-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MLTFRxP2SpXoRY+IQknkqVl7W155zD8KHTarTNe5cs7kaTlPSyuT4Bz6oOCNEqRT ZlL8MQ+YbAmR8gMNyPy+Tg== 0000356130-05-000136.txt : 20051114 0000356130-05-000136.hdr.sgml : 20051111 20051114155830 ACCESSION NUMBER: 0000356130-05-000136 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20050930 FILED AS OF DATE: 20051114 DATE AS OF CHANGE: 20051114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMC INSURANCE GROUP INC CENTRAL INDEX KEY: 0000356130 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 426234555 STATE OF INCORPORATION: IA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-10956 FILM NUMBER: 051201445 BUSINESS ADDRESS: STREET 1: 717 MULBERRY ST CITY: DES MOINES STATE: IA ZIP: 50309 BUSINESS PHONE: 5152802902 MAIL ADDRESS: STREET 1: 717 MULBERRY STREET CITY: DES MOINES STATE: IA ZIP: 50309 10-Q 1 q3rdqtr10q.htm THIRD QUARTER FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended SEPTEMBER 30, 2005

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________to __________________

 

Commission File Number: 0-10956

 

EMC INSURANCE GROUP INC

(Exact name of registrant as specified in its charter)

 

Iowa

 

42-6234555

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

717 Mulberry Street, Des Moines, Iowa

 

50309

(Address of principal executive office)

 

(Zip Code)

 

(515) 280-2902

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

x Yes

o No

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 

 

o Yes

x No

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

o 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 31, 2005

Common stock, $1.00 par value

 

13,617,505

 

Total pages

43  

 

 



 

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

PAGE

PART I

 

FINANCIAL INFORMATION

 

 

Item 1.

 

Financial Statements.

 

3

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

17

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk.

 

37

Item 4.

 

Controls and Procedures.

 

37

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

Item 2.

 

Unregistered sales of Equity Securities and Use of Proceeds.

 

38

Item 6.

 

Exhibits.

 

38

 

 

 

 

 

Signatures

 

39

 

 

 

 

 

Certifications

 

40-43

 

 

 

 

 

 

 

 

 

2

 



 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(Unaudited)

 

 

September 30,

 

December 31,

 

2005

 

2004

ASSETS

 

 

 

Investments:

 

 

 

Fixed maturities:

 

 

 

Securities held-to-maturity, at amortized cost 

 

 

 

(fair value $17,786,192 and $16,908,726)  

$       17,275,657 

 

$   15,895,607 

Securities available-for-sale, at fair value

 

 

 

(amortized cost $746,156,565 and $541,401,950)  

762,785,981 

 

565,000,931 

Fixed maturity securities on loan:

 

 

 

Securities held-to-maturity, at amortized cost

 

 

 

(fair value $2,683,444 and $13,684,880)  

2,625,611 

 

13,310,264 

Securities available-for-sale, at fair value

 

 

 

(amortized cost $1,343,381 and $54,389,046)  

1,379,635 

 

54,653,472 

Equity securities available-for-sale, at fair value

 

 

 

(cost $62,382,022 and $59,589,434)  

87,193,363 

 

78,692,893 

Other long-term investments, at cost  

4,340,451 

 

5,550,093 

Short-term investments, at cost  

48,432,174 

 

46,238,853 

Total investments  

924,032,872 

 

779,342,113 

 

 

 

 

Balances resulting from related party transactions with

 

 

 

Employers Mutual:

 

 

 

Reinsurance receivables  

42,154,166 

 

26,316,358 

Prepaid reinsurance premiums  

5,556,024 

 

3,682,676 

Deferred policy acquisition costs  

37,694,582 

 

27,940,583 

Defined benefit retirement plan, prepaid asset  

1,645,822 

 

2,684,463 

Other assets  

2,614,694 

 

1,877,564 

Indebtedness of related party  

28,569,359 

 

-  

 

 

 

 

Cash  

242,906 

 

61,088 

Accrued investment income 

9,869,383 

 

8,726,292 

Accounts receivable (net of allowance for uncollectible accounts

 

 

 

of $0 and $0)  

227,472 

 

216,836 

Income taxes recoverable  

 

3,399,485 

Deferred income taxes  

12,740,673 

 

9,504,193 

Goodwill, at cost less accumulated amortization

 

 

 

of $2,616,234 and $2,616,234 

941,586 

 

941,586 

Securities lending collateral  

4,229,328 

 

70,122,695 

Total assets  

$  1,070,518,867 

 

$ 934,815,932 

 

 

 

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

3

 

 



 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(Unaudited)

 

 

 

September 30,

 

December 31,

 

2005

 

2004

LIABILITIES

 

 

 

Balances resulting from related party transactions with

 

 

 

Employers Mutual:

 

 

 

Losses and settlement expenses  

$556,081,348 

 

$429,677,302 

Unearned premiums  

177,482,037 

 

131,589,365 

Other policyholders' funds 

3,871,503 

 

2,825,809 

Surplus notes payable  

36,000,000 

 

36,000,000 

Indebtedness to related party 

 

6,058,848 

Employee retirement plans  

13,208,712 

 

9,764,406 

Other liabilities  

32,426,459 

 

20,304,475 

 

 

 

 

Income taxes payable  

1,101,283 

 

-  

Securities lending obligation  

4,229,328 

 

70,122,695 

Total liabilities  

824,400,670 

 

706,342,900 

 

 

 

 

STOCKHOLDERS' EQUITY 

 

 

 

Common stock, $1 par value, authorized 20,000,000

 

 

 

shares; issued and outstanding, 13,617,005

 

 

 

shares in 2005 and 13,568,945 shares in 2004  

13,617,005 

 

13,568,945 

Additional paid-in capital  

104,335,075 

 

103,467,293 

Accumulated other comprehensive income  

26,960,056 

 

27,928,463 

Retained earnings 

101,206,061 

 

83,508,331 

Total stockholders' equity 

246,118,197 

 

228,473,032 

 

 

 

 

Total liabilities and stockholders' equity  

$ 1,070,518,867 

 

$ 934,815,932 

 

 

 

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

4

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

 

(Unaudited)

 

All balances presented below, with the exception of net investment income, realized investment gain and income tax expense (benefit), are the result of related party transactions with Employers Mutual.

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

 

 

 

 

 

 

 

 

2005

 

2004

 

2005

 

2004

REVENUES

 

 

 

 

 

 

 

Premiums earned  

$  103,414,289 

 

 $  87,587,991 

 

$  308,910,568 

 

$   255,030,560 

Net investment income  

10,573,218 

 

7,683,052 

 

29,705,465 

 

21,822,692 

Realized investment gain 

1,184,949 

 

1,048,118 

 

2,746,628 

 

4,629,753 

Other Income 

150,022 

 

136,227 

 

393,692 

 

477,818 

 

115,322,478 

 

96,455,388 

 

341,756,353 

 

281,960,823 

LOSSES AND EXPENSES

 

 

 

 

 

 

 

Losses and settlement expenses 

69,590,738 

 

65,691,564 

 

205,977,422 

 

180,300,190 

Dividends to policyholders 

2,414,677 

 

1,127,104 

 

4,756,749 

 

2,990,727 

Amortization of deferred policy acquisition costs 

21,549,323 

 

18,297,179 

 

67,757,284 

 

54,617,002 

Other underwriting expenses 

9,938,592 

 

9,107,443 

 

29,030,353 

 

24,382,312 

Interest expense 

278,100 

 

278,100 

 

834,300 

 

834,300 

Other  expense 

339,832 

 

312,248 

 

1,254,352 

 

1,055,203 

 

104,111,262 

 

94,813,638 

 

309,610,460 

 

264,179,734 

 

 

 

 

 

 

 

 

Income before income tax expense 

11,211,216 

 

1,641,750 

 

32,145,893 

 

17,781,089 

 

 

 

 

 

 

 

 

INCOME TAX EXPENSE (BENEFIT)

 

 

 

 

 

 

 

Current 

3,583,112 

 

239,091 

 

10,868,949 

 

4,551,829 

Deferred 

(700,617)

 

(455,801)

 

(2,715,031)

 

(444,231)

 

2,882,495 

 

(216,710)

 

8,153,918 

 

4,107,598 

 

 

 

 

 

 

 

 

Net income 

$      8,328,721 

 

$    1,858,460 

 

$    23,991,975 

 

$     13,673,491 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

-basic and diluted 

$               0.61 

 

$             0.16 

 

$               1.76 

 

$                1.18 

 

 

 

 

 

 

 

 

Dividend per common share

$               0.15 

 

$             0.15 

 

$               0.45 

 

$                0.45 

 

 

 

 

 

 

 

 

Average number of common shares outstanding

 

 

 

 

 

 

 

-basic and diluted 

13,609,562 

 

11,561,870 

 

13,598,955 

 

11,547,544 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

5

 

 



 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(Unaudited)

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

Net income 

$ 8,328,721 

 

$ 1,858,460 

 

$ 23,991,975 

 

$ 13,673,491 

 

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising

 

 

 

 

 

 

 

during the period, before deferred

 

 

 

 

 

 

 

income tax expense (benefit) 

(4,454,035)

 

11,736,949 

 

1,256,773 

 

3,965,865 

Deferred income tax expense (benefit) 

(1,558,911)

 

4,107,932 

 

439,872 

 

1,388,053 

 

(2,895,124)

 

7,629,017 

 

816,901 

 

2,577,812 

 

 

 

 

 

 

 

 

Reclassification adjustment for gains

 

 

 

 

 

 

 

included in net income, before

 

 

 

 

 

 

 

income tax expense 

(1,184,949)

 

(1,048,118)

 

(2,746,628)

 

(4,620,654)

Income tax expense 

414,732 

 

366,841 

 

961,320 

 

1,617,229 

 

(770,217)

 

(681,277)

 

(1,785,308)

 

(3,003,425)

 

 

 

 

 

 

 

 

Other comprehensive income (loss) 

(3,665,341)

 

6,947,740 

 

(968,407)

 

(425,613)

Total comprehensive income 

$ 4,663,380 

 

$ 8,806,200 

 

$ 23,023,568 

 

$ 13,247,878 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

6

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(Unaudited)

 

 

 

Nine months ended

 

September 30,

 

2005

 

2004

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

Net  income 

$             23,991,975 

 

$          13,673,491 

Adjustments to reconcile net income to net cash

 

 

 

provided by operating activities:

 

 

 

Balances resulting from related party transactions

 

 

 

with Employers Mutual:

 

 

 

Losses and settlement expenses 

40,645,527 

 

40,651,220 

Unearned premiums 

15,243,447 

 

19,331,198 

Other policyholders' funds 

264,087 

 

704,200 

Indebtedness to related party  

(34,628,207)

 

(23,507,778)

Employee retirement plans 

2,686,949 

 

85,635 

Reinsurance receivables 

(8,897,594)

 

(3,046,174)

Prepaid reinsurance premiums 

(854,735)

 

(771,107)

Commission payable 

(5,286,347)

 

(40,818)

Interest payable 

(278,100)

 

Prepaid assets 

(524,000)

 

(769,358)

Deferred policy acquisition costs 

(3,235,264)

 

(4,083,219)

Other, net 

1,180,579 

 

(1,024,772)

 

 

 

 

Accrued investment income 

(1,143,091)

 

(188,275)

Accrued income tax:

 

 

 

Current 

4,500,768 

 

(5,158,386)

Deferred 

(2,715,031)

 

(444,231)

Realized investments gains 

(2,746,628)

 

(4,629,753)

Other, net 

721,235 

 

184,804 

 

4,933,595 

 

17,293,186 

Cash provided by the change in the property and 

 

 

 

casualty insurance subsidiaries' pooling

 

 

 

agreement 

107,801,259 

 

 

 

 

 

Net cash provided by operating activities 

$           136,726,829 

 

$          30,966,677 

 

 

 

 

 

 

 

7

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

 

(Unaudited)

 

 

 

Nine months ended

 

September 30,

 

2005

 

2004

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

Maturities of fixed maturity securities

 

 

 

held-to-maturity 

 $               9,287,629 

 

 $          11,328,683 

Purchases of fixed maturity securities

 

 

 

available-for-sale 

             (474,092,929)

 

         (581,640,239)

Disposals of fixed maturity securities

 

 

 

available-for-sale 

              335,442,043 

 

           546,068,315 

Purchases of equity securities

 

 

 

available-for-sale 

               (33,786,111)

 

           (26,995,502)

Disposals of equity securities

 

 

 

available-for-sale 

                32,966,439 

 

             24,777,839 

Purchases of other long-term investments ...

