UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1999
---------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------------- ------------------
Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- --------------------------------------- ----------
(Address of principal executive office) (Zip Code)
(515) 280-2902
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at October 31, 1999
----------------------------- -------------------------------
Common stock, $1.00 par value 11,263,627
Total pages 21
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<PAGE>
PART I. FINANCIAL INFORMATION
- ------- ---------------------
Item 1. Financial Statements
- ------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
1999 1998
------------- ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(market value $145,656,593 and $174,623,439) $143,745,452 $164,926,190
Securities available-for-sale, at market value
(amortized cost $230,983,052 and
$208,115,127) .............................. 228,484,565 217,499,600
Equity securities available-for-sale, at market
value (cost $29,780,823 and $29,928,433) ..... 30,132,486 32,785,429
Short-term investments, at cost ................ 27,746,968 22,660,011
------------ ------------
Total investments ..................... 430,109,471 437,871,230
Cash ............................................. 1,862,963 2,133,056
Accrued investment income ........................ 5,902,171 5,865,307
Accounts receivable (net of allowance for
uncollectible accounts of $500,000 and $400,000) 3,503,470 2,779,041
Income taxes recoverable ......................... 1,218,000 3,224,000
Reinsurance receivables .......................... 17,673,603 16,627,791
Deferred policy acquisition costs ................ 14,614,910 12,355,482
Deferred income taxes (notes 7 and 8) ............ 16,495,081 10,371,754
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,313,580
and $2,212,695 ................................. 1,244,240 1,345,125
Prepaid reinsurance premiums ..................... 1,883,675 1,201,737
Other assets ..................................... 3,081,210 2,271,829
------------ ------------
Total assets .......................... $497,588,794 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
1999 1998
------------- ------------
LIABILITIES
Losses and settlement expenses ................... $256,375,268 $245,610,323
Unearned premiums ................................ 70,900,215 61,464,051
Other policyholders' funds ....................... 2,020,764 1,951,683
Indebtedness to related party .................... 4,123,947 3,393,182
Postretirement benefits .......................... 6,584,360 6,017,565
Deferred income .................................. 184,637 277,854
Other liabilities ................................ 10,700,097 13,393,854
Total liabilities ............................ 350,889,288 332,108,512
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,262,105
shares in 1999 and 11,496,389 shares in 1998 ... 11,262,105 11,496,389
Additional paid-in capital ....................... 65,306,149 67,822,412
Accumulated other comprehensive (loss)
income (note 7) ................................ (2,146,824) 8,079,371
Retained earnings ................................ 72,278,076 76,539,668
------------ ------------
Total stockholders' equity ................... 146,699,506 163,937,840
------------ ------------
Total liabilities and stockholders' equity ... $497,588,794 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Income
Three months ended Nine months ended
September 30, September 30,
----------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$52,596,314 $48,817,473 $153,295,867 $141,079,398
Investment income, net ... 6,669,304 6,139,359 19,030,740 18,872,115
Realized investment gains 1,313,608 7,240,947 1,559,775 7,324,406
Other income ............. 705,520 667,101 1,982,028 1,166,657
----------- ----------- ------------ ------------
61,284,746 62,864,880 175,868,410 168,442,576
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 44,080,785 43,758,062 126,844,057 117,100,206
Dividends to policyholders 729,623 (133,255) 1,711,209 1,267,903
Amortization of deferred
policy acquisition costs 11,458,397 11,952,113 34,573,674 30,794,401
Other underwriting
expenses ............... 4,675,398 3,591,254 13,520,600 13,838,674
Other expenses ........... 254,815 329,586 1,198,793 885,745
----------- ----------- ------------ ------------
61,199,018 59,497,760 177,848,333 163,886,929
----------- ----------- ------------ ------------
Income (loss) before
income tax (benefit) 85,728 3,367,120 (1,979,923) 4,555,647
----------- ----------- ------------ ------------
INCOME TAX (BENEFIT):
Current .................. 157,457 297,982 (860,930) 240,982
Deferred (note 8) ........ (864,387) 280,639 (1,961,227) (186,307)
----------- ----------- ------------ ------------
(706,930) 578,621 (2,822,157) 54,675
----------- ----------- ------------ ------------
Net income .........$ 792,658 $ 2,788,499 $ 842,234 $ 4,500,972
=========== =========== ============ ============
Net income per common
share - basic and diluted $ .07 $ .24 $ .07 $ .39
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .45 $ .45
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,259,339 11,487,140 11,352,828 11,422,899
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Net income ................. $ 792,658 $ 2,788,499 $ 842,234 $ 4,500,972
OTHER COMPREHENSIVE INCOME:
Unrealized holding
(losses) gains arising
during the period,
before deferred income
taxes (benefit) ........ (5,582,204) (346,921)(12,836,451) 3,235,176
