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 MARCH 31, 2000
---------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
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(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- --------------------------------------- ------------------
(Address of principal executive office) (Zip Code)
(515) 280-2902
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at May 1, 2000
----- --------------------------
Common stock, $1.00 par value 11,286,459
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Total pages 20
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<PAGE>
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
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EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2000 1999
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $125,473,231 and $126,679,065) $126,114,976 $127,204,160
Securities available-for-sale, at fair value
(amortized cost $276,981,368 and
$263,720,333) .............................. 271,788,589 256,181,429
Equity securities available-for-sale, at fair
value (cost $28,720,650 and $28,494,631) ..... 34,302,022 32,408,272
Short-term investments, at cost ................ 15,268,723 20,164,210
------------ ------------
Total investments ..................... 447,474,310 435,958,071
Cash ............................................. 2,128,084 1,508,678
Accrued investment income ........................ 6,283,155 6,886,939
Accounts receivable (net of allowance for
uncollectible accounts of $633,000 and $633,000) 2,033,637 3,293,537
Income taxes recoverable ......................... 872,001 1,537,000
Reinsurance receivables .......................... 10,940,103 11,129,365
Deferred policy acquisition costs ................ 14,038,547 13,619,192
Deferred income taxes ............................ 17,704,476 18,121,317
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,380,836
and $2,347,208 ................................. 1,176,984 1,210,612
Prepaid reinsurance premiums ..................... 1,559,432 1,280,564
Other assets ..................................... 1,416,759 2,030,703
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Total assets .......................... $505,627,488 $496,575,978
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2000 1999
------------ ------------
LIABILITIES
Losses and settlement expenses ................... $266,047,626 $266,514,024
Unearned premiums ................................ 66,777,636 64,991,129
Other policyholders' funds ....................... 917,738 1,093,254
Indebtedness to related party .................... 9,872,453 3,886,559
Postretirement benefits .......................... 6,998,445 6,768,219
Deferred income .................................. 135,360 158,831
Other liabilities ................................ 8,997,893 11,247,685
------------ ------------
Total liabilities ......................... 359,747,151 354,659,701
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STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,284,403
shares in 2000 and 11,265,232 shares in 1999 ... 11,284,403 11,265,232
Additional paid-in capital ....................... 65,469,712 65,333,686
Accumulated other comprehensive income (loss) .... 256,473 (3,625,263)
Retained earnings ................................ 68,869,749 68,942,622
------------ ------------
Total stockholders' equity ................ 145,880,337 141,916,277
------------ ------------
Total liabilities and stockholders' equity $505,627,488 $496,575,978
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three months ended
March 31,
------------------------
2000 1999
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REVENUES:
Premiums earned .................................. $53,427,335 $49,744,614
Investment income, net ........................... 6,947,416 6,269,253
Realized investment gains ........................ 164,385 89,288
Other income ..................................... 605,501 769,077
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61,144,637 56,872,232
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LOSSES AND EXPENSES:
Losses and settlement expenses ................... 41,766,260 38,466,995
Dividends to policyholders ....................... 274,386 472,189
Amortization of deferred policy acquisition costs 11,969,362 11,735,899
Other underwriting expenses ...................... 4,723,387 4,140,342
Other expenses ................................... 407,568 484,290
----------- -----------
59,140,963 55,299,715
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Income before income tax expense (benefit) 2,003,674 1,572,517
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INCOME TAX EXPENSE (BENEFIT):
Current .......................................... 101,785 14,164
Deferred ......................................... 284,719 (223,390)
----------- -----------
386,504 (209,226)
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Net income ................................. $ 1,617,170 $ 1,781,743
=========== ===========
Net income per common share - basic and diluted .... $ .14 $ .15
=========== ===========
Dividends per common share ......................... $ .15 $ .15
=========== ===========
Average number of shares outstanding - basic and
diluted .......................................... 11,266,820 11,496,312
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended
March 31,
------------------------
2000 1999
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Net income ......................................... $ 1,617,170 $ 1,781,743
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OTHER COMPREHENSIVE INCOME:
Unrealized holding gains (losses) arising during
the period, before deferred income tax expense
(benefit) ...................................... 4,178,243 (3,027,966)
Deferred income tax expense (benefit) ............ 188,013 (1,029,507)
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3,990,230 (1,998,459)
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Reclassification adjustment for gains included
in net income, before income tax expense ....... (164,385) (89,288)
Income tax expense................................ 55,891 30,358
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(108,494) (58,930)
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Other comprehensive income (loss) .......... 3,881,736 (2,057,389)
