-----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, E/7I9GJ5EJFrgpdAnhqpykzz2IBxlTqeL3Fi0x7ELKmJQFVqgpcqzE0m4i5/3Iya RgJJ8NFDOPPcxo/FoQ62Sw== 0000865058-02-000002.txt : 20020415 0000865058-02-000002.hdr.sgml : 20020415 ACCESSION NUMBER: 0000865058-02-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL SECURITY GROUP INC CENTRAL INDEX KEY: 0000865058 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 631020300 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-18649 FILM NUMBER: 02594358 BUSINESS ADDRESS: STREET 1: 661 E DAVIS ST CITY: ELBA STATE: AL ZIP: 36323 BUSINESS PHONE: 2058972273 10-K 1 form10k2001.txt 2001 FORM 10K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 ----------------- Commission File Number 0-18649 The National Security Group, Inc. (Exact name of registrant as specified in its charter) Delaware 63-1020300 661 East Davis Street, Elba, Alabama 36323 - --------- ---------- ------------------------------------ ------ (State or other (IRS Employer (Address of principal executive offices)(Zip code) jurisdiction of identification incorporation or number) organization) Registrant's telephone number, including area code (334) 897-2273 -------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock par value $1.00 per share Title of Each Class Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. (X) Aggregate market value of the voting stock held by nonaffiliates of the Registrant as of February 28, 2002 (based upon the bid price of these shares on NASDAQ on such date) - $10,952,043. Number of Shares of Common Stock outstanding as of February 28, 2002 - 2,466,600 Portions of the Annual Proxy Statement incorporated by reference into Part III. Total Number of Sequentially Numbered Pages: 58 1 THE NATIONAL SECURITY GROUP, INC. INDEX TO THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 Part I Page Item 1. Business 3 Item 2. Properties 11 Item 3. Legal Proceedings 11 Item 4. Submission of Matters to a Vote of Security Holders 11 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 12 Item 6. Selected Financial Data 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 8. Consolidated Financial Statements and Supplementary Data 21 Item 9. Changes in and Disagreements with Accountants and Financial Disclosure 55 Part III Item 10. Directors and Executive Officers of the Registrant 56 Item 11. Executive Compensation 56 Item 12. Security Ownership of Certain Beneficial Owners and Management 56 Item 13. Certain Relationships and Related Transactions 56 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports of Form 8-K 57 Signature Page 58 2 PART I Item 1. Business Summary Description of The National Security Group, Inc. The National Security Group, Inc. (the Company), an insurance holding company, was incorporated in Delaware on March 20, 1990. The Company, through its property and casualty subsidiaries, writes primarily dwelling fire and windstorm, homeowners, mobile homeowners, and personal non-standard automobile lines of insurance. The Company, through its life insurance subsidiary, offers a basic line of life, and health and accident insurance products. Property-casualty insurance is the most significant segment, accounting for 80% of total premium revenues. Industry Segment and Geographical Area Information Property and Casualty Insurance Segment The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1993. NSFC is licensed to write insurance in the states of Alabama, Arkansas, Florida, Georgia, Mississippi, Oklahoma, South Carolina, and Tennessee, and operates on a surplus lines basis in the states of Kentucky, Louisiana, Missouri, and Texas. Omega is licensed to write insurance in Alabama and Louisiana. The following table indicates those states which accounted for more than five percent of direct written premium during 2001: State Percent of direct written premium ------ --------------------------------- Alabama ...................................... 54.37% Arkansas ..................................... 7.98% Georgia ...................................... 6.78% Louisiana .................................... 8.75% Mississippi .................................. 8.26% In general, the property-casualty insurance business involves the transfer by the insured, to an insurance company of all or a portion of certain risks for the payment, by the insured, of a premium to the insurance company. A portion of such risks is often retained by the insured in the form of deductibles which may vary greatly from policy to policy. The premiums or payments to be made by the insured for direct products of the property-casualty subsidiaries are based upon expected cost of providing benefits, writing, and administering the policies. In determining the premium to be charged, the property-casualty subsidiaries utilize data from past claims experience and anticipated claims estimates along with commissions and general expenses. Historically, there has been more price competition among property-casualty insurers than other types of insurers. 3 The operating results of the property-casualty insurance industry are subject to significant fluctuations from quarter to quarter and from year to year due to the effect of competition on pricing, the frequency and severity of losses incurred in connection with weather-related and other catastrophic events, general economic conditions, and other factors such as changes in tax laws and the regulatory environment. The following table sets forth the premiums earned and income (loss) during the periods reported: Year Ended December 31 (Amounts in Thousands) 2001 2000 1999 ----- ----- ----- Net premiums earned: Fire, Allied lines, and Homeowners ........ $14,037 $13,229 $14,600 Automobile ................................ 5,132 4,126 6,086 Other ..................................... 1,028 971 999 ------- ------- ------- $20,197 $18,326 $21,685 ======= ======= ======= Income (loss) before income taxes .......... $ 5,440 $ 3,917 $ 2,365 ======= ======= ======= Life Insurance Segment The Company's life insurance business is conducted by National Security Insurance Company (NSIC), a wholly owned subsidiary organized in 1947. NSIC is licensed to write insurance in six states Alabama, Florida, Georgia, Mississippi, South Carolina, and Texas. The following table indicates NSIC direct premiums collected by state in 2001: State Percentage of Total Direct Premiums Alabama ................................. 80% Georgia ................................. 11% Mississippi ............................. 5% Florida ................................. 4% NSIC has two primary methods of distribution of insurance products, home service agents and independent agents. Home service distribution life insurance products account for 69% of total premium revenues in the life insurance segment. Home service life products consist of products marketed directly at the home or other premises of the insured by an employee agent of the Company. The independent agent distribution method accounts for 22% of total premium revenue in the life insurance segment. Since NSIC began marketing life, accident and health products through independent agents in 1999 the distribution channel has become the fastest growing method of distribution. The products offered by NSIC primarily consist of term and whole life insurance and supplemental accident and health insurance. NSIC does not sell annuities. Term life insurance policies provide death benefits if the insured's death occurs during the specific premium paying term of the policy and generally do not include a savings or investment element in the policy premium. Whole-life insurance policies demand a higher premium than term life, but provide death benefits which are payable under effective policies regardless of the time of the insured's death and have a savings and investment element which may result in the accumulation of a cash surrender value. 4 Accident and health business is primarily accident policies sold through schools, though NSIC is beginning to experience an increase in accident sales through its independent and captive agency force. Accident and health insurance provides coverage for losses sustained through sickness or accident and includes individual hospitalization and accident policies, group supplementary health policies and specialty products, such as cancer policies. These policies generally provide a stated benefit and have not experienced the escalating health care costs which many health and accident insurance policies have experienced in recent years. The following table sets forth certain information respecting the development of the Life Company's business: Year Ended December 31 (Amounts in Thousands) 2001 2000 1999 ---- ---- ---- Life insurance in force at end of period: Ordinary-whole life ............ $104,700 $ 85,000 $ 80,200 Term Life ...................... 40,300 36,000 35,100 Industrial ..................... 33,000 30,000 30,700 Other .......................... 0 0 0 -------- -------- -------- 178,000 151,000 146,000 ======== ======== ======== Year Ended December 31 (Amounts in Thousands) 2001 2000 1999 ---- ---- ---- New life insurance issued: Ordinary-whole life ............... $82,700 $69,400 $66,200 Term Life ......................... 13,500 10,500 7,700 Industrial ........................ 0 0 0 Other ............................. 100 100 100 ------- ------- ------- 96,300 80,000 74,000 ======= ======= ======= Net premiums earned: Life insurance ...................... $4,139 $3,746 $3,396 Accident and health insurance ....... 1,022 848 855 ------ ------ ------ 5,161 4,594 4,251 ====== ====== ====== Investments The insurance subsidiaries are regulated as to the types of investments which they may make and the amount of funds they may maintain in any one type of investment. Through its investment policy, the Company seeks to conserve its capital resources and assets, meet the investment requirements of its reserves and provide a reasonable return on investments. 5 The following table sets forth certain information respecting the Company's investments at the date shown:
Year Ended December 31 (Amounts in thousands) 2001 2000 ---- ---- Investment Securities held-to-maturity, at amortized cost (estimated fair value: 2001 - $23,922, 2000 - $29,035) $23,135 $28,875 Investment Securities available-for-sale, at market (cost: 2001 - $45,975, 2000 - $38,311) ............... 57,648 51,648 Receivable for securities sold ............................... 50 143 Note Receivable from affiliate ............................... 250 0 Mortgage loans on real estate, at cost ....................... 275 116 Investment real estate, at cost .............................. 1,563 1,569 Policy loans ................................................. 726 692 Investment in affiliate ...................................... 53 0 Short-term investments ....................................... 1,796 1,675 ------ ------ $85,496 $84,718 ======= ======
The results with respect to the foregoing investments are as follows: Year Ended December 31 2001 2000 1999 ---- ---- ---- Net investment income ................. $ 4,506 $ 4,434 $ 4,354 Average yield on investments .......... 5.3% 5.3% 5.1% Economic yield on investments (includes realized and unrealized investment gains) ......... 5.6% 6.7% 3.7% Net realized gains on investments (before income taxes) .................. 1,640 1,723 1,951 Changes in net unrealized gains on investments (before income taxes) .... (1,366) (191) (3,196) As of December 31, 2001, the maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows: Maturity Schedule (Amounts in thousands) Available Held to Percentage Maturity for sale Maturity Total of Total -------- -------- -------- ------ -------- Maturity in less than 1 year ...... $ 1,795 $ 2,384 $ 4,179 7.2% Maturity in 1-5 years ............. 6,243 5,783 12,026 20.8 Maturity in 5-10 years ............ 17,734 6,046 23,780 41.1 Maturity after 10 years ........... 8,929 8,922 17,851 30.9 ------- ------- ------- ----- Totals ............................ $34,701 $23,135 $57,836 100.0% ======= ======= ======= ===== 6 Investments in affiliate: In the fourth quarter of 2001 The Company entered into a joint investment with a local manufacturing firm, Cash Brothers Leasing, Inc and formed a new company, The Mobile Attic, Inc. The Mobile Attic, Inc, through a network of dealers, leases portable storage units. The primary customers of The Mobile Attic are building contractors, retail establishments, and residential consumers. At 12/31/2001 the Company held a 50% equity investment in The Mobile Attic. The investment was accounted for in the financial statements on the equity basis and contributed $52,000 to net income for the year. While the investment and impact on earnings was not material in 2001, earnings from The Mobile Attic are expected to become more significant in future periods. Early estimates indicate that The Mobile Attic will add 10 to 15% to consolidated earnings in 2002. Certain Information Regarding Insurance Activities Marketing and Distribution NSIC products are marketed through a field force of agents and service representatives who are employees of the Life Company and through a network of independent agents. The independent agent method of distribution is expected to be more cost effective and has become the fastest growing method of distribution. NSFC's products are marketed through a network of independent agents and brokers, who are independent contractors and who generally maintain relationships with one or more competing insurance companies. Agents receive compensation for their sales efforts. In the case of life insurance agents, compensation is paid in the form of sales commissions plus a servicing commission. Commissions incurred by NSIC in 2001 averaged approximately 34.8% of premiums. Commissions incurred by the NSFC in 2001 averaged approximately 17.1% of premiums and ranged from 12.5% to 27.5% depending on the type and amount of insurance sold. During 2001, no one independent agent accounted for more than 10% of total net earned premium of the property-casualty insurance subsidiaries. NSIC has implemented changes in collection of premium payments, and the method of marketing. If the policyholder so elects, he or she may begin making payments by mail to the home office rather than have a home service agent come to their house periodically to collect premiums. This change is being implemented in response to the change in lifestyles of our policyholders. It is increasingly difficult to reach policyholders at home until early evening, and they are usually too busy to be bothered. Those who elect to pay by mail will still be provided service by an area representative for help with claims and policy related questions. With this method of payment there have been reductions in the number of NSIC employee agents. Also, because it is becoming increasingly difficult to employ people to contact our policy owners at home, NSIC management is continuing to implement changes in the method of marketing of life insurance products. 