UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2000
-------------------------------------
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 July 31, 2000
----- ----------------------------
Common stock, $1.00 par value 11,290,384
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Total pages 20
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<PAGE 1>
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
------- --------------------
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $122,002,675 and $126,679,065) $122,505,743 $127,204,160
Securities available-for-sale, at fair value
(amortized cost $280,731,638 and
$263,720,333) .............................. 274,421,775 256,181,429
Equity securities available-for-sale, at fair
value (cost $28,312,991 and $28,494,631) ..... 33,455,990 32,408,272
Short-term investments, at cost ................ 12,805,824 20,164,210
------------ ------------
Total investments ..................... 443,189,332 435,958,071
Cash ............................................. 1,054,879 1,508,678
Accrued investment income ........................ 7,165,103 6,886,939
Accounts receivable (net of allowance for
uncollectible accounts of $634,000 and $633,000) 1,947,914 3,293,537
Income taxes recoverable ......................... 1,415,404 1,537,000
Reinsurance receivables .......................... 9,981,720 11,129,365
Deferred policy acquisition costs ................ 14,883,513 13,619,192
Deferred income taxes ............................ 18,333,097 18,121,317
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,414,464
and $2,347,208 ................................. 1,143,356 1,210,612
Prepaid reinsurance premiums ..................... 2,073,908 1,280,564
Other assets ..................................... 1,159,487 2,030,703
------------ ------------
Total assets .......................... $502,347,713 $496,575,978
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE 2>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
------------ ------------
LIABILITIES
Losses and settlement expenses ................... $269,686,883 $266,514,024
Unearned premiums ................................ 70,418,517 64,991,129
Other policyholders' funds ....................... 622,637 1,093,254
Indebtedness to related party .................... 2,219,842 3,886,559
Postretirement benefits .......................... 7,228,671 6,768,219
Deferred income .................................. 114,258 158,831
Other liabilities ................................ 9,049,617 11,247,685
------------ ------------
Total liabilities ......................... 359,340,425 354,659,701
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,290,384
shares in 2000 and 11,265,232 shares in 1999 ... 11,290,384 11,265,232
Additional paid-in capital ....................... 65,511,728 65,333,686
Accumulated other comprehensive loss ............. (1,166,864) (3,625,263)
Retained earnings ................................ 67,372,040 68,942,622
------------ ------------
Total stockholders' equity ................ 143,007,288 141,916,277
------------ ------------
Total liabilities and stockholders' equity $502,347,713 $496,575,978
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE 3>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three months ended Six months ended
June 30, June 30,
----------------------- -------------------------
2000 1999 2000 1999
----------- ----------- ------------ ------------
REVENUES:
Premiums earned ..........$55,132,431 $50,954,939 $108,559,766 $100,699,553
Investment income, net ... 7,232,226 6,092,183 14,179,642 12,361,436
Realized investment gains 164,868 156,879 329,253 246,167
Other income ............. 387,550 507,431 993,051 1,276,508
----------- ----------- ------------ ------------
62,917,075 57,711,432 124,061,712 114,583,664
----------- ----------- ------------ ------------
LOSSES AND EXPENSES:
Losses and settlement
expenses ............... 47,106,919 44,296,277 88,873,179 82,763,272
Dividends to policyholders 243,020 509,397 517,406 981,586
Amortization of deferred
policy acquisition costs 12,228,213 11,379,378 24,197,575 23,115,277
Other underwriting
expenses ............... 3,270,361 4,704,860 7,993,748 8,845,202
Other expenses ........... 362,524 459,688 770,092 943,978
----------- ----------- ------------ ------------
63,211,037 61,349,600 122,352,000 116,649,315
----------- ----------- ------------ ------------
(Loss) income before
income tax benefit ... (293,962) (3,638,168) 1,709,712 (2,065,651)
----------- ----------- ------------ ------------
INCOME TAX (BENEFIT)
EXPENSE:
Current ................ 6,689 (1,032,551) 108,474 (1,018,387)
Deferred ............... (496,499) (873,450) (211,780) (1,096,840)
----------- ----------- ------------ ------------
(489,810) (1,906,001) (103,306) (2,115,227)
----------- ----------- ------------ ------------
Net income (loss) ..$ 195,848 $(1,732,167)$ 1,813,018 $ 49,576
=========== =========== ============ ============
