decreases) in
tax resulting from:
Tax-exempt interest income ........ (2,079,465) (1,441,502) (1,509,839)
Other, net ........................ (81,166) (430,413) 13,750
----------- ----------- -----------
Income tax expense (benefit)..... $ 7,633,173 $ 5,790,298 $(3,435,747)
=========== =========== ===========
Comprehensive income tax expense (benefit) included in the consolidated
financial statements for the years ended December 31, 2003, 2002 and 2001 is
as follows:
Year ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
Income tax expense (benefit) on:
Operations .......................... $ 7,633,173 $ 5,790,298 $(3,435,747)
Unrealized holding gains (losses) on
revaluation of securities
available-for-sale ................ 4,242,578 3,714,799 409,790
Minimum pension liability ........... 101,373 (101,373) -
----------- ----------- -----------
Comprehensive income tax
expense (benefit) ............. $11,977,124 $ 9,403,724 $(3,025,957)
=========== =========== ===========
10. SURPLUS NOTES
On December 28, 2001, three of the Company's property and casualty
insurance subsidiaries issued surplus notes totaling $25,000,000 to Employers
Mutual at an annual interest rate of 5.38 percent. On June 27, 2002, the
Company's reinsurance subsidiary issued an $11,000,000 surplus note to
Employers Mutual at an annual interest rate of 5.25 percent. The surplus
notes do not have a maturity date. Effective April 1, 2003, the surplus notes
were reissued at an annual interest rate of 3.09 percent. Payment of interest
and repayment of principal can only be repaid out of the subsidiary's
statutory surplus earnings and is subject to approval by the Iowa Insurance
Commissioner. The surplus notes are subordinate and junior in right of
payment to all obligations or liabilities of the subsidiaries. Interest
expense on surplus notes amounted to $1,320,266 for 2003 and $1,638,716 for
2002.
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 employee benefit plans, including a defined
benefit retirement plan (pension) 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 the Company's share of the total
plans' assets and liabilities, including a minimum pension liability at
December 31, 2003 and 2002.
Employers Mutual's pension 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.
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.
In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." The revised standard
requires new disclosures in addition to those required by the original
standard about the assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension plans and other defined benefit postretirement
plans. SFAS No. 132, as revised, is effective for financial statements for
fiscal years ending after December 15, 2003, except disclosure of estimated
benefit payments, which is effective for fiscal years ended after June 15,
2004. The Company's adoption of this revised statement, which only requires
additional disclosures, did not have any effect on the operating results of
the Company.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act expanded
Medicare to include, for the first time, coverage for prescription drugs.
This legislation is expected to eventually reduce the cost of Employers
Mutual's health care postretirement benefit plan. Because of various
uncertainties, including Employers Mutual's response to this legislation and
the appropriate accounting methodology for this event, the Company has elected
to defer financial recognition of this legislation until the FASB issues final
accounting guidance. When issued, that final guidance could require the
Company to change previously reported information. This deferral election is
permitted under FASB Staff Position No. FAS 106-1 "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003."
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table sets forth the funded status of the Employers Mutual
pension plan and postretirement benefit plans as of December 31, 2003 and
2002, based upon a measurement date of November 1, 2003 and 2002,
respectively:
Postretirement
Pension plan benefit plans
------------------------- --------------------------
2003 2002 2003 2002
------------ ----------- ------------ ------------
Change in projected
benefit obligation:
Benefit obligation at
beginning of year ...$111,790,069 $98,008,250 $ 66,309,000 $ 46,759,000
Service cost .......... 6,161,019 5,299,831 4,401,000 2,964,000
Interest cost ......... 6,992,656 6,576,584 4,263,000 3,223,000
Actuarial loss ........ 5,316,003 6,769,141 (5,157,878) 14,954,000
Benefits paid ......... (9,642,971) (4,960,786) (1,481,498) (1,591,000)
Acquisition ........... - - 4,453,847 -
Amendments ............ - 97,049 - -
----------- ----------- ------------ ------------
Projected benefit
obligation at end
of year ......... 120,616,776 111,790,069 72,787,471 66,309,000
----------- ----------- ------------ ------------
Change in plan assets:
Fair value of plan
assets at beginning
of year ............. 82,198,366 83,408,910 12,737,000 5,937,000
Actual return on plan
assets .............. 11,252,353 (1,240,498) 418,739 326,000
Employer contributions 9,869,000 4,990,740 4,300,000 8,065,000
Benefits paid ......... (9,642,971) (4,960,786) (1,481,498) (1,591,000)
----------- ----------- ------------ ------------
Fair value of plan
assets at end
of year ......... 93,676,748 82,198,366 15,974,241 12,737,000
----------- ----------- ------------ ------------
Funded status ......... (26,940,028) (29,591,703) (56,813,230) (53,572,000)
Unrecognized net
actuarial loss ...... 21,576,909 21,963,572 15,587,383 21,438,000
Unrecognized prior
service costs ....... 4,109,466 4,899,114 - -
Employer contributions - - 500,000 -
----------- ----------- ------------ ------------
Net amount
recognized ...... $(1,253,653) $(2,729,017) $(40,725,847) $(32,134,000)
=========== =========== ============ ============
Amounts recognized in
the consolidated
balance sheets
consist of:
Accrued benefit
liability ....... $(4,831,428) $(8,633,268) $(40,725,847) $(32,134,000)
Intangible asset .. 3,577,775 4,899,114 - -
Accumulated other
comprehensive
loss ............ - 1,005,137 - -
----------- ----------- ------------ ------------
Net amount
recognized .. $(1,253,653) $(2,729,017) $(40,725,847) $(32,134,000)
=========== =========== ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The accumulated benefit obligation for the pension plan amounted to
$98,508,176 and $90,831,634 for the years ended December 31, 2003 and 2002,
respectively.
