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<SEC-DOCUMENT>0000356130-03-000020.txt : 20030327
<SEC-HEADER>0000356130-03-000020.hdr.sgml : 20030327
<ACCEPTANCE-DATETIME>20030327142722
ACCESSION NUMBER: 0000356130-03-000020
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 13
CONFORMED PERIOD OF REPORT: 20021231
FILED AS OF DATE: 20030327
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: EMC INSURANCE GROUP INC
CENTRAL INDEX KEY: 0000356130
STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331]
IRS NUMBER: 426234555
STATE OF INCORPORATION: IA
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 000-10956
FILM NUMBER: 03620574
BUSINESS ADDRESS:
STREET 1: 717 MULBERRY ST
CITY: DES MOINES
STATE: IA
ZIP: 50309
BUSINESS PHONE: 5152802902
MAIL ADDRESS:
STREET 1: 717 MULBERRY STREET
CITY: DES MOINES
STATE: IA
ZIP: 50309
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>bus2002.txt
<DESCRIPTION>BUSINESS SECTION
<TEXT>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the Fiscal Year Ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from ___________ to ___________
Commission File Number: 0-10956
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)
Registrant's telephone number, including area code: (515) 280-2902
--------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.00
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). [ ] Yes [X] No
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 3, 2003 was $41,606,199.
The number of shares outstanding of the registrant's common stock, $1.00
par value, on March 3, 2003, were 11,404,725.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the registrant's annual report to stockholders for the
year ended December 31, 2002 are incorporated by reference under Parts II and
IV.
2. Portions of the registrant's definitive proxy statement, which will
be filed with the Securities and Exchange Commission on or before April 17,
2003, are incorporated by reference under Part III.
<PAGE>
TABLE OF CONTENTS
Part I
Item 1. Business ........................................................ 2
Item 2. Properties ...................................................... 23
Item 3. Legal Proceedings ............................................... 23
Item 4. Submission of Matters to a Vote of Security Holders ............. 23
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters .................................. 23
Item 6. Selected Financial Data ......................................... 23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .......................... 23
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...... 23
Item 8. Financial Statements and Supplementary Data ..................... 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .......................... 24
Part III
Item 10. Directors and Executive Officers of the Registrant .............. 24
Item 11. Executive Compensation .......................................... 25
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters ............... 25
Item 13. Certain Relationships and Related Transactions .................. 25
Item 14. Controls and Procedures ......................................... 26
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K .................................................. 26
Index to Financial Statement Schedules ................................... 26
Signatures ............................................................... 30
Certifications ........................................................... 31
Index to Exhibits ........................................................ 42
<PAGE>
PART I
ITEM 1. BUSINESS.
GENERAL
EMC Insurance Group Inc. is an insurance holding company incorporated in
Iowa in 1974. EMC Insurance Group Inc. is 79.9 percent owned by Employers
Mutual Casualty Company (Employers Mutual), a multiple-line property and
casualty insurance company organized as an Iowa mutual insurance company in
1911 that is licensed in all 50 states and the District of Columbia. The term
"Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent
Company only) and EMC Insurance Group Inc. and its subsidiaries. Employers
Mutual and all of its subsidiaries (including the Company) and an affiliate,
are referred to as the "EMC Insurance Companies."
The Company conducts its insurance business through two business segments
as follows:
...............................
: :
: EMC INSURANCE GROUP INC. :
:.............................:
:
:
Property and :
Casualty Insurance : Reinsurance
......................:................................