7 Reinsurance Both insurance subsidiaries customarily reinsure with other insurers certain portions of the insurance risk. The primary purpose of such reinsurance arrangements is to enable the Company to limit its risk on individual policies, and in the case of property insurance, limit its risk in the event of a catastrophe in various geographic areas. A reinsurance arrangement does not discharge the issuing company from primary liability to the insured, and the issuing company is required to discharge its liability to the insured even if the reinsurer is unable to meet its obligations under the reinsurance arrangements. Reinsurance, however, does make the reinsurer liable to the issuing company to the extent of any reinsurance in force at the time of the loss. Reinsurance arrangements also decrease premiums retained by the issuing company since that company pays the reinsuring company a portion of total premiums based upon the amount of liability reinsured. NSIC generally reinsures all risks in excess of $50,000 with respect to any one policy. NSFC and Omega generally reinsure with third parties any liability in excess of $100,000 on any single policy. In addition, the property-casualty subsidiaries have catastrophe excess reinsurance which protects it in part with respect to aggregate property losses arising out of a single catastrophe, such as a hurricane. In 2001, the property-casualty subsidiaries had catastrophe protection up to a $21 million loss. On a 1 in 200 year loss, that is a loss that has only a 1/2 of 1% chance of occurring in any given year, the property and casualty subsidiaries would pay $2.7 million in losses and reinsurers would pay $17.9 million. In addition to catastrophe reinsurance, NSFC also had a 50% quota share reinsurance agreement on ocean marine exposure with additional excess of loss coverage. Reserve liabilities NSIC maintains life insurance reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are calculated to be sufficient to meet policy and contract obligations as they arise. Liabilities for future policy benefits are calculated using assumptions for interest, mortality, morbidity, expense, and withdrawals determined at the time the policies were issued. As of December 31, 2001, the total reserves of NSIC (including the reserves for accident and health insurance) were approximately $23 million. NSIC believes that such reserves for future policy benefits were calculated in accordance with generally accepted actuarial methods and that such reserves are adequate to provide for future policy benefits. Wakely & Associates, consulting actuaries, provided actuarial services in calculating reserves. The property-casualty subsidiaries are also required to maintain loss reserves (claim liabilities) for all lines of insurance. Such reserves are intended to cover the probable ultimate cost of settling all claims, including those incurred but not yet reported. The reserves of the property-casualty subsidiaries reflect estimates of the liability with respect to incurred claims and are determined by evaluating reported claims on an ongoing basis and by estimating liabilities for incurred but not reported claims. Such reserves include adjustment expenses to cover the cost of investigating losses and defending lawsuits. The establishment of accurate reserves is complicated by the fact that claims in some lines of insurance are settled many years after the policies have been issued, thus raising the possibility that inflation may have a significant effect on the amount of ultimate loss payment, especially when compared to initial loss estimates. The subsidiaries, however, attempt to restrict their writing to risks that settle within one to four years of issuance of the policy. As of December 31, 2001, the property-casualty subsidiaries had reserves for unpaid claims of approximately $13.9 million before subtracting unpaid claims which will be due from reinsurers of $2.4 million leaving net unpaid claims of $11.5 million. The reserves are not discounted for the time value of money. No changes were made in the assumptions used in estimating the reserves during the years ending December 31, 2001, 2000 or 1999. The Company believes such reserves are adequate to provide for settlement of claims. Employees of the Company calculate NSFC and Omega loss reserves. Milliman & Robertson, an independent actuarial consulting firm, issues a Statement of Actuarial Opinion regarding the adequacy of reserves. 8 Underwriting Activities The insurance subsidiaries maintain underwriting departments which seek to evaluate the risks associated with the issuance of an insurance policy. NSIC accepts standard risks and, to an extent, substandard risks and engages medical doctors who review certain applications for insurance. In the case of the property-casualty subsidiaries, the underwriting staff attempts to assess, in light of the type of insurance sought by an applicant, the risks associated with a prospective insured or insurance situation. Depending upon the type of insurance involved, the process by which the risks are assessed will vary. In the case of automobile liability insurance, the underwriting staff assesses the risks involved in insuring a particular driver, and in the case of fire insurance, the underwriting staff assesses the risks involved in insuring a particular dwelling. Where possible, the underwriting staff of the property-casualty insurance subsidiary utilizes standard procedures as guides that quantify the hazards associated with a particular business activity. In general, the property-casualty subsidiaries specialize in writing nonstandard risks. The nonstandard market in which the property-casualty subsidiaries operate reacts to general economic conditions in much the same way as the standard market. When insurers' profits and equity are strong, companies generally cut rates or not seek increases. Also, underwriting rules are less restrictive. As profit and/or capital fall, companies tighten underwriting rules, and seek rate increases. Premiums in the nonstandard market are higher than the standard market because of the increased risk of the insured, which generally comprises more frequent claims. Drivers of autos who have prior traffic convictions are one such increased risk which warrants higher premiums. Lower valued dwellings and mobile homes also warrant higher premiums because of the nature of the risk. The costs of placing such nonstandard policies and making risk determinations are similar to those of the standard market. The added costs due to more frequent claims servicing is reflected in the generally higher premiums which are charged. Regulation The insurance subsidiaries are each subject to regulation by the insurance departments of those states in which they are licensed to conduct business. Although the extent of regulation varies from state to state, the insurance laws of the various states generally establish supervisory departments having broad administrative powers with respect to, among other matters, the granting and revocation of licenses to transact business; the licensing of agents; the establishment of standards of financial solvency, including reserves to be maintained, the nature of investments and, in most cases premium rates; the approval of forms and policies; and the form and content of financial statements. These regulations have as their primary purpose the protection of policyholders and do not necessarily confer a benefit upon stockholders. Many states in which the insurance subsidiaries operate, including Alabama, have laws which require that insurers become members of guaranty associations. These associations guarantee that benefits due policyholders of insurance companies will continue to be provided even if the insurance company which wrote the business is financially unable to fulfill its obligations. To provide these benefits, the associations assess the insurance companies licensed in a state that write the line of insurance for which coverage is guaranteed. The amount of an insurer's assessment is generally based on the relationship between that company's premium volume in the state and the premium volume of all companies writing the particular line of insurance in the state. The Company has paid no material amounts to guaranty associations over the past three years. These payments, when made, are principally related to association costs incurred due to the insolvency of various insurance companies. Future assessments depend on the number and magnitude of insurance company insolvencies and such assessments are therefore difficult to predict. 9 Most states have enacted legislation or adopted administrative rules and regulations covering such matters as the acquisition of control of insurance companies, transactions between insurance companies and the persons controlling them. The National Association of Insurance Commissioners has recommended model legislation on these subjects and all states where the Company's subsidiaries transact business have adopted, with some modifications, that model legislation. Among the matters regulated by such statutes are the payments of dividends. These regulations have a direct impact on the Company since its cash flow is substantially derived from dividends from its subsidiaries. However, the Company has not had nor does it foresee a problem obtaining the necessary funds to operate because of the regulation. Competition The insurance subsidiaries are engaged in a highly competitive business and compete with many insurance companies of substantially greater financial resources, including stock and mutual insurance companies. Mutual insurance companies return profits, if any, to policyholders rather than stockholders; therefore, mutual insurance companies may be able to charge lower net premiums than those charged by stock insurers. Accordingly, stock insurers must attempt to achieve competitive premium rates through greater volume, efficiency of operations and control of expenses. NSIC primarily markets its life and health insurance products through the home service system. Direct competition comes from other home service companies, of which there are many. NSIC's life and health products also compete with products sold by ordinary life companies. NSIC writes policies primarily in Alabama. The market share of the total life and health premiums written is small because of the number of insurers in this highly competitive field. The primary methods of competition in the field are service and price. NSIC attempts to price its products with other home service companies. Because of the increased costs associated with a home service company, premium rates are generally higher than ordinary products, so competition from these ordinary insurers must be met through service. The property-casualty subsidiaries market their products through independent agents and brokers, concentrating on dwelling fire, homeowners and nonstandard auto coverage. NSFC, though one of the larger writers of lower value dwelling fire insurance in Alabama, nevertheless faces a number of competitors in this niche. Moreover, larger general line insurers also compete with NSFC. The market share in states other than Alabama is small. Price is the primary method of competition. Due to the method of marketing through independent agents, commission rates and service to the agent are also important factors in whether the independent agent agrees to offer NSFC products over its competitors. 10 Inflation The Company shares the same risks from inflation as other companies. Inflation causes operating expenses to increase and erodes the purchasing power of the Company's assets. A large portion of the Company's assets are invested in fixed maturity investments. The purchasing power of these investments will be less at maturity because of inflation. This is generally offset by the reserves which are a fixed liability and will be paid with cheaper dollars. Also, inflation tends to increase investment yields, which may reduce the impact of the increased operating expenses caused by inflation. Item 2. Properties The Company owns no property. The Life insurance subsidiary owns its principal executive offices located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 and consists of approximately 26,000 square feet. The Company believes this space to be adequate for its foreseeable future needs. The Company's subsidiaries own certain real estate properties, including approximately 2,700 acres of timberland in Alabama. Item 3. Legal Proceedings The Company and its subsidiaries are named as parties to litigation related to the conduct of their insurance operations. Further information regarding details of pending suits can be found in note N to the consolidated financial statements. Item 4. Submission of Matters to a vote of Security Holders There were no matters submitted to a vote of security holders during the three months ended December 31, 2001. 11 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The capital stock of the Company is traded in the NASDAQ national market. Quotations are furnished by the National Association of Security Dealers Automated Quotations System (NASDAQ). The trade symbol is NSEC. The number of shareholders of the Company's capital stock as of January 31, 2001, was approximately 1,100. Stock Bid Prices Dividends High Low Per Share 2001 First Quarter $15.63 $ 10.21 $ .183 Second Quarter 15.00 11.08 .183 Third Quarter 15.45 11.00 .19 Fourth Quarter 14.49 12.00 .20 2000 First Quarter $11.25 $ 9.17 $ .175 Second Quarter 10.21 9.17 .175 Third Quarter 14.27 10.42 .175 Fourth Quarter 16.04 11.04 .183 12 Item 6. Selected Financial Data (Amounts in thousands, except per share)