During 2003, Employers Modern Life Company (EML), an affiliate of
Employers Mutual, acquired National Travelers Life Company (NTL) and the
company's name was changed to EMC National Life Company (EMCNL). EML
participated in Employers Mutual's pension plan and postretirement benefit
plans. As a result of the acquisition, EML pension plan participants were
"spun-off" into a separate EMCNL pension plan. A payment of $2,567,367 was
made from Employers Mutual's plan assets to the EMCNL pension plan, which is
reflected as a benefit payment. The corresponding reduction in the benefit
obligation is reflected as an actuarial gain of the plan. The employees and
retirees of NTL were also granted benefits under the Employers Mutual
postretirement benefit plans. As a result, an additional liability of
$4,453,847 was recognized by the plans. EMCNL is responsible for the entire
additional liability.
The components of net periodic benefit cost for the Employers Mutual
pension plan and postretirement benefit plans is as follows:
Year ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- -----------
Pension plan:
Service cost ....................... $ 6,161,019 $ 5,299,831 $ 4,885,731
Interest cost ...................... 6,992,656 6,576,584 6,640,491
Expected return on plan assets ..... (6,516,913) (6,744,907) (7,836,882)
Recognized net actuarial loss ...... 967,226 - -
Amortization of prior service costs 789,648 784,219 781,043
----------- ----------- -----------
Net periodic pension benefit
cost ....................... $ 8,393,636 $ 5,915,727 $ 4,470,383
=========== =========== ===========
Postretirement benefit plans:
Service cost ...................... $ 4,401,000 $ 2,964,000 $ 2,299,000
Interest cost ..................... 4,263,000 3,223,000 2,644,000
Expected return on assets ......... (737,000) (518,000) (318,000)
Amortization of net loss (gain) ... 1,011,000 150,000 (1,000)
Amortization of prior service costs - 535,000 571,000
------------ ------------ ------------
Net periodic postretirement
benefit cost ................ $ 8,938,000 $ 6,354,000 $ 5,195,000
============ ============ ============
The weighted average assumptions used to measure the benefit obligations
are as follows:
Year ended December 31,
-----------------------
2003 2002
Pension plan: ---------- -----------
Discount rate ...................... 6.00% 6.50%
Rate of compensation increase ..... 4.82% 5.93%
Postretirement benefit plans:
Discount rate ...................... 6.00% 6.50%
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The weighted average assumptions used to measure the net periodic benefit
cost are as follows:
Year ended December 31,
------------------------------------
2003 2002 2001
Pension plan: ---------- ---------- ----------
Discount rate ...................... 6.50% 7.00% 7.75%
Expected long-term rate of return on
plan assets ........................ 8.00% 8.50% 8.50%
Rate of compensation increase ..... 5.93% 5.96% 5.96%
Postretirement benefit plans:
Discount rate ...................... 6.50% 7.00% 7.75%
Expected long-term rate of return on
plan assets ....................... 5.00% 6.00% 6.00%
The expected long-term rates of return on plan assets were developed
considering actual historical results, current and expected market conditions,
plan asset mix and management's investment strategy.