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Total comprehensive income (loss) .......... $ 5,498,906 $ (275,646)
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended
March 31,
--------------------------
2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 1,617,170 $ 1,781,743
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ (466,398) 3,604,941
Unearned premiums ......................... 1,786,507 (439,400)
Other policyholders' funds ................ (175,516) (158,293)
Deferred policy acquisition costs ......... (419,355) (42,265)
Indebtedness to related party ............. 5,985,894 3,139,245
Accrued investment income ................. 603,784 (415,465)
Accrued income taxes:
Current ................................. 664,999 2,564,000
Deferred ................................ 284,719 (223,390)
Realized investment gains ................. (164,385) (89,288)
Postretirement benefits ................... 230,226 205,620
Reinsurance receivables ................... 189,262 (557,945)
Prepaid reinsurance premiums .............. (278,868) 15,224
Amortization of deferred income ........... (23,471) (34,205)
Other, net ................................ (366,173) (3,545,085)
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7,851,225 4,023,694
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Net cash provided by
operating activities .............. $ 9,468,395 $ 5,805,437
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<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Three months ended
March 31,
--------------------------
2000 1999
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $ - $ (5,975,625)
Maturities of fixed maturity securities
held-to-maturity ............................ 1,097,506 5,903,518
Purchases of fixed maturity securities
available-for-sale .......................... (14,573,157) (16,194,529)
Disposals of fixed maturity securities
available-for-sale .......................... 1,326,393 14,605,213
Purchases of equity securities
available-for-sale .......................... (4,744,432) (7,243,414)
Disposals of equity securities
available-for-sale .......................... 4,684,057 7,037,052
Net sales (purchases) of short-term investments 4,895,490 (2,840,368)
------------ ------------
Net cash used in investing activities ..... (7,314,143) (4,708,153)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 155,197 154,827
Repurchase of common stock .................... - (441,385)
Dividends paid to stockholders ................ (1,690,043) (1,724,100)
------------ ------------
Net cash used in financing activities ..... (1,534,846) (2,010,658)
------------ ------------
NET INCREASE (DECREASE) IN CASH ................. 619,406 (913,374)
Cash at beginning of year ....................... 1,508,678 2,133,056
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Cash at end of quarter .......................... $ 2,128,084 $ 1,219,682
============ ============
Income taxes recovered .......................... $ (563,214) $ (2,550,000)
Interest paid ................................... $ 154,292 $ 18,984
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
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 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. 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.
<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 74 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
82.4 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
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to intercompany balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The information
reflects all adjustments which are, in the opinion of management, necessary for
a fair statement of the results for the interim periods.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months ended March 31, 2000 and 1999 are
as follows:
($ in thousands) 2000 1999
-------- --------
Premiums earned .......................... $ 53,427 $ 49,745
Losses and settlement expenses ........... 41,766 38,467
Acquisition and other expenses ........... 16,967 16,348
-------- --------
Underwriting loss ........................ (5,306) (5,070)
Net investment income .................... 6,948 6,269
Other income ............................. 198 285
-------- --------
Operating income before income tax
expense (benefit) ...................... 1,840 1,484
Realized investment gains ................ 164 89
-------- --------
Income before income tax expense (benefit) 2,004 1,573
Income tax expense (benefit) ............. 387 (209)
-------- --------
Net income ............................... $ 1,617 $ 1,782
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 43,351 $ 39,329
Decrease in provision for insured
events of prior years ................ (1,585) (862)
-------- --------
Total losses and settlement expenses $ 41,766 $ 38,467
======== ========
Catastrophe and storm losses ............. $ 876 $ 1,860
======== ========
Operating results before income taxes improved slightly for the first
three months of 2000 as an improvement in the operating results of the
property and casualty insurance segment more than offset a decline in the
operating results of the reinsurance segment. However, inadequate premium
rates, which have resulted from several years of intense rate competition
within the insurance industry, continue to be the primary cause of the
Company's diminished performance. Premium rates improved moderately during
the first three months of 2000 and this trend is expected to continue. This
gradual but steady improvement in rate adequacy will have a positive impact
on future operating results, but the unpredictable nature of catastrophe and
storm losses will remain. It will take time for premium rates to return to
adequate levels due to the competitive rate environment that persists in the
insurance industry, so management is working to improve profitability through
re-underwriting programs for both the existing book of business and the
agency force.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
Premium income increased 7.4 percent for the three months ended March 31,
2000 from the same period in 1999. The property and casualty insurance segment
achieved significant growth during the first three months of 2000 while the
reinsurance segment reported a decline in premium income because the 1999
amount was inflated by the delayed reporting of several foreign contracts
written in 1998.