Deferred income taxes
(benefit) (note 7) ..... (1,168,027) (117,951) (3,634,473) 1,099,964
----------- ----------- ----------- -----------
(4,414,177) (228,970) (9,201,978) 2,135,212
----------- ----------- ----------- -----------
Reclassification
adjustment for gains
included in net
income, before
income taxes ........... (1,305,677) (7,240,947) (1,551,844) (7,310,987)
Income taxes ............. 443,930 2,461,922 527,627 2,485,736
----------- ----------- ----------- -----------
(861,747) (4,779,025) (1,024,217) (4,825,251)
----------- ----------- ----------- -----------
Other comprehensive
loss ............. (5,275,924) (5,007,995)(10,226,195) (2,690,039)
----------- ----------- ----------- -----------
Total comprehensive
(loss) income .... $(4,483,266)$(2,219,496)$(9,383,961)$ 1,810,933
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine months ended
September 30,
--------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 842,234 $ 4,500,972
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 10,764,945 19,299,157
Unearned premiums ......................... 9,436,164 8,767,265
Other policyholders' funds ................ 69,081 (679,786)
Deferred policy acquisition costs ......... (2,259,428) (2,749,047)
Indebtedness of related party ............. 730,765 (692,485)
Accrued investment income ................. (36,864) (72,845)
Income taxes payable ...................... 2,006,000 (6,182,000)
Deferred income taxes (notes 7 and 8) ..... (1,961,227) (186,307)
Realized investment gains ................. (1,559,775) (7,324,406)
Postretirement benefits ................... 566,795 744,520
Reinsurance receivables ................... (1,045,812) (2,311,314)
Prepaid reinsurance premiums .............. (681,938) (561,574)
Amortization of deferred income ........... (93,217) (131,371)
Other, net ................................ (4,219,194) (1,040,056)
------------ ------------
11,716,295 6,879,751
Cash provided by the change in the
property and casualty insurance
subsidiaries' pooling agreement (note 2) - 5,569,567
------------ ------------
Net cash provided by
operating activities .............. $ 12,558,529 $ 16,950,290
============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Nine months ended
September 30,
------------ ------------
1999 1998
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $(13,459,276) $(15,459,844)
Maturities of fixed maturity securities
held-to-maturity ............................ 34,723,949 32,046,922
Purchases of fixed maturity securities
available-for-sale (note 6) ................. (100,878,679) (24,965,868)
Disposals of fixed maturity securities
available-for-sale (note 6) ................. 79,616,230 15,640,400
Purchases of equity securities
available-for-sale .......................... (17,742,273) (33,374,717)
Disposals of equity securities
available-for-sale .......................... 17,852,208 6,964,169
Purchase of common stock mutual funds
invested in equity securities
available-for-sale .......................... - (102,020)
Disposals of common stock mutual funds
invested in equity securities
available-for-sale .......................... - 28,675,920
Net purchases of short-term investments ....... (5,086,957) (22,851,354)
------------ ------------
Net cash used in investing activities ....... (4,974,798) (13,426,392)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 248,129 749,939
Repurchase of common stock (note 4) ........... (2,998,677) -
Dividends paid to stockholders (note 5) ....... (5,103,276) (3,913,447)
------------ ------------
Net cash used in financing activities ..... (7,853,824) (3,163,508)
------------ ------------
NET (DECREASE) INCREASE IN CASH ................. (270,093) 360,390
Cash at beginning of year ....................... 2,133,056 1,200,300
------------ ------------
Cash at end of quarter .......................... $ 1,862,963 $ 1,560,690
============ ============
Income taxes (recovered) paid ................... $ (2,877,492) $ 6,422,982
Interest paid ................................... $ 88,911 $ -
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
September 30, 1999
Note 1
- ------
The results of operations for the interim periods reported are not necessarily
indicative of results to be expected for the year. The information reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
Certain amounts previously reported in prior years' consolidated financial
statements have been reclassified to conform to current year presentation.
In reading these financial statements, reference should be made to the
Company's 1998 Form 10-K or the 1998 Annual Report to Shareholders for more
detailed footnote information.
Note 2
- ------
Effective January 1, 1998, Farm and City Insurance Company (Farm and City), a
subsidiary of the Company that writes nonstandard risk automobile insurance
business, became a participant in the EMC Insurance Companies pooling
agreement. Farm and City assumes a 1.5 percent participation in the pool,
which increased the Company's aggregate participation in the pool from 22
percent to 23.5 percent. In connection with this change in the pooling
agreement, the Company's liabilities increased $6,224,586 and invested assets
increased $5,569,567. The Company reimbursed Employers Mutual Casualty
Company (Employers Mutual) $726,509 for the expenses that were incurred to
generate the additional business assumed by the Company and Employers Mutual
paid the Company $71,490 in interest income as the actual cash transfer did
not occur until March 25, 1998.