                    (969,000)

 

             (2,124,000)

Disposals of other long-term investments 

                  2,178,642 

 

               1,648,571 

Net sales (purchases) of short-term investments 

                 (2,193,321)

 

             14,233,485 

Net cash used in investing activities 

             (131,166,608)

 

           (12,702,848)

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

Balances resulting from related party transactions

 

 

 

with Employers Mutual:

 

 

 

Issuance of common stock through Employers

 

 

 

Mutual's stock option plans 

                     915,842 

 

               1,418,110 

Dividends paid to Employers Mututal 

                 (3,350,951)

 

             (4,198,218)

Dividends paid to Employers Mututal

 

 

 

(reimbursement for non-GAAP expense) 

                    (172,520)

 

                (274,964)

 

 

 

 

Dividends paid to public stockholders 

                 (2,770,774)

 

             (1,000,518)

Net cash used in financing activities 

                 (5,378,403)

 

             (4,055,590)

 

 

 

 

NET INCREASE  IN CASH 

                     181,818 

 

             14,208,239 

Cash at beginning of year 

                       61,088 

 

           (14,069,102)

 

 

 

 

Cash at the end of the quarter

 $                  242,906 

 

 $               139,137 

 

 

 

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

 

8

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

 

1.

BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the interim financial statements have been included. The results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year.

 

The consolidated balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements.

 

Certain amounts previously reported in prior years’ consolidated financial statements have been reclassified to conform to current year presentation.

 

In reading these financial statements, reference should be made to the Company’s 2004 Form 10-K or the 2004 Annual Report to Shareholders for more detailed footnote information.

 

 

2.

CHANGE IN POOLING AGREEMENT

 

The Company’s aggregate participation in the pooling agreement increased from 23.5 percent to 30.0 percent effective January 1, 2005. In connection with this change in the pooling agreement, the Company’s liabilities increased $115,042,355, invested assets increased $107,801,259 and other assets increased $722,361. The Company reimbursed Employers Mutual $6,518,735 for expenses that were incurred to generate the additional business assumed by the Company, but this expense was offset by an increase in deferred policy acquisition costs. The Company also received $274,963 in interest income from Employers Mutual as the actual cash settlement did not occur until February 15, 2005.

 

 

9

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

3.

REINSURANCE

 

The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, for the three and nine months ended September 30, 2005 and 2004 is presented below.

 

 

 

Three months ended September 30,

 

 

2005

 

2004

Premiums written

 

 

 

 

Direct  

 

 $           56,596,926 

 

 $           54,554,679 

Assumed from nonaffiliates 

 

                1,049,086 

 

                   989,903 

Assumed from affiliates 

 

            126,697,971 

 

            104,138,664 

Ceded to nonaffiliates 

 

              (8,080,144)

 

              (5,102,294)

Ceded to affiliates 

 

            (56,596,926)

 

            (54,554,679)

 

 

 

 

 

Net premiums written 

 

 $         119,666,913 

 

 $         100,026,273 

 

 

 

 

 

Premiums earned

 

 

 

 

Direct  

 

 $           46,696,422 

 

 $           48,624,217 

Assumed from nonaffiliates 

 

                1,240,133 

 

                   936,241 

Assumed from affiliates 

 

            109,356,926 

 

              91,391,212 

Ceded to nonaffiliates 

 

              (7,182,770)

 

              (4,739,462)

Ceded to affiliates 

 

            (46,696,422)

 

            (48,624,217)

 

 

 

 

 

Net premiums earned 

 

 $         103,414,289 

 

 $           87,587,991 

 

 

 

 

 

Losses and settlement expenses incurred

 

 

 

 

Direct  

 

 $           44,955,313 

 

 $           38,493,262 

Assumed from nonaffiliates 

 

                2,032,655 

 

                1,329,683 

Assumed from affiliates 

 

              75,516,618 

 

              66,286,471 

Ceded to nonaffiliates 

 

              (7,958,535)

 

              (1,924,590)

Ceded to affiliates 

 

            (44,955,313)

 

            (38,493,262)

 

 

 

 

 

Net losses and settlement

 

 

 

 

expenses incurred 

 

 $           69,590,738 

 

 $           65,691,564 

 

 

 

 

 

 

 

 

10

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

 

 

Nine months ended September 30,

 

 

2005

 

2004

Premiums written

 

 

 

 

Direct  

 

$         147,313,971 

 

$         151,338,158 

Assumed from nonaffiliates 

 

3,637,247 

 

3,082,002 

Assumed from affiliates 

 

368,654,660 

 

284,325,432 

Ceded to nonaffiliates 

 

(19,410,673)

 

(13,717,647)

Ceded to affiliates 

 

(147,313,971)

 

(151,338,158)

 

 

 

 

 

Net premiums written 

 

$         352,881,234 

 

$         273,689,787 

 

 

 

 

 

Premiums earned

 

 

 

 

Direct  

 

$         139,644,006 

 

$         149,258,970 

Assumed from nonaffiliates 

 

3,520,634 

 

2,988,694 

Assumed from affiliates 

 

322,927,257 

 

264,988,406 

Ceded to nonaffiliates 

 

(17,537,323)

 

(12,946,540)

Ceded to affiliates 

 

(139,644,006)

 

(149,258,970)

 

 

 

 

 

Net premiums earned 

 

$         308,910,568 

 

$         255,030,560 

 

 

 

 

 

Losses and settlement expenses incurred

 

 

 

 

Direct  

 

$         113,132,998 

 

$           91,628,768 

Assumed from nonaffiliates 

 

6,253,288 

 

2,261,168 

Assumed from affiliates 

 

222,984,589 

 

184,539,575 

Ceded to nonaffiliates 

 

(23,260,455)

 

(6,500,553)

Ceded to affiliates 

 

(113,132,998)

 

(91,628,768)

 

 

 

 

 

Net losses and settlement

 

 

 

 

expenses incurred 

 

$         205,977,422 

 

$         180,300,190 

 

 

 

 

 

 

The large increases in net premiums written and earned, and net losses and settlement expenses incurred, in 2005 reflect the increase in the Company’s aggregate participation interest in the pooling agreement. Net premiums written for the nine months ended September 30, 2005 also include a $29,630,612 portfolio adjustment, which serves as an offset to the increase in net unearned premiums recognized in connection with the pooling change.

 

 

4.

STOCK BASED COMPENSATION

 

The Company has no stock based compensation plans of its own; however, Employers Mutual has several stock plans that utilize the common stock of the Company. The Company receives the current fair value for any shares issued under these plans. Under the terms of the pooling and quota share agreements, stock option expense is allocated to the Company as determined on a statutory basis of accounting; however, for these GAAP basis financial statements the Company accounts for the stock option plans using the intrinsic value method of accounting as prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Under the provisions of APB 25, no compensation expense is recognized from the operation of Employers Mutual’s stock option plans since the exercise price of the options is equal to the fair value of the stock on the date of grant.

 

 

11

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

The Company’s subsidiaries reimburse Employers Mutual for their share of the statutory-basis compensation expense associated with stock option exercises under the terms of the pooling and quota share agreements. The statutory-basis compensation expense that was paid by the Company’s subsidiaries to Employers Mutual ($36,495 and $12,696 for the three months and $172,520 and $274,964 for the nine months ended September 30, 2005 and 2004, respectively) has been reclassified as a dividend payment to Employers Mutual in these GAAP-basis financial statements.

 

The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS 148), “Accounting for Stock-Based Compensation,” to Employers Mutual’s stock option plans:

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2005 

 

2004 

 

2005 

 

2004 

Net income, as reported 

$    8,328,721 

 

$    1,858,460 

 

$     23,991,975 

 

$     13,673,491 

 

 

 

 

 

 

 

 

Deduct:  Total stock-based

 

 

 

 

 

 

 

employee compensation 

 

 

 

 

 

 

 

expense determined under the 

 

 

 

 

 

 

 

fair value method for all awards 

29,398 

 

8,093 

 

88,283 

 

24,280 

 

 

 

 

 

 

 

 

Pro forma net income

$    8,299,323 

 

$    1,850,367 

 

$     23,903,692 

 

$     13,649,211 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

Basic and diluted -

 

 

 

 

 

 

 

As reported 

$             0.61 

 

$             0.16 

 

$                1.76 

 

$                1.18 

Pro forma 

$             0.61 

 

$             0.16 

 

$                1.76 

 

$                1.18 

 

 

 

 

 

 

 

 

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees.” SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their grant date fair values. The pro forma disclosures previously allowed under SFAS 123 will no longer be an alternative to financial statement recognition. The transition methods for adoption include the modified-prospective and modified-retroactive methods. The modified-prospective method requires that compensation expense be recorded for all unvested stock options that exist upon the adoption of SFAS 123(R). Under the modified-retroactive method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The effective date for SFAS 123(R) was originally the first interim and annual periods beginning after June 15, 2005, with earlier adoption encouraged. On April 14, 2005, the Securities and Exchange Commission approved a rule which delayed the required effective date of SFAS 123(R) until fiscal years beginning after June 15, 2005. The Company will adopt SFAS 123(R) in the first quarter of 2006 using the modified-prospective adoption method. Adoption of this statement is not expected to have a material effect on the operating results of the Company, as the impact to net income is not anticipated to deviate significantly from the pro forma disclosures provided in this footnote (reduction to after-tax net income of $88,000 for the nine months ended September 30, 2005).

 

 

12

 

 



 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

5.

SEGMENT INFORMATION

 

The Company’s operations consist of a property and casualty insurance segment and a reinsurance segment. The property and casualty insurance segment writes both commercial and personal lines of insurance, with a focus on medium sized commercial accounts. The reinsurance segment provides reinsurance for other insurers and reinsurers. The segments are managed separately due to differences in the insurance products sold and the business environment in which they operate.

 

 

Property and

 

 

 

 

 

 

Three months ended

casualty 

 

 

 

Parent

 

 

September 30, 2005

insurance  

 

Reinsurance

 

company

 

Consolidated

 

 

 

 

 

 

 

 

Premiums earned 

$    79,810,370 

 

$    23,603,919 

 

 $                      - 

 

$    103,414,289 

Underwriting gain (loss) 

(1,379,063)

 

1,300,022 

 

                         - 

 

(79,041)

Net investment income 

7,718,777 

 

2,806,335 

 

48,106 

 

10,573,218 

Realized investment gains 

1,118,975 

 

65,974 

 

                         - 

 

1,184,949 

Other income 

150,022 

 

                       - 

 

                         - 

 

150,022 

Interest expense 

193,125 

 

              84,975 

 

                         - 

 

278,100 

Other expenses 

191,483 

 

                       - 

 

148,349 

 

339,832 

 

 

 

 

 

 

 

 

Income (loss) before income

 

 

 

 

 

 

 

tax expense (benefit) 

$      7,224,103 

 

$      4,087,356 

 

$         (100,243)

 

$      11,211,216 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and

 

 

 

 

 

 

Three months ended

casualty 

 

 

 

Parent

 

 

September 30, 2004

insurance  

 

Reinsurance

 

company

 

Consolidated

 

 

 

 

 

 

 

 

Premiums earned 

$    63,339,332 

 

$    24,248,659 

 

 $                      - 

 

$       87,587,991 

Underwriting gain (loss) 

(9,532,757)

 

2,897,458 

 

                         - 

 

(6,635,299)

Net investment income 

5,321,217 

 

2,329,909 

 

31,926 

 

7,683,052 

Realized investment gains 

785,491 

 

262,627 

 

                         - 

 

1,048,118 

Other income 

136,227 

 

                       - 

 

                         - 

 

136,227 

Interest expense 

193,125 

 

              84,975 

 

                         - 

 

278,100 

Other expenses 

171,959 

 

                       - 

 

140,289 

 

312,248 

 

 

 

 

 

 

 

 

Income (loss) before income

 

 

 

 

 

 