Net income (loss) per common
share - basic and diluted $ .02 $ (.15)$ .16 $ .00
=========== =========== ============ ============
Dividends per common share $ .15 $ .15 $ .30 $ .30
=========== =========== ============ ============
Average number of common
shares outstanding - basic
and diluted .............. 11,288,104 11,302,834 11,277,462 11,399,573
=========== =========== ============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE 4>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
Net income (loss) .......... $ 195,848 $(1,732,167)$ 1,813,018 $ 49,576
----------- ----------- ----------- -----------
OTHER COMPREHENSIVE INCOME:
Unrealized holding
(losses) gains arising
during the period,
before deferred income
tax (benefit) expense .. (1,390,591) (4,226,281) 2,787,652 (7,254,247)
Deferred income tax
(benefit) expense ...... (76,067) (1,436,937) 111,946 (2,466,446)
----------- ----------- ----------- -----------
(1,314,524) (2,789,344) 2,675,706 (4,787,801)
----------- ----------- ----------- -----------
Reclassification
adjustment for gains
included in net income
(loss), before income
tax expense ............ (164,868) (156,879) (329,253) (246,167)
Income tax expense ....... 56,055 53,339 111,946 83,697
----------- ----------- ----------- -----------
(108,813) (103,540) (217,307) (162,470)
----------- ----------- ----------- -----------
Other comprehensive
(loss) income .... (1,423,337) (2,892,884) 2,458,399 (4,950,271)
----------- ----------- ----------- -----------
Total comprehensive
(loss) income .... $(1,227,489)$(4,625,051)$ 4,271,417 $(4,900,695)
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE 5>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended
June 30,
--------------------------
2000 1999
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 1,813,018 $ 49,576
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 3,172,859 6,318,681
Unearned premiums ......................... 5,427,388 2,765,772
Other policyholders' funds ................ (470,617) (232,521)
Deferred policy acquisition costs ......... (1,264,321) (746,393)
Indebtedness of related party ............. (1,666,717) 2,299,923
Accrued investment income ................. (278,164) (419,218)
Accrued income taxes:
Current ................................. 121,596 1,144,000
Deferred ................................ (211,780) (1,096,840)
Realized investment gains ................. (329,253) (246,167)
Postretirement benefits ................... 460,452 409,085
Reinsurance receivables ................... 1,147,645 (987,350)
Prepaid reinsurance premiums .............. (793,344) (387,664)
Amortization of deferred income ........... (44,573) (65,112)
Other, net ................................ 23,377 1,505,502
------------ ------------
5,294,548 10,261,698
------------ ------------
Net cash provided by
operating activities .................. $ 7,107,566 $ 10,311,274
------------ ------------
<PAGE 6>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Six months ended
June 30,
--------------------------
2000 1999
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $ - $(13,459,276)
Maturities of fixed maturity securities
held-to-maturity ............................ 4,715,303 16,537,577
Purchases of fixed maturity securities
available-for-sale .......................... (19,325,277) (34,299,158)
Disposals of fixed maturity securities
available-for-sale .......................... 2,354,424 40,646,268
Purchases of equity securities
available-for-sale .......................... (12,592,468) (11,322,168)
Disposals of equity securities
available-for-sale .......................... 13,108,671 11,086,154
Net sales (purchases) of short-term investments 7,358,388 (14,026,122)
------------ ------------
Net cash used in investing activities ....... (4,380,959) (4,836,725)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 203,194 156,201
Repurchase of common stock .................... - (2,998,677)
Dividends paid to stockholders ................ (3,383,600) (3,414,142)
------------ ------------
Net cash used in financing activities ..... (3,180,406) (6,256,618)
------------ ------------
NET DECREASE IN CASH ............................ (453,799) (782,069)
Cash at beginning of year ....................... 1,508,678 2,133,056
------------ ------------
Cash at end of quarter .......................... $ 1,054,879 $ 1,350,987
============ ============
Income taxes recovered .......................... $ (13,122) $ (2,169,938)
Interest paid ................................... $ 56,532 $ 107,895
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE 7>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
Note 1
------
The results of operations for the interim periods reported are not necessarily
indicative of the results to be expected for the year. The information
reflects all adjustments that 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 1999 Form 10-K or the 1999 Annual Report to Shareholders for more
detailed footnote information.