Losses and settlement expenses increased 8.6 percent for the three months
ended March 31, 2000 from the same period in 1999. This increase reflects the
growth in production noted above and increased loss experience in the
reinsurance segment. Catastrophe and storm losses declined significantly from
the storm plagued first quarter of 1999 and development on prior years'
reserves remained favorable. The Company has historically experienced
favorable development in its reserves and reserving practices have not been
changed; however, the amount of favorable development experienced will
fluctuate from quarter to quarter and from year to year.
Acquisition and other expenses increased 3.8 percent for the three months
ended March 31, 2000 from the same period in 1999. The increase is less than
the increase in production noted above due to a decline in profit sharing
expenses and a modest increase in the estimate of deferrable acquisition
expenses recorded by the property and casualty insurance segment.
Net investment income increased 10.8 percent for the three months ended
March 31, 2000 from the same period in 1999. This increase is due to the
combination of a higher average invested balance in bonds and an increase in
the average rate of return earned on bond investments. 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
is approximately $142,000 of interest expense associated with premium refunds
mandated by the State of North Carolina.
Income tax expense increased $596,000 from a benefit of $209,000 for the
three months ended March 31, 1999 to an expense of $387,000 for the same period
in 2000. This increase is primarily due to a decline in the amount of tax-
exempt interest income earned, which totaled $1,305,000 in 2000 compared to
$2,086,000 in 1999. Also contributing to the increase is $203,000 of income
tax expense generated by a required change in the tax method used to recognize
premiums received in advance of the effective dates of the underlying insurance
policies.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months ended March 31, 2000 and 1999 are
as follows:
($ in thousands) 2000 1999
-------- --------
Premiums earned .......................... $ 44,007 $ 39,769
Losses and settlement expenses ........... 33,700 31,546
Acquisition and other expenses ........... 14,101 13,144
-------- --------
Underwriting loss ........................ (3,794) (4,921)
Net investment income .................... 4,889 4,466
Other income ............................. 277 347
-------- --------
Operating income (loss) before
income taxes ........................... $ 1,372 $ (108)
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 37,019 $ 34,265
Decrease in provision for insured
events of prior years ................ (3,319) (2,719)
-------- --------
Total losses and settlement expenses $ 33,700 $ 31,546
======== ========
Catastrophe and storm losses ............. $ 667 $ 1,211
======== ========
Premium income increased 10.7 percent for the three months ended March 31,
2000 from the same period in 1999. This growth in premium income is primarily
attributable to an increase in policy renewals. Premium rates continued to
show signs of stabilization during the first three months of 2000 as the Company
was able to implement moderate rate increases in both the personal and
commercial lines of business. Overall premium rate adequacy also improved
modestly in the first three months of 2000, reversing a long-term downward
trend. This trend of moderate rate increases is expected to continue during
2000 since large-scale rate increases are not considered likely due to the
significant amount of excess capacity that continues to exist in the
insurance industry. Premium income for first three months of 2000 also
reflects approximately $239,000 of premium refunds mandated by the State of
North Carolina.