 

tax expense (benefit) 

$    (3,654,906)

 

$      5,405,019 

 

$         (108,363)

 

$        1,641,750 

 

 

 

 

 

 

 

 

 

 

 

 

13

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

 

 

Property and

 

 

 

 

 

 

Nine months ended

casualty 

 

 

 

Parent

 

 

September 30, 2005

insurance  

 

Reinsurance

 

company

 

Consolidated

 

 

 

 

 

 

 

 

Premiums earned 

$    240,705,969 

 

$      68,204,599 

 

 $                       - 

 

$        308,910,568 

Underwriting gain (loss) 

(1,909,865)

 

3,298,625 

 

                          - 

 

1,388,760 

Net investment income 

21,548,347 

 

7,966,786 

 

190,332 

 

29,705,465 

Realized investment gains (losses) 

2,797,636 

 

(51,008)

 

                          - 

 

2,746,628 

Other income 

393,692 

 

                          - 

 

                          - 

 

393,692 

Interest expense 

579,375 

 

              254,925 

 

                          - 

 

834,300 

Other expenses 

610,332 

 

                          - 

 

644,020 

 

1,254,352 

 

 

 

 

 

 

 

 

Income (loss) before income

 

 

 

 

 

 

 

tax expense (benefit) 

$      21,640,103 

 

$      10,959,478 

 

$          (453,688)

 

$          32,145,893 

 

 

 

 

 

 

 

 

Assets 

$    818,179,282 

 

$    249,215,484 

 

$    246,328,182 

 

$     1,313,722,948 

Eliminations 

 

 

(242,814,961)

 

(242,814,961)

Reclassifications 

(211,434)

 

 

(177,686)

 

(389,120)

Net assets

$    817,967,848 

 

$    249,215,484 

 

$        3,335,535 

 

$     1,070,518,867 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and

 

 

 

 

 

 

Nine months ended

casualty 

 

 

 

Parent

 

 

September 30, 2004

insurance  

 

Reinsurance

 

company

 

Consolidated

 

 

 

 

 

 

 

 

Premiums earned 

$    186,908,651 

 

$      68,121,909 

 

 $                   -   

 

$        255,030,560 

Underwriting gain (loss) 

(13,553,017)

 

6,293,346 

 

 -   

 

(7,259,671)

Net investment income 

14,841,998 

 

6,922,873 

 

57,821 

 

21,822,692 

Realized investment gains 

3,527,524 

 

1,102,229 

 

 -   

 

4,629,753 

Other income 

477,818 

 

 -   

 

 -   

 

477,818 

Interest expense 

579,375 

 

              254,925 

 

 -   

 

834,300 

Other expenses 

580,422 

 

 -   

 

474,781 

 

1,055,203 

 

 

 

 

 

 

 

 

Income (loss) before income

 

 

 

 

 

 

 

tax expense (benefit) 

$        4,134,526 

 

$      14,063,523 

 

$          (416,960)

 

$          17,781,089 

 

 

 

 

 

 

 

 

Assets 

$    649,070,350 

 

$    251,296,584 

 

$    190,103,146 

 

$     1,090,470,080 

Eliminations 

 

 

(184,250,469)

 

(184,250,469)

Reclassifications 

619,476 

 

(2,374,932)

 

 

(1,755,456)

Net assets

$    649,689,826 

 

$    248,921,652 

 

$        5,852,677 

 

$        904,464,155 

 

 

 

 

 

 

 

 

 

 

14

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

6.

INCOME TAXES

 

The actual income tax expense (benefit) for the three and nine months ended September 30, 2005 and 2004 differed from the “expected” tax expense (benefit) for those periods (computed by applying the United States federal corporate tax rate of 35 percent to income before income tax expense (benefit)) as follows:

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2005 

 

2004 

 

2005 

 

2004 

Computed "expected" tax

 

 

 

 

 

 

 

expense  

$     3,923,926 

 

$        574,612 

 

$   11,251,063 

 

$     6,223,381 

 

 

 

 

 

 

 

 

Increases (decreases) in tax

 

 

 

 

 

 

 

resulting from:

 

 

 

 

 

 

 

Tax-exempt interest

 

 

 

 

 

 

 

income 

(1,107,857)

 

(941,446)

 

(3,294,963)

 

(2,341,735)

Proration of tax-exempt

 

 

 

 

 

 

 

interest and dividends

 

 

 

 

 

 

 

received deduction  

177,002 

 

148,091 

 

524,722 

 

370,518 

Other, net 

(110,576)

 

2,033 

 

(326,904)

 

(144,566)

 

 

 

 

 

 

 

 

Income tax expense (benefit) 

$     2,882,495 

 

$       (216,710)

 

$     8,153,918 

 

$     4,107,598 

 

 

 

 

 

 

 

 

 

 

7. EMPLOYEE RETIREMENT PLANS

 

The components of net periodic benefit cost for the Employers Mutual pension plan and postretirement benefit plans are as follows:

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2005 

 

2004 

 

2005 

 

2004 

Pension Plan:

 

 

 

 

 

 

 

Service cost 

$   1,872,977 

 

$   1,704,630 

 

$   5,618,931 

 

$   5,113,890 

Interest cost 

1,947,072 

 

1,755,222 

 

5,841,216 

 

5,265,666 

Expected return on plan assets 

(2,220,757)

 

(1,690,132)

 

(6,662,271)

 

(5,070,396)

Amortization of net loss 

204,905 

 

213,922 

 

614,715 

 

641,766 

Amortization of prior service costs 

111,864 

 

191,456 

 

335,592 

 

574,368 

Net periodic pension benefit cost 

$   1,916,061 

 

$   2,175,098 

 

$   5,748,183 

 

$   6,525,294 

 

 

 

 

 

 

 

 

 

 

 

15

 

 



 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

 

(Unaudited)

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2005 

 

2004 

 

2005 

 

2004 

Postretirement benefit plans:

 

 

 

 

 

 

 

Service cost 

$   1,039,981 

 

$      737,462 

 

$   3,119,943 

 

$   3,025,716 

Interest cost 

1,018,762 

 

732,040 

 

3,056,286 

 

2,889,058 

Expected return on plan assets 

(272,282)

 

(225,221)

 

(816,846)

 

(675,663)

Amortization of net loss 

10,023 

 

(174,679)

 

30,069 

 

120,981 

Net periodic postretirement

 

 

 

 

 

 

 

benefit cost 

$   1,796,484 

 

$   1,069,602 

 

$   5,389,452 

 

$   5,360,092 

 

 

 

 

 

 

 

 

 

 

Pension expense allocated to the Company was $586,998 and $1,761,002 for the three months and nine months ended September 30, 2005 compared to $528,721 and $1,586,168 for the same periods in 2004.

 

Postretirement benefit expense allocated to the Company was $512,541 and $1,537,629 for the three months and nine months ended September 30, 2005 compared to $240,889 and $1,204,594 for the same periods in 2004.

 

Employers Mutual has contributed $3,770,000 to the postretirement benefit plans and $15,000,000 to the pension plan through October 2005. No additional contributions are planned for 2005.

 

 

8.

CONTINGENT LIABILITIES

 

The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business. The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its net income. The companies involved have reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings.

 

The participants of the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions. The Company’s share of loss reserves eliminated by the purchase of these annuities was $699,913 at December 31, 2004. Due to the change in the Company’s aggregate participation in the pooling agreement, this amount increased to $893,506 effective January 1, 2005. The Company has a contingent liability of $893,506 should the issuers of these annuities fail to perform under the terms of the annuities. The Company’s share of the amount due from any one life insurance company does not equal or exceed one percent of its subsidiaries’ policyholders’ surplus.

 

 

16

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS

 

 

(Unaudited)

 

COMPANY OVERVIEW

 

EMC Insurance Group Inc., a 56.8 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 77.9 percent of consolidated premiums earned in the first nine months of 2005. For purposes of this discussion, the term “Company” is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries (including the Company) and an affiliate are referred to as the “EMC Insurance Companies.”

 

The Company’s four property and casualty insurance subsidiaries and two subsidiaries and an affiliate of Employers Mutual are parties to reinsurance pooling agreements with Employers Mutual (collectively the “pooling agreement”). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All premiums, losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Employers Mutual negotiates reinsurance agreements that provide protection to the pool and each of its participants, including protection against losses arising from catastrophic events.

 

Operations of the pool give rise to inter-company balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the pool participants are not subject to the pooling agreement. The pooling agreement also provides that Employers Mutual will make up any shortfall or difference resulting from an error in its systems and/or computational processes that would otherwise result in the required restatement of the pool participants’ financial statements.

 

The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all the companies. The pooling agreement produces a more uniform and stable underwriting result from year to year for all companies in the pool than might be experienced individually. In addition, each company benefits from the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own assets, and from the wide range of policy forms, lines of insurance written, rate filings and commission plans offered by each of the companies.

 

Effective January 1, 2005, the Company’s aggregate participation in the pooling agreement increased from 23.5 percent to 30.0 percent. In connection with this change in the pooling agreement, the Company’s liabilities increased $115,042,000, invested assets increased $107,801,000 and other assets increased $722,000. The Company reimbursed Employers Mutual $6,519,000 for expenses that were incurred to generate the additional business assumed by the Company, but this expense was offset by an increase in deferred policy acquisition costs. The Company also received $275,000 in interest income from Employers Mutual as the actual cash settlement did not occur until February 15, 2005.

 

 

17

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

The Company’s reinsurance subsidiary assumes a 100 percent quota share portion of Employers Mutual’s assumed reinsurance business, exclusive of certain reinsurance contracts. This includes all premiums and related losses, settlement expenses, and other underwriting and administrative expenses of this business, subject to a maximum loss of $1,500,000 per event. The reinsurance subsidiary does not directly reinsure any of the insurance business written by Employers Mutual or the other pool participants; however, the reinsurance subsidiary assumes reinsurance business from the Mutual Reinsurance Bureau (MRB) pool and this pool provides a very small amount of reinsurance protection to the participants of the pooling agreement. As a result, the reinsurance subsidiary’s assumed exposures include a very small portion of the direct business produced by the participants in the pooling agreement, after ceded reinsurance protections purchased by the MRB pool are applied. In addition, the reinsurance subsidiary does not reinsure any “involuntary” facility or pool business that Employers Mutual assumes pursuant to state law. Operations of the quota share agreement give rise to inter-company balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the reinsurance subsidiary are not subject to the quota share agreement.

 

The reinsurance subsidiary pays an annual override commission to Employers Mutual in connection with the $1,500,000 cap on losses assumed per event. The override commission rate is charged at 4.50 percent of written premiums. The reinsurance subsidiary also pays for 100 percent of the outside reinsurance protection Employers Mutual purchases to protect itself from catastrophic losses on the assumed reinsurance business, excluding reinstatement premiums. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary.

 

In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the interim financial statements have been included. The results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year.

 

INDUSTRY OVERVIEW

 

An insurance company’s underwriting results reflect the profitability of its insurance operations, excluding investment income. Underwriting results are calculated by subtracting losses and expenses incurred from premiums earned. An underwriting profit indicates that a sufficient amount of premium income was received to cover the risks insured. An underwriting loss indicates that premium income was not adequate. The combined ratio is a measure utilized by insurance companies to gauge underwriting profitability and is calculated by dividing losses and expenses incurred by premiums earned. A number less than 100 generally indicates an underwriting gain; a number greater than 100 generally indicates an underwriting loss.

 

Insurance companies collect cash in the form of insurance premiums and pay out cash in the form of loss and settlement expense payments. Additional cash outflows occur through the payment of acquisition and underwriting costs such as commissions, premium taxes, salaries and general overhead. During the loss settlement period, which varies by line of business and by the circumstances surrounding each claim and may cover several years, insurance companies invest the cash premiums and earn interest and dividend income. This investment income supplements underwriting results and contributes to net earnings.

 

Additional information regarding issues affecting the insurance industry is presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2004 Form 10-K.