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 2003 is 11.00 percent, and is assumed to decrease gradually to 5.00
percent in 2009 and remain at that level thereafter. The health care cost
trend rates have a significant effect on the amounts reported for the health
care plan. A one-percentage-point change in assumed health care cost trend
rates would have the following effects:
One-Percentage-Point
----------------------------
Increase Decrease
----------- ------------
Effect on total of service and interest cost .. $ 1,826,788 ($ 1,422,601)
Effect on postretirement benefit obligation ... $12,254,397 ($ 9,724,178)
Pension liabilities reflected in the Company's financial statements
totaled $1,453,421 (including $1,016,492 of additional minimum liability) in
2003 and $2,487,560 (including $1,701,355 of additional minimum liability) in
2002. The Company's financial statements also reflect an intangible asset
associated with the pension plan of $1,016,492 in 2003 and $1,411,716 in 2002.
The $289,639 difference between the additional minimum liability and the
intangible asset in 2002 is reflected as other comprehensive loss in the
Company's stockholders' equity. Pension expense allocated to the Company
amounted to $2,000,219, $1,406,306 and $1,060,259 in 2003, 2002 and 2001,
respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Postretirement benefit liabilities reflected in the Company's financial
statements totaled $8,512,179 in 2003 and $7,526,789 in 2002. Net periodic
postretirement benefit cost allocated to the Company for the years ended
December 31, 2003, 2002 and 2001 was $2,106,010, $1,486,724 and $1,214,255,
respectively.
The Employers Mutual pension plan weighted average asset allocations at
December 31, 2003 and 2002 by asset category are as follows:
Plan Assets at December 31,
---------------------------
Asset Category 2003 2002
- -------------- ------------ ------------
Equity securities ............................ 62.6% 46.2%
Debt securities .............................. 28.0 46.0
Real estate .................................. 9.4 7.8
----- -----
Total ...................................... 100.0% 100.0%
Employers Mutual uses a total return investment strategy for its pension
plan assets. Prior to 2003 the allocation mix for plan assets was targeted at
50 percent for equity securities and 50 percent for debt securities. During
2003, Employers Mutual hired an outside consultant to conduct an
asset/liability study of the pension plan in order to establish long-term
goals for the allocation of plan assets. Based on the results of this study,
Employers Mutual concluded that it could tolerate a higher level of risk to
achieve a higher rate of return and elected to change its target allocation
mix to 70 percent equity securities and 30 percent debt securities. This
change in allocation mix was initiated in 2003 and will be completed in 2004.
Plan assets will be diversified among active and passive managers. Employers
Mutual does not use derivatives in its investment of pension assets.
The Employers Mutual postretirement benefit plan weighted average asset
allocations at December 31, 2003 and 2002 by asset category are as follows:
Plan Assets at December 31,
---------------------------
Asset Category 2003 2002
- -------------- ------------ ------------
Life insurance policies ...................... 64.3% 80.4%
Short-term investments ....................... 29.4 19.6
Debt securities .............................. 6.3 -
----- -----
Total ...................................... 100.0% 100.0%
Plan assets for Employers Mutual's postretirement benefit plans are
primarily invested in universal life insurance policies issued by EMCNL, an
affiliate of Employers Mutual. The assets supporting these universal life
insurance policies are invested in S&P 500 mutual funds and debt securities
and have a guaranteed interest rate of 4.50 percent.
Employers Mutual plans to contribute approximately $10,000,000 to the
pension plan and $3,300,000 to the postretirement benefit plans in 2004.
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
$912,103, $703,555 and $379,988 in 2003, 2002 and 2001, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 500,000 shares have been reserved for the 2003
Employers Mutual Casualty Company Incentive Stock Option Plan (2003 Plan) and
a total of 1,000,000 shares have been reserved for issuance under the 1993
Employers Mutual Casualty Company Incentive Stock Option Plan (1993 Plan).
There is a ten year time limit for granting options under the plans.
Options can no longer be granted under the 1993 Plan. 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 2003, 113,225 options were granted under the 2003 Plan to eligible
participants at a price of $16.88 and 157,392 options were exercised under the
plans at prices ranging from $16.70 to $21.49. A summary of the activity
under Employers Mutual's incentive stock option plans for 2003, 2002 and 2001
is as follows:
2003 2002 2001
------------------ ------------------ -----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price`
------- --------- ------- --------- ------- ---------
Outstanding,
beginning of year 678,757 $11.65 723,378 $10.84 809,882 $10.71
Granted ............. 113,225 16.88 65,900 18.30 10,700 11.38
Exercised ........... (157,392) 10.50 (98,864) 10.26 (85,377) 9.58
Expired ............. (3,975) 13.96 (11,657) 10.88 (11,827) 11.28
------- ------- -------
Outstanding,
end of year ....... 630,615 12.86 678,757 11.65 723,378 10.84
======= ======= =======
Exercisable,
end of year ....... 349,960 $11.85 404,807 $11.35 407,108 $11.18
======= ======= =======
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
December 31, 2003
----------------------------------------------------------
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 - $10.00 229,164 $ 9.31 5.31 130,454 $ 9.35
11.38 - 13.69 226,406 12.96 3.88 206,986 13.03
16.88 - 18.30 175,045 17.39 8.74 12,520 18.30
------- -------
630,615 12.86 5.75 349,960 11.85
======= =======
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 $13,214, $6,817 and $6,889
in 2003, 2002 and 2001, respectively.