Note 3
- ------
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of Effective Date of
FASB Statement No. 133", which defers the effective date of SFAS 133 until
fiscal years beginning after June 15, 2000. Currently, the Company's
investment strategy does not include investments in derivative instruments or
hedging activities. Adoption of this statement is not expected to have any
effect on the operating results of the Company.
Note 4
- ------
During the second quarter of 1999 the Company completed a $3,000,000 stock
repurchase plan that was approved by its Board of Directors on November 20,
1998. A total of 254,950 shares of common stock were repurchased under this
plan at an average cost of $11.76 per share.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
Note 5
- ------
Since the third quarter of 1998, all shares of common stock issued under the
Company's dividend reinvestment plan have been purchased on the open market
through the Company's transfer agent. Accordingly, all dividends paid since
that time are classified as cash dividends.
During the second quarter of 1999, Employers Mutual elected to increase its
participation in the Company's dividend reinvestment plan. As a result,
Employers Mutual is now reinvesting 100 percent of its dividends in additional
shares of the Company's common stock. Prior to the second quarter of 1999,
Employers Mutual was reinvesting 50 percent of its dividends in additional
shares of the Company's common stock.
Note 6
- ------
During the second quarter and third quarter of 1999, the Company disposed of
approximately $55,000,000 of investments in tax-exempt fixed maturity
securities and reinvested the proceeds in taxable fixed maturity securities to
improve after-tax investment returns. This change in asset allocation
was implemented to increase the Company's after-tax rate of return on its
investments in response to the recent deterioration in the Company's
underwriting results and the expectation that underwriting results will not
improve dramatically in the near future.
Note 7
- ------
At September 30, 1999, the Company established a valuation allowance of
$729,921 related to the deferred income tax asset associated with unrealized
holding losses on fixed maturity securities available-for-sale. This
valuation allowance was established due to the uncertainty concerning the
future realization of the tax benefit. Accordingly, the accumulated other
comprehensive loss reported at September 30, 1999 does not reflect the
deferred tax benefit.
Note 8
- ------
The deferred income tax benefit reported for the three months and nine months
ended September 30, 1999 reflects $100,000 and $300,000, respectively,
related to a reduction in the valuation allowance associated with future
postretirement benefit deductions. The valuation allowance is being reduced
as a result of the establishment of Voluntary Employee Beneficiary
Association (VEBA) trusts that will accelerate the postretirement benefit
deductions and reduce the uncertainty of future realization of the tax
benefit.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations
-----------------------------------
OVERVIEW
EMC Insurance Group Inc., an approximately 71 percent owned subsidiary of
Employers Mutual Casualty Company (Employers Mutual), is an insurance holding
company with operations in property and casualty insurance and reinsurance.
Property and casualty insurance is the most significant segment, representing
80.9 percent of consolidated premiums earned. For purposes of this
discussion, the term "Company" is used interchangeably to describe EMC
Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and
its subsidiaries.
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. Operations of the pool
give rise to intercompany balances with Employers Mutual, which are settled on
a quarterly basis. The investment and income tax activities of the pool
participants are not subject to the pooling agreement.
The purpose of the pooling agreement is to spread the risk of an exposure
insured by any of the pool participants among all the companies. The pooling
agreement produces a more uniform and stable underwriting result from year to
year for all companies in the pool than might be experienced individually. In
addition, each company benefits from the capacity of the entire pool, rather
than being limited to policy exposures of a size commensurate with its own
assets, and from the wide range of policy forms, lines of insurance written,
rate filings and commission plans offered by each of the companies. A single
set of reinsurance treaties is maintained for the protection of all companies
in the pool.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related losses
and settlement expenses of this business, subject to a maximum loss of
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to intercompany balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The
information reflects all adjustments which are, in the opinion of management,
necessary for a fair statement of the results for the interim periods.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and nine months ended September
30, 1999 and 1998 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1999 1998 1999 1998
-------- -------- -------- --------
Premiums earned ..................... $ 52,596 $ 48,817 $153,296 $141,079
Losses and settlement expenses ...... 44,081 43,758 126,844 117,100
Acquisition and other expenses ...... 16,863 15,410 49,806 45,901
-------- -------- -------- --------
Underwriting loss ................... (8,348) (10,351) (23,354) (21,922)
Net investment income ............... 6,669 6,139 19,031 18,872
Other income ........................ 451 338 783 282
-------- -------- -------- --------
Operating loss before income taxes .. (1,228) (3,874) (3,540) (2,768)
Realized investment gains ........... 1,314 7,241 1,560 7,324
-------- -------- -------- --------
Income (loss) before income taxes ... $ 86 $ 3,367 $ (1,980)$ 4,556
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 47,235 $ 46,403 $134,135 $126,556
Decrease in provision for
insured events of prior years (3,154) (2,645) (7,291) (9,456)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 44,081 $ 43,758 $126,844 $117,100
======== ======== ======== ========
Catastrophe and storm losses ........ $ 2,117 $ 3,784 $ 8,211 $ 12,930
======== ======== ======== ========
Operating results before income taxes remained unprofitable for the
second consecutive year for both the three months and the nine months ended
September 30, 1999. Inadequate premium rates, a high level of catastrophe and
storm losses and an increase in overall loss severity combined to produce
unfavorable results. Inadequate premium rates, which have resulted from
thirteen consecutive years of intense rate competition within the insurance
industry, continue to be the primary cause of the Company's substandard
performance. Premium rates have begun to show some signs of stabilization
during the first nine months of 1999, an indication that the prolonged decline
in premium rates may be coming to an end. However, overall premium rate
adequacy is not expected to improve dramatically in the near future as there
is still a significant amount of excess capacity in the insurance industry.