 

 

18

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

MANAGEMENT ISSUES AND PERSPECTIVES

 

Hurricanes Katrina and Rita produced a record amount of losses for the insurance and reinsurance industries during the third quarter of 2005. The Company had exposure to these hurricanes in both the property and casualty insurance segment and the reinsurance segment; however, net losses associated with these events were mitigated by the catastrophe reinsurance program protecting the pool participants and the $1,500,000 cap on losses assumed per event under the reinsurance segment’s quota share agreement with Employers Mutual. Hurricanes Katrina and Rita are discussed in greater detail in the “Results of Operations” section of this discussion. Due to the magnitude of the reinsurance industry losses associated with these hurricanes and Hurricane Wilma in October, management anticipates that the renewal of the catastrophe reinsurance program protecting the pool participants for 2006 will most likely include changes in terms and price. Management also recognizes that the terms and conditions of the quota share agreement with Employers Mutual, including the $1,500,000 cap on losses assumed per event, will need to be reviewed and renegotiated. Any such changes to the quota share agreement will be reviewed and approved by the Inter-Company Committee of the Company, which is composed of independent directors of the Company and the Inter-Company Committee of Employers Mutual, which is composed of independent directors of Employers Mutual.

 

In addition to the hurricane issues noted above, management has focused its attention on three primary issues of importance to the Company during the first nine months of 2005. These issues include establishing and maintaining adequate loss and settlement expense reserves, balancing profitability and production as the insurance marketplace becomes increasingly competitive and preparing to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. These issues are discussed further in the following paragraphs. A discussion of other issues being addressed by management is presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2004 Form 10-K.

 

Management has long recognized the importance of adequate capitalization for its insurance subsidiaries and has strived to maintain a strong capital position by investing their assets conservatively and, more importantly, maintaining a consistent level of loss and settlement expense reserve adequacy. Carried reserves are analyzed on a regular basis and adjustments, if necessary, are implemented on a timely basis. This procedure not only assures a consistent level of reserve adequacy, it also minimizes the impact that any required adjustment will have on current operations. This dedication to reserve adequacy was demonstrated in both 2003 and 2004 when the Company strengthened loss and settlement expense reserves in the property and casualty insurance segment in response to the findings of regularly-scheduled actuarial evaluations.

 

In addition to an ongoing review of claim files in the normal course of business, the Company has for many years required each of its 16 branch offices to perform a complete inventory of its open claim files during the fourth quarter of each year and to review the adequacy of each individual case reserve based on current information. This fourth quarter review process has not historically resulted in a significant increase in case reserves; however, because of heightened emphasis placed on case reserve adequacy during 2004, the review performed in the fourth quarter of 2004 generated a significant and unanticipated increase in case reserves and a corresponding increase in settlement expense reserves. In an effort to minimize the likelihood of this occurring in the future, beginning in 2005 the branch offices are required to perform a complete inventory and review of their open claim files semi-annually rather than annually as previously required. The first review was completed during the second quarter of 2005 and the second review will be completed by the end of November. Management believes that this additional review process will help assure that necessary reserve adjustments are implemented on a timely basis.

 

In addition to recent actions taken to improve reserve adequacy, effective March 1, 2005, Richard K. Schulz, an employee of Employers Mutual, became the senior claims executive officer. Mr. Schulz was the claims manager at the Chicago branch office for the last five years and has over ten years of prior insurance industry experience. Mr. Schulz reports to William A. Murray, Executive Vice President and Chief Operating Officer.

 

 

19

 

 



 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

The products offered by an insurance company must be priced so that they are competitive in the marketplace, yet offer the prospect of producing an underwriting profit. Management is keenly aware of the need to achieve an underwriting profit in today’s marketplace and has implemented focused underwriting initiatives that stress profitability over production. Achieving an underwriting profit has become increasingly important during the last several years as investment income, which is used to supplement underwriting results and contribute to net earnings, has been negatively impacted by the lingering low interest rate environment.

 

The Company, which is not currently an accelerated filer, has completed the majority of the documentation of its work flow and internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. Efforts during the first nine months of 2005 have focused on the remediation of identified gaps in existing controls and the verification of controls at the various branch offices. Efforts for the fourth quarter of 2005 will include testing of the documented controls, remediation of additional control gaps identified and the establishment of a maintenance process. Management expects to complete its assessment of the Company’s internal control over financial reporting by mid December. Management is working closely with its independent auditor to ensure that they have sufficient time to perform their analysis and testing procedures and issue their report on the Company’s internal control over financial reporting as of December 31, 2005.

 

CRITICAL ACCOUNTING POLICIES

 

The accounting policies considered by management to be critically important in the preparation and understanding of the Company’s financial statements and related disclosures are presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2004 Form 10-K.

 

 

20

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

RESULTS OF OPERATIONS

 

Segment information and consolidated net income for the three months and nine months ended September 30, 2005 and 2004 are as follows:

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

($ in thousands)

2005

 

2004

 

2005

 

2004

Property and Casualty Insurance

 

 

 

 

 

 

 

Premiums earned 

 $         79,811 

 

 $         63,339 

 

 $       240,706 

 

 $       186,908 

Losses and settlement expenses 

            53,698 

 

            51,926 

 

          159,948 

 

          136,797 

Acquisition and other expenses 

            27,491 

 

            20,946 

 

            82,668 

 

            63,665 

Underwriting loss 

 $          (1,378)

 

 $          (9,533)

 

 $          (1,910)

 

 $        (13,554)

 

 

 

 

 

 

 

 

Loss and settlement expense ratio 

67.3%

 

82.0%

 

66.4%

 

73.2%

Acquisition expense ratio 

34.4%

 

33.1%

 

34.4%

 

34.1%

Combined ratio 

101.7%

 

115.1%

 

100.8%

 

107.3%

 

 

 

 

 

 

 

 

Losses and settlement expenses:

 

 

 

 

 

 

 

Insured events of current year 

 $         58,471 

 

 $         45,909 

 

 $       168,824 

 

 $       127,091 

Increase in provision for insured

 

 

 

 

 

 

 

events of prior years 

            (4,773)

 

              6,017 

 

             (8,876)

 

              9,706 

 

 

 

 

 

 

 

 

Total losses and settlement expenses 

 $         53,698 

 

 $         51,926 

 

 $       159,948 

 

 $       136,797 

 

 

 

 

 

 

 

 

Catastrophe and storm losses 

 $         11,582 

 

$           4,931 

 

 $         19,122 

 

$         12,833 

 

 

 

 

 

 

 

 

 

 

 

21

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

($ in thousands)

2005

 

2004

 

2005

 

2004

Reinsurance

 

 

 

 

 

 

 

Premiums earned 

$          23,604 

 

$          24,249 

 

$          68,205 

 

$          68,122 

Losses and settlement expenses 

15,892 

 

13,765 

 

46,029 

 

43,503 

Acquisition and other expenses 

6,412 

 

7,586 

 

18,877 

 

18,325 

Underwriting loss 

$            1,300 

 

$            2,898 

 

$            3,299 

 

$            6,294 

 

 

 

 

 

 

 

 

Loss and settlement expense ratio 

67.3%

 

56.8%

 

67.5%

 

63.9%

Acquisition expense ratio 

27.2%

 

31.3%

 

27.7%

 

26.9%

Combined ratio 

94.5%

 

88.1%

 

95.2%

 

90.8%

 

 

 

 

 

 

 

 

Losses and settlement expenses:

 

 

 

 

 

 

 

Insured events of current year 

$          16,231 

 

$          17,270 

 

$          46,101 

 

$          48,490 

Decrease in provision for insured 

 

 

 

 

 

 

 

events of prior years 

(339)

 

(3,505)

 

(72)

 

(4,987)

 

 

 

 

 

 

 

 

Total losses and settlement expenses 

$          15,892 

 

$          13,765 

 

$          46,029 

 

$          43,503 

 

 

 

 

 

 

 

 

Catastrophe and storm losses 

$            2,820 

 

$            5,859 

 

$            3,886 

 

$            6,169 

 

 

 

 

 

 

 

 

 

 

 

22

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

($ in thousands)

2005

 

2004

 

2005

 

2004

Consolidated

 

 

 

 

 

 

 

REVENUES

 

 

 

 

 

 

 

Premiums earned 

 $     103,415 

 

 $       87,588 

 

 $       308,911 

 

 $       255,030 

Net investment income 

          10,573 

 

            7,682 

 

            29,705 

 

            21,822 

Realized investment gains 

            1,184 

 

            1,048 

 

              2,746 

 

              4,630 

Other income 

               150 

 

               137 

 

                 394 

 

                 478 

 

        115,322 

 

          96,455 

 

          341,756 

 

          281,960 

LOSSES AND EXPENSES

 

 

 

 

 

 

 

Losses and settlement expenses 

          69,590 

 

          65,691 

 

          205,977 

 

          180,300 

Acquisition and other expenses 

          33,903 

 

          28,532 

 

          101,545 

 

            81,990 

Interest expense 

               278 

 

               278 

 

                 834 

 

                 834 

Other expense 

               339 

 

               312 

 

              1,254 

 

              1,055 

 

        104,110 

 

          94,813 

 

          309,610 

 

          264,179 

 

 

 

 

 

 

 

 

Income before income tax expense (benefit) 

          11,212 

 

            1,642 

 

            32,146 

 

            17,781 

Income tax expense (benefit) 

            2,883 

 

              (216)

 

              8,154 

 

              4,108 

Net income 

 $         8,329 

 

 $         1,858 

 

 $         23,992 

 

 $         13,673 

 

 

 

 

 

 

 

 

Net income per share 

 $           0.61 

 

 $           0.16 

 

 $             1.76 

 

 $             1.18 

 

 

 

 

 

 

 

 

Loss and settlement expense ratio 

67.3%

 

75.0%

 

66.7%

 

70.7%

Acquisition expense ratio 

32.8%

 

32.6%

 

32.9%

 

32.1%

Combined ratio 

100.1%

 

107.6%

 

99.6%

 

102.8%

 

 

 

 

 

 

 

 

Losses and settlement expenses:

 

 

 

 

 

 

 

Insured events of current year 

 $       74,702 

 

 $       63,179 

 

 $       214,925 

 

 $       175,581 

Increase (decrease) in provision for insured

 

 

 

 

 

 

 

events of prior years 

          (5,112)

 

            2,512 

 

             (8,948)

 

              4,719 

 

 

 

 

 

 

 

 

Total losses and settlement expenses 

 $       69,590 

 

 $       65,691 

 

 $       205,977 

 

 $       180,300 

 

 

 

 

 

 

 

 

Catastrophe and storm losses 

 $       14,402 

 

 $       10,790 

 

 $         23,008 

 

 $         19,002 

 

 

 

 

 

 

 

 

 

 

 

23

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Net income increased for both the three months and nine months ended September 30, 2005 from the same periods in 2004. The increase in 2005 net income is attributed to the combination of significantly improved third quarter underwriting results and a large increase in investment income stemming from an increase in invested assets. The Company reported an underwriting loss of $78,000 for the three months ended September 30, 2005 compared to an underwriting loss of $6,635,000 for the same period in 2004. Both of these periods experienced significant levels of hurricane losses. Hurricanes Katrina and Rita, which occurred in the third quarter of 2005, produced estimated losses of $4,855,000 and $4,722,000, respectively (included in the disclosure “Catastrophe and storm losses”). After factoring in reinstatement premium income (net of related commission) in the reinsurance segment and reinstatement premium expense in the property and casualty insurance segment, total losses associated with Hurricanes Katrina and Rita are estimated to be $4,169,000 and $4,801,000, respectively ($5,831,000 combined after tax). The four hurricanes that hit the Southern United States in August and September of 2004 produced total losses to the Company in the third quarter of 2004 of $8,389,000 ($5,453,000 after tax). For the first nine months of 2005 the Company generated an underwriting profit of $1,389,000 compared to an underwriting loss of $7,260,000 in the same period of 2004. The underwriting losses for both the three months and nine months ended September 30, 2004 reflect unfavorable reserve development of $2,512,000 and $4,719,000, respectively, which was attributed to explicit reserve strengthening and adverse development on direct case reserves, settlement expense reserves, and non-voluntary pools. The Company’s invested assets increased as a result of $34,890,000 of net proceeds received from the follow-on stock offering completed in October 2004 and the receipt of $107,801,000 in cash from Employers Mutual in February 2005 in connection with the change in the pooling agreement. The increase in net income for the nine months ended September 30, 2005 was limited to some extent by $2,558,000 ($1,663,000 after tax) of realized investment gains recognized during the second quarter of 2004 in connection with a bankruptcy payout award on bonds issued by MCI Communications Corporation.