: :
: :
Illinois EMCASCO Insurance Company (Illinois EMCASCO) EMC
Dakota Fire Insurance Company (Dakota Fire) Reinsurance
Farm and City Insurance Company (Farm and City) Company
EMCASCO Insurance Company (EMCASCO)
:
:
EMC Underwriters, LLC
Illinois EMCASCO was formed in Illinois in 1976 and was redomesticated to
Iowa in 2001, Dakota Fire was formed in North Dakota in 1957 and EMCASCO was
formed in Iowa in 1958 for the purpose of writing property and casualty
insurance. Farm and City was formed in Iowa in 1962 to write nonstandard risk
automobile insurance and was purchased by the Company in 1984. These
companies are licensed to write insurance in a total of 37 states and are
participants in a pooling agreement with Employers Mutual (see "Property and
Casualty Insurance - Pooling Agreement").
EMC Reinsurance Company was formed in 1981 to assume reinsurance business
from Employers Mutual. The company assumes a 100 percent quota share portion
of Employers Mutual's assumed reinsurance business, exclusive of certain
reinsurance contracts, and is licensed to do business in nine states.
The Company's excess and surplus lines insurance agency, EMC
Underwriters, LLC, was acquired in 1985. The company was formed in Iowa in
1975 as a broker for excess and surplus lines insurance. Effective December
31, 1998, the excess and surplus lines insurance agency was converted to a
limited liability company and the ownership was contributed to EMCASCO.
<PAGE>
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
- ---------------------------------------------
For information concerning the Company's revenues, operating income and
identifiable assets attributable to each of its industry segments over the
past three years, see note 7 of Notes to Consolidated Financial Statements
under Item 8 of this Form 10-K.
PROPERTY AND CASUALTY INSURANCE
- -------------------------------
POOLING AGREEMENT
The four property and casualty insurance subsidiaries of the Company and
two subsidiaries and an affiliate of Employers Mutual (Union Insurance Company
of Providence, EMC Property & Casualty Company and Hamilton Mutual Insurance
Company) 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. The aggregate participation of the Company's
property and casualty insurance subsidiaries is 23.5 percent. 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 pooling agreement is continuous, but may be amended or
terminated at the end of any calendar year as to any one or more parties.
<PAGE>
PRINCIPAL PRODUCTS
The Company's property and casualty insurance subsidiaries and the other
parties to the pooling agreement underwrite both commercial and personal lines
of insurance. The following table sets forth the aggregate direct written
premiums of all parties to the pooling agreement for the three years ended
December 31, 2002.
Percent Percent Percent
of of of
Line of Business 2002 total 2001 total 2000 total
- ---------------- ---------- ----- -------- ----- -------- -----
(Dollars in thousands)
Commercial Lines:
Automobile .......... $ 224,321 21.5% $216,371 21.7% $177,937 21.2%
Property ............ 180,622 17.3 162,670 16.4 135,639 16.2
Workers' compensation 194,853 18.7 208,652 21.0 155,752 18.6
Liability ........... 195,682 18.8 176,774 17.8 141,184 16.8
Other ............... 20,489 2.0 19,325 1.9 17,380 2.0
---------- ----- -------- ----- -------- -----
Total commercial
lines ............ 815,967 78.3 783,792 78.8 627,892 74.8
---------- ----- -------- ----- -------- -----
Personal Lines:
Automobile .......... 134,405 12.9 126,280 12.7 134,763 16.1
Property ............ 89,248 8.6 81,124 8.2 73,996 8.8
Liability ........... 1,815 0.2 3,284 0.3 2,634 0.3
---------- ----- -------- ----- -------- -----
Total personal lines 225,468 21.7 210,688 21.2 211,393 25.2
---------- ----- -------- ----- -------- -----
Total .......... $1,041,435 100.0% $994,480 100.0% $839,285 100.0%
========== ===== ======== ===== ======== =====
MARKETING
Marketing of insurance by the parties to the pooling agreement, excluding
the nonstandard risk automobile insurance sold by Farm and City, is conducted
through 17 branch offices located throughout the United States and
approximately 3,200 independent insurance agencies. These branch offices
allow the Company to respond quickly to changes in local market conditions.
