UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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: 0-18649
THE NATIONAL SECURITY GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-1020300 661 East Davis Street, Elba, Alabama 36323
(State or other (I.R.S.Employer (Address of principal (Zip code)
jurisdiction of Identification executive offices)
Incorporation No.)
or organization)
Registrant's telephone number, including area code (334) 897-2273
Not Applicable
(Former name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
Number of Shares of Common Stock outstanding as of May 1, 1998: 2,262,178
Exhibit index is located on page 13.
Page 1 of 13 pages
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THE NATIONAL SECURITY GROUP, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 11
SIGNATURE 12
EXHIBIT INDEX 13
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Three Months
Ended March 31
1998 1997
Revenues
Net insurance premiums earned ............................. $ 7,501 $ 7,982
Net investment income ..................................... 1,165 1,102
Realized investment gains ................................. 480 63
Other income .............................................. 139 162
Total revenues .......................................... 9,284 9,309
Benefits and Expenses
Policyholder benefits and settlement expenses ............. 5,881 5,346
Policy acquisition costs .................................. 1,671 1,402
General insurance expenses ................................ 1,290 1,166
Insurance taxes, licenses and fees ........................ 397 362
Total benefits and expenses ............................ 9,239 8,276
Income Before Income Taxes and
Cumulative Effect Adjustment .......................... 45 1,033
Income Taxes (Current and deferred) ....................... (275) 411
Net Income ................................................ $ 320 $ 622
Earnings per share ........................................ $ 0.14 $ 0.27
Dividends Declared per Share .............................. $ 0.19 $ 0.17
The Notes to Financial Statements are an integral part of these statements.
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THE NATIONAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
As of As of
March 31, December 31,
Assets 1998 1997
Investments:
Securities held-to-maturity at amortized cost
(estimated fair value: 1998 - $32,155;1997 - 33,959). $ 31,379 $ 29,995
Securities available-for-sale, at estimated
fair value (cost: 1998 - 34,780;1997 - 26,098) ...... 54,212 52,819
Receivable for securities ............................ 0 400
Mortgage loans ....................................... 311 320
Investment real estate, at cost ...................... 1,629 1,645
Policy loans ......................................... 648 660
Total investments .................................. 88,191 85,827
Cash and cash equivalents ............................... 1,989 3,888
Accrued investment income ............................... 897 833
Reinsurance recoverable ................................. 8,543 8,489
Deferred policy acquisition costs ....................... 4,158 4,216
Current income tax recoverable .......................... 0 0
Prepaid reinsurance premiums ............................ 224 341
Other assets ............................................ 2,977 3,364
Total assets ......................................... $ 106,979 $ 106,958
Liabilities
Policy reserves ...................................... $ 18,736 $ 18,667
Claim reserves ....................................... 22,544 22,246
Unearned premiums .................................... 8,659 8,853
Other policyholder funds ............................. 1,684 1,729
Deferred income tax .................................. 4,373 4,078
Current Income tax payable ........................... 104 147
Other liabilities .................................... 4,295 4,886
Total liabilities ................................. $ 60,395 $ 60,606
Shareholders' Equity
Common stock, $1 par value, 2,339,848 shares issued ..... 2,340 2,340
Additional paid in capital .............................. 17 17
Net unrealized appreciation on securities
available-for-sale, net of deferred taxes ............ 13,743 12,497
Retained earnings ....................................... 31,767 31,888
Treasury stock, at cost (77,670 shares) ................. (1,283) (390)
Total shareholders' equity ........................... 46,584 46,352
Total liabilities and shareholder's equity ........... $ 106,979 $ 106,958
Shareholders' Equity per Share .......................... 20.29 20.04
The Notes to Financial Statements are an integral part of these statements.
