UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2005
-------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission File Number: 0-10956
-------
EMC INSURANCE GROUP INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- -------------------------------------- ---------
(Address of principal executive office) (Zip Code)
(515) 280-2902
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at July 29, 2005
----- ----------------------------
Common stock, $1.00 par value 13,605,840
Total pages 45
--
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2005 2004
-------------- ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized
cost (fair value $20,040,392 and
$16,908,726) ............................. $ 19,226,288 $ 15,895,607
Securities available-for-sale, at fair value
(amortized cost $652,649,086 and
$541,401,950) ............................ 678,614,386 565,000,931
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized
cost (fair value $788,432 and
$13,684,880) ............................. 761,879 13,310,264
Securities available-for-sale, at fair value
(amortized cost $53,351,569 and
$54,389,046) ............................. 53,608,811 54,653,472
Equity securities available-for-sale, at fair
value (cost $61,183,374 and $59,589,434) ... 82,076,827 78,692,893
Other long-term investments, at cost ......... 5,706,817 5,550,093
Short-term investments, at cost .............. 59,124,225 46,238,853
-------------- ------------
Total investments ................... 899,119,233 779,342,113
Balances resulting from related party
transactions with Employers Mutual:
Reinsurance receivables .................... 36,156,345 26,316,358
Prepaid reinsurance premiums ............... 4,658,650 3,682,676
Deferred policy acquisition costs .......... 34,134,673 27,940,583
Defined benefit retirement plan, prepaid
asset .................................... 2,232,820 2,684,463
Other assets ............................... 3,370,243 1,877,564
Indebtedness of related party .............. 7,712,226 -
Cash ........................................... 511,958 61,088
Accrued investment income ...................... 9,580,070 8,726,292
Accounts receivable (net of allowance for
uncollectible accounts of $0 and $0) ......... 213,304 216,836
Income taxes recoverable ....................... 2,526,626 3,399,485
Deferred income taxes .......................... 10,066,413 9,504,193
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 ................. 941,586 941,586
Securities lending collateral .................. 55,560,180 70,122,695
-------------- ------------
Total assets ........................ $1,066,784,327 $934,815,932
============== ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2005 2004
-------------- ------------
LIABILITIES
Balances resulting from related party
transactions with Employers Mutual:
Losses and settlement expenses ............. $ 538,186,796 $429,677,302
Unearned premiums .......................... 160,647,881 131,589,365
Other policyholders' funds ................. 3,098,432 2,825,809
Surplus notes payable ...................... 36,000,000 36,000,000
Indebtedness to related party .............. - 6,058,848
Employee retirement plans .................. 12,962,321 9,764,406
Other liabilities .......................... 16,999,267 20,304,475
Securities lending obligation .................. 55,560,180 70,122,695
-------------- ------------
Total liabilities ....................... 823,454,877 706,342,900
-------------- ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized
20,000,000 shares; issued and outstanding,
13,605,671 shares in 2005 and 13,568,945
shares in 2004 ............................... 13,605,671 13,568,945
Additional paid-in capital ..................... 104,142,392 103,467,293
Accumulated other comprehensive income ......... 30,625,397 27,928,463
Retained earnings .............................. 94,955,990 83,508,331
-------------- ------------
Total stockholders' equity .............. 243,329,450 228,473,032
-------------- ------------
Total liabilities and stockholders'
equity ................................ $1,066,784,327 $934,815,932
============== ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
All balances presented below, with the exception of investment income,
realized investment gains and income tax expense (benefit), are the result of
related party transactions with Employers Mutual.
Three months ended Six months ended
June 30, June 30,
------------------------ -------------------------
2005 2004 2005 2004
------------ ----------- ------------ ------------
REVENUES
Premiums earned .........$104,202,209 $83,984,287 $205,496,279 $167,442,569
Net investment income ... 10,200,537 6,865,663 19,132,247 14,139,640
Realized investment
gains ................. 833,237 3,181,108 1,561,679 3,581,635
Other income ............ 147,574 265,112 243,670 341,591
------------ ----------- ------------ ------------
115,383,557 94,296,170 226,433,875 185,505,435
------------ ----------- ------------ ------------
LOSSES AND EXPENSES
Losses and settlement
expenses .............. 73,543,676 63,647,449 136,386,684 114,608,626
Dividends to
policyholders ......... 791,213 1,095,581 2,342,072 1,863,623
Amortization of deferred
policy acquisition
costs ................. 23,721,250 17,900,296 46,207,961 36,319,823
Other underwriting
expenses .............. 10,191,685 7,179,548 19,091,761 15,274,869
Interest expense ........ 278,100 278,100 556,200 556,200
Other expenses .......... 508,390 419,217 914,520 742,955
------------ ----------- ------------ ------------
109,034,314 90,520,191 205,499,198 169,366,096
------------ ----------- ------------ ------------
Income before income
tax expense ......... 6,349,243 3,775,979 20,934,677 16,139,339
------------ ----------- ------------ ------------
INCOME TAX EXPENSE
(BENEFIT)
Current ............... 1,807,444 502,254 7,285,837 4,312,738
Deferred .............. (618,859) (192,211) (2,014,414) 11,570
------------ ----------- ------------ ------------
1,188,585 310,043 5,271,423 4,324,308
------------ ----------- ------------ ------------
Net income ........$ 5,160,658 $ 3,465,936 $ 15,663,254 $ 11,815,031
============ =========== ============ ============
Net income per common
share
- basic and diluted .....$ .38 $ .30 $ 1.15 $ 1.02
============ =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
============ =========== ============ ============
Average number of common
shares outstanding
- basic and diluted ..... 13,602,194 11,558,120 13,593,652 11,540,381
============ =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net income ................. $ 5,160,658 $ 3,465,936 $15,663,254 $11,815,031
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME
Unrealized holding
gains (losses) arising
during the period,
before deferred income
tax expense (benefit) .. 12,225,986 (13,099,776) 5,710,808 (7,771,084)
Deferred income tax
expense (benefit) ...... 4,279,094 (4,584,921) 1,998,783 (2,719,879)
----------- ----------- ----------- -----------
7,946,892 (8,514,855) 3,712,025 (5,051,205)
----------- ----------- ----------- -----------
Reclassification
adjustment for gains
included in net income,
before income tax
expense ................ (833,237) (3,174,315) (1,561,679) (3,572,536)
Income tax expense ....... 291,633 1,111,010 546,588 1,250,388
----------- ----------- ----------- -----------
(541,604) (2,063,305) (1,015,091) (2,322,148)
----------- ----------- ----------- -----------
Other comprehensive
income (loss) .... 7,405,288 (10,578,160) 2,696,934 (7,373,353)
----------- ----------- ----------- -----------
Total comprehensive
income (loss) .... $12,565,946 $(7,112,224)$18,360,188 $ 4,441,678
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
--------------------------
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................... $ 15,663,254 $ 11,815,031
Adjustments to reconcile net income to net
cash provided by operating activities:
Balances resulting from related party
transactions with Employers Mutual:
Losses and settlement expenses ........ 22,750,975 25,125,721
Unearned premiums ..................... (1,590,709) 6,636,071
Other policyholders' funds ............ (508,984) 218,153
Indebtedness to related party ......... (13,771,074) (13,818,168)
Employee retirement plans ............. 1,853,560 (492,864)
Reinsurance receivables ............... (2,899,773) (2,357,448)
Prepaid reinsurance premiums .......... 42,639 (408,275)
Deferred policy acquisition costs ..... 324,645 (1,370,115)
Commissions payable ................... (6,726,327) (1,919,523)
Interest payable ...................... (556,200) (278,100)
Prepaid assets ........................ (1,354,089) (652,703)
Other, net ............................ 545,257 (1,322,416)
Accrued investment income ................. (853,778) (360,915)
Accrued income taxes:
Current ................................. 872,859 (5,531,891)
Deferred ................................ (2,014,414) 11,570
Realized investment gains ................. (1,561,679) (3,581,635)
Other, net ................................ 527,390 (210,516)
------------ ------------
(4,919,702) (313,054)
Cash provided by the change in the property
and casualty insurance subsidiaries'
pooling agreement ....................... 107,801,259 -
------------ ------------
Net cash provided by
operating activities ............... $118,544,811 $ 11,501,977
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
Six months ended
June 30,
--------------------------
2005 2004
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity securities
held-to-maturity ............................ $ 9,206,464 $ 3,101,227
Purchases of fixed maturity securities
available-for-sale .......................... (358,351,306) (382,757,028)
Disposals of fixed maturity securities
available-for-sale .......................... 247,787,328 385,443,985
Purchases of equity securities
available-for-sale .......................... (22,288,869) (19,931,703)
Disposals of equity securities
available-for-sale .......................... 22,098,307 18,034,266
Purchases of other long-term investments ...... (729,000) (1,020,000)
Disposals of other long-term investments ...... 572,276 242,886
Net sales (purchases) of short-term investments (12,885,371) 1,878,341
------------ ------------
Net cash provided by (used in)
investing activities .................... (114,590,171) 4,991,974
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related party
transactions with Employers Mutual:
Issuance of common stock through Employers
Mutual's stock option plans ............. 711,825 1,355,987
Dividends paid to Employers Mutual ........ (2,212,203) (2,795,176)
Dividends paid to Employers Mutual
(reimbursement for non-GAAP expense) .... (136,025) (262,268)
Dividends paid to public stockholders ......... (1,867,367) (669,122)
------------ ------------
Net cash used in financing activities ..... (3,503,770) (2,370,579)
------------ ------------
NET INCREASE IN CASH ............................ 450,870 14,123,372
Cash at beginning of year ....................... 61,088 (14,069,102)
------------ ------------
Cash at end of quarter .......................... $ 511,958 $ 54,270
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared on the basis of U.S. generally accepted accounting principles (GAAP)
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by GAAP for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of the interim
financial statements have been included. The results of operations for the
interim periods reported are not necessarily indicative of results to be
expected for the year.