As a result, management is working to improve profitability through re-
underwriting programs for both the existing book of business and the agency
force.
Premiums earned increased 7.7 percent for the three months and 8.7
percent for the nine months ended September 30, 1999 from the same periods in
1998, primarily due to an increase in policy count. Overall premium rate
adequacy continued to decline in the first nine months of 1999 as a result of
premium rate reductions that were implemented during 1998. Moderate rate
increases have been implemented in select lines of business during the first
nine months of 1999. As these rate increases become more fully reflected in
the determination of earned premiums, premium rate adequacy should begin to
improve.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Losses and settlement expenses increased 0.7 percent for the three months
and 8.3 percent for the nine months ended September 30, 1999 from the same
periods in 1998. Results for both the three months and the nine months of
1999 reflect an increase in overall loss severity. The increase for the three
months ended September 30, 1999 was partially offset by a decline in
catastrophe and storm losses and an increase in the amount of favorable
development experienced in the actual settlement of claims and changes in
reserves associated with prior years' losses.
Acquisition and other expenses increased 9.4 percent for the three months
and 8.5 percent for the nine months ended September 30, 1999 from the same
periods in 1998. These increases primarily reflect the growth in premium
income experienced during 1999.
Net investment income increased 8.6 percent for the three months and 0.8
percent for the nine months ended September 30, 1999 from the same periods in
1998. The large increase for the three months ended September 30, 1999 is
primarily due to the disposal of approximately $55,000,000 of investments in
tax-exempt fixed maturity securities and the subsequent reinvestment of the
proceeds into taxable fixed maturity securities that pay a higher interest
rate. This reallocation program was started during the second quarter and was
completed in the third quarter. This change in asset allocation was
implemented to increase the Company's after-tax rate of return on its
investments in response to the recent deterioration in the Company's
underwriting results and the expectation that underwriting results will not
improve dramatically in the near future.
The deferred income tax benefit reported for the three months and nine
months ended September 30, 1999 reflects $100,000 and $300,000, respectively,
related to a reduction in the valuation allowance associated with future
postretirement benefit deductions. The valuation allowance is being reduced
as a result of the establishment of Voluntary Employee Beneficiary Association
(VEBA) trusts that will accelerate the postretirement benefit deductions
and reduce the uncertainty of future realization of the tax benefits.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and nine months ended September
30, 1999 and 1998 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1999 1998 1999 1998
-------- -------- -------- --------
Premiums earned ..................... $ 42,628 $ 39,530 $124,044 $114,676
Losses and settlement expenses ...... 35,625 35,635 104,214 97,875
Acquisition and other expenses ...... 13,775 12,808 40,413 37,352
-------- -------- -------- --------
Underwriting loss ................... (6,772) (8,913) (20,583) (20,551)
Net investment income ............... 4,711 4,369 13,425 13,374
Other income ........................ 491 375 1,013 456
-------- -------- -------- --------
Operating loss before income taxes .. (1,570) (4,169) (6,145) (6,721)
Realized investment gains ........... 1,096 7,242 1,279 7,318
-------- -------- -------- --------
(Loss) income before income taxes ... $ (474)$ 3,073 $ (4,866)$ 597
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 38,883 $ 38,076 $112,308 $105,794
Decrease in provision for
insured events of prior years.. (3,258) (2,441) (8,094) (7,919)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 35,625 $ 35,635 $104,214 $ 97,875
======== ======== ======== ========
Catastrophe and storm losses ........ $ 1,969 $ 2,415 $ 7,060 $ 10,304
======== ======== ======== ========
Premiums earned increased 7.8 percent for the three months and 8.2
percent for the nine months ended September 30, 1999 from the same periods in
1998, primarily due to an increase in policy count. Premium rates continue to
show signs of stabilization, as the Company was able to implement modest rate
increases in select lines of business during the first nine months of 1999.
