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, 1999
---------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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 July 31, 1999
----- ----------------------------
Common stock, $1.00 par value 11,260,897
Total pages 21
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
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EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, December 31,
1999 1998
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(market value $165,025,794 and $174,623,439) $161,912,897 $164,926,190
Securities available-for-sale, at market value
(amortized cost $202,112,144 and
$208,115,127) .............................. 203,229,637 217,499,600
Equity securities available-for-sale, at market
value (cost $30,075,393 and $29,928,433) ..... 33,698,958 32,785,429
Short-term investments, at cost ................ 36,686,132 22,660,011
------------ ------------
Total investments ..................... 435,527,624 437,871,230
Cash ............................................. 1,350,987 2,133,056
Accrued investment income ........................ 6,284,525 5,865,307
Accounts receivable (net of allowance for
uncollectible accounts of $500,000 and $400,000) 3,090,379 2,779,041
Income taxes recoverable ......................... 2,080,000 3,224,000
Reinsurance receivables .......................... 17,615,141 16,627,791
Deferred policy acquisition costs ................ 13,101,875 12,355,482
Deferred income taxes ............................ 14,018,735 10,371,754
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,279,951
and $2,212,695 ................................. 1,277,869 1,345,125
Prepaid reinsurance premiums ..................... 1,589,401 1,201,737
Other assets ..................................... 2,752,539 2,271,829
------------ ------------
Total assets .......................... $498,689,075 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, December 31,
1999 1998
------------ ------------
LIABILITIES
Losses and settlement expenses ................... $251,929,004 $245,610,323
Unearned premiums ................................ 64,229,823 61,464,051
Other policyholders' funds ....................... 1,719,162 1,951,683
Indebtedness to related party .................... 5,693,105 3,393,182
Postretirement benefits .......................... 6,426,650 6,017,565
Deferred income .................................. 212,742 277,854
Other liabilities ................................ 15,698,062 13,393,854
------------ ------------
Total liabilities ............................ 345,908,548 332,108,512
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,254,768
shares in 1999 and 11,496,389 shares in 1998 ... 11,254,768 11,496,389
Additional paid-in capital ....................... 65,221,557 67,822,412
Accumulated other comprehensive income ........... 3,129,100 8,079,371
Retained earnings ................................ 73,175,102 76,539,668
------------ ------------
Total stockholders' equity ................... 152,780,527 163,937,840
------------ ------------
Total liabilities and stockholders' equity ... $498,689,075 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Income
Three months ended Six months ended
June 30, June 30,
----------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$50,954,939 $46,573,702 $100,699,553 $ 92,261,925
Investment income, net ... 6,092,183 6,438,595 12,361,436 12,732,756
Realized investment
gains (losses) ......... 156,879 (5,706) 246,167 83,459
Other income ............. 507,431 269,965 1,276,508 499,556
----------- ----------- ------------ ------------
57,711,432 53,276,556 114,583,664 105,577,696
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 44,296,277 42,951,894 82,763,272 73,342,144
Dividends to policyholders 509,397 398,819 981,586 1,401,158
Amortization of deferred
policy acquisition costs 11,379,378 9,714,669 23,115,277 18,842,288
Other underwriting
expenses ............... 4,704,860 4,715,656 8,845,202 10,247,420
Other expenses ........... 459,688 320,318 943,978 556,159
----------- ----------- ------------ ------------
61,349,600 58,101,356 116,649,315 104,389,169
----------- ----------- ------------ ------------
(Loss) income before
income tax benefit ... (3,638,168) (4,824,800) (2,065,651) 1,188,527
----------- ----------- ------------ ------------
INCOME TAX BENEFIT:
Current .................. (1,032,551) (1,942,000) (1,018,387) (57,000)
Deferred ................. (873,450) (116,639) (1,096,840) (466,946)
----------- ----------- ------------ ------------
(1,906,001) (2,058,639) (2,115,227) (523,946)