The consolidated balance sheet at December 31, 2004 has been derived from
the audited financial statements at that date but does not include all of the
information and notes required by GAAP for complete financial statements.
Certain amounts previously reported in prior years' consolidated
financial statements have been reclassified to conform to current year
presentation.
In reading these financial statements, reference should be made to the
Company's 2004 Form 10-K or the 2004 Annual Report to Shareholders for more
detailed footnote information.
2. CHANGE IN POOLING AGREEMENT
The Company's aggregate participation in the pooling agreement increased
from 23.5 percent to 30.0 percent effective January 1, 2005. In connection
with this change in the pooling agreement, the Company's liabilities increased
$115,042,355, invested assets increased $107,801,259 and other assets
increased $722,361. The Company reimbursed Employers Mutual $6,518,735 for
expenses that were incurred to generate the additional business assumed by the
Company, but this expense was offset by an increase in deferred policy
acquisition costs. The Company also received $274,963 in interest income from
Employers Mutual as the actual cash settlement did not occur until February
15, 2005.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
3. REINSURANCE
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three and six months ended June 30, 2005
and 2004 is presented below.
Three months ended June 30,
---------------------------
2005 2004
------------ ------------
Premiums written
Direct ............................ $ 45,533,224 $ 49,038,944
Assumed from non-affiliates ....... 1,507,248 1,133,114
Assumed from affiliates ........... 109,997,649 92,155,771
Ceded to non-affiliates ........... (5,378,211) (4,309,189)
Ceded to affiliates ............... (45,533,224) (49,038,944)
------------ ------------
Net premiums written ............ $106,126,686 $ 88,979,696
============ ============
Premiums earned
Direct ............................ $ 46,471,335 $ 48,864,449
Assumed from non-affiliates ....... 1,492,071 1,092,929
Assumed from affiliates ........... 108,197,734 87,059,769
Ceded to non-affiliates ........... (5,487,596) (4,168,411)
Ceded to affiliates ............... (46,471,335) (48,864,449)
------------ ------------
Net premiums earned ............. $104,202,209 $ 83,984,287
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 42,503,944 $ 26,092,955
Assumed from non-affiliates ....... 234,254 172,396
Assumed from affiliates ........... 78,877,065 66,787,191
Ceded to non-affiliates ........... (5,567,643) (3,312,138)
Ceded to affiliates ............... (42,503,944) (26,092,955)
------------ ------------
Net losses and settlement
expenses incurred ............. $ 73,543,676 $ 63,647,449
============ ============
Six months ended June 30,
---------------------------
2005 2004
------------ ------------
Premiums written
Direct ............................ $ 90,717,045 $ 96,783,479
Assumed from non-affiliates ....... 2,588,161 2,092,099
Assumed from affiliates ........... 241,956,689 180,186,768
Ceded to non-affiliates ........... (11,330,529) (8,615,353)
Ceded to affiliates ............... (90,717,045) (96,783,479)
------------ ------------
Net premiums written ............ $233,214,321 $173,663,514
============ ============
Premiums earned
Direct ............................ $ 92,947,584 $100,634,753
Assumed from non-affiliates ....... 2,280,501 2,052,453
Assumed from affiliates ........... 213,570,331 173,597,194
Ceded to non-affiliates ........... (10,354,553) (8,207,078)
Ceded to affiliates ............... (92,947,584) (100,634,753)
------------ ------------
Net premiums earned ............. $205,496,279 $167,442,569
============ ============
Losses and settlement expenses incurred
Direct ............................ $ 68,177,685 $ 53,135,506
Assumed from non-affiliates ....... 4,220,633 931,485
Assumed from affiliates ........... 147,467,971 118,253,104
Ceded to non-affiliates ........... (15,301,920) (4,575,963)
Ceded to affiliates ............... (68,177,685) (53,135,506)
------------ ------------
Net losses and settlement
expenses incurred ............. $136,386,684 $114,608,626
============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
The large increases in net premiums written and earned, and net losses
and settlement expenses incurred, in 2005 reflect the increase in the
Company's aggregate participation interest in the pooling agreement. Net
premiums written for 2005 also include a $29,630,612 portfolio adjustment,
which serves as an offset to the increase in net unearned premiums recognized
in connection with the pooling change.
4. 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,
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." 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.
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. The
statutory-basis compensation expense that was paid by the Company's
subsidiaries to Employers Mutual ($29,378 and $61,073 for the three months and
$136,025 and $262,268 for the six months ended June 30, 2005 and 2004,
respectively) was reclassified as a dividend payment to Employers Mutual in
these GAAP-basis financial statements.
The following table illustrates the effect on net income and net income
per share if the Company had applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS
148), "Accounting for Stock-Based Compensation," to Employers Mutual's stock
option plans:
Three months ended Six months ended
June 30, June 30,
--------------------- ------------------------
2005 2004 2005 2004
---------- ---------- ----------- -----------
Net income, as reported ...... $5,160,658 $3,465,936 $15,663,254 $11,815,031
Deduct: Total stock-based
employee compensation
expense determined under the
fair value method for all
awards ..................... 39,727 8,170 58,885 16,187
---------- ---------- ----------- -----------
Pro forma net income ......... $5,120,931 $3,457,766 $15,604,369 $11,798,844
========== ========== =========== ===========
Net income per share:
Basic and diluted -
As reported .............. $0.38 $0.30 $1.15 $1.02
Pro forma ................ $0.38 $0.30 $1.15 $1.02
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
In December 2004, the Financial Accounting Standards Board issued SFAS
No. 123 (revised 2004) "Share-Based Payment," which is a revision of SFAS 123
and supersedes APB 25. SFAS 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their grant date fair values. The pro forma
disclosures previously allowed under SFAS 123 will no longer be an alternative
to financial statement recognition. The transition methods for adoption
include the modified-prospective and modified-retroactive methods. The
modified-prospective method requires that compensation expense be recorded for
all unvested stock options that exist upon the adoption of SFAS 123(R). Under
the modified-retroactive method, prior periods may be restated either as of
the beginning of the year of adoption or for all periods presented. The
effective date for SFAS 123(R) was originally the first interim and annual
periods beginning after June 15, 2005, with earlier adoption encouraged. On
April 14, 2005, the Securities and Exchange Commission approved a rule which
delayed the required effective date of SFAS 123(R) until fiscal years
beginning after June 15, 2005. The Company will adopt SFAS 123 (R) in the
first quarter of 2006 and is currently evaluating the requirements, including
the adoption method alternatives. Adoption of this statement is not expected
to have a material effect on the operating results of the Company.
5. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate.