 

Premiums Earned

 

Premiums earned increased 18.1 percent and 21.1 percent to $103,415,000 and $308,911,000 for the three months and nine months ended September 30, 2005 from $87,588,000 and $255,030,000 for the same periods in 2004. These increases are primarily attributed to the Company’s increased participation in the pooling agreement, but also reflect the impact of rate increases that were implemented in the property and casualty insurance business during 2004. On an overall basis, rate competition increased moderately in the property and casualty insurance marketplace during the first nine months of 2005; however, there have been indications of more intense competition in select territories and lines of business. In response to these competitive market conditions, management implemented small premium rate decreases where deemed appropriate. Market conditions are expected to remain competitive for the remainder of the year, although some price firming is likely in certain lines of business and regions of the country due to the severe hurricane season. Management continues to emphasize its goal of achieving profitability over production. Achieving an underwriting profit is always stressed, but is even more critical in a lower interest rate environment.

 

 

24

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Premiums earned for the property and casualty insurance segment increased 26.0 percent and 28.8 percent to $79,811,000 and $240,706,000 for the three months and nine months ended September 30, 2005 from $63,339,000 and $186,908,000 for the same periods in 2004. These increases are primarily the result of the change in the pooling agreement. To better understand the results for 2005, it is helpful to look at the net pool numbers, which are not impacted by the pool change. For the pool, net premiums earned decreased 1.3 percent for the three months and increased 0.9 percent for the nine months ended September 30, 2005 from the same periods in 2004. The decrease for the three months ended September 30, 2005 is largely due to ceded reinstatement premium expense recognized in connection with hurricanes Katrina and Rita. No ceded reinstatement premium expense had been recognized in the third quarter of 2004 in connection with the four hurricanes that hit the Southern United States in August and September of that year since none of the events had been projected to exceed reinsurance retentions at that time. Excluding the effects of ceded reinstatement premium expense, net premiums earned for the pool would have declined 0.3 percent for the three months and increased 1.2 percent for the nine months ended September 30, 2005 from the same periods in 2004. The decreasing trend being seen in the pool’s premiums earned reflects a transition from rate increases that were implemented during 2004 to steady or declining rates currently being experienced in 2005, along with declines in policy counts. Increased rate competition during the first nine months of 2005 has resulted in the implementation of some minor decreases in premium rates, slight increases in the use of discretionary credits in commercial lines and declines in policy counts in both commercial and personal lines. Due to the timing of policy renewals and the earning of premiums ratably over the terms of the underlying policies, a time delay exists for implemented rate changes (both increases and decreases) to have a noticeable impact on premiums earned. The Company is attempting to address the loss of policy count through various measures including programs geared towards small businesses and enhanced automation to make it easier and more efficient for agents to do business with the Company.

 

Premiums written for the property and casualty insurance segment increased 25.6 percent and 40.6 percent to $95,775,000 and $285,981,000 for the three months and nine months ended September 30, 2005 from $76,232,000 and $203,376,000 for the same periods in 2004. These increases are attributed to the change in the pooling agreement; however, it should be noted that the large increase for the nine months ended September 30, 2005 includes a portfolio adjustment of $29,631,000, which serves as an offset to the increase in the unearned premium reserve. Excluding this portfolio adjustment, premiums written increased 26.0 percent for the nine months ended September 30, 2005 compared to the same period in 2004. Looking at the net pool numbers, which are not impacted by the pool change, premiums written declined 1.6 percent and 1.2 percent for the three months and nine months ended September 30, 2005 compared to the same periods in 2004. The decline reflects ceded reinstatement premium expense from hurricanes Katrina and Rita (discussed above), a decline in new business, some minor declines in personal lines premium rates and an increase in the use of discretionary credits. During the first nine months of 2005 commercial lines new business premium decreased approximately 1.5 percent and personal lines new business premium decreased approximately 14.2 percent. However, policy retention has increased to 86.0 percent in commercial lines and remained relatively steady in the personal lines at 82.3 percent for property and 82.6 percent for auto. In light of current rate levels and the quality of the Company’s book of business, management is receptive to opportunities to write new business, but continues to stress profitability over production.

 

 

25

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Premiums earned for the reinsurance segment decreased 2.7 percent to $23,604,000 for the three months and increased 0.1 percent to $68,205,000 for the nine months ended September 30, 2005 from $24,249,000 and $68,122,000 for the same periods in 2004. The decrease for the three months ended is primarily the result of a timing difference in the recording of a large foreign reinsurance contract that was reported and recorded in the second quarter of 2005 but was not reported and recorded until the third quarter of 2004. Premiums earned for both the three months and nine months ended September 30, 2005 include reinstatement premium income of $1,569,000 recognized in connection with hurricane Katrina. However, the impact of this reinstatement premium income was more than offset by the loss of a significant account in 2005. Employers Mutual is attempting to replace this business with new accounts and increased participation on existing accounts; however, no significant new accounts were added during the first nine months of 2005. Premium rate increases on excess-of-loss contracts remained relatively flat at both the January and July 2005 renewals, evidence of the increasing competitiveness that was occurring in the reinsurance market. However, the record reinsurance industry losses produced by Hurricanes Katrina, Rita and Wilma are expected to result in premium rate increases on contracts renewing in the fourth quarter of 2005 and throughout 2006. The estimate of earned but not reported premiums increased $160,000 during the three months ended September 30, 2005, resulting in a $40,000 decline for the first nine months of 2005. In comparison, the estimate of earned but not reported premiums decreased $650,000 and $40,000 during the three months and nine months ended September 30, 2004, respectively.

 

As reported in a Form 8-K filing on November 14, 2005, the board of directors of the MRB pool, of which Employers Mutual is a member, has approved the admission of Kentucky Farm Bureau as a new assuming company to the pool effective January 1, 2006. The MRB board also indicated that it will approve the admittance of a second company effective January 1, 2006 if that company’s board of directors approves such participation within the next week, which is considered likely. Both of these companies carry an A.M. Best rating of A+ (Excellent) and their addition will enhance the financial strength of the pool. These actions will provide increased diversification in the Company’s assumed reinsurance business and will reduce the Company’s exposure to catastrophe losses. Additionally, the Company believes that the commitment of two highly rated, well capitalized companies to join the pool sends a strong message regarding the pool’s future business prospects. Currently the MRB pool consists of three assuming companies who share the reinsurance business equally. The increase in assuming companies will have a short-term negative impact on earned premiums for the Company’s reinsurance segment as the pool business will be split between more participants; however, the addition of these new companies will strengthen MRB’s surplus base and should favorably impact future marketing efforts.

 

For calendar year 2005, the Company projects that earned premiums from the MRB pool will total approximately $38 million. Based on preliminary production estimates from MRB, which do not include potential rate increases resulting from this year’s severe hurricane season, the Company’s earned premiums would have declined to approximately $36.5 million in 2006 without the addition of any new participants. With the addition of Kentucky Farm Bureau, the Company estimates that 2006 earned premiums from the MRB pool will decline to approximately $28 million; if both companies join the pool, 2006 earned premiums are estimated to decline to approximately $24 million. It should be noted that if the second company elects to participate in the pool they will only assume property exposures; casualty exposures will be shared among the other four participants.

 

The Company also reported in the November 14, 2005 Form 8-K that effective January 1, 2006, Employers Mutual will no longer participate in a Llyod’s of London marine syndicate due to a planned restructuring of that program. The loss of this account will reduce the Company’s earned premium by approximately $4.0 million in 2006 and an additional $1 to $2 million in 2007. Employers Mutual will attempt to replace this business through increased participation on other programs.

 

 

26

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Losses and settlement expenses

 

Losses and settlement expenses increased 5.9 percent and 14.2 percent to $69,590,000 and $205,977,000 for the three months and nine months ended September 30, 2005 from $65,691,000 and $180,300,000 for the same periods in 2004. The majority of this increase is attributed to the Company’s increased participation in the pooling agreement. The loss and settlement expense ratio declined to 67.3 percent and 66.7 percent for the three months and nine months ended September 30, 2005 from 75.0 percent and 70.7 percent for the same periods in 2004.

 

The loss and settlement expense ratio for the property and casualty insurance segment decreased to 67.3 percent and 66.4 percent for the three months and nine months ended September 30, 2005 from 82.0 percent and 73.2 percent for the same periods in 2004. These improvements occurred in spite of an increase in catastrophe and storm losses driven largely by hurricanes Katrina and Rita during the third quarter of 2005. Losses from these hurricanes totaled $6,577,000 which exceeded the substantial hurricane losses of the third quarter of 2004 that totaled $2,389,000. The improvement in the loss and settlement expense ratios for both the three and nine months ended September 30, 2005 is primarily the result of favorable development on prior years’ reserves of $4,773,000 and $8,876,000, respectively, compared to adverse development of $6,017,000 and $9,706,000 for the same periods in 2004. The favorable development of 2005 is largely attributed to favorable case loss and settlement expense reserve development in the other liability line of business. The adverse development for 2004 reflects $2,383,000 of explicit reserve strengthening ($588,000 in the third quarter and $1,795,000 in the second quarter), $5,217,000 of direct case reserve development (primarily in the workers’ compensation line of business), $1,810,000 of development on settlement expense reserves (largely attributed to IBNR emergence on umbrella business, which is included in the other liability line of business) and $940,000 of development from non-voluntary pools. This adverse development was partially offset by $3,008,000 of reinsurance recoveries associated with the case reserve development and IBNR emergence. The reserve strengthening actions taken were in response to actuarial evaluations of the segment’s carried reserves that indicated a continued upward trend in projected ultimate losses. Claim severity increased during 2005, but did show a decline in the three months ended September 30, 2005 in comparison to the same period in 2004. The increase in severity during the nine months ended September 30, 2005 is generally attributed to the establishment of more adequate case reserves on newly reported claims. Overall loss frequency has continued to trend downward, but there are signs that it may be leveling out, especially in the workers’ compensation line of business.

 

The loss and settlement expense ratio for the reinsurance segment increased to 67.3 percent and 67.5 percent for the three months and nine months ended September 30, 2005 from 56.8 percent and 63.9 percent for the same periods in 2004. The increases in the 2005 loss and settlement expense ratios for both the three months and nine months ended are attributed to the combination of a decline in the amount of favorable development on prior years’ reserves and an increase in the severity of losses on working layer business during the third quarter of 2005. However, the effects of these were limited by a decline in catastrophe and storm losses, which included the four hurricane losses of 2004, each capped at the $1,500,000 occurrence limit of the quota share agreement, compared to the two hurricane losses of 2005 (Katrina and Rita), both of which were capped at the $1,500,000 occurrence limit. Results for the first nine months of 2005 reflect a relatively small amount of favorable development on prior years’ reserves from the HORAD book of business.

 

Acquisition and other expenses

 

Acquisition and other expenses increased 18.8 percent and 23.9 percent to $33,903,000 and $101,545,000 for the three months and nine months ended September 30, 2005 from $28,532,000 and $81,990,000 for the same periods in 2004. These increases are primarily attributed to the Company’s increased participation in the pooling agreement. The acquisition expense ratio increased to 32.8 percent and 32.9 percent for the three and nine months ended September 30, 2005 from 32.6 percent and 32.1 percent for the same periods in 2004. These increases are primarily due to higher salary and premium tax costs.

 

 

27

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

For the property and casualty insurance segment, the acquisition expense ratio increased to 34.4 percent for the three months and nine months ended September 30, 2005 from 33.1 percent and 34.1 percent for the same periods in 2004. These increases are primarily attributed to increases in policyholder dividends, salary, and premium tax costs.

 

The property and casualty insurance subsidiaries incurred $6,519,000 of commission expense in 2005 in connection with the change in the pooling agreement. This commission expense is used to reimburse Employers Mutual for expenses incurred to generate the additional insurance business that was transferred to the Company on January 1, 2005. However, due to the fact that acquisition expenses, which include commissions, are deferred and amortized to expense as the related premiums are earned, all of the $6,519,000 of commission expense was capitalized as a deferred policy acquisition cost, and is being amortized to expense as the unearned premiums become earned. This provides a proper matching of acquisition expenses and premium income.