----------- ----------- ------------ ------------
Net (loss) income ..$(1,732,167)$(2,766,161)$ 49,576 $ 1,712,473
=========== =========== ============ ============
Net (loss) income per common
share - basic and diluted $ (.15)$ (.24)$ .00 $ .15
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,302,834 11,425,177 11,399,573 11,390,779
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Net (loss) income .......... $(1,732,167)$(2,766,161)$ 49,576 $ 1,712,473
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding
(losses) gains arising
during the period,
before deferred income
taxes (benefit) ........ (4,226,281) 624,081 (7,254,247) 3,582,097
Deferred income taxes
(benefit) .............. (1,436,937) 212,188 (2,466,446) 1,217,915
----------- ----------- ----------- -----------
(2,789,344) 411,893 (4,787,801) 2,364,182
----------- ----------- ----------- -----------
Reclassification
adjustment for (gains)
losses included in
net income, before
income taxes (benefit) (156,879) 14,709 (246,167) (70,040)
Income taxes (benefit) ... 53,339 (5,001) 83,697 23,814
----------- ----------- ----------- -----------
(103,540) 9,708 (162,470) (46,226)
----------- ----------- ----------- -----------
Other comprehensive
(loss) income .... (2,892,884) 421,601 (4,950,271) 2,317,956
----------- ----------- ----------- -----------
Total comprehensive
(loss) income .... $(4,625,051)$(2,344,560)$(4,900,695)$ 4,030,429
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Six months ended
June 30,
--------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 49,576 $ 1,712,473
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 6,318,681 13,753,282
Unearned premiums ......................... 2,765,772 1,177,879
Other policyholders' funds ................ (232,521) (68,429)
Deferred policy acquisition costs ......... (746,393) (2,102,052)
Indebtedness of related party ............. 2,299,923 1,372,346
Accrued investment income ................. (419,218) (288,399)
Income taxes payable ...................... 1,144,000 (6,456,000)
Deferred income taxes ..................... (1,096,840) (466,944)
Realized investment gains ................. (246,167) (83,459)
Postretirement benefits ................... 409,085 557,738
Reinsurance receivables ................... (987,350) (2,145,411)
Prepaid reinsurance premiums .............. (387,664) (391,593)
Amortization of deferred income ........... (65,112) (90,718)
Other, net ................................ 1,505,502 131,703
------------ ------------
10,261,698 4,899,943
Cash provided by the change in the
property and casualty insurance
subsidiaries' pooling agreement (note 2) - 5,569,567
------------ ------------
Net cash provided by
operating activities .............. $ 10,311,274 $ 12,181,983
------------ ------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Six months ended
June 30,
--------------------------
1999 1998
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $(13,459,276) $(12,961,406)
Maturities of fixed maturity securities
held-to-maturity ............................ 16,537,577 18,344,757
Purchases of fixed maturity securities
available-for-sale .......................... (34,299,158) (21,812,595)
Disposals of fixed maturity securities
available-for-sale (note 6) ................. 40,646,268 10,227,500
Purchases of equity securities
available-for-sale .......................... (11,322,168) (550,963)
Disposals of equity securities
available-for-sale .......................... 11,086,154 2,689,734
Net purchases of short-term investments ....... (14,026,122) (5,438,393)
------------ ------------
Net cash used in investing activities ....... (4,836,725) (9,501,366)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 156,201 631,474
Repurchase of common stock (note 4) ........... (2,998,677) -
Dividends paid to stockholders (note 5) ....... (3,414,142) (2,190,093)
------------ ------------
Net cash used in financing activities ..... (6,256,618) (1,558,619)
------------ ------------
NET (DECREASE) INCREASE IN CASH ................. (782,069) 1,121,998
Cash at beginning of year ....................... 2,133,056 1,200,300
------------ ------------
Cash at end of quarter .......................... $ 1,350,987 $ 2,322,298
============ ============
Income taxes (recovered) paid ................... $ (2,169,938) $ 6,399,000
Interest paid ................................... $ 88,911 $ -
See accompanying Notes to Interim Consolidated Financial Statements.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
June 30, 1999
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 for a fair
statement of the results for the interim periods.