Note 2
------
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. In June 2000, the FASB issued
SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an amendment of FASB Statement No. 133". SFAS 138 addresses a
limited number of Statement 133 implementation issues, and is effective for
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 these statements is not expected to have any
effect on the operating results of the Company.
<PAGE 8>
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 75 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
82.0 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 inter-company balances with Employers Mutual, which are settled
on a quarterly basis. The investment and income tax activities of the pool
participants are not subject to the pooling agreement.
The 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
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to inter-company balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not necessarily
indicative of the results to be expected for the year. The information
reflects all adjustments that are, in the opinion of management, necessary for
a fair statement of the results for the interim periods.
<PAGE 9>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months and six months ended June 30, 2000
and 1999 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2000 1999 2000 1999
-------- -------- -------- --------
Premiums earned ..................... $ 55,133 $ 50,954 $108,560 $100,699
Losses and settlement expenses ...... 47,107 44,296 88,873 82,763
Acquisition and other expenses ...... 15,742 16,594 32,709 32,942
-------- -------- -------- --------
Underwriting loss ................... (7,716) (9,936) (13,022) (15,006)
Net investment income ............... 7,232 6,092 14,180 12,361
Other income ........................ 25 48 223 333
-------- -------- -------- --------
Operating (loss) income before
income tax benefit ................ (459) (3,796) 1,381 (2,312)
Realized investment gains ........... 165 157 329 246
-------- -------- -------- --------
(Loss) income before income tax
benefit ........................... (294) (3,639) 1,710 (2,066)
Income tax benefit .................. (490) (1,906) (103) (2,115)
-------- -------- -------- --------
Net income (loss) ................... $ 196 $ (1,733) $ 1,813 $ 49
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 48,676 $ 47,570 $ 92,027 $ 86,899
Decrease in provision for
insured events of prior years (1,569) (3,274) (3,154) (4,136)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 47,107 $ 44,296 $ 88,873 $ 82,763
======== ======== ======== ========
Catastrophe and storm losses ........ $ 4,555 $ 4,234 $ 5,431 $ 6,094
======== ======== ======== ========
Operating results before income taxes improved for both the three months
and six months ended June 30, 2000 as compared to the same periods in 1999,
but continue to be constrained by inadequate premium rate levels that have
resulted from several years of intense rate competition within the insurance
industry. The improvement in the 2000 operating results is attributable to
the property and casualty insurance segment, which benefited from a decline in
overall loss frequency and severity and moderate rate increases. Overall
premium rate adequacy has improved during the first six months of 2000 and
this trend is expected to continue; however, it will take time for premium
rates to return to adequate levels due to the competitive rate environment
that persists in the insurance industry. The improvement in rate adequacy
will have a positive impact on future operating results, but the unpredictable
nature of catastrophe and storm losses will remain. In the meantime,
management continues to work toward improving profitability through re-
underwriting programs for both the existing book of business and the agency
force.
<PAGE 10>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
Premium income increased 8.2 percent for the three months and 7.8 percent
for the six months ended June 30, 2000 from the same periods in 1999. This
growth in premium income, which is well above the industry average of
approximately 2.0 percent, is primarily associated with the property and
casualty insurance segment. Applications for insurance coverage have
increased significantly in the first six months of 2000 as some of the
Company's competitors have withdrawn from certain markets or implemented
large, mandatory across-the-board rate increases regardless of loss
experience. The Company has been selective in accepting risks and has been
able to price both new and renewal business at more adequate levels. The
combination of these factors has contributed to the strong growth rate.
