UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
-----------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from__________________ to_____________________
Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
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(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
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at October 30, 1998
----- -------------------------------
Common stock, $1.00 par value 11,492,117
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Total pages 20
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
1998 1997
------------- -------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(market value $181,568,250 and $193,835,013) $ 169,341,686 $ 185,829,063
Securities available-for-sale, at market value
(amortized cost $182,101,914 and
$172,717,206) .............................. 192,726,790 179,652,738
Equity securities available-for-sale, at market
value (cost $31,393,554 and $26,261,157) ..... 28,339,974 30,972,732
Short-term investments, at cost ................ 37,778,346 14,926,994
------------- -------------
Total investments ..................... 428,186,796 411,381,527
Cash ............................................. 1,560,690 1,200,300
Indebtedness of related party .................... 1,514,888 822,403
Accrued investment income ........................ 5,825,140 5,752,295
Income taxes recoverable.......................... 2,634,000 -
Accounts receivable .............................. 1,958,812 1,457,312
Deferred policy acquisition costs ................ 13,309,704 10,560,657
Deferred income taxes ............................ 11,323,803 9,751,721
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,179,067
and $2,078,182 ................................. 1,378,753 1,479,638
Reinsurance receivables .......................... 15,913,005 13,601,691
Prepaid reinsurance premiums ..................... 1,756,639 1,195,065
Other assets ..................................... 2,554,238 1,907,187
------------- -------------
Total assets .......................... $ 487,916,468 $ 459,109,796
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
1998 1997
-------------- -------------
LIABILITIES
Losses and settlement expenses ................... $ 240,385,437 $ 217,777,942
Unearned premiums ................................ 65,885,957 54,857,463
Other policyholders' funds ....................... 2,101,758 2,781,544
Income taxes payable ............................. - 3,548,000
Postretirement benefits .......................... 6,173,433 5,428,913
Deferred income .................................. 315,307 446,678
Other liabilities ................................ 12,060,695 11,922,800
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Total liabilities ............................ 326,922,587 296,763,340
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STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,490,017
shares in 1998 and 11,351,119 shares in 1997 ... 11,490,017 11,351,119
Additional paid-in capital ....................... 67,754,795 65,916,681
Accumulated other comprehensive income ........... 4,997,053 7,687,092
Retained earnings ................................ 76,752,016 77,391,564
------------- -------------
Total stockholders' equity ................... 160,993,881 162,346,456
------------- -------------
Total liabilities and stockholders' equity ... $ 487,916,468 $ 459,109,796
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Income
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ------------ ------------
REVENUES:
Premiums earned .......... $48,817,473 $44,448,319 $141,079,398 $131,050,041
Investment income, net ... 6,321,575 5,843,473 19,018,720 17,483,465
Realized investment
gains (note 3) ......... 7,240,947 1,957,060 7,324,406 2,023,782
Other income ............. 40,653 52,988 131,371 168,899
----------- ----------- ------------ ------------
62,420,648 52,301,840 167,553,895 150,726,187
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 43,758,062 35,026,196 117,100,206 100,223,676
Dividends to policyholders (133,255) 131,875 1,267,903 1,512,921
Amortization of deferred
policy acquisition costs 11,952,113 8,750,924 30,794,401 25,847,696
Other underwriting
expenses ............... 3,476,608 5,328,403 13,835,738 16,083,996
----------- ----------- ------------ ------------
59,053,528 49,237,398 162,998,248 143,668,289
----------- ----------- ------------ ------------
Income before income taxes 3,367,120 3,064,442 4,555,647 7,057,898
----------- ----------- ------------ ------------
INCOME TAXES:
Current .................. 297,982 283,241 240,982 1,301,088
Deferred ................. 280,639 116,549 (186,307) (347,344)
----------- ----------- ------------ ------------
578,621 399,790 54,675 953,744
----------- ----------- ------------ ------------
Net income ......... $ 2,788,499 $ 2,664,652 $ 4,500,972 $ 6,104,154
=========== =========== ============ ============
Net income per common
share - basic and diluted $.24 $.24 $.39 $.55