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THE NATIONAL SECURITY GROUP. INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Three Months
Ended March 31
1998 1997
Cash Flows from Operating Activities
Income from continuing operations ....................... $ 320 $ 622
Adjustments to reconcile income from continuing
operations to net cash provided by (used in)
operating activities:
Accrued investment income ............................. (64) (122)
Reinsurance receivables ............................... (54) 2,020
Deferred Policy acquisition costs ................ ... 58 (82)
Income Taxes ......................................... 252 729
Depreciation expense ................................. 30 35
Policy liabilities and claims ......................... 173 (889)
Other, net ............................................ (103) (53)
Net cash provided by operating activities .......... 612 2,260
Cash Flows from Investing Activities
Cost of investments acquired ......................... (3,786) (4,672)
Sale and maturity of investments .................... 2,667 3,001
Purchase of property and equipment ................... (15) (25)
Proceeds from disposal of property and equipment .... 0 0
Other, net .......................................... 0 0
Net cash used in investing activities .............. (1,134) (1,696)
Cash Flows from Financing Activities
Increase in other policyholder funds ................ (45) (19)
Dividends paid ...................................... (439) (394)
Purchase of treasury stock .......................... (893) 0
Net cash used in financing activities ............. (1,377) (413)
Net increase (decrease) in cash and cash equivalents ..... (1,899) 151
Cash and cash equivalents, beginning of period ........... 3,888 4,722
Cash and cash equivalents, end of period ................. $ 1,989 $ 4,873
The Notes to the Financial Statements are an integral part of these statements.
5
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1-Basis of Presentation
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. The interim financial statements
include all adjustments necessary, in the opinion of management, for fair
statement of financial position, results of operations and cash flows for the
periods reported. These adjustments are all normal recurring adjustments.
Note 2-Reinsurance
National Security Fire and Casualty Company ("NSFC") and National Security
Insurance Company ("NSIC") wholly owned subsidiaries of the Company, reinsure
certain portions of insurance risk which exceed various retention limits. NSFC
and NSIC are liable for these amounts in the event assuming companies are unable
to meet their obligations.
Note 3-Calculation of Earnings Per Share
Earnings per share were based on net income divided by the weighted average
common shares outstanding. The weighted average number of shares outstanding for
the period ending March 31, 1998 was 2,262, and for the period ending March 31,
1997 was 2,319.
Note 4-Changes in Shareholder's Equity
During the three months ended March 31, 1998 and 1997, there were no changes in
shareholders' equity except for net income of $320 and $622 respectively;
dividends paid of $439 and $394 respectively; unrealized investment gains, net
of applicable taxes, of $1,245 and $715 respectively, and (purchases) of
treasury stock of ($893) and 0 respectively.
Note 5 - Deferred Taxes
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
March 31, January 1,
1998 1998
Deferred policy acquisition costs ........................ (1,417) (1,434)
Policy liabilities ....................................... 594 519
Unearned premiums ........................................ 484 442
Claims liabilities ....................................... 540 530
General insurance expenses ............................... 951 931
Unrealized gains on securities available-for-sale ........ (5,689) (5,066)
Other .................................................... 164 0
Net deferred tax assets (liability) ...................... (4,373) (4,078)
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities given the provisions of the enacted tax laws.
6
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 6-Contingencies
The Company and its subsidiaries continue to be named as parties to litigation
related to the conduct of their insurance operations. These suits involve
alleged breaches of contracts, torts, including bad faith and fraud claims based
on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries,
and miscellaneous other causes of action. Most of these lawsuits include claims
for punitive damages in addition to other specified relief. The frequency of
these lawsuits has increased significantly over the past 36 months, particularly
in Alabama where the Company conducts the majority of its business. Certain of
these actions are filed in jurisdictions in Alabama where local juries have
returned large punitive damage verdicts against insurance companies and
financial institutions with, in many cases, the punitive damage award bearing
little or no relation to the actual damages. It is not feasible to predict or
determine the ultimate outcome of these matters.
On October 4, 1996, a jury in the Circuit Court of Palm Beach County, Florida
returned a verdict against National Security Fire & Casualty Company, a
subsidiary of the Company, in the amount of $995,252. The plaintiff, Leon B.