Each branch office employs underwriting, claims, marketing and risk
improvement representatives, as well as field auditors and branch
administrative technicians. The branch offices are supported by technicians
and specialists that operate out of Employers Mutual's home office. Systems
are in place to monitor the underwriting results of each branch office and to
maintain guidelines and policies consistent with the underwriting and
marketing environment in each region.
Farm and City specializes in insuring private passenger automobile risks
that are found to be unacceptable in the standard automobile insurance market.
Farm and City is licensed in a six state area that includes Iowa, Kansas,
Missouri, Nebraska, North Dakota and South Dakota. Private passenger
automobile policies are solicited through the Independent Agency System using
approximately 725 agencies.
<PAGE>
The following table sets forth the geographic distribution of the
aggregate direct written premiums of all parties to the pooling agreement for
the three years ended December 31, 2002.
2002 2001 2000
---- ---- ----
Alabama ............................ 2.9% 2.8% 3.2%
Arizona ............................ 3.8 3.8 3.8
Illinois ........................... 4.7 5.1 4.8
Iowa ............................... 15.9 16.8 17.4
Kansas ............................. 8.8 8.8 8.2
Michigan ........................... 5.1 4.2 4.0
Minnesota .......................... 3.3 3.5 3.5
Nebraska ........................... 6.8 7.0 6.9
North Carolina ..................... 2.7 3.1 2.9
North Dakota ....................... 2.6 2.6 3.1
Pennsylvania ....................... 3.1 2.8 2.6
Texas .............................. 5.0 5.2 5.3
Wisconsin .......................... 5.0 5.0 4.5
Other * ............................ 30.3 29.3 29.8
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
* Includes all other jurisdictions, none of which accounted for more than
3 percent.
COMPETITION
The property and casualty insurance business is very competitive. The
Company's property and casualty insurance subsidiaries and the other pool
members compete in the United States insurance market with numerous insurers,
many of which have greater financial resources. Competition in the types of
insurance in which the property and casualty insurance subsidiaries are
engaged is based on many factors, including the perceived overall financial
strength of the insurer, premiums charged, contract terms and conditions,
services offered, speed of claim payments, reputation and experience. Because
the insurance products of the pool members are marketed exclusively through
independent agencies, the Company faces competition to retain qualified
independent agencies, as well as competition within the agencies. The pool
members also compete with direct writers, who utilize salaried employees and
generally offer their products at a lower cost, exclusive agencies who write
insurance business for only one company, and to a lesser extent, Internet-
based enterprises. The pool members utilize a profit-sharing plan as an
incentive for the independent agencies to place high-quality insurance
business with them.
<PAGE>
BEST'S RATING
A.M. Best Company rates insurance companies based on their relative
financial strength and ability to meet their contractual obligations. A.M.
Best announced on July 10, 2001 that their rating of the EMC Insurance
Companies, which includes the Company's property and casualty insurance
subsidiaries, was changed from "A" (Excellent) to "A-" (Excellent). This
rating action reflected A.M. Best's opinion of the EMC Insurance Companies'
underwriting performance and operating losses during the three years ended
December 31, 2001. Despite this rating action, A.M. Best stated that the EMC
Insurance Companies' "Excellent" rating reflects its strong capitalization,
conservative operating strategies and local-market presence. A.M. Best
reevaluates its ratings from time to time (normally on an annual basis) and
there can be no assurance that the Company's property and casualty insurance
subsidiaries and the other pool members will maintain their current rating in
the future. Management believes that a Best's rating of "A-" (Excellent) or
better is important to the Company's business since many insureds require that
companies with which they insure be so rated. Best's publications indicate
that these ratings are assigned to companies that have achieved excellent
overall performance and have a strong ability to meet their obligations over a
long period of time. Best's ratings are based upon factors of concern to
policyholders and insurance agents and are not necessarily directed toward the
protection of investors.
REINSURANCE CEDED
The parties to the pooling agreement cede insurance in the ordinary
course of business for the purpose of limiting their maximum loss exposure
through diversification of their risks. The pool participants also purchase
catastrophe reinsurance to cover multiple losses arising from a single event.