=========== =========== ============ ============
Dividends per common share $.15 $.15 $.45 $.45
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,487,140 11,227,006 11,422,899 11,159,348
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
NET INCOME...................$ 2,788,499 $ 2,664,652 $ 4,500,972 $ 6,104,154
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding (losses)
gains arising during the
period, before deferred
income taxes (benefit)... (346,921) 3,976,728 3,235,176 8,308,399
Deferred income taxes
(benefit) ............... (117,951) 1,352,090 1,099,964 2,824,857
----------- ----------- ----------- -----------
(228,970) 2,624,638 2,135,212 5,483,542
----------- ----------- ----------- -----------
Reclassification
adjustment for gains
included in net income,
before income taxes...... (7,240,947) (1,957,060) (7,310,987) (2,023,782)
Income taxes .............. 2,461,922 665,401 2,485,736 688,086
----------- ----------- ----------- -----------
(4,779,025) (1,291,659) (4,825,251) (1,335,696)
----------- ----------- ----------- -----------
Other comprehensive
(loss) income ......... (5,007,995) 1,332,979 (2,690,039) 4,147,846
----------- ----------- ----------- -----------
Total comprehensive
(loss) income .....$(2,219,496)$ 3,997,631 $ 1,810,933 $10,252,000
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine months ended
September 30,
--------------------------
1998 1997
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 4,500,972 $ 6,104,154
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 19,299,157 10,482,553
Unearned premiums ......................... 8,767,265 8,069,590
Other policyholders' funds ................ (679,786) (1,042,299)
Deferred policy acquisition costs ......... (2,749,047) (2,072,792)
Indebtedness of related party ............. (692,485) (10,664,900)
Accrued investment income ................. (72,845) 1,048,166
Income taxes payable ...................... (6,182,000) (2,333,000)
Deferred income taxes ..................... (186,307) (347,343)
Realized investment gains ................. (7,324,406) (2,023,782)
Postretirement benefits ................... 744,520 381,991
Reinsurance receivables ................... (2,311,314) (70,616)
Prepaid reinsurance premiums .............. (561,574) (313,034)
Amortization of deferred income ........... (131,371) (168,899)
Other, net ................................ (1,040,056) (1,699,679)
------------ ------------
6,879,751 (754,044)
Cash provided by the change in the
property and casualty insurance
subsidiaries' pooling agreement (note 2) 5,569,567 5,674,458
Cash provided by the change in the
reinsurance subsidiary's quota share
agreement (note 2) ...................... - 3,066,705
------------ ------------
Total adjustments ..................... 12,449,318 7,987,119
------------ ------------
Net cash provided by
operating activities .............. $ 16,950,290 $ 14,091,273
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EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine months ended
September 30,
--------------------------
1998 1997
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $(15,459,844) $(17,992,820)
Maturities of fixed maturity securities
held-to-maturity ............................ 32,046,922 25,638,325
Purchases of fixed maturity securities
available-for-sale .......................... (24,965,868) (32,838,731)
Disposals of fixed maturity securities
available-for-sale .......................... 15,640,400 16,347,711
Purchases of equity securities
available-for-sale .......................... (33,374,717) -
Disposals of equity securities
available-for-sale .......................... 6,964,169 -
Purchases of common stock mutual funds
invested in equity securities
available-for-sale .......................... (102,020) (2,831,605)
Disposals of common stock mutual funds
invested in equity securities
available-for-sale .......................... 28,675,920 1,938,163
Net purchases of short-term investments ....... (22,851,354) (4,034,027)
------------ ------------
Net cash used in investing activities ..... (13,426,392) (13,772,984)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 749,939 640,909
Dividends paid to stockholders ................ (3,913,447) (3,228,816)
------------ ------------
Net cash used in financing activities ..... (3,163,508) (2,587,907)
------------ ------------
NET INCREASE (DECREASE) IN CASH ................. 360,390 (2,269,618)
Cash at beginning of year ....................... 1,200,300 3,500,629
------------ ------------
Cash at end of quarter .......................... $ 1,560,690 $ 1,231,011
============ ============
Income taxes paid ............................... $ 6,422,982 $ 3,634,088
Interest paid ................................... $ - $ 87,980
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
September 30, 1998
Note 1
- ------
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The
information reflects all adjustments which are, in the opinion of
management, necessary to a fair statement of the results for the interim
periods.