King, had alleged that the Company's subsidiary had acted in bad faith in, among
other actions, failing to timely deliver a settlement check in connection with a
1986 automobile accident. This same case was previously tried in 1993 with the
jury returning a verdict in favor of the Company's subsidiary on all counts
alleged. This verdict was subsequently reversed on appeal which resulted in the
subject trial. Various post-trial motions including a motion for a new trial
were denied and this verdict is being appealed. The amount of this verdict is
reflected in the accompanying financial statements. It should be noted, however,
that in the event that this verdict is ultimately upheld, ther could be an award
of additional amounts including interest and attorneys' fees.
A resolution of these matters may significantly impact consolidated earnings and
may significantly impact the Company's consolidated financial position, although
it remains management's opinion, based upon information presently available,
that the ultimate resolution of these matters will not have a material impact on
the Company's consolidated financial position. It should be noted, however, that
management is unable to assess with any degree of accuracy the potential
liability to the Company arising from these matters. The civil tort system,
particularly in Alabama, must be presently regarded as, for the most part,
hostile to insurance companies.
Note 7-Accounting for certain investments in debt and equity securities
The Company's investment securities are classified in two categories and
accounted for as follows:
Securities Held-to-Maturity. Bonds, notes and redeemable preferred stock for
which the Company has the positive intent and ability to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts which are recognized in interest using methods which approximate level
yields over the period to maturity.
Securities Available-for-Sale. Bonds, notes, common stock and non-redeemable
preferred stock not classified as either held-to-maturity, or trading are
reported at fair value, adjusted for other-than-temporary declines in fair
value.
The Company and its subsidiaries have no trading securities.
Unrealized holding gains and losses, net of tax, on securities
available-for-sale are determined using the specific-identification method.
7
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THE NATIONAL SECURITY GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Note 7-Continued
Mortgage loans and policy loans are stated at the unpaid principle balance of
such loans. Investment real estate is reported at cost, less allowances for
depreciation computed on the straight -line basis. Short-term investments are
carried at cost, which approximate market value. Investments with other than
temporary impairment in value are written down to estimated realizable values.
8
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion addresses the financial condition of The National
Security Group, Inc. as of March 31, 1998, compared with December 31, 1997 and
its results of operations and cash flows for the quarter ending March 31, 1998,
compared with the same period last year.
The reader is assumed to have access to the Company's 1997 Annual Report. This
discussion should be read in conjunction with the Annual Report and with
consolidated financial statements on pages 3 through 6 of this form 10-Q.
Information is presented in whole dollars.
CONSOLIDATED RESULTS OF OPERATIONS
Premium revenues:
Earned premiums for the three month period ending March 31, 1998 were $7.5
million versus $7.9 million for the same period last year, a decrease of 6%. The
slight decrease is primarily due to the property/casualty subsidiary's reduction
in homeowner's insurance premiums.
Net investment income:
Net investment income is up slightly over last year due to an increase in
invested assets.
Realized capital gains and losses:
Investment gains of $480,000 were realized in the first quarter of 1998. This is
up significantly from the first quarter of 1997. The gains were primarily
generated from the sale of securities in the subsidiaries available for sale
portfolio. The Company's investment committee only sells selected securities as
market conditions warrant.
Other income:
Other income is down $23,000 due to a decrease in policy fees generated by an
automobile program which was discontinued in the first quarter of 1998.
Policyholder benefits and settlement expenses:
Policyholder benefits as a percent of net insurance premiums earned has
increased significantly compared to the first quarter of last year, 78.4% versus
66.9%. The increase is primarily due to a rise in incurred loss in the
property/casualty subsidiary's private passenger automobile programs. One of
these programs in the State of Louisiana was canceled earlier this year due to
adverse claims experience.
Policy acquisition cost:
Policy acquisition costs are up nearly $300,000 compared to last year. This
increase is due to costs associated with the launch of a new homeowners program
in the State of Louisiana. The program is being underwritten by a managing
general agent in Louisiana. Because managing general agents actually collect
from sub-agents and underwrite policies, acquisition costs are usually higher on
these programs. These costs are offset by lower general and administrative
expenses at the company level.