 

For the reinsurance segment, the acquisition expense ratio decreased to 27.2 percent for the three months ended and increased to 27.7 percent for the nine months ended September 30, 2005 from 31.3 percent and 26.9 percent for the same periods in 2004. The decline for the three months ended September 30, 2005 is due to a large amount of contingent commission expense reported by MRB in the third quarter of 2004. The increase for the nine months ended September 30, 2005 is primarily attributed to $1,064,000 of contingent commission income recognized during the second quarter of 2004 as a result of the favorable underwriting performance of Employers Mutual’s assumed reinsurance book of business. The commission expense for 2004 includes $1,033,000 related to an increase in participation in the MRB pool from 25 percent to 33 percent; however, this expense was partially offset by an increase in the asset for deferred policy acquisition costs.

 

Investment results

 

Net investment income increased 37.6 percent and 36.1 percent to $10,573,000 and $29,705,000 for the three months and nine months ended September 30, 2005 from $7,682,000 and $21,822,000 for the same periods in 2004, and is attributed to a significant increase in invested assets. As previously discussed, the Company received $34,890,000 of net proceeds from the follow-on stock offering in October 2004 and $107,801,000 from Employers Mutual in February 2005 in connection with the change in the pooling agreement. The Company also received $275,000 of interest income from Employers Mutual as the cash settlement for the pooling change did not occur until February 15, 2005.

 

The Company reported net realized investment gains of $1,184,000 and $2,746,000 for the three months and nine months ended September 30, 2005 compared to $1,048,000 and $4,630,000 for the same periods in 2004. The large amount of realized investment gains for the nine months ended September 30, 2004 reflects $2,558,000 of net gains recognized during the second quarter of 2004 on the Company’s investment in MCI Communications Corporation bonds in conjunction with a payout award received under a bankruptcy court approved “Plan of Reorganization.” The Company did not recognize any other-than-temporary impairment losses in the first nine months of 2005 or 2004.

 

Income tax

 

Income tax expense increased for both the three months and nine months ended September 30, 2005 from the same periods in 2004. The effective tax rates for the three months and nine months ended September 30, 2005 were 25.7 percent and 25.4 percent, respectively, compared to negative 13.2 percent and positive 23.1 percent for the same periods of 2004. The increases in the effective tax rates for both the three months and nine months ended September 30, 2005 from the same periods of 2004 is due to increases in pre-tax income in relation to tax-exempt interest income.

 

 

28

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity

 

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet cash obligations as they come due. The Company generated positive cash flows from operations of $136,727,000 during the first nine months of 2005 compared to $30,967,000 for the first nine months of 2004. Included in cash flows from operations for the first nine months of 2005 is $107,801,000 received from Employers Mutual in connection with the change in the pooling agreement. Excluding this amount, cash flows from operations for the first nine months of 2005 amounted to $28,926,000. The Company typically generates substantial positive cash flows from operations because cash from premium payments is generally received in advance of cash payments made to settle claims. These positive cash flows provide the foundation of the Company’s asset/liability management program and are the primary drivers of the Company’s liquidity. When investing funds made available from operations, the Company invests in securities with maturities that approximate the anticipated payments of losses and settlement expenses of the underlying insurance policies. In addition, the Company maintains a portion of its investment portfolio in relatively short-term and highly liquid assets as a secondary source of liquidity should net cash flows from operating activities prove inadequate to fund current operating needs. As of September 30, 2005, the Company did not have any significant variations between the maturity dates of its investments and the expected payments of its loss and settlement expense reserves.

 

The Company is a holding company whose principal assets are its investments in its insurance subsidiaries. As a holding company, the Company is dependent upon cash dividends from its insurance company subsidiaries to meet its obligations and to pay cash dividends to its stockholders. State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval. The maximum amount of dividends that the insurance company subsidiaries can pay to the Company in 2005 without prior regulatory approval is approximately $32.2 million. The Company received $3,623,000 and $5,335,000 of dividends from its insurance company subsidiaries and paid cash dividends to its stockholders totaling $6,122,000 and $5,199,000 in the first nine months of 2005 and 2004, respectively.

 

The Company’s insurance company subsidiaries must have adequate liquidity to ensure that their cash obligations are met; however, because of their participation in the pooling agreement and the quota share agreement, they do not have the daily liquidity concerns normally associated with an insurance or reinsurance company. This is due to the fact that under the terms of the pooling and quota share agreements, Employers Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the Company’s reinsurance subsidiary, and then settles the inter-company balances generated by these transactions with the participating companies on a quarterly basis.

 

At the insurance company subsidiary level, the primary sources of cash are premium income, investment income and maturing investments. The principal outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends, interest and principal payments on debt, and investment purchases. Cash outflows can be variable because of uncertainties regarding settlement dates for unpaid losses and because of the potential for large losses, either individually or in the aggregate. Accordingly, the insurance company subsidiaries maintain investment and reinsurance programs generally intended to provide adequate funds to pay claims without forced sales of investments.

 

 

29

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid investments to ensure the availability of funds to pay claims and expenses. The remainder of the investment portfolio, excluding investments in equity securities and other long-term investments, is invested in securities with maturities that approximate the anticipated liabilities of the insurance written. At September 30, 2005, approximately 43 percent of the Company’s fixed maturity securities were in U.S. government or U.S. government agency issued securities. A variety of maturities are maintained in the Company’s portfolio to assure adequate liquidity. The maturity structure of the fixed maturity investments is also established by the relative attractiveness of yields on short, intermediate and long-term securities. The Company does not invest in high-yield, non-investment grade debt securities; however, an exception was made to this policy in 2004 when non-investment grade MCI debt securities were sold and then repurchased in order to recognize a current income tax benefit.

 

The Company considers itself to be a long-term investor and generally purchases fixed maturity investments with the intent to hold them to maturity. Despite this intent, the Company currently classifies purchases of fixed maturity investments as available-for-sale to provide flexibility in the management of the investment portfolio. The Company had unrealized holding gains, net of deferred taxes, on fixed maturity securities available-for-sale totaling $10,833,000 and $15,511,000 at September 30, 2005 and December 31, 2004, respectively. The fluctuation in the market value of these investments is primarily due to changes in the interest rate environment during this time period. Since the Company does not actively trade in the bond market, such fluctuations in the fair value of these investments are not expected to have a material impact on the operations of the Company, as forced liquidations of investments are not anticipated. The Company closely monitors the bond market and makes appropriate adjustments in its portfolio as changing conditions warrant.

 

The majority of the Company’s assets are invested in fixed maturity securities. These investments provide a substantial amount of investment income that supplements underwriting results and contributes to net earnings. As these investments mature, or are called, the proceeds will be reinvested at current rates, which may be higher or lower than those now being earned; therefore, more or less investment income may be available to contribute to net earnings depending on the interest rate level.

 

The Company participates in a securities lending program administered by Mellon Bank, N.A. whereby certain fixed maturity securities from the investment portfolio are loaned to other institutions for short periods of time. The Company receives a fee for each security loaned out under this program and requires initial collateral, primarily cash, equal to 102 percent of the market value of the loaned securities. The cash collateral that secures the Company’s loaned securities is invested in a Delaware statutory trust that is managed by Mellon Bank. The earnings from this trust are used, in part, to pay the fee the Company receives for each security loaned under the program.

 

The Company held $4,340,000 and $5,550,000 in minority ownership interests in limited partnerships and limited liability companies at September 30, 2005 and December 31, 2004, respectively. The Company does not hold any other unregistered securities.

 

The Company carried a pension asset of $1,646,000 and $2,684,000 at September 30, 2005 and December 31, 2004, respectively. Postretirement benefit liabilities reflected in the Company’s financial statements totaled $12,736,000 and $9,486,000 at September 30, 2005 and December 31, 2004, respectively. Included in the 2005 amounts is $722,000 of pension assets and $2,518,000 of postretirement benefit liabilities transferred to the Company in connection with the change in the pooling agreement.

 

Capital Resources

 

Capital resources consist of stockholders’ equity and debt, representing funds deployed or available to be deployed to support business operations. For the Company’s insurance subsidiaries, capital resources are required to support premium writings. Regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to its statutory surplus should not exceed three to one. All of the Company’s insurance subsidiaries were well under this guideline at September 30, 2005.

 

 

30

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

The Company’s insurance subsidiaries are required to maintain certain minimum surplus on a statutory basis and are subject to regulations under which payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. The Company’s insurance subsidiaries are also subject to Risk Based Capital (RBC) requirements that may further impact their ability to pay dividends. RBC requirements attempt to measure minimum statutory capital needs based upon the risks in a company’s mix of products and investment portfolio. At December 31, 2004, the Company’s insurance subsidiaries had total adjusted statutory capital of $216,868,000, which is well in excess of the minimum RBC requirement of $43,485,000.

 

The Company had total cash and invested assets with a carrying value of $924.3 million and $779.4 million as of September 30, 2005 and December 31, 2004, respectively. The following table summarizes the Company’s cash and invested assets as of the dates indicated:

 

 

 

September 30, 2005

 

 

 

 

 

Percent of

 

 

 

 Amortized 

 

 Fair 

 

total at

 

Carrying

($ in thousands)

 cost 

 

 value 

 

fair value

 

value

Fixed maturities held-to-maturity  

 $                 19,901 

 

 $            20,470 

 

2.2%

 

 $           19,901 

Fixed maturities available-for-sale 

                  747,500 

 

             764,166 

 

82.6%

 

            764,166 

Equity securities available-for-sale 

                    62,382 

 

               87,193 

 

9.4%

 

              87,193 

Cash 

                         243 

 

                    243 

 

0.0%

 

                   243 

Short-term investments  

                    48,432 

 

               48,432 

 

5.3%

 

              48,432 

Other long-term investments 

                      4,340 

 

                 4,340 

 

0.5%

 

                4,340 

 

 $               882,798 

 

 $          924,844 

 

100.0%

 

 $         924,275 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2004

 

 

 

 

 

Percent of

 

 

 

 Amortized 

 

 Fair 

 

total at

 

Carrying

($ in thousands)

 cost 

 

 value 

 

fair value

 

value

Fixed maturities held-to-maturity  

 $                 29,206 

 

 $            30,594 

 

3.9%

 

 $           29,206 

Fixed maturities available-for-sale 

                  595,791 

 

             619,654 

 

79.4%

 

            619,654 

Equity securities available-for-sale 

                    59,589 

 

               78,693 

 

10.1%

 

              78,693 

Cash 

                           61 

 

                      61 

 

0.0%

 

                     61 

Short-term investments  

                    46,239 

 

               46,239 

 

5.9%

 

              46,239 

Other long-term investments 

                      5,550 

 

                 5,550 

 

0.7%

 

                5,550 

 

 $               736,436 

 

 $          780,791 

 

100.0%

 

 $         779,403 

 

 

 

 

 

 

 

 

 

 

 

31

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

The amortized cost and estimated fair value of fixed maturity and equity securities at September 30, 2005 were as follows:

 

 

Held-to-maturity

 

 

 

Gross

 

Gross

 

 

 

Amortized

 

unrealized

 

unrealized

 

Estimated

($ in thousands)

cost

 

gains

 

losses

 

fair value

U.S. treasury securities and obligations of

 

 

 

 

 

 

 

U.S. government corporations and agencies 

 $                 19,018 

 

 $                 499 

 

 $                  - 

 

 $           19,517 

Mortgage-backed securities 

                         883 

 

                      70 

 

                     - 

 

                   953 

Total securities held-to-maturity 

 $                 19,901 

 

 $                 569 

 

 $                  - 

 

 $           20,470 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

Gross

 

Gross

 

 

 

Amortized

 

unrealized

 

unrealized

 

Estimated

($ in thousands)

cost

 

gains

 

losses

 

fair value

U.S. treasury securities and obligations of

 

 

 

 

 

 

 

U.S. government corporations and agencies 

 $               297,464 

 

 $                   35 

 

 $            2,052 

 

 $         295,447 

Obligations of states and political subdivisions 

                  251,065 

 

               11,033 

 

                    42 

 

            262,056 

Mortgage-backed securities 

                    10,176 

 

                    457 

 

                      - 

 

              10,633 

Public utilities 

                      6,004 

 

                    582 

 

                      - 

 

                6,586 

Debt securities issued by foreign governments 

                      7,078 

 

                    129 

 

                      - 

 

                7,207 

Corporate securities 

                  175,713 

 

                 7,345 

 

                  821 

 

            182,237 

Total fixed maturity securities 

                  747,500 

 

               19,581 

 

               2,915 

 

            764,166 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

 

 

 

 

Common stocks 

                    61,882 

 

               25,950 

 

               1,149 

 

              86,683 

Non-redeemable preferred stocks 

                         500 

 

                      10 

 

                      - 

 

                   510 

Total equity securities 

                    62,382 

 

               25,960 

 

               1,149 

 

              87,193 

Total securities available-for-sale 

 $               809,882 

 

 $            45,541 

 

 $            4,064 

 

 $         851,359 

 

 

 

 

 

 

 

 

 

 

The Company’s insurance and reinsurance subsidiaries have $36,000,000 of surplus notes issued to Employer Mutual. These surplus notes have an annual interest rate of 3.09 percent and do not have a maturity date. Payment of interest and repayment of principal can only be made out of the applicable subsidiary’s statutory surplus and is subject to prior approval by the insurance commissioner of the respective state of domicile. The surplus notes are subordinate and junior in right of payment to all obligations or liabilities of the applicable insurance subsidiaries. The Company’s subsidiaries incurred $834,000 of interest expense on these surplus notes in the first nine months of 2005 and 2004. At December 31, 2004, the Company’s subsidiaries had received approval for the payment of interest accrued on the surplus notes during 2004.