Certain amounts previously reported in prior years' consolidated financial
statements have been reclassified to conform to current year presentation.
In reading these financial statements, reference should be made to the
Company's 1997 Form 10-K or the 1997 Annual Report to Shareholders for more
detailed footnote information.
Note 2
- ------
Effective January 1, 1998, Farm and City Insurance Company (Farm and City),
a subsidiary of the company that writes nonstandard risk automobile
insurance business, became a participant in the EMC Insurance Companies
pooling agreement. Farm and City assumes a 1.5 percent participation in
the pool, which increased the Company's aggregate participation in the pool
from 22 percent to 23.5 percent. In connection with this change in the
pooling agreement, the Company's liabilities increased $6,224,586 and
invested assets increased $5,569,567. The Company reimbursed Employers
Mutual Casualty Company (Employers Mutual) $726,509 for commissions
incurred to generate this business and Employers Mutual paid the Company
$71,490 in interest income as the actual cash transfer did not occur until
the end of March.
Effective January 1, 1997 a new affiliate of Employers Mutual began
participating in the pooling agreement. In connection with this change in
the pooling agreement, the Company's liabilities increased $6,393,063 and
invested assets increased $5,674,458. The Company reimbursed Employers
Mutual $794,074 for commissions incurred to generate this business and
Employers Mutual paid the Company $75,469 in interest income as the actual
cash transfer did not occur until the end of March.
Effective January 1, 1997, the reinsurance subsidiary's quota share
participation was increased from 95 percent to 100 percent. In connection
with this change in the quota share agreement, the company's liabilities
increased $3,173,647 and invested assets increased $3,066,705. The Company
reimbursed Employers Mutual $106,942 for commissions incurred to generate
this business.
Note 3
- ------
During the third quarter of 1998 the Company liquidated its common stock
mutual fund portfolio and reinvested the proceeds in individual stock
issues that are being managed in a manner which minimizes current year
income taxes. Total proceeds from the liquidation amounted to $28,675,920
and included $7,585,755 of realized gains. As a result of this change in
investment strategy, realized gains reported by the Company in future
periods are expected to decline significantly from the amounts reported
during the last several years.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
September 30, 1998
Note 4
- ------
The Company adopted Statement of Financial Accounting Standards (SFAS) 130,
"Reporting Comprehensive Income" in the first quarter of 1998. SFAS 130
requires certain disclosures of comprehensive income. Adoption of this
statement had no impact on the net income of the Company.
The Company will adopt the presentation requirements of SFAS 131,
"Disclosures about Segments of an Enterprise and Related Information", in
the fourth quarter of 1998. Management is currently in the process of
evaluating the segment reporting disclosure requirements. Adoption of this
statement will have no effect on the income of the Company.
The Company will adopt the disclosure requirements of SFAS 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits", in the
fourth quarter of 1998. The applicable disclosures will be included in the
footnotes to the financial statements for the year ended December 31, 1998.
Adoption of this statement will have no effect on the income of the
Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations
OVERVIEW
EMC Insurance Group Inc., an approximately 67 percent owned subsidiary
of Employers Mutual Casualty Company (Employers Mutual), is an insurance
holding company with operations in property and casualty insurance,
reinsurance and an excess and surplus lines insurance agency. Property and
casualty insurance is the most significant segment, representing 81.3
percent of consolidated premium income. 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.
The Company's four property and casualty insurance subsidiaries and
two subsidiaries and an affiliate of Employers Mutual are parties to
reinsurance pooling agreements with Employers Mutual (collectively the
"pooling agreement"). Under the terms of the pooling agreement, each
company cedes to Employers Mutual all of its insurance business, with the
exception of any voluntary reinsurance business assumed from nonaffiliated
insurance companies, and assumes from Employers Mutual an amount equal to
its participation in the pool. All losses, settlement expenses and other
underwriting and administrative expenses, excluding the voluntary
reinsurance business assumed by Employers Mutual from nonaffiliated
insurance companies, are prorated among the parties on the basis of
participation in the pool. Operations of the pool give rise to
intercompany balances with Employers Mutual, which are settled on a
quarterly basis. The investment and income tax activities of the pool
participants are not subject to the pooling agreement.