Certain amounts previously reported in prior years' consolidated financial
statements have been reclassified to conform to current year presentation.
In reading these financial statements, reference should be made to the
Company's 1998 Form 10-K or the 1998 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 the expenses that were incurred to
generate the additional business assumed by the Company and Employers Mutual
paid the Company $71,490 in interest income as the actual cash transfer did
not occur until March 25, 1998.
Note 3
- ------
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) 133, ?Accounting for Derivative
Instruments and Hedging Activities?, effective for fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of Effective Date of
FASB Statement No. 133", which defers the effective date of SFAS 133 until
fiscal years beginning after June 15, 2000. 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
effect on the operating results of the Company.
Note 4
- ------
During the second quarter of 1999 the Company completed a $3,000,000 stock
repurchase plan that was approved by its Board of Directors on November 20,
1998. A total of 254,950 shares of common stock were repurchased under this
plan at an average cost of $11.76 per share
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
Note 5
- ------
Since the third quarter of 1998, all shares of common stock issued under the
Company's dividend reinvestment plan have been purchased on the open market
through the Company's transfer agent. Accordingly, all dividends paid since
that time are classified as cash dividends.
During the second quarter of 1999, Employers Mutual elected to increase its
participation in the Company's dividend reinvestment plan. As a result,
Employers Mutual is now reinvesting 100 percent of its dividends in additional
shares of the Company's common stock. Prior to the second quarter of 1999,
Employers Mutual was reinvesting 50 percent of its dividends in additional
shares of the Company's common stock.
Note 6
- ------
During the second quarter of 1999, the Company sold approximately $25,000,000
of investments in tax-exempt fixed maturity securities issued by
municipalities and reinvested the proceeds in taxable fixed maturity
securities issued by corporations in order to improve its after-tax investment
returns. During the third quarter of 1999, the Company plans to expand this
program and sell approximately 50 percent ($64,000,000) of its remaining
investments in tax-exempt fixed maturity securities and reinvest the proceeds
in various types of taxable fixed maturity securities. This change in
investment philosophy is being implemented in order to increase the Company's
after-tax rate of return on its investments in response to the recent
deterioration in the Company's underwriting results and the expectation that
underwriting results will not 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
-----------------------------------
OVERVIEW
EMC Insurance Group Inc., an approximately 70 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
80.9 percent of consolidated premiums earned. For purposes of this
discussion, the term ?Company? is used interchangeably to describe EMC
Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and
its subsidiaries.
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.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related losses
and settlement expenses of this business, subject to a maximum loss of
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to intercompany balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not necessarily
indicative of results to be expected for the year. The information reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and six months ended June 30, 1999
and 1998 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
1999 1998 1999 1998
($ in thousands) -------- -------- -------- --------
Premiums earned ..................... $ 50,954 $ 46,574 $100,699 $ 92,262
Losses and settlement expenses ...... 44,296 42,952 82,763 73,342
Acquisition and other expenses ...... 16,594 14,829 32,942 30,491
-------- -------- -------- --------
Underwriting loss ................... (9,936) (11,207) (15,006) (11,571)
Net investment income ............... 6,092 6,439 12,361 12,733
Other income (loss) ................. 48 (51) 333 (57)
-------- -------- -------- --------
Operating (loss) income before
income taxes ................... (3,796) (4,819) (2,312) 1,105
Realized investment gains (losses) .. 157 (6) 246 84
-------- -------- -------- --------
(Loss) income before income taxes ... $ (3,639)$ (4,825) $ (2,066)$ 1,189
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 47,570 $ 45,385 $ 86,899 $ 80,153
Decrease in provision for
insured events of prior years (3,274) (2,433) (4,136) (6,811)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 44,296 $ 42,952 $ 82,763 $ 73,342
======== ======== ======== ========
Catastrophe and storm losses ........ $ 4,234 $ 8,627 $ 6,094 $ 9,146
======== ======== ======== ========
Operating results before income taxes improved slightly for the three
months ended June 30, 1999 as compared to the same period in 1998, but
remained unprofitable. Results for the second quarter of 1999 benefited from
a substantial decline in catastrophe and storm losses from the storm plagued
second quarter of 1998; however, this benefit was partially offset by an
increase in loss severity and a continued decline in overall premium rate
adequacy. For the first six months of 1999, operating results before income
taxes declined significantly from the same period in 1998 despite a
substantial decrease in catastrophe and storm losses. In addition to the
factors noted above, results for the first six months of 1999 were negatively
impacted by a substantial decrease in the amount of benefit realized from the
actual settlement of claims and changes in reserves associated with prior
years' losses.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Premiums earned increased 9.4 percent for the three months and 9.1
percent for the six months ended June 30, 1999 from the same periods in 1998.