Losses and settlement expenses increased 6.3 percent for the three months
and 7.4 percent for the six months ended June 30, 2000 from the same periods
in 1999. These increases reflect the growth in premium income experienced in
the property and casualty insurance segment and increased loss experience in
the reinsurance segment. Active storm patterns continued to keep catastrophe
and storm losses at elevated levels, compounding the impact of the inadequate
rate levels. The benefit provided by the development of prior years' reserves
declined for the first six months of 2000 but remained positive. The Company
has historically experienced favorable development in its reserves and
reserving practices have not been changed; however, the amount of development
experienced will fluctuate from quarter to quarter and from year to year as
individual claims are settled.
Acquisition and other expenses decreased 5.1 percent for the three months
and 0.7 percent for the six months ended June 30, 2000 as compared to the same
periods in 1999. These decreases reflect a decline in profit sharing
expenses, $839,000 of commission income recorded by the reinsurance subsidiary
during the second quarter of 2000 and a modest increase in the estimate of
deferrable acquisition expenses recorded by the property and casualty
insurance segment.
Net investment income increased 18.7 percent for the three months and
14.7 percent for the six months ended June 30, 2000 from the same periods in
1999. These increases reflect the combination of a higher average invested
balance in fixed-maturity securities and an increase in the average rate of
return earned on the fixed-maturity portfolio. The Company sold approximately
$55,000,000 of tax-exempt investments during 1999 and reinvested the proceeds
into taxable securities in order to achieve a better rate of return after
taxes. Partially offsetting the increase in net investment income for 2000 is
approximately $44,000 of interest expense associated with premium refunds
mandated by the State of North Carolina.
The income tax benefit declined for both the three months and six months
ended June 30, 2000 from the same periods in 1999. The decreases are
primarily due to a decline in the amount of tax-exempt interest income earned.
Tax-exempt interest income totaled $1,302,000 and $2,607,000 for the
three months and six months ended June 30, 2000. In comparison, tax-exempt
interest income amounted to $1,909,000 and $3,995,000 for the same
periods in 1999. Also contributing to the decrease in the income tax benefit
for the six months ended June 30, 2000 was $190,000 of income tax expense
generated by a required change in the tax method used to recognize
installment premiums.
<PAGE 11>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months and six months ended June 30, 2000
and 1999 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2000 1999 2000 1999
-------- -------- -------- --------
Premiums earned ..................... $ 45,060 $ 41,647 $ 89,067 $ 81,416
Losses and settlement expenses ...... 38,111 37,043 71,811 68,589
Acquisition and other expenses ...... 13,450 13,494 27,551 26,638
-------- -------- -------- --------
Underwriting loss ................... (6,501) (8,890) (10,295) (13,811)
Net investment income ............... 5,175 4,247 10,064 8,713
Other income ........................ 136 175 413 522
-------- -------- -------- --------
Operating (loss) income before
income taxes ...................... $ (1,190)$ (4,468) $ 182 $ (4,576)
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 40,449 $ 39,159 $ 77,468 $ 73,424
Decrease in provision for
insured events of prior years.. (2,338) (2,116) (5,657) (4,835)
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 38,111 $ 37,043 $ 71,811 $ 68,589
======== ======== ======== ========
Catastrophe and storm losses ........ $ 4,162 $ 3,880 $ 4,829 $ 5,091
======== ======== ======== ========
Premiums earned increased 8.2 percent for the three months and 9.4
percent for the six months ended June 30, 2000 from the same periods in 1999.
These increases reflect an increase in policy count and exposure base in the
commercial lines of business, as well as rate increases. Overall premium rate
adequacy continued to improve during the second quarter of 2000 as the Company
implemented rate increases in both the personal and commercial lines of
business. Management expects premium rate adequacy to improve further during
the remainder of 2000 as the rate increases implemented in 1999 and 2000
become more fully recognized.
Losses and settlement expenses increased 2.9 percent for the three months
and 4.7 percent for the six months ended June 30, 2000 as compared to the same
periods in 1999. These increases, which are less than the increases in
premium income noted above, reflect a decline in overall loss frequency and
severity from the elevated levels experienced during 1999. Catastrophe and
storm losses continued to have a significant impact on operating results due
to the persistence of active storm patterns.