Property
Three months ended and casualty Parent
June 30, 2005 insurance Reinsurance company Consolidated
- ------------------ ------------ ------------ ------------ ------------
Premiums earned ...... $ 81,177,327 $ 23,024,882 $104,202,209
Underwriting gain
(loss) ............. (5,735,276) 1,689,661 (4,045,615)
Net investment income 7,488,089 2,665,174 $ 47,274 10,200,537
Realized investment
gains .............. 811,547 21,690 - 833,237
Other income ......... 147,574 - - 147,574
Interest expense ..... 193,125 84,975 - 278,100
Other expense ........ 247,520 - 260,870 508,390
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit)........... $ 2,271,289 $ 4,291,550 $ (213,596) $ 6,349,243
============ ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Property
Three months ended and casualty Parent
June 30, 2004 insurance Reinsurance company Consolidated
- ------------------ ------------ ------------ ------------- --------------
Premiums earned ..... $ 62,209,091 $ 21,775,196 $ 83,984,287
Underwriting gain
(loss) ............ (8,060,609) 2,222,022 (5,838,587)
Net investment income 4,554,410 2,297,481 $ 13,772 6,865,663
Realized investment
gains ............. 2,452,066 729,042 - 3,181,108
Other income ........ 265,112 - - 265,112
Interest expense .... 193,125 84,975 - 278,100
Other expense ....... 228,066 - 191,151 419,217
------------ ------------ ------------- --------------
Income (loss) before
income tax expense
(benefit) ......... $ (1,210,212)$ 5,163,570 $ (177,379) $ 3,775,979
============ ============ ============= ==============
Property
Six months ended and casualty Parent
June 30, 2005 insurance Reinsurance company Consolidated
- ---------------- ------------ ------------ ------------- --------------
Premiums earned ..... $160,895,599 $ 44,600,680 $ 205,496,279
Underwriting gain
(loss) ............ (530,802) 1,998,603 1,467,801
Net investment income 13,829,570 5,160,451 $ 142,226 19,132,247
Realized investment
gains (losses) .... 1,678,661 (116,982) - 1,561,679
Other income ........ 243,670 - - 243,670
Interest expense .... 386,250 169,950 - 556,200
Other expense ....... 418,849 - 495,671 914,520
------------ ------------ ------------- --------------
Income (loss) before
income tax expense
(benefit) ......... $ 14,416,000 $ 6,872,122 $ (353,445) $ 20,934,677
============ ============ ============= ==============
Assets .............. $822,693,417 $242,515,255 $ 243,582,599 $1,308,791,271
Eliminations ........ - - (238,613,022) (238,613,022)
Reclassifications ... - (3,355,653) (38,269) (3,393,922)
------------ ------------ ------------- --------------
Net assets ..... $822,693,417 $239,159,602 $ 4,931,308 $1,066,784,327
============ ============ ============= ==============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
Property
Six months ended and casualty Parent
June 30, 2004 insurance Reinsurance company Consolidated
- ---------------- ------------ ------------ ------------- --------------
Premiums earned ..... $123,569,319 $ 43,873,250 $ 167,442,569
Underwriting gain
(loss) ............ (4,020,260) 3,395,888 (624,372)
Net investment income 9,520,781 4,592,964 $ 25,895 14,139,640
Realized investment
gains ............. 2,742,033 839,602 - 3,581,635
Other income ........ 341,591 - - 341,591
Interest expense .... 386,250 169,950 - 556,200
Other expense ....... 408,463 - 334,492 742,955
------------ ------------ ------------- --------------
Income (loss) before
income tax expense
(benefit) ......... $ 7,789,432 $ 8,658,504 $ (308,597) $ 16,139,339
============ ============ ============= ==============
Assets .............. $654,951,908 $253,871,082 $ 183,089,792 $1,091,912,782
Eliminations ........ - - (175,788,921) (175,788,921)
Reclassifications ... (4,829) (861,719) (116,944) (983,492)
------------ ------------ ------------- --------------
Net assets ..... $654,947,079 $253,009,363 $ 7,183,927 $ 915,140,369
============ ============ ============= ==============
6. INCOME TAXES
The actual income tax expense for the three and six months ended June 30,
2005 and 2004 differed from the "expected" tax expense for those periods
(computed by applying the United States federal corporate tax rate of 35
percent to income before income tax expense) as follows:
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Computed "expected" tax
expense ................ $ 2,222,235 $ 1,321,593 $ 7,327,137 $ 5,648,769
Increases (decreases) in
tax resulting from:
Tax-exempt interest
income ............. (1,099,410) (789,216) (2,187,106) (1,400,289)
Proration of
tax-exempt interest
and dividends
received deduction 176,918 124,405 347,720 222,427
Other, net ........... (111,158) (346,739) (216,328) (146,599)
----------- ----------- ----------- -----------
Income tax
expense ........ $ 1,188,585 $ 310,043 $ 5,271,423 $ 4,324,308
=========== =========== =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
7. EMPLOYEE RETIREMENT PLANS
The components of net periodic benefit cost for the Employers Mutual
pension plan and postretirement benefit plans are as follows:
Three months ended Six months ended
June 30, June 30,
---------------------- ----------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Pension Plan:
Service cost .............. $1,872,977 $1,704,630 $3,745,954 $3,409,260
Interest cost ............. 1,947,072 1,755,222 3,894,144 3,510,444
Expected return on plan
assets .................. (2,220,757) (1,690,132) (4,441,514) (3,380,264)
Amortization of net loss .. 204,905 213,922 409,810 427,844
Amortization of prior
service costs ........... 111,864 191,456 223,728 382,912
---------- ---------- ---------- ----------
Net periodic pension
benefit cost .......... $1,916,061 $2,175,098 $3,832,122 $4,350,196
========== ========== ========== ==========
Postretirement benefit plans:
Service cost .............. $1,039,981 $1,144,127 $2,079,962 $2,288,254
Interest cost ............. 1,018,762 1,078,509 2,037,524 2,157,018
Expected return on plan
assets .................. (272,282) (225,221) (544,564) (450,442)
Amortization of net loss .. 10,023 147,830 20,046 295,660
---------- ---------- ---------- ----------
Net periodic
postretirement
benefit cost .......... $1,796,484 $2,145,245 $3,592,968 $4,290,490
========== ========== ========== ==========
Pension expense allocated to the Company was $587,002 and $1,174,004 for
the three months and six months ended June 30, 2005 compared to $528,724 and
$1,057,447 for the same periods in 2004.
Postretirement benefit expense allocated to the Company was $512,544 and
$1,025,088 for the three months and six months ended June 30, 2005 compared to
$481,852 and $963,705 for the same periods in 2004.
Employers Mutual plans to contribute approximately $10,000,000 to the
pension plan and $3,770,000 to the postretirement benefit plans in 2005. As
of June 30, 2005, Employers Mutual has not made a contribution to the pension
plan and has contributed the $3,770,000 to the postretirement benefit plans.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
8. 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 net income. The
companies involved have reserves which are believed adequate to cover any
potential liabilities arising out of all such pending or threatened
proceedings.
The participants of the pooling agreement have purchased annuities from
life insurance companies, under which the claimant is payee, to fund future
payments that are fixed pursuant to specific claim settlement provisions. The
Company's share of loss reserves eliminated by the purchase of these annuities
was $699,913 at December 31, 2004. Due to the change in the Company's
aggregate participation in the pooling agreement, this amount increased to
$893,506 effective January 1, 2005. The Company has a contingent liability of
$893,506 should the issuers of these annuities fail to perform under the terms
of the annuities. The Company's share of the amount due from any one life
insurance company does not equal or exceed one percent of its subsidiaries'
policyholders' surplus.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Unaudited)
COMPANY OVERVIEW
EMC Insurance Group Inc., a 55.4 percent owned subsidiary of Employers
Mutual Casualty Company (Employers Mutual), is an insurance holding company
with operations in property and casualty insurance and reinsurance. Property
and casualty insurance is the most significant segment, representing 78.3
percent of consolidated premiums earned in the first six months of 2005. For
purposes of this discussion, the term "Company" is used interchangeably to
describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance
Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries
(including the Company) and an affiliate are referred to as the "EMC Insurance
Companies."
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All premiums, 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. Employers Mutual
negotiates reinsurance agreements that provide protection to the pool and each
of its participants, including protection against losses arising from
catastrophic events.
Operations of the pool give rise to inter-company balances with Employers
Mutual, which are settled on a quarterly basis. The investment and income tax
activities of the pool participants are not subject to the pooling agreement.
The pooling agreement also provides 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 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.
Effective January 1, 2005, the Company's aggregate participation in the
pooling agreement increased from 23.5 percent to 30.0 percent. In connection
with this change in the pooling agreement, the Company's liabilities increased
$115,042,000, invested assets increased $107,801,000 and other assets
increased $722,000. The Company reimbursed Employers Mutual $6,519,000 for
expenses that were incurred to generate the additional business assumed by the
Company, but this expense was offset by an increase in deferred policy
acquisition costs. The Company also received $275,000 in interest income from
Employers Mutual as the actual cash settlement did not occur until February
15, 2005.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
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,
settlement expenses, and other underwriting and administrative expenses of
this business, subject to a maximum loss of $1,500,000 per event. The
reinsurance subsidiary does not directly reinsure any of the insurance
business written by Employers Mutual; however, the reinsurance subsidiary
assumes reinsurance business from the Mutual Reinsurance Bureau (MRB) pool and
this pool provides a very small amount of reinsurance protection to the EMC
Insurance Companies. As a result, the reinsurance subsidiary's assumed
exposures include a very small portion of the EMC Insurance Companies' direct
business, after ceded reinsurance protections purchased by the MRB pool are
applied. In addition, the reinsurance subsidiary does not reinsure any
"involuntary" facility or pool business that Employers Mutual assumes pursuant
to state law. 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.
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation of the
interim financial statements have been included. The results of operations
for the interim periods reported are not necessarily indicative of results to
be expected for the year.
INDUSTRY OVERVIEW
An insurance company's underwriting results reflect the profitability of
its insurance operations, excluding investment income. Underwriting results
are calculated by subtracting losses and expenses incurred from premiums
earned. An underwriting profit indicates that a sufficient amount of premium
income was received to cover the risks insured. An underwriting loss
indicates that premium income was not adequate. The combined ratio is a
measure utilized by insurance companies to gauge underwriting profitability
and is calculated by dividing losses and expenses incurred by premiums earned.
A number less than 100 generally indicates an underwriting gain; a number
greater than 100 generally indicates an underwriting loss.
Insurance companies collect cash in the form of insurance premiums and pay
out cash in the form of loss and settlement expense payments. Additional cash
outflows occur through the payment of acquisition and underwriting costs such
as commissions, premium taxes, salaries and general overhead. During the loss
settlement period, which varies by line of business and by the circumstances
surrounding each claim and may cover several years, insurance companies invest
the cash premiums and earn interest and dividend income. This investment
income supplements underwriting results and contributes to net earnings.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Additional information regarding issues affecting the insurance industry
is presented in the Management's Discussion and Analysis of Financial
Condition and Results of Operations section of the Company's 2004 Form 10-K.