This growth in premium income is primarily attributable to an increase in
policy count. Overall premium rate adequacy continued to decline in the first
six months of 1999 as a result of premium rate reductions that were
implemented during 1998. However, premium rates continued to show some signs
of stabilization during the first six months of 1999 as the Company
implemented moderate rate increases in select lines of business. As the 1999
premium rate increases become more fully reflected in the determination of
earned premiums, overall premium rate adequacy should begin to gradually
improve. However, it should be noted that this improvement will be modest;
consequently, overall premium rate adequacy is not expected to improve
dramatically in the near future.
Losses and settlement expenses increased 3.1 percent for the three months
and 12.8 percent for the six months ended June 30, 1999 from the same periods
in 1998. The modest increase reported for the second quarter of 1999 is due
to an exceptionally large amount of storm losses experienced during the second
quarter of 1998. The increase reported for the first six months of 1999
reflects a substantial decrease in the amount of favorable development
experienced in the actual settlement of claims and changes in reserves
associated with prior years' losses as well as an increase in overall loss
severity.
Acquisition and other expenses increased 11.9 percent for the three
months and 8.0 percent for the six months ended June 30, 1999 as compared to
the same periods in 1998. These increases primarily reflect the growth in
premium income experienced in 1999.
Net investment income decreased 5.4 percent for the three months and 2.9
percent for the six months ended June 30, 1999 from the same periods in 1998.
These decreases are primarily attributed to a decline in the average rate of
return earned on fixed maturity securities.
During the second quarter of 1999, the Company sold approximately
$25,000,000 of investments in tax-exempt fixed maturity securities issued by
municipalities and reinvested the proceeds in taxable fixed maturity
securities issued by corporations in order to improve its after-tax investment
returns. During the third quarter of 1999, the Company plans to expand this
program and sell approximately 50 percent ($64,000,000) of its remaining
investments in tax-exempt fixed maturity securities and reinvest the proceeds
in various types of taxable fixed maturity securities. This change in
investment philosophy is being implemented in order to increase the Company's
after-tax rate of return on its investments in response to the recent
deterioration in the Company's underwriting results and the expectation that
underwriting results will not improve dramatically in the near future.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and six months ended June 30, 1999
and 1998 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
1999 1998 1999 1998
($ in thousands) -------- -------- -------- --------
Premiums earned ..................... $ 41,647 $ 38,236 $ 81,416 $ 75,146
Losses and settlement expenses ...... 37,043 37,336 68,589 62,240
Acquisition and other expenses ...... 13,494 11,894 26,638 24,544
-------- -------- -------- --------
Underwriting loss ................... (8,890) (10,994) (13,811) (11,638)
Net investment income ............... 4,247 4,534 8,713 9,005
Other income ........................ 175 42 522 80
-------- -------- -------- --------
Operating loss before income taxes .. (4,468) (6,418) (4,576) (2,553)
Realized investment gains (losses) .. 94 (8) 183 77
-------- -------- -------- --------
Loss before income taxes ............ $ (4,374)$ (6,426) $ (4,393)$ (2,476)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 39,159 $ 38,648 $ 73,424 $ 67,717
Decrease in provision for
insured events of prior years.. (2,116) (1,312) (4,835) (5,477)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 37,043 $ 37,336 $ 68,589 $ 62,240
======== ======== ======== ========
Catastrophe and storm losses ........ $ 3,880 $ 7,533 $ 5,091 $ 7,889
======== ======== ======== ========
Premiums earned increased 8.9 percent for the three months and 8.3
percent for the six months ended June 30, 1999 from the same periods in 1998.