Operating results 2001 2000 1999 1998 1997 - ----------------- ------ ---- ---- ----- ---- Net premiums earned ...... $ 25,357 $ 22,921 $ 25,936 $ 28,451 $ 31,156 Net investment income .... 4,506 4,434 4,354 4,351 4,204 Net realized investment gains ............... 1,640 1,723 1,951 4,117 2,720 Other income ............. 1,280 597 385 385 695 --------- --------- --------- --------- --------- Total revenues ................ $ 32,783 $ 29,675 $ 32,626 $ 37,304 $ 38,775 ========= ========= ========= ========= ========= Net Income .................... $ 4,130 $ 3,776 $ 3,756 $ 930 $ 2,998 ========= ========= ========= ========= ========= Net income per share .......... $ 1.67 $ 1.53 $ 1.52 $ 0.35 $ 1.07 ========= ========= ========= ========= ========= Other Selected Financial Data Total shareholders' equity .... $ 44,884 $ 43,780 $ 41,888 $ 41,968 $ 46,352 Book value per share .......... $ 18.18 $ 17.74 $ 16.98 $ 17.05 $ 16.70 Dividends per share ........... $ 0.76 $ 0.71 $ 0.68 $ 0.64 $ 0.58 Net change in unrealized capital gains (net of tax) ($ 1,161) ($ 136) ($ 2,231) ($ 351) $ 4,556 Total assets .................. $ 99,484 $ 97,563 $ 98,105 $ 103,973 $ 106,958
13 Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related notes included elsewhere herein. Results of Operations Consolidated Results of Operations: Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Consolidated net income for The National Security Group (The Company) was $4.130 million in 2001 compared to $3.776 million in 2000. On a per share basis earnings were 1.67 in 2001 compared to 1.53 in 2000. A second consecutive year of underwriting profits in the property/casualty insurance subsidiaries boosted earnings to the highest levels in more than a decade. Realized capital gains in 2001 were 1.64 million and 1.72 million in 2000. Consolidated revenues were $32.8 million in 2001 compared to $29.7 million in 2000. The operating results of the subsidiaries are discussed in further detail in the sections that follow. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 Consolidated net income for The National Security Group was $3.776 million in 2000 compared to $3.756 million in 1999. On a per share basis earnings were $1.53 in 2000 compared to $1.52 in 1999. Operating results in The Company's property/casualty subsidiaries were much improved due to the elimination of several general agent auto programs, but a non-recurring charge incurred in the life insurance subsidiary due to a management decision to strengthen reserves in certain blocks of industrial life policies decreased earnings by approximately $.29 per share. Realized capital gains in 2000 were $1.72 million compared to $1.95 million in 1999. Consolidated revenues were $29.7 million in 2000 compared to $32.6 million in 1999. Industry Segment Data Certain financial information for The National Security Group's three segments (life and accident and health insurance, property and casualty insurance, and other) is summarized as follows (amounts in thousands):
Premium revenues: 2001 % 2000 % 1999 % ---- - ----- -- ----- -- Life and accident and health insurance $ 5,161 20.4 $ 4,594 20.1 $ 4,251 16.4 Property and casualty insurance $20,196 79.6 18,326 79.9 21,685 83.6 ------ ---- ------ ---- ------- ---- $25,357 100.0 $22,920 100.0 $25,936 100.0
14 Income before taxes and equity in income of affiliate:
2001 % 2000 % 1999 % ---- - ---- - ----- -- Life and accident and health insurance $ 586 10.7 $ 1,667 34.5 $ 2,556 56.6 Property and casualty insurance ...... $ 5,440 99.4 3,917 80.9 2,365 52.4 Other ................................ (313) (5.7) (473) (9.8) (110) (2.4) Interest expense ..................... (243) (4.4) (267) (5.6) (295) (6.6) ------- ----- ------- ----- ------- ----- $ 5,470 100.0 $ 4,844 100.0 $ 4,516 100.0 ======= ===== ======= ===== ======= =====
Life and Accident and Health Insurance Operations: The Company's life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. Year Ended December 31, 2001 Compared to Year Ended December 31, 2000: Income before income taxes in 2001 was $586,000 compared to $1,667,000 in 2000. Increased field cost and general expenses and a decrease in realized capital gains were the primary factors contributing to the decrease in income in the life insurance subsidiary. NSIC increased premium income 12.3% to $5,161,000 in 2001 compared to $4,594,000 in 2000. Life insurance premium income increased 10.5% in 2001, and accident and health insurance also had an increase of 20.5% in 2001. The life insurance sales through independent agents were the source of premium growth in NSIC in 2001. Commission expenses increased due to the continued increase in new business production. Life insurance commissions are front loaded, meaning that significantly higher commission rates are paid in the early years of a policy and decrease significantly particularly after the first two years of the policy. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999: Income before income taxes in 2000 was $1,667,000 compared to $2,556,000 in 1999. A one time charge for reserve increases on certain blocks of old industrial life insurance which NSIC no longer sells was the primary factor contributing to the decrease in income before income taxes. NSIC increased premium income 8% to $4,594,000 in 2000 compared to $4,251,000 in 1999. Life insurance premium income increased 10.3% in 2000, and accident and health insurance decreased slightly compared to 1999. Life insurance sales through independent agents were the source of premium growth in NSIC in 2000. As experienced in 1999, life insurance commission expense increased again in 2000. Life insurance issued by NSIC pays a higher commission in early years of the policy and the commission rate decreases in succeeding years. Since NSIC has experienced a large increase in new business volume, commission expense has increased. 15 Property & Casualty Operations: The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1993. Year Ended December 31, 2001 Compared to Year Ended December 31, 2000: Net income before income tax was $5,440,000 in 2001 compared to $3,917,000 in 2000. Improved underwriting results continued to be the primary factor contributing to the improvement in income before taxes. Earned premium for 2001 was $20,196,000 compared to $18,326,000 in 2000. The property/casualty subsidiaries experienced premium growth in dwelling fire, homeowners, and private passenger auto lines of business. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999: Net income before income tax was $3,917,000 in 2000 compared to $2,365,000 in 1999. Improved underwriting results were the primary factor contributing to the improvement in income before tax. The elimination of several unprofitable private passenger and commercial auto insurance programs run by managing general agents was the primary factor leading to the improvement in underwriting results. Management terminated the contract of the last remaining auto general agent program in 2000. The program, which produced private passenger auto premium in Florida, was terminated due to continued poor underwriting results. The final policies in force on this program expired in mid 2001. With the elimination of this program and other similar programs over the last two years management has significantly improved underwriting results. The elimination of the general agent programs combined with slight decreases in other core lines of business led to a 16% decrease in earned premium in 2000 compared to 1999. However, in the last half of 2000 NSFC did begin to experience a slight turnaround in premium production in core lines of business, which management attributes to an increase focus on marketing to independent insurance agents. Also, the elimination of the unprofitable managing general agent programs greatly improved underwriting profitability. In an effort to increase premium production in internally managed auto programs, as opposed the managing general agent form of distribution, Omega acquired 100% of the outstanding stock of Liberty Southern Insurance Company for a total cash purchase price of approximately $700,000. The purchase was consummated in the second quarter of 2000. With the purchase of Liberty Southern, Omega gained entry into the monthly bill private passenger auto market. The program is expected to produce $1,500,000 in direct written premium in 2001. 16 Property & Casualty Combined Ratio: A measure used to analyze a property/casualty insurer's underwriting performance is the statutory combined ratio. It is the sum of two ratios: a. The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premiums earned. b. The underwriting expense ratio, which measures underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premiums written during the year. The results of these ratios for the past three years were: 2001 2000 1999 ---- ---- ---- Loss and LAE Ratio ....... 54.3% 61.6% 70.9% Underwriting Expense Ratio 36.1% 34.8% 35.8% ---- ---- ----- Combined Ratio ........... 90.4% 96.4% 106.7% Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, and adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi, Louisiana, or Texas could cause the combined ratio to fluctuate materially from prior years. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe. The combined ratio for 2001 compared to 2000 decreased six percentage points. This improvement was attributable to a lack of storm activity in the dwelling property lines of business and the elimination of unprofitable general agent auto programs from prior years. Asset Portfolio Review: The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 2001, the company's holdings in debt securities amounted to 68% of total investments and 58% of total assets. The following is a breakdown of the bond portfolio quality according to National Association of Insurance Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the nationally recognized rating organization equivalents of Moody's and Standard and Poor's: SVO Equivalents % of Total SVO Class Moody's Standard and Poor's Bond Portfolio - --------- ------- ---------------- -------------- 1 Aaa to A3 AAA to A- 82.2 2 Baa to Baa3 BBB+ to BBB- 15.4 3 Ba1 to Ba3 BB+ to BB- 2.4 4 B1 to B3 B+ to B- 0.0 5 Caa to Ca CCC+ to C 0.0 6 C CI to D 0.0 17 As of January 1, 1994, the Company adopted Financial Accounting Standards Board Statement 115 and reclassified a portion of its fixed maturity securities portfolio as "available-for-sale," with the remainder being classified as "held-to-maturity." With that reclassification, the fixed maturity securities classified as "available-for-sale" are carried at fair value and changes in fair values, net of related income taxes, are charged or credited to shareholders' equity (see Note D to the consolidated financial statements). The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $9.2 million and $11.4 million at December 31, 2001 and 2000 respectively. The mortgage-backed bonds are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments cause those securities to have different actual maturities than that expected at the time of purchase. Securities that are purchased at a premium to par value and prepay faster than expected will incur a reduction in yield or loss. Securities that are purchased at a discount to par value and prepay faster than expected will generate an increase in yield or gain. The degree to which a security is susceptible to either gains or losses is influenced by the difference between amortized cost and par value, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure. Market Risk Disclosures: Since the Company's assets and liabilities are largely monetary in nature, the Company's financial position and earnings are subject to risks resulting from changes in interest rates at varying maturities, changes in spreads over U.S. Treasuries on new investment opportunities, changes in the yield curve and equity pricing risks. The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $23 million. If the market value of the S & P 500 Index decreased 10% from its December 31, 2001 value, the fair value of the Company's common stock would decrease by approximately $2.3 million. Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note A presents additional disclosures concerning fair values of Financial Assets and Financial Liabilities, and is incorporated by reference herein. The Company limits the extent of its market risk by purchasing securities that are backed by stable collateral, the majority of the assets are issued by U.S. government sponsored entities. Also, the majority of all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higher-risk mortgage backed bonds. To reduce the risk of loss of principal should prepayments exceed expectations, the Company does not purchase mortgage backed securities at significant premiums over par value. The Company's investment approach in the equity markets is based primarily on a fundamental analysis of value. This approach requires the investment committee to invest in well managed, primarily dividend paying companies, which have a low debt to capital ratio, above average return on net worth for a sustained period of time, and low price to book value or low volatility rating (beta) relative to the market. The dividends provide a steady cash flow to help pay current claim liabilities, and it has been the Company's experience that by following this investment strategy, long term investment results have been superior to those offered by bonds, while keeping the risk of loss of capital to a minimum. 18 Liquidity and Capital Resources: Due to regulatory restrictions, the majority of the Company's cash is required to be invested in investment-grade securities to provide ample protection for policyholders. The liabilities of the insurance subsidiaries are of various terms and, therefore, those subsidiaries invest in securities with various maturities spread over periods usually not exceeding 10 years. The liquidity requirements for the Company are primarily met by funds generated from operations of the life insurance and property/casualty insurance subsidiaries. Premium and investment income as well as maturities and sales of invested assets provide the primary sources of cash for both the life and property/casualty businesses, while applications of cash are applied by both businesses to the payment of policy benefits, the cost of acquiring new business (principally commissions), operating expenses, purchases of new investment, and in the case of life insurance, policy loans. The National Security Group's consolidated statement of cash flows indicate that operating activities provided (used) cash of $2,913,000, $(442,000), $868,000 in 2001, 2000, and 1999 respectively. Those statements also classify the other sources and uses of cash by investing activities, and financing activities and disclose the amount of cash available at the end of the year to meet the Company's obligations. The Company has standby letters of credit of less than $25,000. These letters are used to guarantee obligations of the property/casualty subsidiary under assumed reinsurance contracts. The letters of credit are secured by certain invested assets of the Company. The Company also routinely incurs liability for declared but unpaid dividends. Long term liquidity needs of the Company constitute only those items which are directly related to the principal business operations of the Company. The Company has notes payable of $2.1 million at December 31, 2001. The notes payable are to be repaid in quarterly installments over five years. The ability of the Company to meet its commitments for timely payment of claims and other expenses depends, in addition to current cash flow, on the liquidity of its investments. On December 31, 2001, the Company had no known impairments of assets or changes in operation, which would have a material adverse effect upon liquidity. Approximately 83% of the Company's assets are invested in cash, investment grade fixed income securities, short-term investments and broadly traded equity securities which are highly liquid. The values of these investments are subject to the conditions of the markets in which they are traded. Past fluctuations in these markets have had little effect on the liquidity of the Company. The Company has relatively little exposure to lower grade fixed income investments which might be especially subject to liquidity problems due to thinly traded markets. Except as discussed in Note N to the consolidated financial statements, the Company is aware of no known trends, events, or uncertainties reasonably likely to have a material effect on its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect. 19 As disclosed in note K to the consolidated financial statements, in 2002, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company is limited to $1.1 million in the life insurance subsidiary and $2.7 million in the property/casualty insurance subsidiary. However, that condition poses no short-term or long-term liquidity concerns for the parent company. Statutory Risk-Based Capital of Insurance Subsidiaries: The NAIC has adopted Risk-Based Capital (RBC) requirements for life/health and property/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching, benefit and loss reserve adequacy, and other business factors. State insurance regulators will use the RBC formula as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within levels, each of which requires corrective action. The levels and ratios are as follows: Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) ---------------- ----------------------- Company action level 2 Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7 The ratios of Total Adjusted Capital to Authorized Control Level RBC for The National Security Group's life/health and property/casualty insurance subsidiaries are all in excess of eight to one at December 31, 2001. National Security Insurance Company (life insurer) has regulatory adjusted capital of $13 million and $14.3 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 15.7 and 12.9 at December 31, 2001 and 2000 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements. National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $23.6 million and $24.1 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 7.0 and 9.7 at December 31, 2001 and 2000 respectively. Accordingly, National Security Fire & Casualty Company meets the minimum RBC requirements. Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $5.0 million and $4.1 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 8.4 and 8.4 at December 31, 2001 and 2000 respectively. Accordingly, Omega One Insurance Company meets the minimum RBC requirements. 20 Item 8. Consolidated Financial Statements and Supplementary Data Index to Financial Statements Consolidated Financial Statements: Reports of Independent Certified Public Accountants 22 Consolidated Statements of Income - Years Ended December 31, 2001, 2000, and 1999 24 Consolidated Balance Sheets - December 31, 2001 and 2000 25 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 2001, 2000, and 1999 26 Consolidated Statements of Cash Flows - Years Ended December 31, 2001, 2000, and 1999 27 Notes to Consolidated Financial Statements - December 31, 2001 28 Financial Statement Schedules: Reports of Independent Certified Public Accountants on Financial Statement Schedules 47 Schedule I. Summary of Investments - December 31, 2001 and 2000 48 Schedule II. Condensed Financial Information of Registrant - December 31, 2001 and 2000 49 Schedule III. Supplementary Insurance Information - December 31, 2001, 2000, and 1999 53 Schedule IV. Reinsurance - Years Ended December 31, 2001, 2000, and 1999 54 All other Schedules are not required under related instructions or are inapplicable and therefore have been omitted. 21 INDEPENDENT AUDITORS REPORT To the Board of Directors and Shareholders of The National Security Group, Inc. Elba, Alabama We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, shareholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The National Security Group, Inc. and subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Barfield, Murphy, Shank & Smith, P.C. Birmingham, Alabama February 22, 2002 22 Report of Independent Certified Public Accountants To the Board of Directors and Shareholders of The National Security Group, Inc. We have audited the accompanying consolidated statements of income and cash flows of The National Security Group, Inc. and subsidiaries for the year ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated statements of income and cash flows are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated statements of income and cash flows. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated statements of income and cash flows. We believe that our audit of the statements of income and cash flows provides a reasonable basis for our opinion. In our opinion, the consolidated statements of income and cash flows referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of The National Security Group, Inc. and subsidiaries for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. DUDLEY, HOPTON-JONES, SIMS & FREEMAN PLLP Birmingham, Alabama February 18, 2000 23 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except per share amounts) Years Ended December 31, --------------------------- --------------------------- REVENUES 2001 2000 1999 Net premiums earned ........................................ $25,357 $22,921 $25,936 Net investment income ...................................... 4,506 4,434 4,354 Net realized investment gains .............................. 1,640 1,723 1,951 Other income ............................................... 1,280 597 385 ------ ------ ------ 32,783 29,675 32,626 BENEFITS AND EXPENSES Policyholder benefits paid or provided ..................... 13,516 14,125 17,275 Amortization of deferred policy acquisition costs .......... 1,778 1,302 1,202 Commissions ................................................ 4,338 3,206 3,563 General insurance expenses ................................. 6,223 5,157 4,786 Insurance taxes, licenses and fees ......................... 1,215 774 987 Interest expense ........................................... 243 267 297 ------ ------ ------ 27,313 24,831 28,110 ------ ------ ------ Income Before Income Taxes and Equity in Income of Affiliate 5,470 4,844 4,516 INCOME TAX EXPENSE Current .................................................... 1,051 608 925 Deferred ................................................... 341 460 (165) ------ ------ ------ 1,392 1,068 760 ------ ------ ------ Income Before Equity in Income of Affiliate 4,078 3,776 3,756 Equity in Income of Affiliate 52 -- -- ------ ------ ------ Net Income $ 4,130 $ 3,776 $ 3,756 ====== ====== ====== EARNINGS PER COMMON SHARE Net Income $ 1.67 $ 1.53 $ 1.52 ====== ====== ======
See notes to consolidated financial statements. 24 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) December 31, ------------------------- ------------------------- ASSETS 2001 2000 Investments Securities held-to-maturity, at amortized cost (estimated fair value: 2001 - $23,922 2000 - $29,035) .................................................................................. $ 23,135 $ 28,875 Securities available-for-sale, at estimated fair value (cost: 2001 - $45,975; 2000 - $38,311) ................................................................................. 57,648 51,648 Receivable for securities ......................................................................... 50 143 Note receivable from affiliate .................................................................... 250 -- Mortgage loans on real estate, at cost ............................................................ 275 116 Investment real estate, at book value (accumulated depr.: 2001 - $17; 2000 - $39) ................. 1,563 1,569 Policy loans ...................................................................................... 726 692 Investment in affiliate ........................................................................... 53 -- Short-term investments ............................................................................ 1,796 1,675 ------ ------ Total Investments 85,496 84,718 ------ ------ Cash ................................................................................................. 1,595 954 Accrued investment income ............................................................................ 938 881 Reinsurance recoverable .............................................................................. 3,524 3,534 Deferred policy acquisition costs .................................................................... 4,615 4,469 Prepaid reinsurance premiums ......................................................................... 291 293 Other assets ......................................................................................... 3,025 2,714 ------ ------ Total Assets $ 99,484 $ 97,563 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Policy and claim reserves ............................................................................ $ 41,739 $ 41,918 Checks outstanding in excess of bank balance ......................................................... 1,905 1,107 Other policyholder funds ............................................................................. 1,503 1,488 Long-term debt ....................................................................................... 2,108 2,401 Accrued income taxes ................................................................................. 593 336 Other liabilities .................................................................................... 3,669 3,114 Deferred income tax .................................................................................. 3,083 3,419 ------ ------ Total Liabilities 54,600 53,783 ====== ====== Commitments and Contingencies ........................................................................ -- -- Shareholders' Equity Preferred stock, $1 par value, 500,000 shares authorized, none issued or outstanding .............. -- -- Class A common stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding ....... -- -- Common stock, $1 par value, 2,500,000 shares authorized, 2,466,600 and 2,339,848 shares issued and 2,466,600 and 2,055,811 shares outstanding, respectively ....................... 2,467 2,340 Additional paid in capital ........................................................................ 4,951 17 Accumulated other comprehensive income ............................................................ 8,618 9,779 Retained earnings ................................................................................. 28,848 35,225 Treasury stock, at cost (0 and 284,037 shares, respectively) ...................................... -- (3,581) ------ ------ Total Shareholders' Equity 44,884 43,780 ------ ------ Total Liabilities and Shareholders' Equity $ 99,484 $ 97,563 ====== ======