Losses and settlement expenses increased 6.8 percent for the three months
ended March 31, 2000 from the same period in 1999, primarily as a result of the
increase in production noted above. Results for the first three months of 2000
benefited from a decline in catastrophe and storm losses and an increase in the
amount of favorable development experienced on prior years' reserves.
<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 7.3 percent for the three months
ended March 31, 2000 from the same period in 1999. This increase, which is
attributable to the growth in premium income, was mitigated somewhat by a
decline in profit sharing expenses and a moderate increase in the estimate of
deferrable acquisition expenses. 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.
Underwriting results for the property and casualty insurance segment
improved for the first quarter of 2000, but continue to be constrained by the
competitive rate environment of the insurance industry. Premium rate levels
are beginning to show signs of improvement, but this improvement has been
moderate and this trend is expected to continue. Underwriting results should
continue to improve as a result of the rate increases being implemented, but
it will take time for rates to return to adequate levels. Management
continues to work toward improving profitability through re-underwriting
programs for both the existing book of business and the agency force and by
reducing the use of discretionary rate credits.
Reinsurance
Operating results for the three months ended March 31, 2000 and 1999 are
as follows:
($ in thousands) 2000 1999
-------- --------
Premiums earned ............................ $ 9,420 $ 9,976
Losses and settlement expenses ............. 8,066 6,921
Acquisition and other expenses ............. 2,866 3,204
-------- --------
Underwriting loss .......................... (1,512) (149)
Net investment income ...................... 1,987 1,703
Other income ............................... 23 33
-------- --------
Operating income before income taxes ....... $ 498 $ 1,587
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ....... $ 6,332 $ 5,064
Increase in provision for insured
events of prior years .................. 1,734 1,857
-------- --------
Total losses and settlement expenses $ 8,066 $ 6,921
======== ========
Catastrophe losses ......................... $ 209 $ 649
======== ========
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
Premiums earned decreased 5.6 percent for the three months ended March 31,
2000 from the same period in 1999. This decrease is primarily attributable to
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 quarter and premium rate
increases are anticipated for the reinsurance contracts renewing later in the
year. Despite these anticipated rate increases, overall premium rate
adequacy is not expected to improve significantly during 2000 since 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 16.5 percent for the three months
ended March 31, 2000 from the same period in 1999. This increase is primarily
due to an unusually large increase in loss severity. Results for the first
quarter of 2000 were also negatively impacted by a significant amount of
adverse development on prior years' reserves, including $800,000 related to
December 1999 storms in Europe. Results for the first quarter of 1999 also
reflected a significant amount of adverse development on prior years'
reserves. This adverse development was primarily associated with the 1998
accident year, which experienced heavy catastrophe and storm losses.
Acquisition and other expenses decreased 10.5 percent for the three months
ended March 31, 2000 as compared to the same period in 1999. This decrease is
primarily attributable to the decline in premium income noted above. Effective
January 1, 2000, the override commission rate paid by the reinsurance
subsidiary to Employers Mutual in connection with the $1,500,000 cap on
losses assumed per event was reduced from 5.25 percent of written premiums
to 4.50 percent of written premiums due to good loss experience. Total
override commission paid to Employers Mutual declined to $439,000 in 2000
from $517,000 in 1999.
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 quarter of 2000;
however, the excess capacity that led to the reduction in premium rate levels
continues to exist. Underwriting results for the reinsurance subsidiary
should begin to improve as the impact of the anticipated rate increases is
realized; however, the timing and extent of these increases has not been
determined. As a result, underwriting results are not expected to improve
significantly in 2000. Employers Mutual will continue to address this issue
by accepting a larger share of coverage on desirable programs, strengthening
its relationships with reinsurance intermediaries and emphasizing
profitability over premium growth.
Parent Company
Operating results before income taxes declined to a loss of $30,000 for
the three months ended March 31, 2000 from income of $5,000 for the same
period in 1999. This decline is primarily attributable to a decrease in the
amount of investment income earned resulting from a lower average invested
balance in fixed maturity securities.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of its 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.