However, the increases implemented in the commercial lines of business, in
which the Company conducts the majority of its insurance business, were not as
large as those in the personal lines due to the intense competition that
continues to exist for select classes of business and in certain marketing
territories. Overall premium rate adequacy continued to decline in the first
nine months of 1999 as prior year rate reductions had a greater impact on the
determination of earned premiums than the recent rate increases. As the
impact of the 1999 rate increases becomes more fully reflected in earned
premiums, profit margins should begin to improve.
Losses and settlement expenses remained flat for the three months and
increased 6.5 percent for the nine months ended September 30, 1999 from the
same periods in 1998. Although catastrophe and storm losses have declined
from the storm-plagued levels experienced in 1998, they continue to have a
significant impact on the operating results reported for 1999. For the third
quarter of 1999, total catastrophe and storm losses amount to $4,713,000 and
included $1,780,000 related to a Midwest wind storm and $940,000 related to
Hurricane Floyd. Net catastrophe and storm losses for the third quarter of
1999 amounted to $1,969,000 after deducting $2,744,000 of reinsurance
recoverable under an aggregate excess of loss catastrophe reinsurance
agreement. For the first nine months of 1999, recoveries under the aggregate
excess of loss reinsurance agreement totaled $3,826,000 compared to $495,000
for the same period in 1998. In addition to the high level of catastrophe and
storm losses, operating results for 1999 reflect an increase in overall loss
severity.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Acquisition and other expenses increased 7.5 percent for the three months
and 8.2 percent for the nine months ended September 30, 1999 as compared to
the same periods in 1998. These increases are primarily due to the growth in
premium income experienced during 1999; however, these increases also reflect
the impact of a change in the estimate of acquisition expenses that was
implemented in 1998. This change in estimate had the effect of increasing the
amount of acquisition costs that were deferred, which resulted in a smaller
increase in the amount of acquisition and other expense reported for 1998.
Underwriting results for the three months and nine months ended September
30, 1999 were negatively impacted by inadequate rate levels, a high level of
catastrophe and storm losses and an increase in overall loss severity.
Management is working to improve profitability through re-underwriting
programs for both the existing book of business and the agency force and by
implementing rate increases where possible. In addition, the Company has
acquired, and is developing, several new tools that will provide its employees
with enhanced underwriting capabilities using the latest available
technologies. Examples of these tools include catastrophe modeling software,
market demographics software and Internet based underwriting and premium
rating technologies.
Reinsurance
Operating results for the three months and nine months ended September
30, 1999 and 1998 are as follows:
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
($ in thousands) 1999 1998 1999 1998
-------- -------- -------- --------
Premiums earned ..................... $ 9,968 $ 9,287 $ 29,252 $ 26,403
Losses and settlement expenses ...... 8,456 8,123 22,630 19,225
Acquisition and other expenses ...... 3,088 2,602 9,393 8,549
-------- -------- -------- --------
Underwriting (loss) ................. (1,576) (1,438) (2,771) (1,371)
Net investment income ............... 1,847 1,638 5,302 5,128
Other income ........................ 28 40 93 131
-------- -------- -------- --------
Operating income before
income taxes ...................... 299 240 2,624 3,888
Realized investment gains (losses) .. 218 (1) 281 6
-------- -------- -------- --------
Income before income taxes .......... $ 517 $ 239 $ 2,905 $ 3,894
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 8,352 $ 8,327 $ 21,827 $ 20,762
Increase (decrease) in
provision for insured events
of prior years ................ 104 (204) 803 (1,537)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 8,456 $ 8,123 $ 22,630 $ 19,225
======== ======== ======== ========
Catastrophe losses .................. $ 148 $ 1,369 $ 1,151 $ 2,626
======== ======== ======== ========
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Premiums earned increased 7.3 percent for the three months and 10.8
percent for the nine months ended September 30, 1999 from the same periods in
1998. This growth is primarily attributable to the delayed reporting of
foreign reinsurance contracts written in 1998. Current year production has
been relatively flat due to the continued intense rate competition within the
reinsurance marketplace. Premium rates have shown some signs of stabilization
during 1999 as moderate rate increases were implemented on some foreign
contracts that were exposed to losses in 1998; however, overall rate adequacy
has not improved as rate decreases were experienced on domestic contracts with
good loss experience.
Losses and settlement expenses increased 4.1 percent for the three
months and 17.7 percent for the nine months ended September 30, 1999 from the
same periods in 1998. Results for both the three months and the nine months
ended September 30, 1999 have been negatively impacted by an increase in
property losses and by adverse development experienced in the actual
settlement of claims and changes in reserves associated with prior years'
losses. Most of the adverse development reported in 1999 is associated with
the 1998 accident year, which experienced heavy catastrophe and storm losses.