See notes to consolidated financial statements 25 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands) --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- Accumulated Other Comprehensive Retained Comprehensive Common Paid-in Treasury Total Income Earnings Income Stock Capital Stock --------- --------- --------- ------- ------- -------- --------- --------- --------- --------- ------- ------- -------- --------- Balance at January 1, 2000 ................ $41,888 $33,197 $9,915 $2,340 $ 17 $(3,581) Comprehensive income: Net income for 2000 .................. 3,776 $3,776 3,776 -- -- -- -- Other comprehensive income, net of tax Unrealized loss on securities, net of reclassification adjustment .. (136) (136) -- (136) -- -- -- ----- Comprehensive income ...................... $3,640 Cash dividends ....................... (1,748) ===== (1,748) -- -- -- -- ----- ----- ----- ----- ----- ----- Balance at December 31, 2000 .............. 43,780 35,225 9,779 2,340 17 (3,581) Comprehensive income: Net income for 2001 .................. 4,130 4,078 4,130 -- -- -- -- Other comprehensive income, net of tax Unrealized loss on securities, net of reclassification adjustment ... (1,161) (1,161) -- (1,161) -- -- -- ----- Comprehensive income ...................... $2,917 ===== Retirement of treasury stock ......... -- (3,297) (284) 3,581 Stock dividend (20%) ................. (5,345) 411 4,934 Cash dividends ....................... (1,865) (1,865) -- -- -- -- ----- ------ ----- ------- ------ ------ Balance at December 31, 2001 .............. $44,884 $28,848 $8,618 $ 2,467 $4,951 $ -- ====== ====== ====== ======= ====== ======
See notes to consolidated financial statements 26 THE NATIONAL SECURITY GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Year ended December 31, -------------------------------- -------------------------------- 2001 2000 1999 Cash flows from operating activities: Net income .......................................................... $ 4,130 $ 3,776 $ 3,756 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Change in accrued investment income ............................. (57) (51) (66) Change in reinsurance recoverable ............................... 10 1,153 2,146 Amortization of deferred policy acquisition costs ............... 1,778 1,119 1,201 Change in receivable for securities ............................. 93 (143) -- Net realized gains on investments ............................... (1,593) (1,941) (2,024) Gain on disposal of property and equipment ...................... (47) (32) -- Policy acquisition costs deferred ............................... (1,924) (1,315) (1,320) Change in current income taxes receivable ....................... -- -- 75 Change in prepaid reinsurance premiums .......................... 2 (36) 9 Depreciation expense and amortization/accretion ................. (42) 115 219 Change in policy liabilities and claims ......................... (179) (3,021) (4,514) Change in income tax payable .................................... 257 459 53 Change in deferred income taxes ................................. 169 284 (166) Change in other liabilities ..................................... 555 13 109 Equity in earnings of investee .................................. (52) -- -- Other, net ...................................................... (187) (822) 1,390 ------ ------ ------- Net cash (used in) provided by operating activities .......... 2,913 (442) 868 Cash flows from investing activities: Purchases of held-to-maturity securities ......................... (982) (668) (3,759) Purchases of available-for-sale securities ....................... (16,575) (7,139) (10,189) Proceeds from maturities of held-to-maturity securities .......... 6,926 2,622 3,805 Proceeds from sales of available-for-sale securities ............. 10,508 6,973 10,747 (Purchases of) proceeds from real estate held for investment ..... 38 (13) 71 Net (purchases) proceeds from short-term investment .............. (121) 454 1,161 Receipts from repayment of loans, net ............................ (443) (27) (1) Purchase of property and equipment ............................... (335) (378) (230) Proceeds from sale of property and equipment ..................... 57 51 36 ------ ------ ------ Net cash (used in) provided by investing activities .......... (927) 1,875 1,641 Cash flows from financing activities: Payments on notes payable ........................................ (293) (271) (332) Change in other policyholder funds ............................... 15 (38) (109) Dividends paid ................................................... (1,865) (1,748) (1,664) Change in treasury stock ......................................... -- -- 60 Change in checks outstanding in excess of bank balances .......... 798 195 136 ------ ------ ------ Net cash used in financing activities ........................ (1,345) (1,862) (1,909) ------ ------ ------ Net (decrease) increase in cash .............................. 641 (429) 600 Cash at beginning of year ........................................... 954 1,383 783 ------ ----- ------ Cash at end of year ................................................. $ 1,595 $ 954 $1,383 ====== ===== ====== Cash paid during the year for: Interest ......................................................... $ 241 $ 266 $ 296 ====== ===== ====== Income taxes ..................................................... $ 800 $ 500 $ 630 ====== ===== ======
27 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries: National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO). NSFC includes a wholly-owned subsidiary - Omega One Insurance Company (Omega). Omega included a wholly-owned subsidiary - Liberty Southern Insurance Company (LSIC) through September 30, 2001. LSIC was liquidated on September 30, 2001. All significant intercompany transactions and accounts have been eliminated. Investment in Affiliate The companys investment in affiliate consists of a 50% interest in Mobile Attic, Inc., a portable storage leasing company. The company accounts for this investment using the equity method (see note N commitment). Description of Major Products NSIC is licensed in the states of Alabama, Georgia, Mississippi, Texas, South Carolina and Florida and was organized in 1947 to provide life and burial insurance policies to the home service market. Premiums sold and serviced by company agents primarily include industrial life, larger ordinary life, accident and health, limited hospital, cancer and low valued life insurance. NSFC operates in various property and casualty lines, the most significant of which are low valued dwelling property, home service fire, nonstandard automobile physical damage and liability, nonstandard commercial, ocean marine and inland marine. Omega operates in property and casualty lines, the most significant of which is commercial auto liability. Basis of Presentation The significant accounting policies followed by The National Security Group, Inc. and subsidiaries that materially affect financial reporting are summarized below. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) which, as to the subsidiary insurance companies, differ from statutory accounting practices permitted by regulatory authorities. 28 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Investments The Companys securities are classified in two categories and accounted for as follows: o Securities Held-to-Maturity. Bonds, notes and redeemable preferred stock for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using methods which approximate level yields over the period to maturity. o Securities Available-for-Sale. Bonds, notes, common stock and non-redeemable preferred stock not classified as either held-to-maturity, or trading are reported at fair value, adjusted for other-than-temporary declines in fair value. The Company and its subsidiaries have no trading securities. Unrealized holding gains and losses, net of tax, on securities available-for-sale are reported as a net amount in a separate component of shareholders equity until realized. Realized gains and losses on the sale of securities available-for-sale are determined using the specific-identification method. Mortgage loans and policy loans are stated at the unpaid principal balance of such loans. Investment real estate is reported at cost, less allowances for depreciation computed on the straight-line basis. Short-term investments are carried at cost, which approximates market value. Investments with other than temporary impairment in value are written down to estimated realizable values. Disclosures About Fair Value of Financial Instruments SFAS No. 107 defines fair value as the quoted market prices for those instruments that are actively traded in financial markets. In cases where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. The fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Companys entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument. 29 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE A - SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Disclosures About Fair Value of Financial Instruments continued SFAS No. 107 excludes certain financial instruments, particularly insurance liabilities other than financial guarantees and investment contracts, from its disclosure requirements. In evaluating the Companys management of interest rate and liquidity risk, the fair values of all assets and liabilities should be taken into consideration. The fair values of cash, cash equivalents, short-term investments and balances due on accounts from agents, reinsurers and others approximate their carrying amounts as reflected in the consolidated balance sheets due to their short-term availability or maturity. The fair values of debt and equity securities have been determined using values supplied by independent pricing services and are disclosed together with carrying amounts in Note D. The fair value of the mortgage loan portfolio was approximately equal to the carrying amount of $275,000 on December 31, 2001 ($116,000 on December 31, 2000). As of December 31, 2001, the fair value of policy loans approximated their carrying amount of $726,000 ($692,000 as of December 31, 2000). The fair value of other policyholder funds on deposit is estimated to approximate their carrying amount of $1,503,000 on December 31, 2001 ($1,488,000 on December 31, 2000). Statement of Cash Flows For purposes of reporting cash flows, cash includes cash-on-hand and demand deposits with banks. Premium Revenues Life insurance premiums are recognized as revenues when due. Property and casualty insurance premiums, less amounts ceded to reinsurers, are recognized on a pro rata basis over the terms of the policies. Reinsurance premiums assumed are recognized as reported by the ceding company. 30 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE A - SIGNIFICANT ACCOUNTING POLICIES CONTINUED Deferred Policy Acquisition Costs The costs of acquiring new insurance business are deferred and amortized over the lives of the policies. Deferred costs include commissions, other agency compensation and expenses, and other underwriting expenses directly related to the level of new business produced. Acquisition costs relating to life contracts are amortized over the premium paying period of the contracts, or the first renewal period of term policies, if earlier. Assumptions utilized in amortization are consistent with those utilized in computing policy liabilities. The method of computing the deferred policy acquisition costs for property and casualty policies limits the amount deferred to a percentage of related unearned premiums. Policy Liabilities The liability for future life insurance policy benefits is computed using a net level premium method including the following assumptions: Years of Issue Interest Rate 1947 - 1968 4% 1969 - 1978 6% graded to 5% 1979 - 2001 7% graded to 6% Mortality assumptions include various percentages of the 1955-60 and 1965-70 Select and Ultimate Basic Male Mortality Table. Withdrawal assumptions are based on the Companys experience. Claim Liabilities The liability for unpaid claims represents the estimated liability for claims reported to the Company and its subsidiaries plus claims incurred but not yet reported and the related adjustment expenses. The liabilities for claims and related adjustment expenses are determined using case-basis evaluations and statistical analyses and represent estimates of the ultimate net cost of all losses incurred through December 31 of each year. Although considerable variability is inherent in such estimates, management believes that the liabilities for unpaid claims and related adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations. 31 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE A - SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Earnings Per Share Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding were 2,466,600 (2,466,600 in 2000 and 1999). Reinsurance In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for prospective reinsurance contracts are reported as prepaid reinsurance premiums and amortized over the remaining contract period. In the normal course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage contracts. NSIC retains a maximum of $30,000 of coverage per individual life. The cost of reinsurance is amortized over the contract period of the reinsurance. Reclassifications Certain reclassifications have been made in the previously reported financial statements to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on the previously reported net income or shareholders equity. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recently Issued Accounting Standards On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133, as amended by SFAS Nos. 137 and 138, requires the Company to record all derivative financial instruments at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 did not have a material effect on the Companys financial position or results of operations. Prospectively, the adoption of No. 133 may introduce volatility into the Companys 32 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE A - SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Recently Issued Accounting Standards continued reported net income and other comprehensive income depending on future market conditions and the Companys hedging activities. In September 2000 the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125. SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. Recently Issued Accounting Standards- Continued The adoption of this accounting standard did not have a material effect on the Companys financial position or results of operations. In June 2001, the FASB issued SFAS Nos. 141, Business Combinations, and 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that business combinations initiated after June 30, 2001, be accounted for using the purchase method. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and effective for any goodwill or intangible asset acquired after June 30, 2001. The Company does not expect the adoption of SFAS No. 142 to have a material effect on the Companys financial position or results of operations. In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Companys financial position or results of operations. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 revises SFAS No. 121 by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 144 to have a material effect on the Companys financial position or results of operations. 33 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE B - BUSINESS COMBINATION During the second quarter of 2000, Omega acquired 100% of the outstanding stock of Liberty Southern Insurance Company (LSIC) for a total cash purchase price of approximately $700,000. Effective December 31, 2000, all insurance related assets and liabilities of LSIC were transferred to Omega as the result of a novation. This transaction was approved by the Alabama Department of Insurance during a hearing relating to the acquisition of LSIC by Omega. The purchase of LSIC was accounted for by the purchase method, whereby the underlying assets acquired and liabilities assumed from the purchased corporation are recorded by Omega at their fair value. The excess of the amount paid over the fair value of LSICs identifiable net assets was approximately $200,000, which has been recorded as a charge to earnings in year 2000. The operating results of LSIC have been included in the Companys consolidated financial statements since the date of acquisition. The purchase agreement provides for additional consideration to be paid the former stockholders contingent upon specified premium growth of the LSIC block of business. Pro forma results of consolidated operations for 2000 and 1999, assuming the LSIC acquisition was made at the beginning of each year, is as follows: 2000 1999 Net premiums earned .......................... $23,817 $26,787 Income before taxes .......................... $ 4,653 $ 4,450 Net income ................................... $ 3,585 $ 3,690 Earnings per common share .................... $ 1.45 $ 1.50 34 THE NATIONAL SECURITY GROUP, INC. NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE C - STATUTORY ACCOUNTING PRACTICES The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) which vary in certain respects from reporting practices prescribed or permitted by insurance regulatory authorities. The significant differences for statutory reporting include: (a) acquisition costs of acquiring new business are charged to operations as incurred, (b) life policy liabilities are established utilizing interest and mortality factors specified by regulatory authorities, (c) the Asset Valuation Reserve (AVR) and the Interest Maintenance Reserve (IMR) are recorded as liabilities, and (d) non-admitted assets (furniture and equipment, agents debit balances and prepaid expenses) are charged directly to surplus. Statutory net gains from operations and capital and surplus, excluding intercompany transactions, are summarized as follows:
(Dollars in thousands) Year Ended December 31, --------------------------- --------------------------- 2001 2000 1999 NSIC - including realized capital gains of $652, $986 and $818, respectively ................................................. $ 709 $ 1,016 $ 2,092 ====== ====== ====== NSFC - including realized capital gains of $875, $709 and $684, respectively ........................................... $ 2,720 $ 2,140 $ 1,703 ====== ====== ====== Omega - including realized capital gains of $152, $257, and $480, respectively ........................................... $ 1,047 $ 1,155 $ 231 ====== ====== ====== LSIC (nine months ended September 30 for 2001) ................. $ 6 $ 8 $ -- ====== ====== ====== Statutory capital and surplus: NSIC - including AVR of $1,586, $1,780 and $2,639, respectively ................................................. $11,416 $14,925 $15,202 ====== ====== ====== NSFC ........................................................... $23,572 $24,170 $23,443 ====== ====== ====== Omega .......................................................... $ 5,000 $ 4,079 $ 3,182 ====== ====== ====== LSIC ........................................................... $ 0 $ 500 $ 0 ====== ====== ======
The above amounts exclude allocation of overhead from the Company. NSIC, NSFC and Omega are in compliance with statutory restrictions with regard to minimum amounts of surplus and capital. LSIC was liquidated on September 30, 2001. 35 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE D - INVESTMENT SECURITIES The amortized cost and aggregate fair values of investments in securities are as follows:
(Dollars in thousands) December 31, 2001 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available-for-sale securities: Corporate debt securities ............................ $19,564 $ 356 $ (441) $19,479 Obligations of states and political subdivisions ..... 2,895 99 (4) 2,990 U.S. Treasury securities and obligations of U.S. government corporations and agencies .......... 12,242 436 (2) 12,676 Equity securities .................................... 11,274 12,237 (1,008) 22,503 ------- ------ ------- ------ Total $45,975 $13,128 $(1,455) $57,648 ======= ====== ======= ====== Held-to-maturity securities: Corporate debt securities ............................ $ 9,517 $ 324 $ (65) $ 9,776 Obligations of states and political subdivisions ..... 4,235 273 (12) 4,496 U.S. Treasury securities and obligations of U.S. government corporations and agencies .......... 9,383 281 (14) 9,650 ------- ------ ------- ------ Total $23,135 $ 878 $ (91) $23,922 ======= ====== ======= ====== (Dollars in thousands) December 31, 2000 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Available-for-sale securities: Corporate debt securities ............................ $10,870 $ 120 $ (418) $10,572 Obligations of states and political subdivisions ..... 2,447 40 (28) 2,459 U.S. Treasury securities and obligations of U.S. government corporations and agencies .......... 13,450 255 (51) 13,654 Equity securities .................................... 11,544 14,628 (1,209) 24,963 ------- ------ ------- ------ Total $38,311 $15,043 $(1,706) $51,648 ======= ====== ======= ======
36 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE D - INVESTMENT SECURITIES CONTINUED
(Dollars in thousands) December 31, 2000 Gross Gross Amortized Unrealized Unrealized Fair Held-to-maturity securities: Cost Gains Losses Value Corporate debt securities ............................ $10,683 $ 116 $ (108) $10,691 Obligations of states and political subdivisions ..... 4,338 245 (66) 4,517 U.S. Treasury securities and obligations of U.S. government corporations and agencies .......... 13,854 113 (140) 13,827 ------- ------ ------- ------ Total $28,875 $ 474 $ (314) $29,035 ======= ====== ======= ======
The amortized cost and aggregate fair value of debt securities at December 31, 2001, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. (Dollars in Thousands) Amortized Fair Available-for-sale securities: Cost Value Due in one year or less ............................... $ 1,795 1,812 Due after one year through five years ................. 6,243 6,285 Due after five years through ten years ................ 17,734 18,142 Due after ten years ................................... 8,929 8,906 ------- ------- Total $34,701 $35,145 ======= ======= Held-to-maturity securities: Due in one year or less ............................... $ 2,384 $2,454 Due after one year through five years ................. 5,783 6,049 Due after five years through ten years ................ 6,046 6,262 Due after ten years ................................... 8,922 9,157 ------ ------ Total $23,135 $23,922 ====== ====== For 2001, gross gains of $1,785,394 ($2,715,057 for 2000) and gross losses of $323,829 ($774,196 for 2000) were realized on sales of available-for-sale-securities. 37 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE E - NET INVESTMENT INCOME Major categories of investment income are summarized as follows: (Dollars in thousands) Year ended December 31, ------------------------------ ------------------------------ 2001 2000 1999 Fixed maturities .............................. $ 3,819 $ 3,629 $ 3,567 Equity securities ............................. 544 642 630 Mortgage loans on real estate ................. 16 7 9 Investment real estate ........................ 138 142 18 Policy loans .................................. 35 43 33 Other, principally short-term investments ..... 88 121 129 ------ ------ ------ 4,640 4,584 4,386 Less: Investment expenses ..................... (134) (150) (32) ------ ------ ------ Net investment income ......................... $ 4,506 $ 4,434 $ 4,354 ====== ====== ====== An analysis of investment gains follows: Year ended December 31, 2001 2000 1999 Net realized investment gains (losses): Fixed maturities ........................... $ 149 $ (419) $ (16) Other, principally equity securities ....... 1,491 2,142 1,967 ------ ------ ------ $ 1,640 $ 1,723 $ 1,951 ====== ====== ====== An analysis of net decrease in unrealized appreciation on available-for-sale securities follows:
Year ended December 31, -------------------------------------- -------------------------------------- 2001 2000 1999 Net Decrease in unrealized appreciation on available-for- sale securities before deferred tax .................. $ (1,366) $(191) $(3,196) Deferred income tax ..................................... 205 55 965 -------- ------- ------- Net Decrease in unrealized appreciation on available-for- sale securities ...................................... $ (1,161) $(136) $ (2,231) ======== ======= =======
38 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE F - INCOME TAXES Total income tax expense varies from amounts computed by applying current federal income tax rates to income before income taxes. The reason for these differences and the approximate tax effects are as follows:
(Dollars in thousands) Year ended December 31, ----------------------------- ----------------------------- 2001 2000 1999 Federal income tax rate applied to pre-tax income .. $ 1,860 $ 1,647 $ 1,535 Dividends received deduction and tax-exempt interest (182) (213) (198) Small life insurance company deduction ............. (122) (209) (410) other, net ......................................... (164) (157) (167) ------- ------- ------- Federal income tax expense ......................... $ 1,392 $ 1,068 $ 760 ======= ======= =======
Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws. The tax effect of significant differences representing deferred assets and liabilities are as follows: (Dollars in Thousands) --------------------------- --------------------------- Year ended December 31, 2001 2000 --------------------------- Deferred policy acquisition costs $ (1,569) $ (1,519) Policy liabilities 349 419 Unearned premiums 464 383 Claim liabilities 310 432 General insurance expenses 757 694 Alternative minimum tax credit carryforward 0 67 Unrealized gains on securities available-for-sale (3,394) (3,895) -------- -------- Net deferred tax liabilities $ (3,083) $ (3,419) ======== ======== 39 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE F - INCOME TAXES - CONTINUED The appropriate income tax effects of changes in temporary differences are as follows: Year ended December 31, ---------------------- ---------------------- 2001 2000 1999 Deferred policy acquisition costs .......... $ 49 $ 66 $ 41 Policy liabilities ......................... 70 69 (25) Unearned premiums .......................... (81) (56) 113 General insurance expenses ................. (62) 18 (1) Alternative minimum tax credit carryforward 243 247 (314) Claim liabilities .......................... 122 116 21 ------ -------- ------- $ 341 $ 460 $(165) ====== ======== ======= Under pre-1984 life insurance company tax laws, a portion of NSIC's gain from operations was not subject to current income taxation, but was accumulated for tax purposes in a memorandum account designated "policyholders' surplus". The aggregate balance in this account, $3,720,000 at December 31, 2001, would be taxed at current rates only if distributed to shareholders or if the account exceeded a prescribed minimum. The Deficit Reduction Act of 1984 eliminated additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have not been provided on amounts designated as policyholders' surplus. The deferred income tax liability not recognized is approximately $1,270,000 at December 31, 2001. NOTE G - LONG-TERM DEBT Long-term debt consisted of the following as of December 31: (Dollars in thousands) ---------------------- 2001 2000 Note payable to bank with a 7% interest rate dated October 9, 1998; matures May 28, 2004 Payments of $63,575 due quarterly. Unsecured ...... $2,108 $2,208 Note payable to bank with a 7.44% interest rate dated February 25, 1998; matures February 26, 2003 Payments of $45,374 due quarterly. Unsecured ...... 0 193 ------ ------ 2,108 $2,401 Aggregate maturities of long-term debt for each of the three years subsequent to December 31, 2001 are as follows (dollars in thousands): 2002-$110; 2003-$118; 2004-$1,880. 40 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE H - POLICY AND CLAIM RESERVES At December 31, policy and claim reserves consisted of the following: (Dollars in thousands) 2001 2000 ---- ---- Benefit and loss reserves Property and casualty ...................... $11,489 $15,409 Accident and health ........................ 318 301 Life and annuity ........................... 22,416 19,486 Unearned premiums ............................ 7,115 6,364 Policy and contract claims ................... 401 358 ------- ------- $41,739 $41,918 ======= ======= The following table is a reconciliation of beginning and ending property and casualty reserve balances for claims and claim adjustment expense for the years ended December 31: (Dollars in thousands) -------------------------------- 2001 2000 1999 Claims and claim adjustment expense reserves at beginning of year $15,409 $18,471 $21,528 Less reinsurance recoverables on unpaid losses 3,092 3,907 5,889 ------ ------ ------ Net balances at beginning of year 12,317 14,564 15,639 Provision for claims and claim adjustment expenses for claims arising in current year 14,045 14,465 15,859 Estimated claims and claims adjustment expenses for claims arising in prior years (3,089) (5,411) (3,074) ------ ------ ------ Total increases 10,956 9,054 12,785 Claims and claim adjustment expense payments for claims arising in: Current year 9,891 8,792 9,934 Prior years 4,289 2,509 3,926 ------ ------ ------ Total payments 14,180 11,301 13,860 ------ ------ ------ Net balance at end of year 9,093 12,317 14,564 Plus reinsurance recoverables on unpaid losses 2,396 3,092 3,907 ------ ------ ------ Claims and claim adjustment expense reserves at end of year $11,489 $15,409 $18,471 ====== ====== ====== 41 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE H - POLICY AND CLAIM RESERVES - CONTINUED As a result of changes in estimates of insured events in prior years, the provision of claims and claim adjustment expenses (net of reinsurance recoveries) decreased in 2001, 2000 and 1999 because of lower-than-anticipated losses in commercial and private passenger automobile lines of business. The Company has a geographic exposure to catastrophe losses in certain areas of the country. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophe losses are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance. NOTE I - REINSURANCE The Companys insurance operations participate in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term. Property and casualty reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of reinsurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurers and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize their exposure to significant losses from reinsurance insolvencies. At December 31, 2001, reinsurance receivables with a carrying value of $618,000 ($912,000 at December 31, 2000) and prepaid reinsurance premiums of $291,000 ($293,000 at December 31, 2000) were associated with a single reinsurer. The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2001, 2000 and 1999 were approximately $988,801, $605,000, and $1,819,000, respectively The effect of reinsurance on premiums written and earned was as follows: (Dollars in Thousands) 2001 ---------------------------------------------------- ---------------------------------------------------- NSIC NSFC ----------------------- ---------------------------- ----------------------- ---------------------------- Written Earned Written Earned Direct ........... $5,047 $ 5,206 $ 22,528 $ 21,777 Assumed .......... -- -- -- -- Ceded ............ (45) (45) (1,579) (1,581) ------ ------- -------- -------- Net .............. $5,002 $ 5,161 $ 20,949 $ 20,196 ====== ======= ======== ======== 42 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE I - REINSURANCE - CONTINUED (Dollars in Thousands) 2000 ---------------------------------------------------- ---------------------------------------------------- NSIC NSFC ----------------------- ---------------------------- ----------------------- ---------------------------- Written Earned Written Earned Direct ........... $4,456 $ 4,645 $ 18,951 $ 20,628 Assumed .......... -- -- -- -- Ceded ............ (51) (51) (1,460) (2,302) ------ ------- -------- -------- Net .............. $4,405 $ 4,594 $ 17,491 $ 18,326 ====== ======= ======== ======== (Dollars in Thousands) 1999 ---------------------------------------------------- ---------------------------------------------------- NSIC NSFC ----------------------- ---------------------------- ----------------------- ---------------------------- Written Earned Written Earned Direct ........... $4,047 $ 4,300 $ 21,421 $ 23,078 Assumed .......... -- -- -- -- Ceded ............ (49) (49) (1,385) (1,393) ------ ------- -------- -------- Net .............. $3,998 $ 4,251 $ 20,036 $ 21,685 ====== ====== ======== ======== NOTE J - EMPLOYEE BENEFIT PLAN In 1989, the Company and its subsidiaries established a retirement savings plan and transferred the assets from the defined contribution profit sharing plan into the new plan. All full-time employees who have completed one year of service at January 1 or July 1 are eligible to participate and all employee contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Contributions for 2001, 2000, and 1999 amounted to $130,000, $127,000, and $161,000, respectively. Contributions are at the Board of Directors discretion subject to governmental limitations. In 1987, the Company established a deferred compensation plan for its Board of Directors. The Board members have an option of deferring their fees to a cash account or to a stock account and all share deferrals are recorded at the fair market value on the date of the award. Costs of the deferred compensation plan for 2001, 2000, and 1999 amounted to approximately $35,065, $54,755, and $48,490, respectively. NOTE K - REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS The amount of dividends paid from NSIC to the Company in any year may not exceed, without prior approval of regulatory authorities, the greater of 10% of statutory surplus as of the end of the preceding year, or the statutory net gain from operations for the preceding year. At December 31, 2001, NSICs retained earnings unrestricted for the payment of dividends in 2002 amounted to $1,141,562. 43 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE K - REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS - CONTINUED NSFC is similarly restricted in the amount of dividends payable to the Company; dividends may not exceed the greater of 10% of statutory surplus as of the end of the preceding year, or net income for the preceding year. As a result, dividends from NSFC to the Company are limited to $2,719,538 in 2002. At December 31, 2001, securities with market values of $3,458,441 ($3,745,717 at December 31, 2000) were deposited with various states pursuant to statutory requirements. Under applicable Alabama insurance laws and regulations, NSFC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $100,000. Under applicable Alabama insurance laws and regulations, NSIC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $200,000. Under applicable Alabama insurance laws and regulations, Omega is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $600,000. NOTE L - SHAREHOLDERS EQUITY Preferred Stock The Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference. Common Stock The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share. In the event of any liquidation, dissolution or distribution of the assets of the Company remaining after the payments to the holders of the Preferred Stock of the full preferential amounts to which they may be entitled as provided in the resolution or resolutions creating any series thereof, the remaining assets of the Company shall be divided and distributed among the holders of both classes of common stock, except as may otherwise be provided in any such resolution or resolutions. 44 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE M - INDUSTRY SEGMENTS The Company and its subsidiaries operate primarily in the insurance industry. Premium revenues and operating income by industry segment for the years ended December 31, 2001, 2000 and 1999 are summarized below: (Dollars in thousands) Year ended December 31, 2001 2000 1999 ---- ----- ------ Premium Revenues: Individual life and accident and health insurance $ 5,161 $ 4,595 $ 4,251 Property and casualty insurance 20,196 18,326 21,685 ------ ------ ------ $25,357 $22,921 $25,936 ====== ====== ====== Income (loss) before income taxes: Individual life and accident and health insurance $ 586 $1,667 $2,556 Property and casualty insurance 5,440 3,917 2,365 Other (313) (473) (110) ------ ------ ------ 5,713 5,111 4,811 (243) (267) (295) ------ ------ ------ Interest expense $ 5,470 $4,844 $4,516 ====== ====== ====== Assets Individual life and accident and health insurance $44,513 $42,150 $41,323 Property and casualty insurance 54,962 55,256 56,714 Other 509 157 68 ------ ------ ------ $99,984 $97,563 $ 98,105 ====== ====== ====== Amortization of deferred policy acquisition costs and depreciation expense: Individual life and accident and health insurance $ 609 $ ( 61) $(252) Property and casualty Insurance 1,279 1,406 1,615 ------ ------ ------ $ 1,888 $1,345 $1,363 ====== ====== ====== Capital expenditures are not material, and consequently not reported. NOTE N - COMMITMENTS AND CONTINGENCIES Commitments The Company is obligated under a commitment to extend credit to Mobile Attic, Inc., in the form of a $1,000,000 credit line. The credit line is secured by inventory and matures on September 18, 2002. Interest is due on the unpaid principal at the rate of 8% per annum. The Company may, at its option anytime on or before the payment by Mobile Attic, Inc. of all outstanding principal and interest, elect to convert the outstanding principal and accrued interest to a proportionate share of common stock in Mobile Attic, Inc. 45 THE NATIONAL SECURITY GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE N - COMMITMENTS AND CONTINGENCIES - CONTINUED Contingencies The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Companys subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief. NSFC, a subsidiary of the Company, was named as a defendant in a purported class action filed in Lee County, Alabama. On January 4, 2000, the Circuit Court of Lee County preliminarily approved a consent settlement to this action and the settlement was finalized in the second quarter of 2000. A provision for this settlement was reflected in the 1999 results of operations of the Company. In two separate recently filed actions, NSIC is named as a defendant in purported class actions relating to the past sale of industrial burial insurance. The actions address whether the premiums charged were excessive relative to the benefit provided and whether the premiums charged were in any manner discriminatory relative to the race of the person insured. In addition, several individual actions on behalf of specifically named persons have been filed with similar allegations. These actions are in the initial phases and little discovery has been undertaken and no class has been certified. While the cases entail separate and distinguishable facts, the legal issues are similar to the issues pending in numerous other actions currently pending nationwide against numerous insurers. While NSIC did at one time sell industrial burial insurance, no such plans have been sold for several decades. The company establishes and maintains reserves on contingent liabilities. In many instances, however, it is not feasible to predict the ultimate outcome with any degree of accuracy. While a resolution of these matters may significantly impact consolidated earnings and the Companys consolidated financial position, it remains managements opinion, based on information presently available, that the ultimate resolution of these matters will not have a material impact on the Companys consolidated financial position. However, it should be noted that instances of class action lawsuits against insurance companies appear to be increasing in several states in which insurance subsidiaries of the company operate. NOTE O - CONCENTRATION OF CREDIT RISK The Company maintains its cash accounts primarily with banks located in Alabama. The total cash balances are insured by the FDIC up to $100,000 per bank. The Company had cash balances on deposit with Alabama banks at December 31, 2001 that exceeded the balance insured by the FDIC in the amount of $617,888. 46 INDEPENDENT AUDITORS REPORT ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Shareholders of The National Security Group, Inc. Elba, Alabama Under date of February 22, 2002, we reported on the balance sheets of The National Security Group, Inc. as of December 31, 2001 and 2000, and the related statements of income, shareholders equity and cash flows for the years then ended, which are included in this Form 10-K. In connection with our audit of the aforementioned financial statements, we also audited the related financial statement schedules listed in the accompanying index. These financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statement schedules based on our audit. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Barfield, Murphy, Shank & Smith, P.C. Birmingham, Alabama February 22, 2002 47 THE NATIONAL SECURITY GROUP, INC. SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED) (AMOUNTS IN THOUSANDS)