Premium growth was experienced in nearly all the geographic areas served by
the Company's existing branch structure and was primarily the result of an
increase in policy count. Premium rates in the personal lines marketplace
continue to show signs of stabilization as the Company was able to implement
moderate rate increases during the first six months of 1999. Premium rates
also showed some signs of stabilization in the commercial lines marketplace
where the Company conducts the majority of its insurance business. However,
the commercial lines premium rate increases implemented during the first six
months of 1999 were not as large as those implemented in the personal lines
due to the intense competition that continues to exist for select commercial
lines and classes of business and in certain marketing territories. Overall
rate adequacy continues to be restricted by this competitive rate environment
and market conditions are not expected to improve significantly in the near
future.
Losses and settlement expenses decreased 0.8 percent for the three months
and increased 10.2 percent for the six months ended June 30, 1999 as compared
to the same periods in 1998. The decrease reported for the three months ended
June 30, 1999 is due to the fact that an exceptionally large amount of storm
losses were experienced during the second quarter of 1998. The increase
reported for the six months ended June 30, 1999 reflects a decline in the
amount of favorable development experienced in the actual settlement of claims
and changes in reserves associated with prior years' losses as well as an
increase in overall loss severity.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Acquisition and other expenses increased 13.5 percent and 8.5 percent for
the three months and six months ended June 30, 1999 as compared to the same
periods in 1998. These increases primarily reflect the growth in premium
income experienced during the first six months of 1999. In addition, the
increases reported for 1999 also reflect the impact of a change in estimate
that was reported in 1998. During the first six months of 1998 the property
and casualty insurance subsidiaries increased the estimate of expenses related
to acquisition costs. As a result, more acquisition costs were deferred in
1998, which resulted in a smaller increase in the amount of acquisition and
other expenses reported for the period.
Underwriting results for the three months and six months ended June 30,
1999 were negatively impacted by a high level of catastrophe and storm losses,
inadequate rate levels and an increase in overall loss severity. Management
is working to improve profitability through re-underwriting programs for both
the existing book of business and the agency force, controlled usage of
discretionary rate credits and the implementation of rate increases where
possible. In addition, the Company has acquired, and is developing, several
new tools that will provide its employees with enhanced underwriting
capabilities using the latest available technologies. Examples of these tools
include catastrophe modeling software, market demographics software and
Internet based underwriting and premium rating technologies.
Reinsurance
Operating results for the three months and six months ended June 30, 1999
and 1998 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
1999 1998 1999 1998
($ in thousands) -------- -------- -------- --------
Premiums earned ..................... $ 9,307 $ 8,338 $ 19,283 $ 17,116
Losses and settlement expenses ...... 7,253 5,616 14,174 11,102
Acquisition and other expenses ...... 3,100 2,935 6,304 5,947
-------- -------- -------- --------
Underwriting (loss) gain ............ (1,046) (213) (1,195) 67
Net investment income ............... 1,752 1,787 3,455 3,490
Other income ........................ 32 43 65 91
-------- -------- -------- --------
Operating income before
income taxes ...................... 738 1,617 2,325 3,648
Realized investment gains ........... 63 3 63 7
-------- -------- -------- --------
Income before income taxes .......... $ 801 $ 1,620 $ 2,388 $ 3,655
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 8,411 $ 6,737 $ 13,475 $ 12,436
(Decrease) increase in
provision for insured events
of prior years ................ (1,158) (1,121) 699 (1,334)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 7,253 $ 5,616 $ 14,174 $ 11,102
======== ======== ======== ========
Catastrophe losses .................. $ 354 $ 1,094 $ 1,003 $ 1,257
======== ======== ======== ========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Premiums earned increased 11.6 percent for the three months and 12.7
percent for the six months ended June 30, 1999 from the same periods in 1998.