During the third quarter and the first nine months of 1999, bulk incurred but
not reported (IBNR) reserves have been increased $875,000 and $1,625,000,
respectively, as a result of increased claims activity on the property book of
business.
Acquisition and other expenses increased 18.7 percent for the three
months and 9.9 percent for the nine months ended September 30, 1999 from the
same periods in 1998. These increases reflect the higher premium volume
experienced in 1999 as well as a substantial reduction in the reserve carried
for contingent commissions at September 30, 1998, which reduced the amount of
incurred acquisition costs reported in 1998.
Underwriting results continue to decline in the highly competitive
reinsurance marketplace. This decline can be attributed in part to intense
rate competition, which is a result of excess capacity in the reinsurance
marketplace. Employers Mutual is working to address this issue by accepting a
larger share of coverage on desirable programs and strengthening its
relationships with reinsurance intermediaries. Management is aware of the
narrowing profit margin on reinsurance business and continues to emphasize
profitability over premium volume.
Parent Company
Operating results before income taxes totaled $43,000 and ($19,000) for
the three months and nine months ended September 30, 1999 compared to $55,000
and $65,000 for the same periods in 1998. The decline in operating results
for 1999 is primarily due to a reduction in investment income that resulted
from a decline in the invested asset balance.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of the investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to meet claims and expenses. The remainder of the investment portfolio,
excluding investments in equity securities, is invested in securities with
maturities that approximate the anticipated liabilities of the insurance
issued.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
The Company previously classified a portion of its investments in fixed
maturity securities, primarily bonds issued by municipalities and
corporations, as available-for-sale securities. Beginning in the third
quarter of 1999, all newly acquired securities are being classified as
available-for-sale to provide additional flexibility in the management of the
portfolio. Unrealized holding losses on fixed maturity securities
available-for-sale, net of tax, totaled $2,379,000 at September 30, 1999
compared to unrealized holding gains of $6,194,000 at December 31, 1998. The
decrease in the market value of these investments is primarily due to an
increase in interest rates during the third quarter, which caused the bond
values to decline. Since the Company does not actively trade in the bond
market, such fluctuations in the fair value of these investments are not
expected to have a material impact on the operations of the Company, as forced
liquidations of investments are not anticipated. The Company closely monitors
the bond market and makes appropriate adjustments in investment policy as
changing conditions warrant. At September 30, 1999, a valuation allowance of
$729,921 related to the deferred tax asset associated with the unrealized
holding losses was established due to the uncertainty concerning the future
realization of the tax benefit.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of income which
supplements underwriting results and contributes to net earnings. As these
investments mature, the proceeds will be reinvested at current rates, which
may be higher or lower than those now being earned; therefore, more or less
investment income may be available to contribute to net earnings depending on
the interest rate level.
During the second and third quarters of 1999 the Company disposed of
approximately $55,000,000 of investments in tax-exempt fixed maturity
securities and reinvested the proceeds in taxable fixed maturity securities
with similar durations. This change in asset allocation is not expected
to have a material impact on the operations of the Company as forced
liquidations of investments are not anticipated.
During the third quarter of 1998 the Company liquidated its common stock
mutual fund portfolio and reinvested the proceeds in individual stock issues
that are being managed on a tax-aware basis. This change in asset allocation
is not expected to have a material impact on the operations of the Comany
as forced liquidations of investments are not anticipated; however,
realized investment gains reported in future periods are expected to decline
significantly from the amounts reported during the last several years as the
Company will have the ability to control both the timing and the amount of
sales that occur in these investments.
The major ongoing sources of the Company's liquidity are insurance
premium income, investment income and cash provided from maturing or
liquidated investments. The principal outflows of cash are payments of
claims, commissions, premium taxes, operating expenses, income taxes,
dividends and investment purchases.
During the first nine months of 1999, the Company generated positive cash
flows from operations of $12,558,529 compared to $16,950,290 for the same
period of 1998. The amount for 1998 includes $5,569,567 received from
Employers Mutual in connection with the addition of Farm and City to the
pooling agreement.
During the second quarter of 1999 the Company completed a $3,000,000
stock repurchase plan that was approved by its Board of Directors on November
20, 1998. A total of 254,950 shares of common stock were repurchased under
this plan at an average cost of $11.76 per share.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
During the second quarter of 1999, Employers Mutual elected to increase
its participation in the Company's dividend reinvestment plan. As a result,
Employers Mutual is now reinvesting 100 percent of its dividends in additional
shares of the Company's common stock. Prior to the second quarter of 1999,
Employers Mutual was reinvesting 50 percent of its dividends in additional
shares of the Company's common stock.
IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS
The Year 2000 issue presents both operational and underwriting risks to
the Company. Operational risks include the failure of computer systems and
equipment owned and operated by Employers Mutual, as well as those owned and
operated by vendors and other parties with which the Company conducts
business. Underwriting risks include, but are not limited to, potential
claims by the Company's insureds to recover losses due to interruption of
business or liability to third parties that result from the failure of
computer systems.
Employers Mutual owns and maintains the computer systems utilized in the
operation of the Company's businesses, and is currently in the process of
finalizing changes to these systems in order to be Year 2000 compliant.
Employers Mutual uses a four step process for preparing systems for Year 2000
compliance:
1) Inventory and impact - systems are reviewed to assess the impact
of Year 2000, including the consequences of failure to achieve
Year 2000 compliance.
2) Planning and scheduling - modifications are planned and
scheduled.
3) Modification and testing - necessary system modifications are
made and tested.
4) Certification - a formal test of the system for compliance and
approval by the appropriate management personnel.
All internal systems, including the critical systems of policy issuance,
billing and claims processing, have been certified as compliant. Employers
Mutual has completed its research of Year 2000 compliance information with its
vendors of computer and facility equipment and software. The majority of the
necessary upgrades of equipment or software from these vendors to achieve Year
2000 compliance have been implemented, and all remaining upgrades are
scheduled for implementation by the end of 1999. Employers Mutual has also
contracted with an outside consulting firm to provide an independent
assessment of Year 2000 compliance efforts. The consultants issued a report
which included findings and recommendations. This information has all been
considered by management in its assessment of Year 2000 compliance issues.
Employers Mutual is also monitoring Year 2000 compliance of third parties
with which it has a material business relationship. Employers Mutual has
contacted financial institutions providing custodial and other services and
suppliers to ascertain their Year 2000 compliance status. The Company is
relying upon the Year 2000 readiness statements of these third parties and has
not independently verified the accuracy of such statements.
The Company has distributed a letter to all of its commercial insureds
notifying them that their current policies do not cover Year 2000 losses, but
that coverage may be available through an endorsement to the policy. A
questionnaire has been developed and provided to them to aid in assessing
potential risks from Year 2000 noncompliance. Employers Mutual has in place
reinsurance protection for potential third party liability claims against
policyholders arising from Year 2000 issues.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Year 2000 compliance efforts have been in process for a number of years.
The majority of the costs associated with these efforts is the internal
payroll and payroll related expenses of the information systems department.
These expenses were charged to operations in the year incurred and were not
separately tracked. In addition, nearly all purchases of software and
hardware applications were not made specifically for Year 2000 compliance, and
are not considered costs of the Year 2000 compliance effort. Costs incurred
to date for outside consultants and software and hardware applications
specifically purchased for Year 2000 compliance efforts have amounted to less
than $100,000 for the EMC Insurance Companies. The Company's share of all
remaining costs associated with the Year 2000 compliance project are not
expected to exceed $35,000.
The most likely worst case scenario for failing to achieve Year 2000
compliance would be a delay in processing of non-critical functions. Due to
the current state of readiness, it is unlikely that the processing of policy
issuance, billing, or claim handling activities will be delayed. However, it
is reasonably likely that delays in the processing of ancillary activities may
be experienced. The effect of these delays are not expected to be material to
the Company's results of operations, liquidity, or financial condition.
The Company believes it has addressed the potential exposures related to
Year 2000 noncompliance. If an unforeseen Year 2000 failure occurs, manual
processing may be used until the necessary corrections are implemented. In
addition, data on the computer systems is regularly backed-up and held off-
site in both soft and hard copy format. This historical data would be
available in the event of any processing failures. A formalized and
documented business continuation plan is also in place to support operations
in cases of business interruption.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 133, "Accounting for
Derivative Instruments and Hedging Activities", effective for fiscal years
beginning after June 15, 1999. In June 1999, the FASB issued SFAS 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS 133 until fiscal years beginning after June 15, 2000. Currently, the
Company's investment strategy does not include investments in derivative
instruments or hedging activities. Adoption of this statement is not expected
to have any effect on the operating results of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained in this
report is based on management's current expectations and actual results of the
Company may differ materially from such expectations. The risks and
uncertainties that may affect the actual results of the Company include but
are not limited to the following: catastrophic events and the occurrence of
significant severe weather conditions; state and federal legislation and
regulations; changes in the demand for, pricing of, or supply of insurance or
reinsurance; changes in interest rates and the performance of financial
markets; the adequacy of loss and settlement expense reserves, including
asbestos and environmental claims; failure in Year 2000 compliance by the
Company, its vendors or third party service providers; and other risks and
uncertainties inherent in the Company's business.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------- ----------------------------------------------------------
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective boards of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Interest rate risk includes the price sensitivity of a fixed maturity
security to changes in interest rates and the affect on future earnings from
short-term investments and maturing long-term investments, given a change in
interest rates. The following analysis illustrates the sensitivity of the
Company's financial instruments to selected changes in market rates and
prices. A hypothetical one percent increase or decrease in interest rates as
of September 30, 1999 and December 31, 1998 would result in corresponding
pretax decreases or increases in the fair value of the fixed maturity
portfolios of approximately $19,300,000 or 4.8 percent at September 30, 1999
and $16,000,000 or 3.9 percent at December 31, 1998. In addition, a
hypothetical one percent increase or decrease in interest rates at September
30, 1999 and December 31, 1998 would result in corresponding increases or
decreases in pretax income over the next twelve months of approximately
$600,000 from September 30, 1999 and $800,000 from December 31, 1998, assuming
the current maturity and prepayment patterns. The Company monitors interest
rate risk through the analysis of interest rate simulations, and adjusts the
average duration of its fixed maturity portfolio by investing in either longer
or shorter term instruments given the results of interest rate simulations and
judgments of cash flow needs.