December 31, 2001 December 31, 2000 ---------------------------------- -------------------------------------- Amount Amount per the per the Original Fair Balance Original Fair Balance Cost Value Sheet Cost Value Sheet -------- -------- --------- --------- ----------- ---------- Securities Held to Maturity: United States government $9,364 $9,650 $9,383 $14,080 $14,093 $14,104 States, municipalities and political subdivisions 4,224 4,496 4,235 4,037 4,214 4,052 Public Utilities 974 989 969 1,597 1,570 1,595 Industrial and Miscellaneous 8,506 8,787 8,549 9,075 9,158 9,124 -------- -------- --------- --------- ----------- ---------- Total Securities Held to Maturity . . . . . . . 23,068 23,922 23,136 28,789 29,035 28,875 -------- -------- --------- --------- ----------- ---------- Securities Available for Sale: Equity Securities: Public utilities 1,543 2,953 2,953 1,443 3,345 3,345 Banks and insurance companies 1,758 4,886 4,886 1,952 5,500 5,500 Industrial and all other 7,973 14,664 14,664 8,150 16,118 16,118 -------- -------- --------- --------- ----------- ---------- Total equity securities 11,274 22,503 22,503 11,545 24,963 24,963 -------- -------- --------- --------- ----------- ---------- Debt Securities: United States government 12,243 12,676 12,676 13,450 13,654 13,654 States, municipalities and political subdivisions 2,895 2,990 2,990 2,447 2,459 2,459 Public Utilities 656 667 667 191 196 196 Industrial and Miscellaneous 18,907 18,811 18,811 10,680 10,376 10,376 -------- -------- --------- --------- ----------- ---------- Total Debt Securities 34,701 35,144 35,144 26,768 26,685 26,685 -------- -------- --------- --------- ----------- ---------- Total Available for Sale 45,975 57,647 57,647 38,313 51,648 51,648 -------- -------- --------- --------- ----------- ---------- Total Securities 69,043 81,569 80,783 67,102 80,683 80,523 Receivable for securities 50 50 143 143 Note receivable from affiliate 250 250 0 0 Mortgage loans on real estate 275 275 116 116 Investment real estate 1,563 1,563 1,569 1,569 Policy loans 726 726 692 692 Investment in affiliate 53 53 0 0 Short term investments 1,796 1,796 1,675 1,675 -------- --------- --------- ---------- Total investments $73,756 $85,496 $71,297 $84,718 ======== ========= ========= ==========
48 THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS (AMOUNTS IN THOUSANDS) December 31, ------------------------ 2001 2000 ------ ---- Assets Cash $101 $66 Investment in subsidiaries (equity method) eliminated upon consolidation 47,062 46,481 Other assets 722 458 ----- ------ Total Assets $47,885 $47,005 ====== ====== Liabilities and Shareholders Equity Accrued general expenses $893 $824 Notes Payable 2,108 2,401 ----- ------ Total Liabilities 3,001 3,225 ----- ------ Total Shareholders' Equity $44,884 $43,780 ------ ------ Total Liabilities and Shareholders' Equity $47,885 $47,005 ======= ====== 49 THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS)
For the Years Ended December 31, ---------------------------- 2001 2000 1999 ------- ----- ----- Income From subsidiaries-eliminated upon consolidation Dividends ................................. $ 2,550 $ 2,400 $ 2,300 ------- ------- ------- Expenses State taxes ................................... 19 13 26 Other expenses ................................ 543 454 304 ------- ------- ------- 562 467 330 ------- ------- ------- Income before income taxes and equity in undistributed earnings of subsidiaries ........ 1,988 1,933 1,970 Income tax benefit ............................... (407) (129) (17) ------- ------- ------- Income before equity in undistributed earnings of subsidiaries ............................... 2,395 2,062 1,987 Equity in undistributed earnings (losses) of subsidiaries ..................................... 1,735 1,714 1,769 ------- ------- ------- Net Income .................................... $ 4,130 $ 3,776 $ 3,756 ======= ======= =======
50 THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
For the Years Ended December 31, -------------------------------- 2001 2000 1999 ------ ----- ---- Cash flows from operating activities: Net income .......................................... $ 4,130 $ 3,776 $ 3,756 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed (income) loss of subsidiaries ..................................... (1,735) (1,714) (1,769) Change in other assets ............................. (271) (68) (33) Change in other liabilities ........................ 69 22 (69) ------- ------- ------- Net cash provided by operating activities .......... 2,193 2,016 1,885 ------- ------- ------- Cash flows from financing activities: Proceeds from notes payable ......................... 0 0 0 Payments on notes payable ........................... (293) (271) (332) Purchase of treasury stock .......................... 0 0 60 Cash dividends ...................................... (1,865) (1,747) (1,664) ------- ------- ------- Net cash used in financing activities .............. (2,158) (2,018) (1,936) ------- ------- ------- Net increase (decrease) in cash and cash equivalents 35 (2) (51) Cash and due from banks at beginning of year ........ 66 68 119 ------- ------- ------- Cash and due from banks at end of year .............. $ 101 $ 66 $ 68 ======= ======= =======
51 Notes to Condensed Financial Information of Registrant Note 1-Basis of Presentation Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Information of the Registrant does not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles. It is, therefore, suggested that this Condensed Financial Information be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Registrant's Annual Report as referenced in Form 10-K, Part II, Item 8, page 18. Note 2-Cash Dividends from Subsidiaries Dividends of $2.5 million in 2001, $2.4 million in 2000 and $2.3 million in 1999 were paid to the Registrant by it subsidiaries. 52 THE NATIONAL SECURITY GROUP, INC. SCHEDULE III. SUPPLEMENTARY INSURANCE INFORMATION (CONSOLIDATED) (Amounts in thousands) Policy Claims Deferred Future and Other Acquisition Policy Unearned Benefits Costs Benefits Premiums Payable ------- ------- ------- ------ At December 31, 2001: Life and accident and health insurance $3,306 $22,734 $0 $401 Property and casualty insurance 1,309 0 7,115 11,489 ----- ------- ----- ------- Total $4,615 $22,734 $7,115 $11,890 ===== ======= ===== ======= At December 31, 2000: Life and accident and health insurance $3,240 $19,787 $0 $358 Property and casualty insurance 1,229 0 6,364 15,409 ------ ------- ----- ------- Total $4,469 $19,787 $6,364 $15,767 ====== ======= ====== ======= At December 31, 1999: Life and accident and health insurance $2,881 $18,987 $0 $394 Property and casualty insurance 1,392 0 7,088 18,471 ------ ------ ----- ------ Total $4,273 $18,987 $7,088 $18,865 ====== ====== ===== ======
Commissions, Benefits, Amortization General Claims, of Deferred Expenses, Net Losses and Policy Taxes, Premium Investment Other Settlement Acquisition Licenses Premiums Revenue Income Income Expenses Costs and Fees Written ------- -------- ------ --------- ----- ------- -------- For the year ended December 31, 2001: Life and accident and health insurance .................... $ 5,161 $ 2,303 $ 4 $ 3,183 $ 1,753 $ 3,096 $ 5,002 Property and casualty insurance ........... 20,196 2,203 1,276 10,333 4,363 4,017 20,949 Other ........................ 0 0 0 0 0 568 0 ------- ------- ------- ------- ------- ------- ------- Total .................... $25,357 $ 4,506 $ 1,280 $13,516 $ 6,116 $ 7,681 $25,951 ======= ======= ======= ======= ======= ======= ======= For the year ended December 31, 2000: Life and accident and health insurance .................... $ 4,594 $ 2,160 $ 11 $ 3,263 $ 970 $ 2,430 $ 4,405 Property and casualty insurance ........... 18,327 2,274 586 10,862 3,538 3,292 17,491 Other ........................ 0 0 0 0 0 476 0 ------- ------- ------- ------- ------- ------- ------- Total .................... $22,921 $ 4,434 $ 597 $14,125 $ 4,508 $ 6,198 $21,896 ======= ======= ======= ======= ======= ======= ======= For the year ended December 31, 1999: Life and accident and health insurance .................... $ 4,252 $ 2,124 $ 2 $ 2,404 $ 593 $ 1,895 $ 3,998 Property and casualty insurance ........... 21,685 2,230 383 14,871 4,172 3,845 20,036 Other ........................ 0 0 0 0 0 330 0 ------- ------- ------- ------- ------- ------- ------- Total .................... $25,937 $ 4,354 $ 385 $17,275 $ 4,765 $ 6,070 $24,034 ======= ======= ======= ======= ======= ======= =======
Note: Investment income and other operating expenses are reported separately by segment and not allocated. 53 THE NATIONAL SECURITY GROUP, INC. SCHEDULE IV. REINSURANCE (CONSOLIDATED) (Amounts in thousands)
Percentage Ceded Assumed of Amount Gross to Other from Other Net Assumed Amount Companies Companies Amount to Net -------- ------- ----- ------- --- For the year ended December 31, 2001: Life insurance in force ................... $184,128 $ 6,555 $ 0 $177,573 0.0% ======= ======= ==== ======= === Premiums: Life insurance and accident and health insurance .............. $ 5,206 $ 45 $ 0 $ 5,161 0.0% Property and casualty insurance 21,777 1,581 0 20,196 0.0% ------- ------- ---- -------- --- Total premiums ............ $ 26,983 $ 1,626 $ 0 $ 25,357 0.0% ======== ======== ===== ======== === For the year ended December 31, 2000: Life insurance in force ................... $155,924 $ 5,320 $ 0 $150,604 0.0% ======== ======== ===== ======== === Premiums: Life insurance and accident and health insurance .............. $ 4,645 $ 51 $ 0 $ 4,594 0.0% Property and casualty insurance 20,629 2,302 0 18,327 0.0% -------- -------- ----- -------- --- Total premiums ............ $ 25,274 $ 2,353 $ 0 $ 22,921 0.0% ======== ======== ===== ======== === For the year ended December 31, 1999: Life insurance in force ................... $146,096 $ 5,449 $ 0 $140,647 0.0% ======== ======== ===== ======== === Premiums: Life insurance and accident and health insurance .............. $ 4,300 $ 49 $ 0 $ 4,251 0.0% Property and casualty insurance 23,078 1,393 0 21,685 0.0% -------- -------- ----- -------- --- Total premiums ............ $ 27,378 $ 1,442 $ 0 $ 25,936 0.0% ======== ======== ===== ======== ===
54 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 55 PART III Item 10. Directors and Executive Officers of the Registrant The information contained on pages 2-4 of The National Security Group's Proxy Statement dated March 18, 2002, with respect to directors and executive officers of the Company, is incorporated herein by reference in response to this item. Item 11. Executive Compensation The information contained on pages 7 and 8 of The National Security Group's Proxy Statement dated March 18, 2002, with respect to executive compensation and transactions, is incorporated herein by reference in response to this item. Item 12. Security Ownership of Certain Beneficial Owners and Management The information contained on page 10 of The National Security Group's Proxy Statement dated March 18, 2002, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference to this item. Item 13. Certain Relationships and Related Transactions The information contained on pages 6 and 7 of The National Security Group's Proxy Statement dated March 18, 2002, with respect to certain relationships and related transactions, is incorporated herein by reference in response to this item. 56 PART IV Item 14. Exhibits, financial statement schedules, and reports on Form 8-K a. The following documents are filed as part of this report: Page # Reports of Independent Certified Public Accountants 22 Consolidated Statements of Income--Years Ended December 31, 2001, 2000, and 1999 24 Consolidated Balance Sheets--December 31, 2001 and 2000 25 Consolidated Statements of Shareholders' Equity--Years Ended December 31, 2001, 2000, and 1999 26 Consolidated Statements of Cash Flows--Years Ended December 31, 2001, 2000, and 1999 27 Notes To Consolidated Financial Statements--December 31, 2001 28 Schedule I. Summary Of Investments--December 31, 2001 and 2000 48 Schedule II. Condensed Financial Information of Registrant--December 31, 2001 and 2000 49 Schedule III. Supplementary Insurance Information-- December 31, 2001, 2000, and 1999 53 Schedule IV. Reinsurance--Years Ended December 31, 2001, 2000, and 1999 54 All other Schedules are not required under the related instructions or are inapplicable and therefore have been omitted. b. Reports on Form 8-K Incorporated by reference to the Registrant's Current Report on Form 8-K filed on April 20, 2001. 57 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) 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. THE NATIONAL SECURITY GROUP, INC. /s/ M.L. Murdock /s/ W.L. Brunson, Jr. - ------------------ ----------------------- M.L. Murdock W.L. Brunson, Jr. Sr. Vice President, President, Chief Executive Treasurer Officer and Director Date: March 29, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in their capacity as a Director of The National Security Group, Inc. On March 29, 2002. SIGNATURE /s/ D.M. English /s/ Fred D. Clark Jr. /s/ Winfield Baird /s/ M.L. Murdock /s/ Carolyn Brunson /s/ James B. Saxon /s/ J.E. Brunson /s/ Walter P. Wilkerson /s/ J.R. Brunson /s/ William L. Brunson,Jr. 58 -----END PRIVACY-ENHANCED MESSAGE-----