The purpose of the pooling agreement is to spread the risk of an
exposure insured by any of the pool participants among all the companies.
The pooling agreement produces a more uniform and stable underwriting
result from year to year for all companies in the pool than might be
experienced individually. In addition, each company benefits from the
capacity of the entire pool, rather than being limited to policy exposures
of a size commensurate with its own assets, and from the wide range of
policy forms, lines of insurance written, rate filings and commission plans
offered by each of the companies. A single set of reinsurance treaties is
maintained for the protection of all companies in the pool.
Effective January 1, 1998, Farm and City Insurance Company (Farm and
City), a subsidiary of the Company that writes nonstandard risk automobile
insurance business, became a participant in the pooling agreement. Farm
and City assumes a 1.5 percent participation in the pool, which increased
the Company's aggregate participation in the pool from 22 percent to 23.5
percent. As a result of this change in structure, the Company now has four
subsidiaries that comprise the property and casualty insurance segment and
no longer has a separate segment for the nonstandard risk automobile
insurance business.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related
losses and settlement expenses of this business, subject to a maximum loss
of $1,500,000 per event. The reinsurance subsidiary does not reinsure any
of Employers Mutual's direct insurance business, nor any "involuntary"
facility or pool business that Employers Mutual assumes pursuant to state
law. In addition, the reinsurance subsidiary is not liable for credit risk
in connection with the insolvency of any reinsurers of Employers Mutual.
The excess and surplus lines insurance agency provides insurance
agents access to the excess and surplus lines markets and also functions as
managing underwriter for such lines for Employers Mutual and several of the
pool members.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The
information reflects all adjustments which are, in the opinion of
management, necessary to a fair statement of the results for the interim
periods.
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and nine months ended
September 30, 1998 and 1997 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1998 1997 1998 1997
-------- -------- -------- --------
Premiums earned ..................... $ 48,817 $ 44,448 $141,079 $131,050
Losses and settlement expenses ...... 43,758 35,026 117,100 100,224
Acquisition and other expenses ...... 15,294 14,211 45,897 43,445
-------- -------- -------- --------
Underwriting loss ................... (10,235) (4,789) (21,918) (12,619)
Net investment income ............... 6,322 5,843 19,019 17,484
Other income ........................ 40 53 131 169
-------- -------- -------- --------
Operating (loss) income before
income taxes ...................... (3,873) 1,107 (2,768) 5,034
Realized investment gains ........... 7,240 1,957 7,324 2,024
-------- -------- -------- --------
Income before income taxes .......... $ 3,367 $ 3,064 $ 4,556 $ 7,058
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 46,403 $ 35,970 $126,556 $101,758
Decrease in provision for
insured events of prior years (2,645) (944) (9,456) (1,534)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 43,758 $ 35,026 $117,100 $100,224
======== ======== ======== ========
Catastrophe and storm losses ........ $ 3,784 $ 1,833 $ 12,930 $ 4,934
======== ======== ======== ========
Operating results before income taxes decreased significantly for both
the three months and nine months ended September 30, 1998 as compared to
the same periods in 1997. These declines are primarily attributable to an
unusually large amount of catastrophe and storm losses and a substantial
increase in both the frequency and severity of losses that are unrelated to
catastrophe and storm activity. Operating results for 1998 have also been
negatively impacted by a general decline in overall rate adequacy. While
there has been some indication of rate stabilization in the personal lines
market during 1998, the commercial lines market, in which the Company
conducts the majority of its insurance business, continues to experience
intense rate competition.
Premiums earned increased 9.8 percent for the three months and 7.7
percent for the nine months ended September 30, 1998 from the same periods
in 1997. Both the property and casualty insurance segment and the
reinsurance segment achieved above average growth in the competitive
markets within which they operate. The growth in the property and casualty
insurance segment is primarily in the personal lines of business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
Losses and settlement expenses increased 24.9 percent for the three
months and 16.8 percent for the nine months ended September 30, 1998 from
the same periods in 1997. These increases are primarily attributable to an
unusually large amount of catastrophe and storm losses and a substantial
increase in both the frequency and severity of losses that are unrelated to
catastrophe and storm activity. This large increase in current accident
year losses was partially offset by a significant increase in the amount of
favorable development experienced in the actual settlement of claims and
changes in reserves associated with prior year losses.