All major reinsurance treaties, with the exception of the pooling
agreement and a boiler treaty, are on an "excess of loss" basis whereby the
reinsurer agrees to reimburse the primary insurer for covered losses in excess
of a predetermined amount, up to a stated limit. The boiler treaty provides
for 100 percent reinsurance of the pool's direct boiler coverage written.
Facultative reinsurance from approved domestic markets, which provides
reinsurance on an individual risk basis and requires specific agreement of the
reinsurer as to the limits of coverage provided, is purchased when coverage by
an insured is required in excess of treaty capacity or where a high-risk type
policy could expose the treaty reinsurance programs.
Each type of reinsurance coverage is purchased in layers, and each layer
may have a separate retention level. Retention levels are adjusted according
to reinsurance market conditions and the surplus position of the EMC Insurance
Companies. The inter-company pooling arrangement aids efficient buying of
reinsurance since it allows for higher retention levels and correspondingly
decreased dependence on the reinsurance marketplace.
<PAGE>
A summary of the reinsurance treaties benefiting the parties to the
pooling agreement as of December 31, 2002 is presented below. Retention
amounts reflect the accumulated retentions of all layers within a treaty.
Type of Reinsurance Treaty Retention Limits
-------------------------- ----------- --------------------------
Property per risk ........... $ 3,000,000 100 percent of $37,000,000
Property catastrophe ........ $13,950,000 96 percent of $79,000,000
Casualty .................... $ 2,000,000 100 percent of $38,000,000
Workers' compensation excess $ - $20,000,000 excess of
$40,000,000
Umbrella .................... $ 1,400,000(1) 100 percent of $ 8,600,000
Fidelity .................... $ 1,150,000(2) 95 percent of $ 3,000,000
Surety ...................... $ 2,200,000(3) 98 percent of $13,000,000
Non-obligatory surety
quota share ............... $10,500,000 70 percent of $35,000,000
Boiler ...................... $ - 100 percent of $50,000,000
Property - terrorism ........ $10,000,000 100 percent of $30,000,000
Workers' compensation -
terrorism ................. $14,000,000 100 percent of $46,000,000
Employment practices
liability ................. $ 500,000 50 percent of $ 1,000,000
(1) An annual aggregate deductible of $3,600,000 must be reached before the
reinsurers may be petitioned.
(2) Subject to annual aggregate limits for all losses of $14,000,000.
(3) Subject to annual aggregate limits for all losses of $14,000,000 in the
first layer and $15,000,000 in the second layer.
Although reinsurance does not discharge the original insurer from its
primary liability to its policyholders, it is the practice of insurers for
accounting purposes to treat reinsured risks as risks of the reinsurer since
the primary insurer would only reassume liability in those situations where
the reinsurer is unable to meet the obligations it assumed under the
reinsurance agreements. The ability to collect reinsurance is subject to the
solvency of the reinsurers.
The major participants in the pool members' reinsurance programs as of
December 31, 2002 are presented below. The percentages represent the
reinsurers' share of the total reinsurance protection under all coverages.
Each type of coverage is purchased in layers, and an individual reinsurer may
participate in more than one type of coverage and at various layers within
these coverages. The property per risk, property catastrophe and casualty
reinsurance programs are handled by a reinsurance intermediary (broker). The
reinsurance of those programs is syndicated to approximately 40 domestic and
foreign reinsurers.
<PAGE>
In formulating reinsurance programs, Employers Mutual is selective in its
choice of reinsurers. Employers Mutual selects reinsurers on the basis of
financial stability and long-term relationships, as well as price of the
coverage. Reinsurers are generally required to have a Best's rating of "A-"
or higher and policyholders' surplus of $50,000,000 ($100,000,000 for casualty
reinsurance).