These increases primarily reflect the addition of two large reinsurance
contracts during the second half of 1998. Rate competition within the
reinsurance marketplace continues to be very intense, but there have been some
signs of stabilization during the first six months of 1999. Moderate rate
increases were implemented on some foreign contracts that were exposed to
losses in 1998; however, overall rate adequacy has not improved as rate
decreases were experienced on domestic contracts with good loss experience.
Losses and settlement expenses increased 29.1 percent for the three
months and 27.7 percent for the six months ended June 30, 1999 from the same
periods in 1998. Results for the second quarter of 1999 reflect a large
increase in current accident year property losses while the results for the
first six months of 1999 were negatively impacted by adverse development
experienced in the actual settlement of claims and changes in reserves
associated with prior years' losses. Most of the adverse development reported
in 1999 is associated with the 1998 accident year, which experienced heavy
catastrophe and storm losses.
Acquisition and other expenses increased 5.6 percent for the three months
and 6.0 percent for the six months ended June 30, 1999 from the same periods
in 1998. These increases are attributed to the growth in premium income
experienced in 1999 and reflect a decline in contingent commission expense due
to the deterioration in the profitability of the assumed reinsurance business.
Underwriting results continue to decline, but are still considered
satisfactory in the highly competitive reinsurance marketplace. This decline
can be attributed in part to rate reductions, which are the result of excess
capacity in the reinsurance marketplace. Employers Mutual is working to
address this issue by accepting a larger share of coverage on desirable
programs and strengthening its relationships with reinsurance intermediaries.
Management is aware of the narrowing profit margin on reinsurance business and
continues to emphasize profitability over premium growth.
Parent Company
Operating results before income taxes totaled ($66,000) and ($61,000) for
the three months and six months ended June 30, 1999 compared to ($18,000) and
$10,000 for the same periods in 1998. The decline in operating results for
1999 is primarily due to a reduction in investment income that resulted from a
decline in the invested asset balance.
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.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
The Company has classified a portion of its investments in fixed maturity
securities, primarily bonds issued by municipalities and corporations, as
available-for-sale securities to provide flexibility in the management of the
portfolio. Unrealized holding gains on fixed maturity securities
available-for-sale, net of tax, totaled $738,000 at June 30, 1999 compared to
$6,194,000 at December 31, 1998. Since the Company does not actively trade in
the bond market, such fluctuations in the fair value of these investments are
not expected to have a material impact on the operations of the Company, as
forced liquidations of investments are not anticipated. The Company closely
monitors the bond market and makes appropriate adjustments in investment
policy as changing conditions warrant.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of 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.
During the third quarter of 1999, the Company plans to liquidate
approximately 50 percent ($64,000,000) of its investments in tax-exempt fixed
maturity securities and reinvest the proceeds in various types of taxable
fixed maturity securities with similar durations. This change in investment
philosophy is not expected to have a material impact on the operations of the
Company as forced liquidations of investments are not anticipated.
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 on a tax-aware basis. This change in investment
philosophy is not expected to have a material impact on the operations of the
Company as forced liquidations of investments are not anticipated; however,
realized investment gains reported in future periods are expected to decline
significantly from the amounts reported during the last several years as the
Company will have the ability to control both the timing and the amount of
sales that occur in these investments.
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 six months of 1999, the Company generated positive cash
flows from operations of $10,311,274 compared to $12,181,983 for the same
period of 1998. 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.
During the second quarter of 1999 the Company completed a $3,000,000
stock repurchase plan that was approved by its Board of Directors on November
20, 1998. A total of 254,950 shares of common stock were repurchased under
this plan at an average cost of $11.76 per share.