Acquisition and other expenses increased 7.6 percent for the three
months and 5.6 percent for the nine months ended September 30, 1998 as
compared to the same periods in 1997. The amounts reported for 1998
reflect additional expenses associated with the increased production levels
noted previously, as well as an increase in commission costs that have
resulted from higher commission rates on the growing book of property
business and the intense competition for insurance business. The amounts
reported for 1998 also reflect an increase in deferrable acquisition
expenses for the property and casualty insurance segment. This change in
estimate, which was based upon recent studies, had the effect of increasing
the amount of acquisition costs that were deferred in 1998.
Net investment income increased 8.2 percent for the three months and
8.8 percent for the nine months ended September 30, 1998 from the same
periods in 1997. These increases are the result of a higher average
invested balance in fixed maturity securities and a decrease in investment
expenses.
Realized investment gains increased substantially for the three months
and nine months ended September 30, 1998 from the same periods in 1997.
During the third quarter of 1998 the Company liquidated its common stock
mutual fund portfolio and reinvested the proceeds in individual stock
issues that are being managed in a manner which minimizes current year
income taxes. Total proceeds from the liquidation amounted to $28,675,920
and included $7,585,755 of realized gains. As a result of this change in
investment strategy, realized gains reported by the Company in future
periods are expected to decline significantly from the amounts reported
during the last several years.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and nine months ended
September 30, 1998 and 1997 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1998 1997 1998 1997
-------- -------- -------- --------
Premiums earned ..................... $ 39,530 $ 33,780 $114,676 $ 99,160
Losses and settlement expenses ...... 35,635 26,408 97,875 75,764
Acquisition and other expenses ...... 12,914 11,122 37,579 33,636
-------- -------- -------- --------
Underwriting loss ................... (9,019) (3,750) (20,778) (10,240)
Net investment income ............... 4,492 3,783 13,371 11,461
-------- -------- -------- --------
Operating (loss) income before
income taxes ...................... (4,527) 33 (7,407) 1,221
Realized investment gains ........... 7,241 1,947 7,318 1,995
-------- -------- -------- --------
Income (loss) before income taxes ... $ 2,714 $ 1,980 $ (89) $ 3,216
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 38,076 $ 27,658 $105,794 $ 77,437
Decrease in provision for
insured events of prior years (2,441) (1,250) (7,919) (1,673)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 35,635 $ 26,408 $ 97,875 $ 75,764
======== ======== ======== ========
Catastrophe and storm losses ........ $ 2,415 $ 1,386 $ 10,304 $ 3,770
======== ======== ======== ========
As previously noted, the property and casualty insurance subsidiaries'
aggregate participation in the pooling agreement increased from 22 percent
to 23.5 percent on January 1, 1998, when Farm and City became a participant
in the pooling agreement. Beginning in 1998, the underwriting results of
the nonstandard risk automobile insurance business written by Farm and City
are included in the pool, with 23.5 percent of this business assumed by the
property and casualty insurance subsidiaries. In addition, the investment
results of Farm and City are now included in the property and casualty
insurance segment. Prior year amounts have not been restated for this
change in structure.
Premiums earned increased 17.0 percent for the three months and 15.6
percent for the nine months ended September 30, 1998 from the same periods
in 1997. Excluding the addition of Farm and City to the property and
casualty insurance segment, the increases would have been 7.4 percent for
the three months and 6.3 percent for the nine months ended September 30,
1998. These production increases are primarily the result of growth in the
personal lines of business and are attributed to competitive rates, and an
emphasis on building and maintaining strong working relationships with
local agents. Rate competition continues to be intense, especially in the
commercial lines marketplace where the property and casualty insurance
subsidiaries conduct the majority of their insurance business. Although
there have been some signs of rate stabilization during 1998, rates are not
expected to improve dramatically in the near future.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
Losses and settlement expenses increased 34.9 percent for the three
months and 29.2 percent for the nine months ended September 30, 1998 as
compared to the same periods in 1997. Excluding the addition of Farm and
City to the property and casualty insurance segment, the increases would
have been 24.2 percent for the three months and 18.8 percent for the nine
months ended September 30, 1998. These increases reflect an unusually
large amount of catastrophe and storm losses and a substantial increase in
both the frequency and severity of losses that are unrelated to catastrophe
and storm activity. The majority of the catastrophe and storm losses
experienced in the third quarter were attributable to a series of small but
intense storms; however, a substantial amount of losses were also generated
by additional reported losses associated with the late second quarter
storms and Hurricane Bonnie. The large increase in current accident year
losses was partially offset by a significant increase in the amount of
favorable development experienced in the actual settlement of claims and
changes in reserves associated with prior year losses.