MANAGEMENT ISSUES AND PERSPECTIVES
During the first six months of 2005 management has focused its attention
on three primary issues of importance to the Company. These issues include
establishing and maintaining adequate loss and settlement expense reserves,
balancing profitability and production as the insurance marketplace becomes
increasingly competitive and preparing to comply with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002. These issues are discussed
further in the following paragraphs. A discussion of other issues being
addressed by management is presented in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section of the
Company's 2004 Form 10-K.
Management has long recognized the importance of adequate capitalization
for its insurance subsidiaries and has strived to maintain a strong capital
position by investing their assets conservatively and, more importantly,
maintaining a consistent level of loss and settlement expense reserve
adequacy. Carried reserves are analyzed on a regular basis and adjustments,
if necessary, are implemented on a timely basis. This procedure not only
assures a consistent level of reserve adequacy, it also minimizes the impact
that any required adjustment will have on current operations. This dedication
to reserve adequacy was demonstrated in both 2003 and 2004 when the Company
strengthened loss and settlement expense reserves in the property and casualty
insurance segment in response to the findings of regularly-scheduled actuarial
evaluations.
In addition to an ongoing review of claim files in the normal course of
business, the Company has for many years required each of its 16 branch
offices to perform a complete inventory of its open claim files during the
fourth quarter of each year and to review the adequacy of each individual case
reserve based on current information. This fourth quarter review process has
not historically resulted in a significant increase in case reserves; however,
because of heightened emphasis placed on case reserve adequacy during 2004,
the review performed in the fourth quarter of 2004 generated a significant and
unanticipated increase in case reserves and a corresponding increase in
settlement expense reserves. In an effort to minimize the likelihood of this
occurring in the future, beginning in 2005 the branch offices are required to
perform a complete inventory and review of their open claim files semi-
annually rather than annually as previously required. The first review was
completed during the second quarter of 2005 and the second review will be
completed by the end of November. Management believes that this additional
review process will help assure that necessary reserve adjustments are
implemented on a timely basis.
In addition to recent actions taken to improve reserve adequacy,
effective March 1, 2005, Richard K. Schulz, an employee of Employers Mutual,
became the senior claims executive officer. Mr. Schulz was the claims manager
at the Chicago branch office for the last five years and has over ten years of
prior insurance industry experience. Mr. Schulz reports to William A. Murray,
Executive Vice President and Chief Operating Officer.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The products offered by an insurance company must be priced so that they
are competitive in the marketplace, yet offer the prospect of producing an
underwriting profit. Management is keenly aware of the need to achieve an
underwriting profit in today's marketplace and has implemented focused
underwriting initiatives that stress profitability over production. Achieving
an underwriting profit has become increasingly important during the last
several years as investment income, which is used to supplement underwriting
results and contribute to net earnings, has been negatively impacted by the
lingering low interest rate environment.
The Company, which is not currently an accelerated filer, has completed
the majority of the documentation of its work flow and internal control over
financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
2002. Efforts during the first six months of 2005 focused on the remediation
of identified gaps in existing controls and the verification of controls at
the various branch offices. Efforts for the remainder of 2005 will include
testing of the documented controls, remediation of any controls that are found
to be not working as designed and the establishment of a maintenance process.
Management expects to complete its initial assessment of the Company's
internal control over financial reporting by the end of August, which will
allow sufficient time for the Company's independent auditor to perform their
analysis and testing procedures and issue their report on the Company's
internal control over financial reporting as of December 31, 2005.
CRITICAL ACCOUNTING POLICIES
The accounting policies considered by management to be critically
important in the preparation and understanding of the Company's financial
statements and related disclosures are presented in the Management's
Discussion and Analysis of Financial Condition and Results of Operations
section of the Company's 2004 Form 10-K.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
RESULTS OF OPERATIONS
Segment information and consolidated net income for the three months and
six months ended June 30, 2005 and 2004 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2005 2004 2005 2004
-------- -------- -------- --------
Property and Casualty Insurance
Premiums earned ..................... $ 81,177 $ 62,209 $160,895 $123,569
Losses and settlement expenses ...... 59,119 48,476 106,250 84,871
Acquisition and other expenses ...... 27,794 21,794 55,177 42,719
-------- -------- -------- --------
Underwriting loss ................... $ (5,736)$ (8,061) $ (532)$ (4,021)
======== ======== ======== ========
Loss and settlement expense ratio ... 72.9% 77.9% 66.0% 68.7%
Acquisition expense ratio ........... 34.2 35.1 34.3 34.6
-------- -------- -------- --------
Combined ratio ...................... 107.1% 113.0% 100.3% 103.3%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 56,629 $ 41,362 $110,353 $ 81,182
Increase (decrease) in provision
for insured events of prior
years ......................... 2,490 7,114 (4,103) 3,689
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 59,119 $ 48,476 $106,250 $ 84,871
======== ======== ======== ========
Catastrophe and storm losses ........ $ 5,776 $ 7,032 $ 7,540 $ 7,902
======== ======== ======== ========
Reinsurance
Premiums earned ..................... $ 23,025 $ 21,775 $ 44,601 $ 43,873
Losses and settlement expenses ...... 14,425 15,172 30,137 29,738
Acquisition and other expenses ...... 6,910 4,381 12,465 10,739
-------- -------- -------- --------
Underwriting gain ................... $ 1,690 $ 2,222 $ 1,999 $ 3,396
======== ======== ======== ========
Loss and settlement expense ratio ... 62.7% 69.7% 67.6% 67.8%
Acquisition expense ratio ........... 30.0 20.1 27.9 24.5
-------- -------- -------- --------
Combined ratio ...................... 92.7% 89.8% 95.5% 92.3%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 14,865 $ 16,289 $ 29,870 $ 31,220
Increase (decrease) in provision
for insured events of prior
years ......................... (440) (1,117) 267 (1,482)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 14,425 $ 15,172 $ 30,137 $ 29,738
======== ======== ======== ========
Catastrophe and storm losses ........ $ 205 $ 165 $ 1,066 $ 310
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2005 2004 2005 2004
-------- -------- -------- --------
Consolidated
REVENUES
Premiums earned ..................... $104,202 $ 83,984 $205,496 $167,442
Net investment income ............... 10,200 6,866 19,132 14,140
Realized investment gains ........... 834 3,181 1,562 3,582
Other income ........................ 148 265 244 341
-------- -------- -------- --------
115,384 94,296 226,434 185,505
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and settlement expenses ...... 73,544 63,648 136,387 114,609
Acquisition and other expenses ...... 34,704 26,175 67,642 53,458
Interest expense .................... 278 278 556 556
Other expense ....................... 509 419 915 743
-------- -------- -------- --------
109,035 90,520 205,500 169,366
-------- -------- -------- --------
Income before income tax expense .... 6,349 3,776 20,934 16,139
Income tax expense .................. 1,189 310 5,271 4,324
-------- -------- -------- --------
Net income .......................... $ 5,160 $ 3,466 $ 15,663 $ 11,815
======== ======== ======== ========
Net income per share ................ $ 0.38 $ 0.30 $ 1.15 $ 1.02
======== ======== ======== ========
Loss and settlement expense ratio ... 70.6% 75.8% 66.4% 68.4%
Acquisition expense ratio ........... 33.3 31.2 32.9 32.0
-------- -------- -------- --------
Combined ratio ...................... 103.9% 107.0% 99.3% 100.4%
======== ======== ======== ========
Losses and settlement expenses:
Insured events of current year .. $ 71,494 $ 57,651 $140,223 $112,402
Increase (decrease) in provision
for insured events of prior
years ......................... 2,050 5,997 (3,836) 2,207
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 73,544 $ 63,648 $136,387 $114,609
======== ======== ======== ========
Catastrophe and storm losses ........ $ 5,981 $ 7,197 $ 8,606 $ 8,212
======== ======== ======== ========
Net income increased for both the three months and six months ended June
30, 2005 from the same periods in 2004, but the increase was limited to some
extent by $2,558,000 ($1,663,000 or $0.14 per share after tax) of realized
investment gains recognized during the second quarter of 2004 in connection
with a bankruptcy payout award on bonds issued by MCI Communications
Corporation. The increase in 2005 net income is primarily attributed to a
significant increase in investment income stemming from a large increase in
invested assets. The Company's invested assets increased as a result of
$34,890,000 of net proceeds received from the follow-on stock offering
completed in October 2004 and the receipt of $107,801,000 in cash from
Employers Mutual in February 2005 in connection with the change in the pooling
agreement. Also contributing to the increase in 2005 net income was an
improvement in underwriting results. For the first six months of 2005 the
Company posted an underwriting profit of $1,468,000 compared to an
underwriting loss of $624,000 in the same period of 2004. Included in the
underwriting loss of 2004 is $2,940,000 ($1,910,000 or $0.17 per share after
tax) of bulk loss and settlement expense reserve strengthening that was
implemented during the second quarter in response to actuarial evaluations.