 

As of September 30, 2005, the Company had no material commitments for capital expenditures.

 

 

32

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Off-Balance Sheet Arrangements

 

Employers Mutual receives all premiums and pays all losses and expenses associated with the assumed reinsurance business ceded to the reinsurance subsidiary and the insurance business produced by the pool participants, and then settles the inter-company balances generated by these transactions with the participating companies on a quarterly basis. When settling the inter-company balances, Employers Mutual provides the reinsurance subsidiary and the pool participants with full credit for the premiums written during the quarter and retains all receivable amounts. Any receivable amounts that are ultimately deemed to be uncollectible are charged-off by Employers Mutual and the expense is charged to the reinsurance subsidiary or allocated to the pool members on the basis of pool participation. As a result, the Company has an off-balance sheet arrangement with an unconsolidated entity that results in a credit-risk exposure that is not reflected in the Company’s financial statements. Based on historical data, this credit-risk exposure is not considered to be material to the Company’s results of operations or financial position.

 

Investment Impairments and Considerations

 

The Company has not recorded any other-than-temporary investment impairments during the first nine months of 2005. During 2004 the Company had one fixed maturity security series (MCI Communications Corporation) that was determined to be other-than-temporarily impaired. MCI Communications Corporation was owned by WorldCom Inc., whose corporate bonds were downgraded to junk status in May 2002 when it reported the detection of accounting irregularities. On June 30, 2002 the Company recognized $3,821,000 of realized loss when the carrying value of this investment was reduced from an aggregate book value of $5,604,000 to the then current fair value of $1,783,000. The fair value of the MCI bonds then partially recovered, resulting in pre-tax unrealized gains of $1,035,000 recognized during 2002 and $1,811,000 recognized during 2003. During the second quarter of 2004 the Company received three new series of fixed maturity securities (with impaired book values) issued by MCI Communications Corporation in conjunction with a payout award received under a bankruptcy court approved “Plan of Reorganization.” This payout was recorded as a tax-free exchange and the new bonds were assigned a book value equal to the book value of the defaulted bonds that were replaced ($5,509,000). The par value of the new bonds reflected the settlement amount of 79.2 cents per dollar ($4,552,000) and the fair value of the new bonds was $4,241,000 at the time of the payout. Based on these facts, a realized investment gain of $3,826,000 was recognized in the second quarter of 2004 to offset the other-than-temporary impairment loss previously recognized in the second quarter of 2002 and an other-than-temporary impairment loss of $1,268,000 was recognized to reduce the book value of the new bonds to fair value at the time of the payout. The new bonds were sold during the third quarter of 2004 for income tax purposes, resulting in an additional realized gain of $187,000.

 

At September 30, 2005, the Company had unrealized losses on held-to-maturity and available-for-sale securities as presented in the table below. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services. None of these securities are considered to be in concentrations by either security type or industry. The Company uses several factors to determine whether the carrying value of an individual security has been other-than-temporarily impaired. Such factors include, but are not limited to, the security’s value and performance in the context of the overall markets, length of time and extent the security’s fair value has been below carrying value, key corporate events and collateralization of fixed maturity securities. Based on these factors, and the Company’s ability and intent to hold the fixed maturity securities until maturity, it was determined that the carrying value of these securities was not other-than-temporarily impaired at September 30, 2005. Risks and uncertainties inherent in the methodology utilized in this evaluation process include interest rate risk, equity price risk and the overall performance of the economy, all of which have the potential to adversely affect the value of the Company’s investments. Should a determination be made at some point in the future that these unrealized losses are other-than-temporary, the Company’s earnings would be reduced by approximately $2,642,000, net of tax; however, the Company’s financial position would not be affected due to the fact that unrealized losses on available-for-sale securities are reflected in the Company’s financial statements as a component of stockholders’ equity, net of deferred taxes.

 

 

33

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

Following is a schedule of the length of time securities have continuously been in an unrealized loss position as of September 30, 2005.

 

 

Description of securities

Fair value 

 

Unrealized losses 

($ in thousands)

 

 

 

Fixed maturity securities:

 

 

 

Less than six months 

 $    254,048 

 

 $                      1,713 

Six to twelve months 

         33,436 

 

                         1,166 

Twelve months or longer 

           2,808 

 

                              36 

Total fixed maturity securities 

       290,292 

 

                         2,915 

 

 

 

 

Equity securities:

 

 

 

Less than six months 

         15,289 

 

                            915 

Six to twelve months 

           1,804 

 

                            224 

Twelve months or longer 

                66 

 

                              10 

Total equity securities 

         17,159 

 

                         1,149 

 

 

 

 

Total temporarily

 

 

 

impaired securities 

 $    307,451 

 

 $                      4,064 

 

 

 

 

 

The Company held two series of General Motors Acceptance Corporation fixed maturity securities that were considered non-investment grade at September 30, 2005, with one of those series in an unrealized loss position ($643,000 unrealized loss before tax). All other non-investment grade fixed maturity securities held at September 30, 2005 (Great Lakes Chemical Corporation, Sears Roebuck Acceptance Corporation and US Freightways Corporation) were in an unrealized gain position. The Company does not invest in non-investment grade securities. Any non-investment grade securities held by the Company are the result of rating downgrades that occurred subsequent to their purchase. An exception was made to this policy in 2004 when the Company sold and then repurchased non-investment grade MCI debt securities (Moody’s bond rating of B) in order to recognize a current income tax benefit.

 

Following is a schedule of gross realized losses recognized in 2005 along with the associated book values and sales prices aged according to the length of time the underlying securities were in an unrealized loss position. This schedule does not include realized losses stemming from corporate actions such as calls, pay-downs, redemptions, etc. The Company’s equity portfolio is managed on a “tax-aware” basis, which generally results in sales of securities at a loss to offset sales of securities at a gain, thus minimizing the Company’s income tax expense. Fixed maturity securities were not included in the schedule since no realized losses were recognized on these investments stemming from disposals other than corporate actions. Fixed maturity securities are generally held until maturity.

 

 

Book

 

Sales

 

Gross

($ in thousands)

value

 

price

 

realized loss

Equity securities:

 

 

 

 

 

Three months or less 

 $    12,208 

 

 $    11,129 

 

 $            1,079 

Over three months to six months 

         3,530 

 

         2,925 

 

                  605 

Over six months to nine months 

            154 

 

            136 

 

                    18 

Over nine months to twelve months 

            297 

 

            254 

 

                    43 

Over twelve months 

                 - 

 

                 - 

 

                      - 

 

 $    16,189 

 

 $    14,444 

 

 $            1,745 

 

 

 

 

 

 

 

 

34

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

LEASES, COMMITMENTS AND CONTINGENT LIABILITIES

 

The increase in the Company’s aggregate participation in the pooling agreement effective January 1, 2005 had a significant affect on its contractual obligations for expected payments in the settlement of its loss reserves and its share of real estate operating leases and software operating leases expensed through the pool. The Company’s contractual obligation for long-term debt did not change from that presented in the Company’s 2004 Form 10-K. The following table reflects the Company’s contractual obligations as of September 30, 2005.

 

 

Payments due by period

 

 

 

Less than

 

1 - 3

 

4 - 5 

 

More than

 

Total

 

1 year

 

years

 

years

 

5 years

($ in thousands)

 

 

 

 

 

 

 

 

 

Contractual Obligations

 

 

 

 

 

 

 

 

 

Loss and settlement expense

 

 

 

 

 

 

 

 

 

reserves (1) 

 $  556,081 

 

 $  221,487 

 

 $  203,359 

 

 $    68,565 

 

 $    62,670 

Long term debt 

       36,000 

 

                 - 

 

                 - 

 

                 - 

 

       36,000 

Real estate operating leases 

         8,798 

 

            354 

 

         2,675 

 

         2,165 

 

         3,604 

Software operating leases 

            479 

 

            479 

 

                 - 

 

                 - 

 

                 - 

Total 

 $  601,358 

 

 $  222,320 

 

 $  206,034 

 

 $    70,730 

 

 $  102,274 

 

 

 

 

 

 

 

 

 

 

 

(1) The amounts presented are estimates of the dollar amounts and time periods in which the Company expects to pay out its gross loss and settlement expense reserves. These amounts are based on historical payment patterns and do not represent actual contractual obligations. The actual payment amounts and the related timing of those payments could differ significantly from these estimates.

 

Estimated guaranty fund assessments of $1,558,000 and $1,207,000, which are used by states to pay claims of insolvent insurers domiciled in that state, have been accrued as of September 30, 2005 and December 31, 2004, respectively. The guaranty fund assessments are expected to be paid over the next two years with premium tax offsets of $1,757,000 expected to be realized within ten years of the payments. Estimated second injury fund assessments of $1,769,000 and $1,390,000, which are designed to encourage employers to employ a worker with a pre-existing disability, have been accrued as of September 30, 2005 and December 31, 2004, respectively. The second injury fund assessment accruals are based on projected loss payments. The periods over which the assessments will be paid is not known.

 

The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions. The Company’s share of loss reserves eliminated by the purchase of these annuities was $700,000 at December 31, 2004. Due to the change in the Company’s aggregate participation in the pooling agreement, this amount increased to $894,000 effective January 1, 2005, therefore, the Company has a contingent liability of $894,000 should the issuers of these annuities fail to perform under the terms of the annuities. The Company’s share of the amount due from any one life insurance company does not equal or exceed one percent of its subsidiaries’ policyholders’ surplus.

 

 

35

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

 

CONDITION AND RESULTS OF OPERATIONS, CONTINUED

 

 

(Unaudited)

 

NEW ACCOUNTING PRONOUNCEMENTS

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) “Share-Based Payment,” which is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees.” SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their grant date fair values. The pro forma disclosures previously allowed under SFAS 123 will no longer be an alternative to financial statement recognition. The transition methods for adoption include the modified-prospective and modified-retroactive methods. The modified-prospective method requires that compensation expense be recorded for all unvested stock options that exist upon the adoption of SFAS 123(R). Under the modified-retroactive method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The effective date for SFAS 123(R) was originally the first interim and annual periods beginning after June 15, 2005, with earlier adoption encouraged. On April 14, 2005, the Securities and Exchange Commission approved a rule which delayed the required effective date of SFAS 123(R) until fiscal years beginning after June 15, 2005. The Company will adopt SFAS 123(R) in the first quarter of 2006 using the modified-prospective adoption method. Adoption of this statement is not expected to have a material effect on the operating results of the Company, as the impact to net income is not anticipated to deviate significantly from the pro forma disclosures provided in footnote 4 to the financial statements (reduction to after-tax net income of $88,000 for the nine months ended September 30, 2005).