<PAGE 12>
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 decreased 0.3 percent and increased 3.4
percent for the three months and six months ended June 30, 2000 as compared to
the same periods in 1999. Profit sharing expenses, which take the form of
policyholder dividends and contingent commissions, have declined as a result
of the recent deterioration in the profitability of the underlying insurance
policies. As a result, acquisition and other expenses have not increased at
the same pace as production. Results for the first six months of 2000 also
reflect a moderate increase in the estimate of deferrable acquisition
expenses.
Underwriting results for the three months and six months ended June 30,
2000 improved from the same periods in 1999, but continue to be constrained by
the competitive rate environment of the insurance industry. Premium rate
levels are showing improvement, but this improvement has been moderate and
it will take time for rates to return to adequate levels. Underwriting
results are expected to improve gradually, but steadily, as the Company
realizes the positive impact of various initiatives implemented during the
past couple of years and as additional rate increases are implemented.
The Company continues to work toward improving profitability through re-
underwriting programs for both the existing book of business and the agency
force.
Reinsurance
Operating results for the three months and six months ended June 30, 2000
and 1999 are as follows:
Three months ended Six months ended
June 30, June 30,
----------------- -----------------
($ in thousands) 2000 1999 2000 1999
-------- -------- -------- --------
Premiums earned ..................... $ 10,073 $ 9,307 $ 19,493 $ 19,283
Losses and settlement expenses ...... 8,996 7,253 17,062 14,174
Acquisition and other expenses ...... 2,292 3,100 5,158 6,304
-------- -------- -------- --------
Underwriting loss ................... (1,215) (1,046) (2,727) (1,195)
Net investment income ............... 1,959 1,752 3,946 3,455
Other income ........................ 22 32 45 65
-------- -------- -------- --------
Operating income before
income taxes ...................... $ 766 $ 738 $ 1,264 $ 2,325
======== ======== ======== ========
Incurred losses and
settlement expenses:
Insured events of current year .. $ 8,227 $ 8,411 $ 14,559 $ 13,475
Increase (decrease) in
provision for insured events
of prior years ................ 769 (1,158) 2,503 699
-------- -------- -------- --------
Total losses and
settlement expenses ....... $ 8,996 $ 7,253 $ 17,062 $ 14,174
======== ======== ======== ========
Catastrophe losses .................. $ 393 $ 354 $ 602 $ 1,003
======== ======== ======== ========
<PAGE 13>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
Premiums earned increased 8.2 percent for the three months and 1.1
percent for the six months ended June 30, 2000 from the same periods in 1999.
The increase for the three months ended June 30, 2000 is primarily due to the
addition of several new contracts. The increase for the six months ended June
30, 2000 is distorted by the delayed reporting of several foreign reinsurance
contracts written in 1998 that were included in the results of the first
quarter of 1999. The majority of the reinsurance subsidiary's reinsurance
contracts renew on January 1 and premium rates for those renewals were
relatively flat. However, industry premium rates have improved during the
first six months of 2000 and premium rate increases have been implemented on
the reinsurance contracts that renewed during the second quarter. Despite
these rate increases, which have varied from very modest to significant
depending on prior loss experience, overall premium rate adequacy is not
expected to improve significantly during 2000. This is due to the fact that a
large portion of the assumed book of business will not receive rate increases
in 2000 and those implemented during 2000 will not be fully recognized.
Losses and settlement expenses increased 24.0 percent for the three
months and 20.4 percent for the six months ended June 30, 2000 from the same
periods in 1999. These increases are primarily due to an unusually large
increase in loss severity, particularly on property contracts. In addition,
results for the second quarter of 2000 reflect increased loss activity in the
workers' compensation line of business. Results for both the three months and
six months ended June 30, 2000 were negatively impacted by significant levels
of adverse development on prior years' reserves, including $800,000 related to
December 1999 storms in Europe and $800,000 related to other 1999 property
losses.