Premium rate competition has increased during 2005, but management continues
to emphasize its goal of achieving profitability over production. Achieving
an underwriting profit is always stressed, but has become even more critical
in this lingering low interest rate environment.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Premiums Earned
Premiums earned increased 24.1 percent and 22.7 percent to $104,202,000
and $205,496,000 for the three months and six months ended June 30, 2005 from
$83,984,000 and $167,442,000 for the same periods in 2004. These increases
are primarily attributed to the Company's increased participation in the
pooling agreement, but also reflect the impact of rate increases that were
implemented in the property and casualty insurance business during 2004. On
an overall basis, rate competition increased moderately in the property and
casualty insurance marketplace during the first six months of 2005; however,
there have been indications of more intense rate competition in select
territories and lines of business and the Company expects market conditions to
remain competitive for the remainder of the year. In response to these
competitive market conditions, the Company has implemented slight decreases in
premium rates where warranted.
Premiums earned for the property and casualty insurance segment increased
30.5 percent and 30.2 percent to $81,177,000 and $160,895,000 for the three
months and six months ended June 30, 2005 from $62,209,000 and $123,569,000
for the same periods in 2004. These increases are primarily the result of the
change in the pooling agreement. To better understand the results for 2005,
it is helpful to look at the net pool numbers, which are not impacted by the
pool change. For the pool, net premiums earned increased 2.2 percent and 2.1
percent for the three months and six months ended June 30, 2005, respectively,
from the same periods in 2004 as a result of rate increases implemented during
2004. Increased rate competition during the first six months of 2005 has
resulted in the implementation of some minor decreases in premium rates,
slight increases in the use of discretionary credits in commercial lines and
declines in policy counts in both commercial and personal lines. Due to the
timing of policy renewals and the earning of premiums ratably over the terms
of the underlying policies, a time delay exists for implemented rate changes
(both increases and decreases) to have a noticeable impact on premiums earned.
The Company is attempting to address the loss of policy count through various
measures including programs geared towards small businesses and enhanced
automation to make it easier and more efficient for agents to do business with
the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Premiums written for the property and casualty insurance segment
increased 26.0 percent and 49.6 percent to $84,354,000 and $190,207,000 for
the three months and six months ended June 30, 2005 from $66,960,000 and
$127,144,000 for the same periods in 2004. These increases are attributed to
the change in the pooling agreement; however, it should be noted that the
large increase for the six months ended June 30, 2005 includes a portfolio
adjustment of $29,631,000, which serves as an offset to the increase in the
unearned premium reserve. Excluding this portfolio adjustment, premiums
written increased 26.3 percent for the six months ended June 30, 2005 compared
to the same period in 2004. Looking at the net pool numbers, which are not
impacted by the pool change, premiums written declined 1.3 percent and 1.0
percent for the three months and six months ended June 30, 2005 compared to
the same periods in 2004, which reflects a decline in new business, some minor
declines in personal lines premium rates and an increase in the use of
discretionary credits. During the first half of 2005 commercial lines new
business premium decreased approximately 3.1 percent and personal lines new
business premium decreased approximately 16.0 percent. However, policy
retention has increased to 86.1 percent in commercial lines and remained
relatively steady in the personal lines at 82.3 percent for property and 83.2
percent for auto. In light of the improvements that have been achieved in
both the pricing and the quality of the Company's book of business, management
is receptive to opportunities to write new business, but continues to stress
profitability over production.
Premiums earned for the reinsurance segment increased 5.7 percent and 1.7
percent to $23,025,000 and $44,601,000 for the three months and six months
ended June 30, 2005 from $21,775,000 and $43,873,000 for the same periods in
2004. These increases are primarily the result of a timing difference in the
recording of a large foreign reinsurance contract that was reported and
recorded in the second quarter of 2005 but was not reported and recorded until
the third quarter of 2004. However, the impact of this timing difference was
partially offset by the loss of a significant account in 2005. Employers
Mutual was not able to retain this account due to its current "A-" (Excellent)
A.M. Best rating. Employers Mutual is attempting to replace this business
with new accounts and increased participation on existing accounts; however,
no significant new accounts were added during the first half of 2005.
Premium rate increases on excess-of-loss contracts remained relatively flat
at both the January and July 2005 renewals, evidence of the increasing
competitiveness of the reinsurance market. Premium rate levels continue to be
considered adequate, as the rate increases implemented during the last several
years were realized in conjunction with moderate declines in the related
exposure base due to increased retention levels and coverage exclusions for
terrorist activities. In addition, both excess-of-loss and pro-rata contracts
have benefited from improved industry-wide rate levels at the primary company
level. The estimate of earned but not reported premiums decreased $600,000
during the three months ended June 30, 2005, resulting in a $200,000 decline
for the first half of 2005. In comparison, the estimate of earned but not
reported premiums increased $1,400,000 and $610,000 during the three months
and six months ended June 30, 2004, respectively.
As previously reported, the board of directors of the MRB pool, of which
Employers Mutual is a member, has authorized management to pursue the addition
of one or two new assuming companies to the pool. No action was taken during
the first half of 2005 and the earliest that a new member could begin
participating in the pool would be January 2006. If additional assuming
companies are added to the pool, Employers Mutual's participation will be
reduced and the reinsurance segment's premium volume will decline in the
short-term; however, this action will strengthen MRB's surplus base and should
favorably impact their ability to attract new business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Losses and settlement expenses
Losses and settlement expenses increased 15.6 percent and 19.0 percent to
$73,544,000 and $136,387,000 for the three months and six months ended June
30, 2005 from $63,648,000 and $114,609,000 for the same periods in 2004. The
majority of this increase is attributed to the Company's increased
participation in the pooling agreement. The loss and settlement expense
ratios declined to 70.6 percent and 66.4 percent for the three months and six
months ended June 30, 2005 from 75.8 percent and 68.4 percent for the same
periods in 2004.
The loss and settlement expense ratio for the property and casualty
insurance segment decreased to 72.9 percent and 66.0 percent for the three
months and six months ended June 30, 2005 from 77.9 percent and 68.7 percent
for the same periods in 2004. This improvement is largely due to reserve
strengthening actions taken in 2004, including a $2,940,000 increase in bulk
loss and settlement expense reserves implemented during the second quarter in
response to actuarial evaluations of the segment's carried reserves that
indicated a continued upward trend in projected ultimate losses. The property
and casualty insurance segment reported adverse development on prior years'
reserves of $2,490,000 (0.8 percent of the December 31, 2004 carried reserves)
during the three months ended June 30, 2005, but experienced favorable
development of $4,103,000 for the six months ended June 30, 2005. In
comparison, adverse development totaling $7,114,000 and $3,689,000 was
reported for the three months and six months ended June 30, 2004,
respectively. The adverse development experienced during the second quarter
of 2005 was concentrated in a few branch offices and primarily occurred in the
workers' compensation and commercial auto lines. Claim severity has increased
during 2005, which is generally attributed to the establishment of more
adequate case reserves on newly reported claims. Overall loss frequency has
continued to trend downward, but there are signs that it may be leveling out,
especially in the workers' compensation line of business.
The loss and settlement expense ratio for the reinsurance segment
decreased to 62.7 percent and 67.6 percent for the three months and six months
ended June 30, 2005 from 69.7 percent and 67.8 percent for the same periods in
2004. The improvement in the 2005 ratios is primarily attributed to low
levels of reported loss activity during the second quarter. Results for the
first six months of 2005 reflect adverse development on prior years' reserves
in the MRB pool and an increase in catastrophe and storm losses, most notably
European storm Erwin.
Acquisition and other expenses
Acquisition and other expenses increased 32.6 percent and 26.5 percent to
$34,704,000 and $67,642,000 for the three months and six months ended June 30,
2005 from $26,175,000 and $53,458,000 for the same periods in 2004. These
increases are primarily attributed to the Company's increased participation in
the pooling agreement. The acquisition expense ratio increased to 33.3
percent and 32.9 percent for the three and six months ended June 30, 2005 from
31.2 percent and 32.0 percent for the same periods in 2004. These increases
are primarily due to higher salary, information technology and premium tax
costs.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
For the property and casualty insurance segment, the acquisition expense
ratio decreased to 34.2 percent and 34.3 percent for the three months and six
months ended June 30, 2005 from 35.1 percent and 34.6 percent for the same
periods in 2004. These decreases are primarily attributed to declines in
policyholder dividends and agents' profit share expense, however, these
declines were partially offset by increases in salary, information technology
and premium tax costs.
The property and casualty insurance subsidiaries incurred $6,519,000 of
commission expense in connection with the change in the pooling agreement.
This commission expense is used to reimburse Employers Mutual for expenses
incurred to generate the additional insurance business that was transferred to
the Company on January 1, 2005. However, due to the fact that acquisition
expenses, which include commissions, are deferred and amortized to expense as
the related premiums are earned, all of the $6,519,000 of commission expense
was capitalized as a deferred policy acquisition cost, and is being amortized
to expense as the unearned premiums become earned. This provides a proper
matching of acquisition expenses and premium income.
For the reinsurance segment, the acquisition expense ratio increased to
30.0 percent and 27.9 percent for the three months and six months ended June
30, 2005 from 20.1 percent and 24.5 percent for the same periods in 2004.
These increases are primarily attributed to $1,064,000 of contingent
commission income recognized during the second quarter of 2004 as a result of
the favorable underwriting performance of Employers Mutual's assumed
reinsurance book of business. The commission expense for 2004 includes
$1,033,000 related to an increase in participation in the MRB pool from 25
percent to 33 percent; however, this expense was partially offset by an
increase in the asset for deferred policy acquisition costs.