 

In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and SFAS No. 3.” SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless express guidance in newly issued pronouncements indicate alternative transition accounting or it is impracticable to determine the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of a change in accounting principles, the new accounting principle is applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable, with a corresponding adjustment made to the opening balance of retained earnings for that period. If it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, the new accounting principle is applied prospectively from the earliest date practicable. Corrections of errors are to be handled in a similar manner. The provisions of SFAS 154 are to be applied to changes in accounting principles and corrections of errors on or after January 1, 2006. The Company does not expect adoption of this statement to have an effect on the operating results of the Company.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

The Private Securities Litigation Reform Act of 1995 provides issuers the opportunity to make cautionary statements regarding forward-looking statements. Accordingly, any forward-looking statement contained in this report is based on management’s current beliefs, assumptions and expectations of the Company’s future performance, taking into account all information currently available to management. These beliefs, assumptions and expectations can change as the result of many possible events or factors, not all of which are known to management. If a change occurs, the Company’s business, financial condition, liquidity, results of operations, plans and objectives may vary materially from those expressed in the forward-looking statements The risks and uncertainties that may affect the actual results of the Company include, but are not limited to, the following: catastrophic events and the occurrence of significant severe weather conditions; the adequacy of loss and settlement expense reserves; state and federal legislation and regulations; changes in our industry, interest rates or the performance of financial markets and the general economy; rating agency actions and other risks and uncertainties inherent to the Company’s business. When the Company uses the words “believe”, “expect”, “anticipate”, “estimate” or similar expressions, the Company intends to identify forward-looking statements. You should not place undue reliance on these forward-looking statements.

 

 

36

 



 

 

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

(Unaudited)

 

The main objectives in managing the investment portfolios of the Company are to maximize after-tax investment income and total investment return while minimizing credit risks, in order to provide maximum support for the underwriting operations. Investment strategies are developed based upon many factors including underwriting results and the Company’s resulting tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are centrally managed by investment professionals and are supervised by the investment committees of the respective board of directors for each of the Company’s subsidiaries.

 

Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks of the financial instruments of the Company relate to the investment portfolio, which exposes the Company to interest rate and equity price risk, and to a lesser extent credit quality and prepayment risk. Monitoring systems and analytical tools are in place to assess each of these elements of market risk.

 

Two categories of influences on market risk exist as it relates to financial instruments. First are systematic aspects, which relate to the investing environment and are out of the control of the investment manager. Second are non-systematic aspects, which relate to the construction of the investment portfolio through investment policies and decisions, and are under the direct control of the investment manager. Due to systematic changes, several components of market risk increased noticeably during 2002 and 2003, but appear to have leveled off or declined in 2004 and 2005. As it relates to equity price risk, the poor performance of the markets during that period resulted in declines in the values of the Company’s equity investments. This risk appears to be declining due to the recovery of the markets. Credit quality risk rose, resulting in declines in the values of several bond investments stemming from the many high-profile bankruptcies and other downgrade activities during that period. This risk also appears to be subsiding as the general economic condition continues to show signs of strengthening. Prepayment risk increased, primarily for the mortgage-backed securities, as declines in interest rates during that period accelerated the payment of higher-interest rate mortgages through re-financing activity. And finally, to a lesser extent interest rate risk increased due to interest rates bottoming-out during that period. Future interest rate increases will result in declines in the values of fixed maturity securities from their current values. Throughout all these systematic changes, the Company has continued its commitment to controlling non-systematic risk through sound investment policies and diversification.

 

Further analysis of the components of the Company’s market risk (including interest rate risk, equity price risk, credit quality risk, and prepayment risk) can be found in the Company’s 2004 Form 10-K.

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the Company has conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were functioning effectively as of the end of the period covered by this report to provide reasonable assurance that the Company can meet its disclosure obligations. There were no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

37

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

PART II.

OTHER INFORMATION

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURIES AND USE OF PROCEEDS

 

The following table sets forth information regarding purchases of equity securities by the Company and affiliated purchasers for the three months ended September 30, 2005:

 

 

 

 

 

 

 

(c) Total number

 

(d) Maximum number

 

(a) Total

 

(b) Average

 

of shares (or  

 

(or approximate dollar

 

number of

 

price

 

units) purchased

 

value) of shares 

 

shares

 

paid

 

as part of publicly

 

(or units) that may yet

 

(or units)

 

per share

 

announced plans

 

be purchased under

Period

purchased

 

(or unit)

 

or programs

 

 the plans or programs

 

 

 

 

 

 

 

 

7/1/05 - 7/31/05

7,913 

(1)

$            18.09 

 

                      7,500 

(2)

 $                  10,444,865 

 

 

 

 

 

 

 

 

8/1/05 - 8/31/05

37,479 

(1)

17.94 

 

                    37,365 

(2)

                       9,774,739 

 

 

 

 

 

 

 

 

9/1/05 - 9/30/05

158,006 

(1)

17.95 

 

                  156,400 

(2)

                       6,966,003 

 

 

 

 

 

 

 

 

Total

203,398 

 

$            17.96 

 

                  201,265 

 

 $                    6,966,003 

 

 

 

 

 

 

 

 

 

(1) 413, 114 and 1,606 shares were purchased in the open market in July, August and September, respectively, under the Company’s dividend reinvestment and common stock purchase plan.

 

(2) On May 12, 2005 the Company announced that its parent company, Employers Mutual Casualty Company, had initiated a $15 million stock purchase program under which Employers Mutual would purchase shares of the Company’s common stock in the open market. This purchase program was effective immediately and does not have an expiration date.

 

 

ITEM 6.

EXHIBITS

 

 

31.1

Certification of the President and Chief Executive Officer as required by Section 302 of the

 

Sarbanes-Oxley Act of 2002.

 

 

 

31.2

Certification of the Senior Vice President and Chief Financial Officer as required by Section 302

 

of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as

 

Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

Certification of the Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section

 

1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

 

38

 



 

 

EMC INSURANCE GROUP INC. AND SUBSIDIARIES

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

EMC INSURANCE GROUP INC.

Registrant

 

 

/s/ Bruce G. Kelley

Bruce G. Kelley

President & Chief Executive Officer

 

 

 

 

/s/ Mark E. Reese

Mark E. Reese

Senior Vice President and

Chief Financial Officer

 

 

 

Date: November 14, 2005

 

 

 

39

 

 

 

EX-31 2 exh311.htm CERTIFICATION CEO

 

 

EXHIBIT 31.1

CERTIFICATIONS

 

I, Bruce G. Kelley, certify that:

 

 

1.

I have reviewed this report on Form 10-Q of EMC Insurance Group Inc.;

 

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a

 

material fact necessary to make the statements made, in light of the circumstances under which such

 

 

statements were made, not misleading with respect to the period covered by this report;

 

 

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report,

 

fairly present in all material respects the financial condition, results of operations and cash flows of the

 

 

registrant as of, and for, the periods presented in this report;

 

 

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure

 

 

controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control

 

 

over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and

 

have:

 

 

 

a.

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to

 

 

be designed under our supervision, to ensure that material information relating to the registrant, including

 

its consolidated subsidiaries, is made known to us by others within those entities, particularly during the

 

 

period in which this report is being prepared;

 

 

 

b.

Designed such internal control over financial reporting, or caused such internal control over financial

 

reporting to be designed under our supervision, to provide reasonable assurance regarding the

 

 

reliability of financial reporting and the preparation of financial statements for external purposes in

 

 

accordance with generally accepted accounting principles;

 

 

 

c.

Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this

 

 

report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of

 

the period covered by this report based on such evaluation; and

 

 

 

d.

Disclosed in this report any change in the registrant's internal control over financial reporting that

 

 

occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case

 

of an annual report) that has materially affected, or is reasonably likely to materially affect, the

 

 

registrant's internal control over financial reporting; and

 

 

 

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal

 

control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of

 

 

directors (or persons performing the equivalent functions):

 

 

 

a.

All significant deficiencies and material weaknesses in the design or operation of internal control over

 

financial reporting which are reasonably likely to adversely affect the registrant's ability to record,

 

 

process, summarize and report financial information; and

 

 

 

b.

Any fraud, whether or not material, that involves management or other employees who have a significant

 

role in the registrant's internal control over financial reporting.

 

 

 

Date:

November 14, 2005

 

/s/ Bruce G. Kelley

Bruce G. Kelley, President and

Chief Executive Officer

 

 

 

40

 

 

 

 

EX-31 3 exh312.htm CERTIFICATION CFO

 

 

EXHIBIT 31.2

CERTIFICATIONS

 

I, Mark E. Reese, certify that:

 

 

1.

I have reviewed this report on Form 10-Q of EMC Insurance Group Inc.;

 

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a

 

material fact necessary to make the statements made, in light of the circumstances under which such

 

 

statements were made, not misleading with respect to the period covered by this report;

 

 

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report,

 

fairly present in all material respects the financial condition, results of operations and cash flows of the

 

 

registrant as of, and for, the periods presented in this report;

 

 

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure

 

 

controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control

 

 

over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and

 

have:

 

 

 

a.

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to

 

 

be designed under our supervision, to ensure that material information relating to the registrant, including

 

its consolidated subsidiaries, is made known to us by others within those entities, particularly during the

 

 

period in which this report is being prepared;

 

 

 

b.

Designed such internal control over financial reporting, or caused such internal control over financial

 

reporting to be designed under our supervision, to provide reasonable assurance regarding the

 

 

reliability of financial reporting and the preparation of financial statements for external purposes in

 

 

accordance with generally accepted accounting principles;

 

 

 

c.

Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this

 

 

report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of

 

the period covered by this report based on such evaluation; and

 

 

 

d.

Disclosed in this report any change in the registrant's internal control over financial reporting that

 

 

occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case

 

of an annual report) that has materially affected, or is reasonably likely to materially affect, the

 

 

registrant's internal control over financial reporting; and

 

 

 

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal

 

control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of

 

 

directors (or persons performing the equivalent functions):

 

 

 

a.

All significant deficiencies and material weaknesses in the design or operation of internal control over

 

financial reporting which are reasonably likely to adversely affect the registrant's ability to record,

 

 

process, summarize and report financial information; and

 

 

 

b.

Any fraud, whether or not material, that involves management or other employees who have a significant

 

role in the registrant's internal control over financial reporting.

 

 

 

Date:

November 14, 2005

 

/s/ Mark E. Reese

Mark E. Reese, Senior Vice President

and Chief Financial Officer

 

 

 

41

 

 

 

 

EX-32 4 exh321.htm 906 CERTIFICATION OF CEO

 

 

EXHIBIT 32.1

 

 

CERTIFICATION OF PRESIDENT & CHIEF EXECUTIVE OFFICER PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

 

In connection with the accompanying Quarterly Report of EMC Insurance Group Inc. on Form 10-Q for the period ended September 30, 2005, the undersigned herby certifies, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his capacity as an officer of EMC Insurance Group Inc. that:

 

 

(1)

The report fully complies with the requirements of Section 13(a) or 15(d) of Securities Exchange

 

Act of 1934, and

 

 

 

(2)

The information contained in this report fairly presents, in all material respects, the company's

 

financial condition and results of operations.

 

 

EMC INSURANCE GROUP INC.

Registrant

 

 

/s/ Bruce G. Kelley

Bruce G. Kelley

President & Chief Executive Officer

 

 

 

Date: November 14, 2005

 

 

42

 

 

 

EX-32 5 exh322.htm 906 CERTIFICATION OF CFO

 

 

EXHIBIT 32.2

 

 

CERTIFICATION OF PRESIDENT & CHIEF EXECUTIVE OFFICER PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

 

In connection with the accompanying Quarterly Report of EMC Insurance Group Inc. on Form 10-Q for the period ended September 30, 2005, the undersigned herby certifies, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his capacity as an officer of EMC Insurance Group Inc. that:

 

 

(1)

The report fully complies with the requirements of Section 13(a) or 15(d) of Securities Exchange

 

Act of 1934, and

 

 

 

(2)

The information contained in this report fairly presents, in all material respects, the company's

 

financial condition and results of operations.

 

 

EMC INSURANCE GROUP INC.

Registrant

 

 

/s/ Mark E. Reese

Mark E. Reese

Senior Vice President and Chief Financial Officer

 

 

 

Date: November 14, 2005

 

 

43

 

 

 

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