The valuation of the Company's marketable equity portfolios is subject to
equity price risk. In general, equities have more year-to-year price
variability than bonds. However, returns from equity securities over longer
time frames have been consistently higher. The Company invests in a
diversified portfolio of readily marketable equity securities. A hypothetical
10 percent increase or decrease in the S&P 500 as of September 30, 1999 and
December 31, 1998 would result in corresponding pretax increases or decreases
in the fair value of the Company's equity portfolio of approximately
$2,700,000 at September 30, 1999 and $2,900,000 at December 31, 1998.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At September 30, 1999 the portfolio of long-
term fixed maturity securities consists of 19.7 percent U.S. Treasury, 13.8
percent government agency, 16.5 percent mortgage-backed, 26.0 percent
municipal, and 24.0 percent corporate securities. At December 31, 1998 the
portfolio of long-term fixed maturity securities consisted of 24.5 percent
U.S. Treasury, 13.3 percent government agency, 6.8 percent mortgage-backed,
42.1 percent municipal, and 13.3 percent corporate securities. No securities
are below investment grade.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risk, Continued
- ------- ---------------------------------------------------------------------
Prepayment risk refers to the changes in prepayment patterns that can
either shorten or lengthen the expected timing of the principal repayments and
thus the average life and the effective yield of a security. Such risk exists
primarily within the portfolio of mortgage-backed securities. The prepayment
risk analysis is monitored regularly through the analysis of interest rate
simulations. At September 30, 1999 the effective duration of the mortgage-
backed securities is 4.0 years with an average life and current yield of 7.2
years and 7.6 percent, respectively. At December 31, 1998 the effective
duration of the mortgage-backed securities was 1.5 years with an average life
and current yield of 2.1 years and 7.7 percent, respectively.
PART II. OTHER INFORMATION
- -------- -----------------
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) None.
(b) No Form 8-K was filed by the registrant during the
quarter ended September 30, 1999.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
-----------------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
-----------------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: November 12, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
9/30/99 balance sheet and income statement and is qualified in its
entirety by reference.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 228,484,565
<DEBT-CARRYING-VALUE> 143,745,452
<DEBT-MARKET-VALUE> 145,656,593
<EQUITIES> 30,132,486
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 430,109,471
<CASH> 1,862,963
<RECOVER-REINSURE> 17,673,603
<DEFERRED-ACQUISITION> 14,614,910
<TOTAL-ASSETS> 497,588,794
<POLICY-LOSSES> 256,375,268
<UNEARNED-PREMIUMS> 70,900,215
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 2,020,764
<NOTES-PAYABLE> 0
0
0
<COMMON> 11,262,105
<OTHER-SE> 135,437,401
<TOTAL-LIABILITY-AND-EQUITY> 497,588,794
153,295,867
<INVESTMENT-INCOME> 19,030,740
<INVESTMENT-GAINS> 1,559,775
<OTHER-INCOME> 1,982,028
<BENEFITS> 126,844,057
<UNDERWRITING-AMORTIZATION> 34,573,674
<UNDERWRITING-OTHER> 13,520,600
<INCOME-PRETAX> (1,979,923)
<INCOME-TAX> (2,822,157)
<INCOME-CONTINUING> 842,234
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 842,234
<EPS-BASIC> .07
<EPS-DILUTED> .07
<RESERVE-OPEN> 245,610,323
<PROVISION-CURRENT> 134,134,989
<PROVISION-PRIOR> (7,290,932)
<PAYMENTS-CURRENT> 51,416,789
<PAYMENTS-PRIOR> 62,097,493
<RESERVE-CLOSE> 256,375,268
<CUMULATIVE-DEFICIENCY> (7,290,932)
</TABLE>