Investment results
Net investment income increased 48.6 percent and 35.3 percent to
$10,200,000 and $19,132,000 for the three months and six months ended June 30,
2005 from $6,866,000 and $14,140,000 for the same periods in 2004, and is
attributed to a significant increase in invested assets. As previously
discussed, the Company received $34,890,000 of net proceeds from the follow-on
stock offering in October 2004 and $107,801,000 from Employers Mutual in
February 2005 in connection with the change in the pooling agreement. The
Company also received $275,000 of interest income from Employers Mutual as the
cash settlement for the pooling change did not occur until February 15, 2005.
The Company reported net realized investment gains of $834,000 and
$1,562,000 for the three months and six months ended June 30, 2005 compared to
$3,181,000 and $3,582,000 for the same periods in 2004. The large amount of
realized investment gains in the second quarter of 2004 reflects $2,558,000 of
net gains recognized on the Company's investment in MCI Communications
Corporation bonds in conjunction with a payout award received under a
bankruptcy court approved "Plan of Reorganization." The Company did not
recognize any other-than-temporary impairment losses in the first half of 2005
or 2004.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Income Tax
Income tax expense increased for both the three months and six months
ended June 30, 2005 from the same periods in 2004. The effective tax rates
for the three months and six months ended June 30, 2005 were 18.7 percent and
25.2 percent, respectively, compared to 8.2 percent and 26.8 percent for the
same periods of 2004. The decrease in the effective tax rate for the first
six months of 2005 primarily reflects the Company's increased emphasis on tax-
exempt securities.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of a company's ability to generate sufficient cash
flows to meet cash obligations as they come due. The Company generated
positive cash flows from operations of $118,545,000 during the first half of
2005 compared to $11,502,000 for the first half of 2004. Included in cash
flows from operations for the first half of 2005 is $107,801,000 received from
Employers Mutual in connection with the change in the pooling agreement.
Excluding this amount, cash flows from operations for the first half of 2005
amounted to $10,744,000. The Company typically generates substantial positive
cash flows from operations because cash from premium payments is generally
received in advance of cash payments made to settle claims. These positive
cash flows provide the foundation of the Company's asset/liability management
program and are the primary drivers of the Company's liquidity. When
investing funds made available from operations, the Company invests in
securities with maturities that approximate the anticipated payments of losses
and settlement expenses of the underlying insurance policies. In addition,
the Company maintains a portion of its investment portfolio in relatively
short-term and highly liquid assets as a secondary source of liquidity should
net cash flows from operating activities prove inadequate to fund current
operating needs. As of June 30, 2005, the Company did not have any
significant variations between the maturity dates of its investments and the
expected payments of its loss and settlement expense reserves.
The Company is a holding company whose principal assets are its
investments in its insurance subsidiaries. As a holding company, the Company
is dependent upon cash dividends from its insurance company subsidiaries to
meet its obligations and to pay cash dividends to its stockholders. State
insurance regulations restrict the maximum amount of dividends insurance
companies can pay without prior regulatory approval. The maximum amount of
dividends that the insurance company subsidiaries can pay to the Company in
2005 without prior regulatory approval is approximately $32.2 million. The
Company received $3,086,000 and $4,947,000 of dividends from its insurance
company subsidiaries and paid cash dividends to its stockholders totaling
$4,080,000 and $3,464,000 in the first six months of 2005 and 2004,
respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The Company's insurance company subsidiaries must have adequate liquidity
to ensure that their cash obligations are met; however, because of their
participation in the pooling agreement and the quota share agreement, they do
not have the daily liquidity concerns normally associated with an insurance or
reinsurance company. This is due to the fact that under the terms of the
pooling and quota share agreements, Employers Mutual receives all premiums and
pays all losses and expenses associated with the insurance business produced
by the pool participants and the assumed reinsurance business ceded to the
Company's reinsurance subsidiary, and then settles the inter-company balances
generated by these transactions with the participating companies on a
quarterly basis.
At the insurance company subsidiary level, the primary sources of cash
are premium income, investment income and maturing investments. The principal
outflows of cash are payments of claims, commissions, premium taxes, operating
expenses, income taxes, dividends, interest and principal payments on debt,
and investment purchases. Cash outflows can be variable because of
uncertainties regarding settlement dates for unpaid losses and because of the
potential for large losses, either individually or in the aggregate.
Accordingly, the insurance company subsidiaries maintain investment and
reinsurance programs generally intended to provide adequate funds to pay
claims without forced sales of investments.
The Company maintains a portion of its investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to pay claims and expenses. The remainder of the investment portfolio,
excluding investments in equity securities and other long-term investments, is
invested in securities with maturities that approximate the anticipated
liabilities of the insurance written. At June 30, 2005, approximately 43
percent of the Company's fixed maturity securities were in U.S. government or
U.S. government agency issued securities. A variety of maturities are
maintained in the Company's portfolio to assure adequate liquidity. The
maturity structure of the fixed maturity investments is also established by
the relative attractiveness of yields on short, intermediate and long-term
securities. The Company does not invest in high-yield, non-investment grade
debt securities; however, an exception was made to this policy in 2004 when
non-investment grade MCI debt securities were sold and then repurchased in
order to recognize a current income tax benefit.
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
Despite this intent, the Company currently classifies purchases of fixed
maturity investments as available-for-sale to provide flexibility in the
management of the investment portfolio. The Company had unrealized holding
gains, net of deferred taxes, on fixed maturity securities available-for-sale
totaling $17,045,000 and $15,511,000 at June 30, 2005 and December 31, 2004,
respectively. The fluctuation in the market value of these investments is
primarily due to changes in the interest rate environment during this time
period. Since the Company does not actively trade in the bond market, such
fluctuations in the fair value of these investments are not expected to have a
material impact on the operations of the Company, as forced liquidations of
investments are not anticipated. The Company closely monitors the bond market
and makes appropriate adjustments in its portfolio as changing conditions
warrant.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of investment
income that supplements underwriting results and contributes to net earnings.
As these investments mature, or are called, the proceeds will be reinvested at
current rates, which may be higher or lower than those now being earned;
therefore, more or less investment income may be available to contribute to
net earnings depending on the interest rate level.
The Company participates in a securities lending program administered by
Mellon Bank, N.A. whereby certain fixed maturity securities from the
investment portfolio are loaned to other institutions for short periods of
time. The Company receives a fee for each security loaned out under this
program and requires initial collateral, primarily cash, equal to 102 percent
of the market value of the loaned securities. The cash collateral that
secures the Company's loaned securities is invested in a Delaware statutory
trust that is managed by Mellon Bank. The earnings from this trust are used,
in part, to pay the fee the Company receives for each security loaned under
the program.
The Company held $5,707,000 and $5,550,000 in minority ownership
interests in limited partnerships and limited liability companies at June 30,
2005 and December 31, 2004, respectively. The Company does not hold any other
unregistered securities.
The Company carried a pension asset of $2,233,000 and $2,684,000 at June
30, 2005 and December 31, 2004, respectively. Postretirement benefit
liabilities reflected in the Company's financial statements totaled
$12,492,000 and $9,486,000 at June 30, 2005 and December 31, 2004,
respectively. Included in the 2005 amounts is $722,000 of pension assets and
$2,518,000 of postretirement benefit liabilities transferred to the Company in
connection with the change in the pooling agreement.
Capital Resources
Capital resources consist of stockholders' equity and debt, representing
funds deployed or available to be deployed to support business operations.
For the Company's insurance subsidiaries, capital resources are required to
support premium writings. Regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to its statutory
surplus should not exceed 3 to 1. All of the Company's insurance subsidiaries
were well under this guideline at June 30, 2005.
The Company's insurance subsidiaries are required to maintain certain
minimum surplus on a statutory basis and are subject to regulations under
which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
The Company's insurance subsidiaries are also subject to Risk Based Capital
(RBC) requirements that may further impact their ability to pay dividends.