Acquisition and other expenses increased 16.1 percent and 11.7 percent
for the three months and nine months ended September 30, 1998 as compared
to the same periods in 1997. Excluding the addition of Farm and City to
the property and casualty insurance segment, acquisition and other expenses
would have increased 7.0 percent and 3.2 percent for the three months and
nine months ended September 30, 1998. The amounts reported for 1998
reflect additional expenses associated with the increased production levels
noted previously, as well as an increase in commission costs that have
resulted from higher commission rates on the growing book of property
business and the intense competition for insurance business. The amounts
reported for 1998 also reflect an increase in deferrable acquisition
expenses. This change in estimate, which was based upon recent studies,
had the effect of increasing the amount of acquisition costs that were
deferred in 1998.
Net investment income increased 18.7 percent for the three months and
16.7 percent for the nine months ended September 30, 1998 as compared to
the same periods in 1997. Excluding the addition of Farm and City to the
property and casualty insurance segment, the increases would have been 11.4
percent for the three months and 8.9 percent for the nine months ended
September 30, 1998. A higher average invested balance in fixed maturity
securities, coupled with a decrease in investment expenses, contributed to
this increase.
The large increase in realized investment gains is due to the
liquidation of the common stock mutual fund portfolio during the third
quarter. Proceeds from the liquidation were reinvested in individual stock
issues that are being managed in a manner which minimizes current year
income taxes.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
Reinsurance
Operating results for the three months and nine months ended
September 30, 1998 and 1997 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1998 1997 1998 1997
-------- -------- -------- --------
Premiums earned ..................... $ 9,287 $ 8,042 $ 26,403 $ 24,419
Losses and settlement expenses ...... 8,123 6,072 19,225 17,134
Acquisition and other expenses ...... 2,602 2,451 8,549 7,672
-------- -------- -------- --------
Underwriting loss ................... (1,438) (481) (1,371) (387)
Net investment income ............... 1,638 1,696 5,128 4,898
Other income ........................ 40 53 131 169
-------- -------- -------- --------
Operating income before income taxes 240 1,268 3,888 4,680
Realized investment (losses) gains .. (1) 9 6 22
-------- -------- -------- --------
Income before income taxes .......... $ 239 $ 1,277 $ 3,894 $ 4,702
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 8,327 $ 5,811 $ 20,762 $ 17,320
(Decrease) increase in provision
for insured events of prior
years ......................... (204) 261 (1,537) (186)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 8,123 $ 6,072 $ 19,225 $ 17,134
======== ======== ======== ========
Catastrophe and storm losses ........ $ 1,369 $ 447 $ 2,626 $ 1,164
======== ======== ======== ========
Premiums earned increased 15.5 percent for the three months and 8.1
percent for the nine months ended September 30, 1998 from the same periods
in 1997. The premium increases achieved in 1998 reflect the addition of
several new accounts during the first half of 1998. Rate competition
within the reinsurance marketplace remains very intense and is not expected
to improve in the near future due to excess capacity and the high level of
merger and acquisition activity occurring in the industry.
Losses and settlement expenses increased 33.8 percent for the three
months and 12.2 percent for the nine months ended September 30, 1998 from
the same periods in 1997. These increases are primarily due to poor loss
experience in a reinsurance pool in which the company participates and a
substantial increase in catastrophe and storm losses, including $700,000
from Hurricane Georges. The large increase in current accident year losses
was partially offset by a significant increase in the amount of favorable
development realized in the actual settlement of claims and changes in
reserves associated with prior year losses.