Percent
of total 2002
Property per risk, property catastrophe reinsurance Best's
and casualty coverages: protection rating
- --------------------------------------- ---------- ------
Underwriters at Lloyd's of London .................... 29.0% A-
Mutual Reinsurance Bureau ............................ 19.8 (2)
XL Reinsurance America, Inc. ......................... 9.6 A+
Converium AG, Zurich ................................. 6.5 (1)
Transatlantic Reinsurance Company .................... 5.8 A++
Workers' compensation excess coverage:
- --------------------------------------
Underwriters at Lloyd's of London .................... 89.4% A-
Terra Nova Insurance Company, Ltd. ................... 7.7 (1)
Umbrella coverage:
- ------------------
General Reinsurance Corporation ...................... 100.0% A++
Fidelity and surety coverages:
- ------------------------------
SCOR Reinsurance Company ............................. 42.0% A
Hannover Ruckversicherung AG ......................... 18.0 (1)
Transatlantic Reinsurance Company .................... 18.0 A++
Everest Reinsurance Company .......................... 17.0 A+
Berkley Insurance Company ............................ 5.0 A
Boiler coverage:
- ----------------
Hartford Steam Boiler Inspection and Insurance Company 100.0% A+
Property - terrorism:
- ---------------------
Underwriters at Lloyd's of London .................... 100.0% A-
Workers' compensation - terrorism:
- ----------------------------------
Underwriters at Lloyd's of London .................... 49.0% A-
Axis Specialty LTD ................................... 11.7 (1)
Everest Reinsurance Company .......................... 8.4 A+
Odyssey America Reinsurance Corporation .............. 7.7 A
(1) Not rated.
(2) Mutual Reinsurance Bureau (MRB) is composed of Employers Mutual and four
other nonaffiliated mutual insurance companies. Each of the five members
cede primarily property insurance to MRB and assume, on an equal and
joint basis, proportionate shares of this business. Each member
benefits from the increased capacity provided by MRB. MRB is backed by
the financial strength of the five member companies. All of the members
of MRB were assigned an "A-" (Excellent) or better rating by A.M. Best.
<PAGE>
Premiums ceded under the pool members' reinsurance programs by all pool
members and by the Company's property and casualty insurance subsidiaries for
the year ended December 31, 2002 are presented below. Each type of
reinsurance coverage is purchased in layers, and an individual reinsurer may
participate in more than one type of coverage and at various layers within the
coverages. Since each layer of coverage is priced separately, with the lower
layers being more expensive than the upper layers, a reinsurer's overall
participation in a reinsurance program does not necessarily correspond to the
amount of premiums it receives.
Premiums ceded by
------------------------
Property
and casualty
All pool insurance
Reinsurer members subsidiaries
- --------- ----------- ------------
General Reinsurance Corporation..................... $ 6,498,922 $ 1,527,247
Hartford Steam Boiler Inspection & Insurance Company 6,266,751 1,472,686
XL Reinsurance America Inc. ........................ 2,281,111 536,061
Converium AG, Zurich ............................... 1,411,896 331,796
Managing Agency Partners ........................... 1,401,000 329,235
SCOR Reinsurance Company ........................... 1,278,935 300,550
Transatlantic Reinsurance Company .................. 1,175,209 276,174
Amlin Underwriting ................................. 963,432 226,407
Hannover Ruckversicherung AG ....................... 947,678 222,704
PXRE Reinsurance Company ........................... 638,964 150,157
Other Reinsurers ................................... 9,997,208 2,349,343
----------- ------------
Total ............................................ $32,861,106 $ 7,722,360
=========== ============
The parties to the pooling agreement also cede reinsurance on both a
voluntary and a mandatory basis to state and national organizations in
connection with various workers' compensation and assigned risk programs and
to private organizations established to handle large risks. Premiums ceded by
all pool members and by the Company's property and casualty insurance
subsidiaries for the year ended December 31, 2002 are presented below.