RBC requirements attempt to measure minimum statutory capital needs based upon
the risks in a company's mix of products and investment portfolio. At
December 31, 2004, the Company's insurance subsidiaries had total adjusted
statutory capital of $216,868,000, which is well in excess of the minimum RBC
requirement of $43,485,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The Company had total cash and invested assets with a carrying value of
$899.6 million and $779.4 million as of June 30, 2005 and December 31, 2004,
respectively. The following table summarizes the Company's cash and invested
assets as of the dates indicated:
June 30, 2005
---------------------------------------------
Amortized Total at Carrying
($ in thousands) Cost Fair Value Fair Value Value
--------- ---------- ---------- --------
Fixed maturities,
held-to-maturity ........ $ 19,988 $ 20,829 2.3% $ 19,988
Fixed maturities,
available-for-sale ...... 706,001 732,223 81.3% 732,223
Equity securities,
available-for-sale ...... 61,183 82,077 9.1% 82,077
Cash ...................... 512 512 0.1% 512
Short-term investments .... 59,124 59,124 6.6% 59,124
Other long-term
investments ............. 5,707 5,707 0.6% 5,707
-------- -------- ----- --------
$852,515 $900,472 100.0% $899,631
======== ======== ===== ========
December 31, 2004
---------------------------------------------
Amortized Total at Carrying
($ in thousands) Cost Fair Value Fair Value Value
--------- ---------- ---------- --------
Fixed maturities,
held-to-maturity ........ $ 29,206 $ 30,594 3.9% $ 29,206
Fixed maturities,
available-for-sale ...... 595,791 619,654 79.4 619,654
Equity securities,
available-for-sale ...... 59,589 78,693 10.1 78,693
Cash ...................... 61 61 - 61
Short-term investments .... 46,239 46,239 5.9 46,239
Other long-term
investments ............. 5,550 5,550 0.7 5,550
-------- -------- ----- --------
$736,436 $780,791 100.0% $779,403
======== ======== ===== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
The amortized cost and estimated fair value of fixed maturity and equity
securities at June 30, 2005 were as follows:
Held-to maturity
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
($ in thousands) cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 19,025 $ 756 $ - $ 19,781
Mortgage-backed securities 963 85 - 1,048
--------- ---------- ---------- ---------
Total securities
held-to-maturity ..... $ 19,988 $ 841 $ - $ 20,829
========= ========== ========== =========
Available-for sale
----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
U.S. treasury securities and
obligations of U.S.
government corporations
and agencies ............. $ 292,896 $ 855 $ 137 $ 293,614
Obligations of states and
political subdivisions ... 251,976 14,009 5 265,980
Mortgage-backed securities 10,409 645 - 11,054
Public utilities ........... 9,198 1,211 - 10,409
Debt securities issued by
foreign governments ...... 7,112 260 - 7,372
Corporate securities ....... 134,410 9,858 474 143,794
---------- ---------- ---------- ---------
Total fixed maturity
securities ........... 706,001 26,838 616 732,223
---------- ---------- ---------- ---------
Equity securities .......... 61,183 22,018 1,124 82,077
---------- ---------- ---------- ---------
Total securities
available-for-sale ... $ 767,184 $ 48,856 $ 1,740 $ 814,300
========== ========== ========== =========
The Company's insurance and reinsurance subsidiaries have $36,000,000 of
surplus notes issued to Employer Mutual. These surplus notes have an annual
interest rate of 3.09 percent and do not have a maturity date. Payment of
interest and repayment of principal can only be made out of the applicable
subsidiary's statutory surplus and is subject to prior approval by the
insurance commissioner of the respective state of domicile. The surplus notes
are subordinate and junior in right of payment to all obligations or
liabilities of the applicable insurance subsidiaries. The Company's
subsidiaries incurred $556,000 of interest expense on these surplus notes in
the first six months of 2005 and 2004. At December 31, 2004, the Company's
subsidiaries had received approval for the payment of interest accrued on the
surplus notes during 2004.
As of June 30, 2005, the Company had no material commitments for capital
expenditures.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Off-Balance Sheet Arrangements
Employers Mutual receives all premiums and pays all losses and expenses
associated with the assumed reinsurance business ceded to the reinsurance
subsidiary and the insurance business produced by the pool participants, and
then settles the inter-company balances generated by these transactions with
the participating companies on a quarterly basis. When settling the inter-
company balances, Employers Mutual provides the reinsurance subsidiary and the
pool participants with full credit for the premiums written during the quarter
and retains all receivable amounts. Any receivable amounts that are
ultimately deemed to be uncollectible are charged-off by Employers Mutual and
the expense is charged to the reinsurance subsidiary or allocated to the pool
members on the basis of pool participation. As a result, the Company has an
off-balance sheet arrangement with an unconsolidated entity that results in a
credit-risk exposure that is not reflected in the Company's financial
statements. Based on historical data, this credit-risk exposure is not
considered to be material to the Company's results of operations or financial
position.
Investment Impairments and Considerations
The Company has not recorded any other-than-temporary investment
impairments during the first six months of 2005. During 2004 the Company had
one fixed maturity security series (MCI Communications Corporation) that was
determined to be other-than-temporarily impaired. MCI Communications
Corporation was owned by WorldCom Inc., whose corporate bonds were downgraded
to junk status in May 2002 when it reported the detection of accounting
irregularities. On June 30, 2002 the Company recognized $3,821,000 of
realized loss when the carrying value of this investment was reduced from an
aggregate book value of $5,604,000 to the then current fair value of
$1,783,000. The fair value of the MCI bonds then partially recovered,
resulting in pre-tax unrealized gains of $1,035,000 recognized during 2002 and
$1,811,000 recognized during 2003. During the second quarter of 2004 the
Company received three new series of fixed maturity securities (with impaired
book values) issued by MCI Communications Corporation in conjunction with a
payout award received under a bankruptcy court approved "Plan of
Reorganization." This payout was recorded as a tax-free exchange and the new
bonds were assigned a book value equal to the book value of the defaulted
bonds that were replaced ($5,509,000). The par value of the new bonds
reflected the settlement amount of 79.2 cents per dollar ($4,552,000) and the
fair value of the new bonds was $4,241,000 at the time of the payout. Based
on these facts, a realized investment gain of $3,826,000 was recognized in the
second quarter of 2004 to offset the other-than-temporary impairment loss
previously recognized in the second quarter of 2002 and an other-than-
temporary impairment loss of $1,268,000 was recognized to reduce the book
value of the new bonds to fair value at the time of the payout. The new bonds
were sold during the third quarter of 2004 for income tax purposes, resulting
in an additional realized gain of $187,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
At June 30, 2005, the Company had unrealized losses on held-to-maturity
and available-for-sale securities as presented in the table below. The
estimated fair value is based on quoted market prices, where available, or
on values obtained from independent pricing services. None of these
securities are considered to be in concentrations by either security type or
industry. 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 June 30, 2005. Risks and
uncertainties inherent in the methodology utilized in this evaluation process
include interest rate risk, equity price risk and the overall performance of
the economy, all of which have the potential to adversely affect the value of
the Company's investments. Should a determination be made at some point in
the future that these unrealized losses are other-than-temporary, the
Company's earnings would be reduced by approximately $1,131,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position as of June 30, 2005.
Description of securities Fair value Unrealized losses
- ------------------------- ---------- -----------------
($ in thousands)
Fixed maturity securities:
Less than six months ........ $ 14,636 $ 489
Six to twelve months ........ 29,386 105
Twelve months or longer ..... 4,399 22
-------- ------
Total fixed maturity
securities .............. 48,421 616
-------- ------
Equity securities:
Less than six months ........ 16,456 939
Six to twelve months ........ 1,225 185
Twelve months or longer ..... - -
-------- ------
Total equity securities ... 17,681 1,124
-------- ------
Total temporarily
impaired securities ... $ 66,102 $1,740
======== ======
The Company held two series of General Motors Acceptance Corporation
fixed maturity securities that were considered non-investment grade at June
30, 2005, with one of those series in an unrealized loss position ($453,000
unrealized loss before tax). All other non-investment grade fixed maturity
securities held at June 30, 2005 (MCI, Sears Roebuck Acceptance Corporation,
and US Freightways Corporation) were in an unrealized gain position. The
Company does not invest in non-investment grade securities. Any non-
investment grade securities held by the Company are the result of rating
downgrades that occurred subsequent to their purchase. An exception was made
to this policy in 2004 when the Company sold and then repurchased non-
investment grade MCI debt securities (Moody's bond rating of B) in order to
recognize a current income tax benefit.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Following is a schedule of gross realized losses recognized in 2005 along
with the associated book values and sales prices aged according to the length
of time the underlying securities were in an unrealized loss position. This
schedule does not include realized losses stemming from corporate actions such
as calls, pay-downs, redemptions, etc. The Company's equity portfolio is
managed on a "tax-aware" basis, which generally results in sales of securities
at a loss to offset sales of securities at a gain, thus minimizing the
Company's income tax expense. Fixed maturity securities were not included in
the schedule since no realized losses were recognized on these investments
stemming from disposals other than corporate actions. Fixed maturity
securities are generally held until maturity.
Gross
Book Sales realized
($ in thousands) value price loss
--------- --------- ---------
Equity securities:
Three months or less ............... $ 8,282 $ 7,640 $ 642
Over three months to six months .... 1,009 917 92
Over six months to nine months ..... - - -
Over nine months to twelve months .. 297 254 43
Over twelve months ................. - - -
--------- --------- ---------
$ 9,588 $ 8,811 $ 777
========= ========= =========
LEASES, COMMITMENTS AND CONTINGENT LIABILITIES
The increase in the Company's aggregate participation in the pooling
agreement effective January 1, 2005 had a significant affect on its
contractual obligations for expected payments in the settlement of its loss
reserves and its share of real estate operating leases and software operating
leases expensed through the pool. The Company's contractual obligation for
long-term debt did not change from that presented in the Company's 2004 Form
10-K. The following table reflects the Company's contractual obligations as
of June 30, 2005.