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, net of tax, totaled $3,427,000 at March 31, 2000 compared
to $7,539,000 at December 31, 1999. The decrease 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 December 31, 1999 a valuation allowance of $1,233,000 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
benefits. At March 31, 2000 the Company had a net unrealized holding gain on
the available-for-sale securities, thus eliminating the deferred tax asset
and the related valuation allowance.
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.
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.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------- -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS, CONTINUED
----------------------------------------------
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 quarter of 2000, the Company generated positive cash
flows from operations of $9,468,395 compared to $5,805,437 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.
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 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 insureds to recover losses due 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 future 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>
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 were in process for a number of years. The
majority of the costs associated with these efforts represented the salaries
and benefit expenses of the information systems department of Employers Mutual.
These costs were charged to operations in the year incurred and were not
separately tracked. In addition, most purchases of computer hardware and
software applications were not made specifically for Year 2000 compliance, and
were not considered costs of the Year 2000 compliance effort. The Company's
share of the costs associated with the Year 2000 compliance project did not
exceed estimates.
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.
Currently, the Company's investment strategy does not include investments in
derivative instruments or hedging activities. Accordingly, 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;
and other risks and uncertainties inherent in the Company's business.
<PAGE>
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 an investment
committee of the respective board of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
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 March 31, 2000
would result in a corresponding pre-tax decrease in the fair value of the fixed
maturity portfolios of approximately $22,609,000 or 5.4 percent. In addition,
a hypothetical one percent decrease in interest rates at March 31, 2000 would
result in a corresponding decrease in pre-tax income over the next twelve
months of approximately $336,000, 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 March 31,
2000 was 5.26 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 March 31, 2000 would result in a
corresponding pre-tax decrease in the fair value of the Company's equity
portfolio of approximately $3,161,000.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At March 31, 2000 the portfolio of long-term
fixed maturity securities consists of 14.0 percent U.S. Treasury, 13.0 percent
government agency, 14.0 percent mortgage-backed, 23.0 percent municipal, and
36.0 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.
<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 March 31, 2000 the effective duration of the mortgage-backed
securities is 4.0 years with an average life and current yield of 7.2 years and
7.7 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.
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 March 31, 2000.
<PAGE>
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: May 12, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
3/31/00 balance sheet and income statement and is qualified in its
entirety by reference.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-END> MAR-31-2000
<DEBT-HELD-FOR-SALE> 271,788,589
<DEBT-CARRYING-VALUE> 126,114,976
<DEBT-MARKET-VALUE> 125,473,231
<EQUITIES> 34,302,022
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 447,474,310
<CASH> 2,128,084
<RECOVER-REINSURE> 10,940,103
<DEFERRED-ACQUISITION> 14,038,547
<TOTAL-ASSETS> 505,627,488
<POLICY-LOSSES> 266,047,626
<UNEARNED-PREMIUMS> 66,777,636
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 917,738
<NOTES-PAYABLE> 0
0
0
<COMMON> 11,284,403
<OTHER-SE> 134,595,934
<TOTAL-LIABILITY-AND-EQUITY> 505,627,488
53,427,335
<INVESTMENT-INCOME> 6,947,416
<INVESTMENT-GAINS> 164,385
<OTHER-INCOME> 605,501
<BENEFITS> 41,766,260
<UNDERWRITING-AMORTIZATION> 11,969,362
<UNDERWRITING-OTHER> 4,723,387
<INCOME-PRETAX> 2,003,674
<INCOME-TAX> 386,504
<INCOME-CONTINUING> 1,617,170
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,617,170
<EPS-BASIC> .14
<EPS-DILUTED> .14
<RESERVE-OPEN> 266,514,024
<PROVISION-CURRENT> 43,351,135
<PROVISION-PRIOR> (1,584,875)
<PAYMENTS-CURRENT> 9,728,362
<PAYMENTS-PRIOR> 32,144,810
<RESERVE-CLOSE> 266,047,626
<CUMULATIVE-DEFICIENCY> (1,584,875)
</TABLE>