Premiums ceded by
------------------------
Property
and casualty
All pool insurance
Reinsurer members subsidiaries
- --------- ----------- ------------
Wisconsin Compensation Rating Bureau ............... $10,669,290 $ 2,507,283
North Carolina Reinsurance Facility ................ 1,434,632 337,139
Mutual Reinsurance Bureau .......................... 1,093,509 256,975
Other Reinsurers ................................... 1,128,870 265,284
----------- ------------
Total ............................................ $14,326,301 $ 3,366,681
=========== ============
For information concerning amounts due the Company from reinsurers for
losses and settlement expenses and prepaid reinsurance premiums and the effect
of reinsurance on premiums written and earned, and losses and settlement
expenses incurred, see "Property and Casualty Insurance Subsidiaries and
Reinsurance Subsidiary - Reinsurance Ceded."
The September 11, 2001 terrorist attack on the World Trade Center had a
significant impact on the pricing and terms of reinsurance coverage for 2002.
The parties to the pooling agreement were not immune to these factors and
experienced significantly higher costs and increased retentions when their
reinsurance program was renewed in January 2002. In addition, the parties to
the pooling agreement elected to purchase separate terrorism coverage for 2002
in order to provide limited protection from future terrorist exposures, as all
standard reinsurance policies excluded coverage for terrorist activities.
<PAGE>
RELATIONSHIP BETWEEN NET PREMIUMS WRITTEN AND SURPLUS
The amount of insurance a property and casualty insurance company writes
under industry standards is commonly expressed as a multiple of its surplus
calculated in accordance with statutory accounting practices. Generally, a
ratio of 3 to 1 or less is considered satisfactory by regulatory authorities.
The ratios of the pool members for the past three years are as follows:
Year ended December 31,
------------------------------
2002 2001 2000
---- ---- ----
Employers Mutual .................... 1.55 1.35 1.01
EMCASCO ............................. 2.41 2.25 2.39
Illinois EMCASCO .................... 2.36 2.20 2.46
Dakota Fire ......................... 2.41 2.23 2.46
Farm and City ....................... 2.49 2.70 2.32
EMC Property & Casualty Company ..... .94 .97 .87
Union Insurance Company of Providence .93 .96 .86
Hamilton Mutual Insurance Company ... 2.13 2.34 1.94
The 2002 and 2001 ratios for three of the Company's property and casualty
insurance subsidiaries (EMCASCO, Illinois EMCASCO and Dakota Fire) reflect the
issuance of an aggregate of $25,000,000 of surplus notes to Employers Mutual
on December 28, 2001. Surplus notes are considered to be a component of
surplus for statutory reporting purposes; however, under generally accepted
accounting principals, surplus notes are considered to be debt and are
reported as a liability in the Company's financial statements.
OUTSTANDING LOSSES AND SETTLEMENT EXPENSES
The property and casualty insurance subsidiaries' reserve information is
included in the property and casualty loss reserve development for 2002. See
"Property and Casualty Insurance Subsidiaries and Reinsurance Subsidiary -
Outstanding Losses and Settlement Expenses."
REINSURANCE
The reinsurance subsidiary is a property and casualty treaty reinsurer
with a concentration in property lines. The reinsurance subsidiary assumes a
100 percent quota share portion of Employers Mutual's assumed reinsurance
business, exclusive of certain reinsurance contracts. The reinsurance
subsidiary assumes its quota share portion of 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, or 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 investment
and income tax activities of the reinsurance subsidiary are not subject to the
quota share agreement.
<PAGE>
PRINCIPAL PRODUCTS
The reinsurance subsidiary assumes both pro rata and excess of loss
reinsurance from Employers Mutual. The following table sets forth the assumed
written premiums of the reinsurance subsidiary for the three years ended
December 31, 2002.