Payments due by period
-----------------------------------------------
Less More
than 1-3 4-5 than
Total 1 year years years 5 years
-------- -------- -------- ------- --------
($ in thousands)
Contractual Obligations
Loss and settlement expense
reserves (1) ............. $538,187 $214,360 $196,815 $66,358 $ 60,654
Long-term debt ............. 36,000 - - - 36,000
Real estate operating leases 9,152 709 2,675 2,164 3,604
Software operating leases .. 479 479 - - -
-------- -------- -------- ------- --------
Total ...................... $583,818 $215,548 $199,490 $68,522 $100,258
======== ======== ======== ======= ========
(1) The amounts presented are estimates of the dollar amounts and time
periods in which the Company expects to pay out its gross loss and settlement
expense reserves. These amounts are based on historical payment patterns and
do not represent actual contractual obligations. The actual payment amounts
and the related timing of those payments could differ significantly from these
estimates.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
Estimated guaranty fund assessments of $1,285,000 and $1,207,000, which
are used by states to pay claims of insolvent insurers domiciled in that
state, have been accrued as of June 30, 2005 and December 31, 2004,
respectively. The guaranty fund assessments are expected to be paid over the
next two years with premium tax offsets of $1,682,000 expected to be realized
within ten years of the payments. Estimated second injury fund assessments of
$1,760,000 and $1,390,000, which are designed to encourage employers to employ
a worker with a pre-existing disability, have been accrued as of June 30, 2005
and December 31, 2004, respectively. The second injury fund assessment
accruals are based on projected loss payments. The periods over which the
assessments will be paid is not known.
The participants in the pooling agreement have purchased annuities from
life insurance companies, under which the claimant is payee, to fund future
payments that are fixed pursuant to specific claim settlement provisions. The
Company's share of loss reserves eliminated by the purchase of these annuities
was $700,000 at December 31, 2004. Due to the change in the Company's
aggregate participation in the pooling agreement, this amount increased to
$894,000 effective January 1, 2005, therefore, the Company has a contingent
liability of $894,000 should the issuers of these annuities fail to perform
under the terms of the annuities. The Company's share of the amount due from
any one life insurance company does not equal or exceed one percent of its
subsidiaries' policyholders' surplus.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004)
"Share-Based Payment," which is a revision of SFAS No. 123 "Accounting for
Stock-Based Compensation" and supersedes Accounting Principles Board (APB)
Opinion No. 25 "Accounting for Stock Issued to Employees." SFAS 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the financial statements based on their
grant date fair values. The pro forma disclosures previously allowed under
SFAS 123 will no longer be an alternative to financial statement recognition.
The transition methods for adoption include the modified-prospective and
modified-retroactive methods. The modified-prospective method requires that
compensation expense be recorded for all unvested stock options that exist
upon the adoption of SFAS 123(R). Under the modified-retroactive method,
prior periods may be restated either as of the beginning of the year of
adoption or for all periods presented. The effective date for SFAS 123(R) was
originally the first interim and annual periods beginning after June 15, 2005,
with earlier adoption encouraged. On April 14, 2005, the Securities and
Exchange Commission approved a rule which delayed the required effective date
of SFAS 123(R) until fiscal years beginning after June 15, 2005. The Company
will adopt SFAS 123 (R) in the first quarter of 2006 and is currently
evaluating the requirements, including the adoption method alternatives.
Adoption of this statement is not expected to have a material effect on the
operating results of the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
(Unaudited)
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and SFAS No. 3." SFAS 154
requires retrospective application to prior periods' financial statements of
changes in accounting principles, unless express guidance in newly issued
pronouncements indicate alternative transition accounting or it is
impracticable to determine the period-specific effects or the cumulative
effect of the change. When it is impracticable to determine the period-
specific effects of a change in accounting principles, the new accounting
principle is applied to the balances of assets and liabilities as of the
beginning of the earliest period for which retrospective application is
practicable, with a corresponding adjustment made to the opening balance of
retained earnings for that period. If it is impracticable to determine the
cumulative effect of applying a change in accounting principle to all prior
periods, the new accounting principle is applied prospectively from the
earliest date practicable. Corrections of errors are to be handled in a
similar manner. The provisions of SFAS 154 are to be applied to changes in
accounting principles and corrections of errors on or after January 1, 2006.
The Company does not expect adoption of this statement to have an effect on
the operating results of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained in this
report is based on management's current beliefs, assumptions and expectations
of the Company's future performance, taking into account all information
currently available to management. These beliefs, assumptions and expectations
can change as the result of many possible events or factors, not all of which
are known to management. If a change occurs, the Company's business, financial
condition, liquidity, results of operations, plans and objectives may vary
materially from those expressed in the forward-looking statements The risks
and uncertainties that may affect the actual results of the Company include,
but are not limited to, the following: catastrophic events and the occurrence
of significant severe weather conditions; the adequacy of loss and settlement
expense reserves; state and federal legislation and regulations; changes in
our industry, interest rates or the performance of financial markets and the
general economy; rating agency actions and other risks and uncertainties
inherent to the Company's business. When the Company uses the words
"believe", "expect", "anticipate", "estimate" or similar expressions, the
Company intends to identify forward-looking statements. You should not place
undue reliance on these forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Unaudited)
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective board of directors for each of the Company's
subsidiaries.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(CONTINUED)
(Unaudited)
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Two categories of influences on market risk exist as it relates to
financial instruments. First are systematic aspects, which relate to the
investing environment and are out of the control of the investment manager.
Second are non-systematic aspects, which relate to the construction of the
investment portfolio through investment policies and decisions, and are under
the direct control of the investment manager. Due to systematic changes,
several components of market risk increased noticeably during 2002 and 2003,
but appear to have leveled off or declined in 2004 and the first quarter of
2005. As it relates to equity price risk, the poor performance of the markets
during that period resulted in declines in the values of the Company's equity
investments. This risk appears to be declining due to the recovery of the
markets. Credit quality risk rose, resulting in declines in the values of
several bond investments stemming from the many high-profile bankruptcies and
other downgrade activities during that period. This risk also appears to be
subsiding as the general economic condition continues to show signs of
strengthening. Prepayment risk increased, primarily for the mortgage-backed
securities, as declines in interest rates during that period accelerated the
payment of higher-interest rate mortgages through re-financing activity. And
finally, to a lesser extent interest rate risk increased due to interest rates
bottoming-out during that period. Future interest rate increases will result
in declines in the values of fixed maturity securities from their current
values. Throughout all these systematic changes, the Company has continued
its commitment to controlling non-systematic risk through sound investment
policies and diversification.
Further analysis of the components of the Company's market risk
(including interest rate risk, equity price risk, credit quality risk, and
prepayment risk) can be found in the Company's 2004 Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including
the Chief Executive Officer and the Chief Financial Officer, the Company has
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company's
disclosure controls and procedures were functioning effectively as of the end
of the period covered by this report to provide reasonable assurance that the
Company can meet its disclosure obligations. There were no changes in the
Company's internal control over financial reporting that occurred during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURIES AND USE OF PROCEEDS
The following table sets forth information regarding purchases of equity
securities by the Company and affiliated purchasers for the three months ended
June 30, 2005:
(a) Total (b) Average (c) Total (d) Maximum Number
Number of Price Paid Number of (or Approximate
Shares Per Share Shares (or Dollar Value) of
(or Units) (or Unit) Units) Shares (or Units)
Purchased Purchased as that May Yet Be
Part of Purchased Under
Publicly The Plans or
Announced Programs
Plans or
Period Programs
- ---------------- --------- ---------- -------------- -----------------
4/1/05 - 4/30/05 176 (1) $16.95 - $ -
5/1/05 - 5/31/05 149,815 (1) 18.03 149,683 (2) 12,301,674
6/1/05 - 6/30/05 97,089 (1) 18.03 95,500 (2) 10,580,140
--------- --------- --------- -----------------
Total 247,080 $18.03 245,183 $10,580,140
========= ========= ========= =================
(1) 176, 132 and 1,589 shares were purchased in the open market in April, May
and June, respectively, under the Company's dividend reinvestment and common
stock purchase plan.
(2) On May 12, 2005 the Company announced that its parent company, Employers
Mutual Casualty Company, had initiated a $15 million stock purchase program
under which Employers Mutual would purchase shares of the Company's common
stock in the open market. This purchase program was effective immediately and
does not have an expiration date.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 26, 2005
(b) The following eight persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter, III Margaret A. Ball
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek Joanne L. Stockdale
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS (CONTINUED)
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
------------------------ ---------- ---------
George C. Carpenter, III 12,159,178 1,121,929
Margaret A. Ball 10,239,434 3,041,673
David J. Fisher 12,688,736 592,371
Bruce G. Kelley 11,125,803 2,155,304
George W. Kochheiser 11,124,119 2,156,988
Raymond A. Michel 12,158,295 1,122,812
Fredrick A. Schiek 11,122,467 2,158,640
Joanne L. Stockdale 12,692,764 588,343
2. Proposal to amend Employers Mutual Casualty Company's 2003
Incentive Stock Option Plan to increase by 500,000 the number of
shares subject thereto:
For 11,310,484 Against 889,022 Abstain 20,392
---------- ------- ------
Delivered not voted 1,061,209
---------
3. Proposal to ratify the appointment of Ernst & Young LLP as
the independent auditor of the Company for the year ended
December 31, 2005:
For 13,265,330 Against 5,908 Abstain 9,869
---------- ------- ------
(d) None.
ITEM 6. EXHIBITS
31.1 Certification of the President and Chief Executive Officer as
required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Senior Vice President and Chief Financial
Officer as required by Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of the President and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Senior Vice President and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
---------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark E. Reese
---------------------------
Mark E. Reese
Senior Vice President and
Chief Financial Officer
Date: August 12, 2005