Acquisition and other expenses increased 6.1 percent for the three
months and 11.4 percent for the nine months ended September 30, 1998 from
the same periods in 1997. The increase for the three months is primarily
attributable to increased commission expenses resulting from higher
production levels. The increase for the nine months reflects this
increased level of commission expense as well as an elevated level of
contingent commissions resulting from favorable loss experience on the
assumed book of business during 1997.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
Nonstandard Risk Automobile Insurance
As previously noted, effective January 1, 1998 the underwriting results
of the nonstandard risk automobile insurance business are included in the
pooling agreement and the operating results of Farm and City are included
in the property and casualty insurance segment. Separate operating results
for the nonstandard risk automobile insurance business are no longer
presented.
The loss ratio of the nonstandard risk automobile insurance business
has improved somewhat during 1998 from the substandard results reported in
1997. This improvement is attributable to better winter driving conditions
in the Midwest and improved working relationships with the agency force.
Operating results for the three months and nine months ended
September 30, 1997 are as follows:
Three Nine
months months
ended ended
Sept. 30, Sept. 30,
($ in thousands) 1997 1997
-------- --------
Premiums earned ..................... $ 2,626 $ 7,471
Losses and settlement expenses ...... 2,546 7,325
Acquisition and other expenses ...... 736 2,203
-------- --------
Underwriting loss ................... (656) (2,057)
Net investment income ............... 244 762
-------- --------
Operating loss before income taxes .. (412) (1,295)
Realized investment gains ........... 1 6
-------- --------
Loss before income taxes ............ $ (411) $ (1,289)
======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 2,501 $ 7,000
Increase in provision for insured
events of prior years ......... 45 325
-------- --------
Total losses and
settlement expenses .......... $ 2,546 $ 7,325
======== ========
Excess and Surplus Lines Insurance Agency
Operating income before income taxes increased to $359,000 for the
three months and $686,000 for the nine months ended September 30, 1998
compared to $192,000 and $423,000 for the same periods in 1997. Production
levels were increased primarily due to a long-haul trucking program
introduced in 1997. Additionally, investment income has increased due to a
larger invested asset balance.
Parent Company
Operating results before income taxes totaled $64,000 and $55,000 for
the three months and nine months ended September 30, 1998 compared to
$27,000 and $5,000 for the same periods in 1997. The improvement in the
results for 1998 is due to an increase in investment income, which is
attributable to a higher invested asset balance.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of the investment portfolio in
relatively short-term and highly liquid investments to ensure the
availability of funds to meet claims and expenses. The remainder of the
investment portfolio, excluding investments in equity securities, is
invested in securities with maturities that approximate the anticipated
liabilities of the insurance issued. Unrealized holding gains on fixed
maturity securities available-for-sale, net of tax, totaled $7,012,000 at
September 30, 1998 and $4,577,000 at December 31, 1997. Since the Company
does not actively trade in the bond market, such fluctuations in the fair
value of these investments are not expected to have a material impact on
the operations of the Company, as forced liquidations of investments are
not anticipated. The Company closely monitors the bond market and makes
appropriate adjustments in investment policy as changing conditions
warrant.
During the third quarter of 1998, the Company liquidated its common
stock mutual fund portfolio and reinvested the proceeds in individual stock
issues that are managed in a manner which minimizes current year income
taxes. This change in investment philosophy did not have a material impact
on the operations of the Company since the proceeds from the sale of the
mutual funds were generally reinvested and were not utilized in the daily
operations of the Company.
During the fourth quarter of 1998, the Company decided to dispose of a
portion of the common stock portfolio that will generate realized losses
and allow the Company to recognize current year tax benefits associated
with those losses. All proceeds from the sale of these common stocks would
be reinvested in the equity market. The Company is also exploring the
possibility of increasing its total investment in common stocks through
equity investments in the reinsurance subsidiary. These transactions are
not expected to have a material impact on the operations of the Company as
forced liquidations of the equity investments are not anticipated.
The majority of the Company's assets are invested in fixed maturities.
These investments provide a substantial amount of income which supplements
underwriting results and contributes to net earnings. As these investments
mature, 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 major ongoing sources of the Company's liquidity are insurance
premium income, investment income and cash provided from maturing or
liquidated investments. The principal outflows of cash are payments of
claims, commissions, premium taxes, operating expenses, income taxes,
dividends and investment purchases.