9
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General insurance expenses:
General insurance expenses are up 10% from last year due to slight increase
among several expense categories.
Insurance taxes, licenses, and fees:
Insurance taxes, licenses and fees have increased slightly both in total and as
a percent of premiums earned due to an increase in homeowners premiums written
in the property/casualty subsidiaries.
Income taxes:
Income taxes are down compared to last year due to a decrease in income of
nearly $1 million and an increase in deferred tax assets. These future
deductible amounts reduce overall income tax expense.
Summary:
Net income decreased $300,000 primarily due to an increase in policyholder
benefits associated with losses incurred in the property/casualty subsidiaries
private passenger automobile programs.
Investments:
Investments increased $2.3 million during the first quarter of 1998. The
increase in investments was due to an increase in unrealized capital gains and
new investments made with increased cash flow from the property/casualty
insurance subsidiaries.
Capital resources:
At March 31, 1998, the Company had aggregate equity capital, unrealized
investment gains (net of income taxes) and retained earnings of $46.5 million,
up slightly from December 31, 1997. The increase reflects net income of
$320,000, an increase in unrealized investment gains of $1.2 million, dividends
paid of $439,000, and purchases of treasury stock of $893,000. The Company
assumed long term debt of $750,000 to finance the purchase of treasury stock.
This debt is to be repaid over five years at 7% interest.
Liquidity:
The liquidity requirements of the Company are primarily met by funds provided
from operations of the life insurance and property/casualty subsidiaries.
Premium and investment income, as well as maturities, calls, and sales of
invested assets, provide the primary sources of cash for both subsidiaries. Cash
is used by subsidiaries for payments of policy benefits, the acquisition of new
business (principally commissions), operating expenses, and purchases of new
investments.
The Company had $2.0 million in cash and cash equivalents at March 31, 1998. Net
cash provided by operating activities was $600,000 for the current period,
compared to $2.2 million for the period ended March 31, 1997. Cash used in
investing activities was $1.1 million for the quarter. This use of cash was used
to increase bond and stock investments. Cash dividends paid to stockholders' of
$439,000, and purchases of treasury stock of $893,000 are the primary use of
cash used in financing activities.
10
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Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
See Exhibit Index
11
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed by the undersigned duly
authorized officer, on its behalf and in the capacity indicated.
The National Security Group, Inc.
By M.L. Murdock /s/
--------------------------
M.L. Murdock
Senior Vice President and
Chief Financial Officer
Dated: May 14, 1998
12
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EXHIBIT INDEX
Exhibit Description Page
(a) 11 Statement Regarding Computation of Per Share Earnings Filed Herewith;
See Note 3 to
Financial
(b) Form 8-K None
13
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<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 19,990
<DEBT-CARRYING-VALUE> 31,379
<DEBT-MARKET-VALUE> 32,155
<EQUITIES> 34,222
<MORTGAGE> 311
<REAL-ESTATE> 1,629
<TOTAL-INVEST> 88,191
<CASH> 1,989
<RECOVER-REINSURE> 8,543
<DEFERRED-ACQUISITION> 4,158
<TOTAL-ASSETS> 106,979
<POLICY-LOSSES> 18,736
<UNEARNED-PREMIUMS> 8,659
<POLICY-OTHER> 22,544
<POLICY-HOLDER-FUNDS> 1,684
<NOTES-PAYABLE> 750
0
0
<COMMON> 2,340
<OTHER-SE> 44,244
<TOTAL-LIABILITY-AND-EQUITY> 106,979
7,501
<INVESTMENT-INCOME> 1,165
<INVESTMENT-GAINS> 480
<OTHER-INCOME> 139
<BENEFITS> 5,881
<UNDERWRITING-AMORTIZATION> 1,671
<UNDERWRITING-OTHER> 1,687
<INCOME-PRETAX> 45
<INCOME-TAX> (275)
<INCOME-CONTINUING> 320
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<EPS-PRIMARY> .14
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