Acquisition and other expenses decreased 26.1 percent for the three
months and 18.2 percent for the six months ended June 30, 2000 from the same
periods in 1999. These decreases are attributed to $839,000 of commission
income recorded during the second quarter of 2000. This commission income
includes $420,000 of profit share commission associated with an outside
reinsurance contract that the reinsurance subsidiary pays for to protect
Employers Mutual from catastrophic losses on the assumed book of business and
$419,000 of contingent commission that was returned to a reinsurance pool by a
ceding company client because of loss experience on a treaty.
The underwriting results of the reinsurance subsidiary continue to be
negatively impacted by reduced premium rate levels and increased loss
severity. Industry premium rate levels improved during the first six months
of 2000; however, the excess capacity that led to the reduction in premium
rate levels continues to exist. Underwriting results of the reinsurance
subsidiary are not expected to improve significantly during the last six
months of 2000 since the majority of the contracts were renewed in January at
flat rates; however, underwriting results for 2001 should benefit from the
improving rate environment. Employers Mutual will continue to work toward
improving profitability on the assumed book of business by accepting a larger
share of coverage on desirable programs, strengthening its relationships with
reinsurance intermediaries and monitoring premium growth.
<PAGE 14>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
Parent Company
Operating loss before income taxes totaled $35,000 and $65,000 for the
three months and six months ended June 30, 2000 compared to $66,000 and
$61,000 for the same periods in 1999. Operating expenses of the Company
declined during the first six months of 2000; however, interest income, the
Company's primary source of income, also declined as a result of a decrease in
the average 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
maturity dates that approximate the anticipated liabilities of the insurance
issued.
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
The Company has previously classified a portion of its investments in fixed
maturity securities, primarily bonds issued by municipalities and
corporations, as available-for-sale securities to provide flexibility in the
management of the portfolio. Beginning in the third quarter of 1999, all
newly acquired securities are being classified as available-for-sale to
provide increased management flexibility. Unrealized holding losses on fixed
maturity securities available-for-sale totaled $6,310,000 at June 30, 2000
compared to $7,539,000 at December 31, 1999. The decline in the market value
of these investments is primarily due to an increase in interest rates. 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 June 30, 2000 a valuation allowance of $397,000 was established for the
deferred tax asset associated with the net unrealized holding losses on the
Company's available-for-sale securities. This valuation allowance was
established due to uncertainties concerning the future realization of the tax
benefit. At December 31, 1999 the valuation allowance was $1,233,000.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of income which
supplements underwriting results and contributes to net earnings. As these
investments mature, the proceeds will be reinvested at current rates, which
may be higher or lower than those now being earned; therefore, more or less
investment income may be available to contribute to net earnings depending on
the interest rate level.
During the third quarter of 1999, the Company began participating in a
securities-lending program whereby certain fixed maturity securities from the
investment portfolio are loaned to other institutions for short periods of
time. The Company receives a fee for each security loaned out under this
program and requires initial collateral equal to 102 percent of the market
value of the loaned securities.
<PAGE 15>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
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.
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.
The major ongoing sources of the Company's liquidity are insurance
premium income, investment income and cash provided from maturing or
liquidated investments. The principal outflows of cash are payments of
claims, commissions, premium taxes, operating expenses, income taxes,
dividends and investment purchases.
During the first six months of 2000, the Company generated positive cash
flows from operations of $7,107,566 compared to $10,311,274 for the same
period of 1999.
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.
IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS
The Year 2000 issue presented both operational and underwriting risks to
the Company. Operational risks included 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 included, but were not limited to, potential
claims by the Company's policyholders to recover losses due to interruption of
business or liability to third parties that resulted from the failure of
computer systems.
To date, the Company has not encountered any problems as a result of the
Year 2000 date rollover. All of the Company's systems are functioning
normally. In addition, the Company has not encountered any problems with any
vendor-supplied hardware or software. The Company continues to monitor the
situation closely for any potential Year 2000 issues.
The Company distributed a letter during 1999 to all of its commercial
policyholders notifying them that their policies did not cover Year 2000
losses, but that coverage was available through an endorsement to the policy.