During the first nine months of 1998, the Company generated positive
cash flows from operations of $16,950,290 compared to $14,091,273 for the
same period in 1997. The amount for 1998 includes $5,569,567 received from
Employers Mutual in connection with the addition of Farm and City to the
pooling agreement. The amount for 1997 includes $8,741,163 received from
Employers Mutual in connection with the addition of a new member to the
pooling agreement and an increase in the reinsurance subsidiary's quota
share percentage.
As of September 30, 1998, 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
IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS
The Year 2000 issue presents both operational and underwriting risks
to the Company. Operational risks include the failure of computer systems
owned and operated by Employers Mutual, as well as those owned and operated
by vendors and other parties with which the Company conducts business.
Underwriting risks of Year 2000 relate to potential claims of the Company's
insureds to recover losses due to interruption of business or liability to
third parties that result from the failure of computer systems.
Employers Mutual owns and maintains the computer systems utilized in
the operation of the Company's businesses. Employers Mutual is currently
in the process of finalizing changes to these systems in order to be Year
2000 compliant. All critical systems, including policy issuance, billing
and claims processing, have been updated and the majority of these systems
have been tested. Testing of the critical system is expected to be
completed during the remainder of 1998. Employers Mutual has also
contracted with an outside consulting firm to provide an independent
assessment of Year 2000 compliance efforts. The consulting firm is
currently in the process of preparing their final assessment. In addition,
Employers Mutual is aware of and is monitoring Year 2000 compliance on
systems purchased from and used by vendors and other parties with which it
interacts. By verifying Year 2000 compliance with these parties,
management is further minimizing the risks of Year 2000 noncompliance.
The Company has distributed a letter to all of its commercial insureds
notifying them that their current policies do not cover Year 2000 losses,
but that coverage will be offered through an endorsement to the policy. A
questionnaire has been developed and provided to them to aide in assessing
potential risks from Year 2000 noncompliance. Employers Mutual is also
working with its reinsurance carriers to ensure that reinsurance protection
will be in place for potential claims arising from Year 2000 issues.
Year 2000 compliance efforts have been in process for a number of
years and the costs associated with these efforts have been charged to
operations in the year incurred. The Company's share of the remaining
costs associated with the Year 2000 compliance project is not expected to
exceed $250,000.
The Company believes it has addressed all potential exposures related
to Year 2000 noncompliance. If an unforeseen Year 2000 failure occurs, a
formalized and documented business continuation plan is in place to support
the Company's operations until corrective actions are taken.
NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted Statement of Financial Accounting Standards (SFAS)
130, "Reporting Comprehensive Income", in the first quarter of 1998. SFAS
130 requires certain disclosures of comprehensive income. Adoption of this
statement had no impact on the net income of the Company.
The Company will adopt the presentation requirements of SFAS 131,
"Disclosures about Segments of an Enterprise and Related Information", in
the fourth quarter of 1998. Management is currently in the process of
evaluating the segment reporting disclosure requirements. Adoption of this
statement will have no effect on the net income of the Company.
The Company will adopt the disclosure requirements of SFAS 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits",
in the fourth quarter of 1998. The applicable disclosures will be included
in the footnotes to the financial statements for the year ended December
31, 1998. Adoption of this statement will have no effect on the net income
of the Company.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- Condition and Results of Operations, Continued
In June of 1998, the Financial Accounting Standards Board issued SFAS
133, "Accounting for Derivative Instruments and Hedging Activities",
effective for fiscal years beginning after June 15, 1999. Currently, the
Company's investment strategy does not include investments in derivative
instruments or hedging activities. Adoption of this statement is not
expected to have any effectt on the net income of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The 1995 Private Securities Litigation Reform Act provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained herein or
in any other oral or written statement by the Company or any of its
officers, directors or employees is qualified by the fact that actual
results of the Company may differ materially from such statement due to the
following important factors, among other risks and uncertainties inherent
in the Company's business: catastrophic events, state insurance
regulations, rate competition, adverse changes in interest rates,
unforeseen losses with respect to loss and settlement expense reserves for
unreported and reported claims, including asbestos and environmental
claims.
PART II. OTHER INFORMATION
- -------- -----------------
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) None.
(b) No Form 8-K was filed by the registrant during the
quarter ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
--------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
--------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: November 13, 1998