During the second quarter of 1999, Employers Mutual elected to increase
its participation in the Company's dividend reinvestment plan. As a result,
Employers Mutual is now reinvesting 100 percent of its dividends in additional
shares of the Company's common stock. Prior to the second quarter of 1999,
Employers Mutual was reinvesting 50 percent of its dividends in additional
shares of the Company's common stock.
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 and
equipment 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 include, but are not limited to, potential
claims by 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, and is currently in the process of
finalizing changes to these systems in order to be Year 2000 compliant.
Employers Mutual uses a four step process for preparing systems for Year 2000
compliance:
1) Inventory and impact - systems are reviewed to assess the impact
of Year 2000, including the consequences of failure to achieve
Year 2000 compliance.
2) Planning and scheduling - modifications are planned and
scheduled.
3) Modification and testing - necessary system modifications are
made and tested.
4) Certification - a formal test of the system for compliance and
approval by the appropriate management personnel.
All internal systems, including the critical systems of policy issuance,
billing and claims processing, have been certified as compliant. Employers
Mutual is near completion of its research of Year 2000 compliance information
with its vendors of computer and facility equipment and software. Any
necessary upgrades of equipment or software from these vendors to achieve Year
2000 compliance have been scheduled for implementation by the end of 1999.
Employers Mutual has also contracted with an outside consulting firm to
provide an independent assessment of Year 2000 compliance efforts. The
consultants issued a report which included findings and recommendations. This
information has all been considered by management in its assessment of Year
2000 compliance issues.
Employers Mutual is also monitoring Year 2000 compliance of third parties
with which it has a material business relationship. Employers Mutual has
contacted financial institutions providing custodial and other services and
suppliers to ascertain their Year 2000 compliance status. The Company is
relying upon the Year 2000 readiness statements of these third parties and has
not independently verified the accuracy of such statements.
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 may be available through an endorsement to the policy. A
questionnaire has been developed and provided to them to aid in assessing
potential risks from Year 2000 noncompliance. Employers Mutual has in place
reinsurance protection for potential third party liability claims against
policyholders arising from Year 2000 issues.
Year 2000 compliance efforts have been in process for a number of years.
The majority of the costs associated with these efforts is the internal
payroll and payroll related expenses of the information systems department.
These expenses were charged to operations in the year incurred and were not
separately tracked. In addition, nearly all purchases of software and
hardware applications were not made specifically for Year 2000 compliance, and
are not considered costs of the Year 2000 compliance effort. Costs incurred
to date for outside consultants and software and hardware applications
specifically purchased for Year 2000 compliance efforts have amounted to less
than $100,000 for the EMC Insurance Companies. The Company's share of all
remaining costs associated with the Year 2000 compliance project are not
expected to exceed $70,000.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
The most likely worst case scenario for failing to achieve Year 2000
compliance would be a delay in processing of non-critical functions. Due to
the current state of readiness, it is unlikely that the processing of policy
issuance, billing, or claim handling activities will be delayed. However, it
is reasonably likely that delays in the processing of ancillary activities may
be experienced. The effect of these delays are not expected to be material to
the Company's results of operations, liquidity, or financial condition.