A questionnaire was developed and provided to them to aid in the assessment of
potential risks associated with Year 2000 noncompliance. Very few
policyholders elected to purchase the additional coverage provided by this
endorsement. The parties to the pooling agreement purchased reinsurance
protection for potential third party liability claims against policyholders
arising from Year 2000 issues. To date, no claims have been reported relating
to Year 2000 losses.
<PAGE 16>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued 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.
In June 2000, the FASB issued SFAS 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of FASB Statement
No. 133". SFAS 138 addresses a limited number of Statement 133 implementation
issues, and is effective for fiscal years beginning after June 15, 2000.
Currently, the Company's investment strategy does not include investments in
derivative instruments or hedging activities. Accordingly, adoption of these
statements 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; and other risks and uncertainties inherent
in the Company's business.
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 an investment
committee composed of representatives from each of the Company's subsidiary's
board of directors.
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.
<PAGE 17>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, CONTINUED
------- ---------------------------------------------------------------------
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 in interest rates as of June 30,
2000 would result in a corresponding pre-tax decrease in the fair value of the
fixed maturity portfolios of approximately $22,584,000 or 5.5 percent. In
addition, a hypothetical one percent decrease in interest rates at June 30,
2000 would result in a corresponding decrease in pre-tax income over the next
twelve months of approximately $292,000, 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 effective duration of the fixed maturity portfolio at
June 30, 2000 was 5.29 years.
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 decrease in the S&P 500 as of June 30, 2000 would result in a
corresponding pretax decrease in the fair value of the Company's equity
portfolio of approximately $2,959,000.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At June 30, 2000 the portfolio of long-term
fixed maturity securities consists of 13.6 percent U.S. Treasury, 13.1 percent
government agency, 13.6 percent mortgage-backed, 23.0 percent municipal, and
36.7 percent corporate securities. At December 31, 1999 the portfolio of
long-term fixed maturity securities consisted of 15.0 percent U.S. Treasury,
13.9 percent government agency, 15.2 percent mortgage-backed, 24.6 percent
municipal, and 31.3 percent corporate securities. No securities are below
investment grade.
Prepayment risk refers to the changes in prepayment patterns that can
either shorten or lengthen the expected timing of the principal repayments and
thus the average life and the effective yield of a security. Such risk exists
primarily within the portfolio of mortgage-backed securities. The prepayment
risk analysis is monitored regularly through the analysis of interest rate
simulations. At June 30, 2000 the effective duration of the mortgage-backed
securities is 4.1 years with an average life and current yield of 7.1 years
and 7.7 percent, respectively. At December 31, 1999 the effective duration of
the mortgage-backed securities was 4.4 years with an average life and current
yield of 7.5 years and 7.7 percent, respectively.
<PAGE 18>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
-------- -----------------
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
------- ----------------------------------------------------
(a) Annual Meeting of Stockholders
EMC Insurance Group Inc.
May 25, 2000
(b) The following seven persons were elected to serve as directors
of the Company for the ensuing year:
George C. Carpenter III Elwin H. Creese
David J. Fisher Bruce G. Kelley
George W. Kochheiser Raymond A. Michel
Fredrick A. Schiek
(c) Items voted upon and number of votes cast:
1. Election of directors
Votes Votes
Nominee Cast for Withheld
----------------------- ---------- ---------
George C. Carpenter III 10,654,281 113,535
Elwin H. Creese 10,646,123 121,693
David J. Fisher 10,658,596 109,220
Bruce G. Kelley 10,605,464 162,352
George W. Kochheiser 10,654,595 113,221
Raymond A. Michel 10,654,281 113,535
Fredrick A. Schiek 10,599,175 168,641
2. Proposal to ratify the appointment of KPMG LLP as
the independent auditors of the Company:
For 10,742,136 Against 7,410 Withheld 18,270
------------ -------- --------
The total number of qualified shares voted by proxy
is: 10,767,816
(d) None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
------- --------------------------------
(a) None.
(b) No Form 8-K was filed by the registrant during the
quarter ended June 30, 2000.
<PAGE 19>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
-------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
-------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: August 14, 2000
<PAGE 20>