During 2003, a total of 11,884 options were exercised at prices of $16.03
and $17.97. Activity under the plan was as follows:
Year ended December 31,
----------------------------
2003 2002 2001
-------- -------- --------
Shares available for purchase,
beginning of year ...................... 302,039 313,755 327,489
Shares purchased under plan .............. (11,884) (11,716) (13,734)
------- ------- -------
Shares available for purchase, end of year 290,155 302,039 313,755
======= ======= =======
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 2003 Employers Mutual Casualty Company Non-
Employee Director Stock Purchase Plan. All non-employee directors of
Employers Mutual and its subsidiaries and affiliates 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 2012 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. The Employers Mutual Casualty Company Non-Employee
Director Stock Purchase Plan previously in place expired on May 20, 2003 and
the remaining 139,328 shares were deregistered. Expenses allocated to the
Company in connection with these plans totaled $1,878, $0 and $5,819 in 2003,
2002 and 2001, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2003, a total of 3,713 options were exercised at prices ranging
from $12.34 to $14.47. Activity under the plan was as follows:
Year ended December 31,
----------------------------
2003 2002 2001
-------- -------- --------
Shares available for purchase,
beginning of year ...................... 141,197 143,158 143,158
Shares purchased under expired plan ...... (1,869) - -
Shares deregistered under expired plan ... (139,328) - -
Shares registered for use in 2003 plan ... 200,000 - -
Shares purchased under 2003 plan ......... (1,844) (1,961) -
------- ------- -------
Shares available for purchase, end of year 198,156 141,197 143,158
======= ======= =======
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. Employers Mutual continued to
participate in the Dividend Reinvestment Plan in 2003. In March of 2003,
Employers Mutual surpassed the 80 percent ownership threshold of EMC Insurance
Group Inc. Employers Mutual has indicated that it may continue to participate
in the dividend reinvestment plan in the future; however, its reinvestment
percentage will be adjusted to the level necessary to maintain the 80 percent
ownership threshold. Activity under the plan was as follows:
Year ended December 31,
--------------------------------
2003 2002 2001
-------- -------- --------
Shares available for purchase,
beginning of year .................. 416,899 501,230 880,679
Shares purchased under plan .......... (145,061) (84,331) (379,449)
------- ------- -------
Shares available for purchase,
end of year ........................ 271,838 416,899 501,230
======= ======= =======
Range of purchase prices ............. $16.98 $15.38 $11.50
to to to
$21.32 $21.99 $17.25
14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL 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 and the
companies' credit ratings have not changed.
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, 2003.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The estimated fair value of the Company's financial instruments is
summarized below.
Carrying Estimated
amount fair value
------------ ------------
December 31, 2003
- -----------------
Assets:
Fixed maturity securities:
Held-to-maturity ............................ $ 49,845,348 $ 53,854,424
Available-for-sale .......................... 523,785,758 523,785,758
Equity securities available-for-sale .......... 49,008,498 49,008,498
Short-term investments ........................ 63,568,064 63,568,064
Other long-term investments ................... 4,758,019 4,758,019
Liabilities:
Surplus notes ................................. 36,000,000 36,000,000
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
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 $752,884
in the event that the issuing company would be unable to fulfill its
obligations.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
16. UNAUDITED INTERIM FINANCIAL INFORMATION
Three months ended,
-----------------------------------------------------
March 31 June 30 September 30 December 31
----------- ----------- ------------ -----------
2003
- ----
Total revenues ........ $86,646,867 $90,215,736 $92,594,260 $92,900,176
=========== =========== =========== ===========
Income before income
tax expense ......... $ 9,543,476 $ 1,419,592 $ 8,922,814 $ 8,096,414
Income tax expense
(benefit) ........... 3,097,798 (10,600) 2,540,710 2,005,265
----------- ----------- ----------- -----------
Net income ....... $ 6,445,678 $ 1,430,192 $ 6,382,104 $ 6,091,149
=========== =========== =========== ===========
Net income per share
- basic and diluted* $ .57 $ .12 $ .56 $ .53
=========== =========== =========== ===========
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)
=========== =========== =========== ===========
* 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.