The Company believes it has addressed the potential exposures related to
Year 2000 noncompliance. If an unforeseen Year 2000 failure occurs, manual
processing may be used until the necessary corrections are implemented. In
addition, data on the computer systems is regularly backed-up and held off-
site in both soft and hard copy format. This historical data would be
available in the event of any processing failures. A formalized and
documented business continuation plan is also in place to support operations
in cases of business interruption.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 133, ?Accounting for
Derivative Instruments and Hedging Activities?, effective for fiscal years
beginning after June 15, 1999. In June 1999, the FASB issued SFAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS 133 until fiscal years beginning after June 15, 2000. 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 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 expectations and actual results of the
Company may differ materially from such expectations. The risks and
uncertainties that may affect the actual results of the Company include but
are not limited to the following: catastrophic events and the occurrence of
significant severe weather conditions; state and federal legislation and
regulations; changes in the demand for, pricing of, or supply of insurance or
reinsurance; changes in interest rates and the performance of financial
markets; the adequacy of loss and settlement expense reserves, including
asbestos and environmental claims; failure in Year 2000 compliance by the
Company, its vendors or third party service providers; and other risks and
uncertainties inherent in the Company's business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------- ----------------------------------------------------------
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 boards of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Interest rate risk includes the price sensitivity of a fixed maturity
security to changes in interest rates and the affect on future earnings from
short-term investments and maturing long-term investments, given a change in
interest rates. The following analysis illustrates the sensitivity of the
Company's financial instruments to selected changes in market rates and
prices. A hypothetical one percent increase or decrease in interest rates as
of June 30, 1999 and December 31, 1998 would result in corresponding pretax
decreases or increases in the fair value of the fixed maturity portfolios of
approximately $17,800,000 or 4.4 percent at June 30, 1999 and $16,000,000 or
3.9 percent at December 31, 1998. In addition, a hypothetical one percent
increase or decrease in interest rates at June 30, 1999 and December 31, 1998
would result in corresponding increases or decreases in pretax income over the
next twelve months of approximately $800,000 from June 30, 1999 and $800,000
from December 31, 1998, assuming the current maturity and prepayment patterns.
The Company monitors interest rate risk through the analysis of interest rate
simulations, and adjusts the average duration of its fixed maturity portfolio
by investing in either longer or shorter term instruments given the results of
interest rate simulations and judgments of cash flow needs.
The valuation of the Company's marketable equity portfolios is subject to
equity price risk. In general, equities have more year-to-year price
variability than bonds. However, returns from equity securities over longer
time frames have been consistently higher. The Company invests in a
diversified portfolio of readily marketable equity securities. A hypothetical
10 percent increase or decrease in the S&P 500 as of June 30, 1999 and
December 31, 1998 would result in corresponding pretax increases or decreases
in the fair value of the Company's equity portfolio of approximately
$3,000,000 at June 30, 1999 and $2,900,000 at December 31, 1998.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At June 30, 1999 the portfolio of long-term
fixed maturity securities consists of 23.7 percent U.S. Treasury, 14.9 percent
government agency, 5.9 percent mortgage-backed, 36.1 percent municipal, and
19.4 percent corporate securities. At December 31, 1998 the portfolio of
long-term fixed maturity securities consisted of 24.5 percent U.S. Treasury,
13.3 percent government agency, 6.8 percent mortgage-backed, 42.1 percent
municipal, and 13.3 percent corporate securities. No securities are below
investment grade.
Prepayment risk refers to the changes in prepayment patterns that can
either shorten or lengthen the expected timing of the principal repayments and
thus the average life and the effective yield of a security. Such risk exists
primarily within the portfolio of mortgage-backed securities. The prepayment
risk analysis is monitored regularly through the analysis of interest rate
simulations. At June 30, 1999 the effective duration of the mortgage-backed
securities is 2.5 years with an average life and current yield of 5.0 years
and 7.7 percent, respectively. At December 31, 1998 the effective duration of
the mortgage-backed securities was 1.5 years with an average life and current
yield of 2.1 years and 7.7 percent, respectively.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- -------- -----------------
Item 4. Submissions of Matters to a Vote of Security Holders
- ------- ----------------------------------------------------
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 24, 1999
(b) The following seven persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter III Elwin H. Creese
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
----------------------- ---------- --------
George C. Carpenter III 11,067,262 30,909
Elwin H. Creese 11,071,428 26,743
David J. Fisher 11,080,908 17,263
Bruce G. Kelley 11,077,060 21,110
George W. Kochheiser 11,079,728 18,443
Raymond A. Michel 11,077,281 20,889
Fredrick A. Schiek 11,081,661 16,510
2. Proposal to ratify the appointment of KPMG LLP as
the independent auditors of the Company:
For 11,067,101 Against 19,910 Withheld 11,160
---------- ------ ------
The total number of qualified shares voted by proxy
is: 11,098,171
(d) None.
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 June 30, 1999.
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: August 13, 1999
21