Percent Percent Percent
of of of
Line of Business 2002 total 2001 total 2000 total
- ---------------- ------- ----- ------- ----- ------- -----
(Dollars in thousands)
Pro rata reinsurance:
Property and Casualty $ 2,457 3.2% $ 3,864 5.8% $14,441 30.4%
Property ............. 20,379 26.8 16,694 25.1 7,399 15.6
Crop ................. 1,160 1.5 2,372 3.6 4,188 8.8
Casualty ............. 11,949 15.7 10,537 15.9 5,319 11.2
Marine/aviation ...... 11,765 15.4 6,143 9.3 1,869 3.9
Other ................ 211 0.3 122 0.2 374 0.8
------- ----- ------- ----- ------- -----
Total pro rata
Reinsurance ...... 47,921 62.9 39,732 59.9 33,590 70.7
------- ----- ------- ----- ------- -----
Excess reinsurance:
Excess per risk
reinsurance:
Property ............. 9,066 11.9 7,406 11.2 3,011 6.3
Casualty ............. 9,737 12.8 7,915 11.9 3,882 8.2
Other ................ 2,039 2.7 1,571 2.4 856 1.8
------- ----- ------- ----- ------- -----
Total excess per
risk reinsurance 20,842 27.4 16,892 25.5 7,749 16.3
------- ----- ------- ----- ------- -----
Excess catastrophe/
aggregate reinsurance:
Property ............. 6,076 8.0 8,662 13.1 5,357 11.3
Crop ................. 493 0.6 392 0.6 297 0.6
Other ................ 872 1.1 609 0.9 537 1.1
------- ----- ------- ----- ------- -----
Total excess
catastrophe/
aggregate
reinsurance ...... 7,441 9.7 9,663 14.6 6,191 13.0
------- ----- ------- ----- ------- -----
Total excess
Reinsurance ...... 28,283 37.1 26,555 40.1 13,940 29.3
------- ----- ------- ----- ------- -----
Total .............. $76,204 100.0% $66,287 100.0% $47,530 100.0%
======= ===== ======= ===== ======= =====
MARKETING
Over the last several years Employers Mutual has emphasized writing
excess of loss reinsurance business and has worked to increase its
participation on existing contracts that had favorable terms. Employers
Mutual strives to be flexible in the types of reinsurance products it offers,
but generally limits its writings to direct reinsurance business rather than
providing retrocessional covers. During the last three years there has been a
trend in the reinsurance marketplace for "across the board" participation on
excess of loss reinsurance contracts. As a result, reinsurance companies must
be willing to participate on all layers offered under a specific contract in
order to be considered a viable reinsurer.
<PAGE>
COMPETITION
The reinsurance marketplace is generally considered to be competitive;
however, competition for reinsurance business has declined significantly as a
result of the September 11, 2001 terrorist attack on the World Trade Center.
Industry wide premium increases for January 2003 renewals averaged 11.2
percent for excess of loss business and retentions increased again this year
as well. Exclusions for terrorist activities remained commonplace. The
market for terrorism coverage is still evolving, but is becoming more
available (sometimes including nuclear, biological and chemical perils).
Terrorism coverage is still being written on a stand-alone basis, but this may
change in the future. New reinsurance capacity, primarily from Bermuda, has
entered the reinsurance marketplace to take advantage of higher reinsurance
pricing, which could lead to increased rate competition in the future.
Employers Mutual competes in the global reinsurance market with numerous
reinsurance companies, many of which have greater financial resources.
Competition for reinsurance business is based on many factors, including
financial strength, industry ratings, stability in products offered and
licensing status. During the last several years, reinsurance brokers have
tended to favor large, financially strong reinsurance companies who are able
to provide "mega" line capacity for all lines of business. The Company faces
the risk of reinsurance brokers becoming less interested in diversity and
spread of reinsurance risk in favor of highly capitalized reinsurance
companies.
REINSURANCE CEDED
The reinsurance subsidiary does not purchase outside reinsurance
protection due to the $1,500,000 cap on losses assumed per event under the
terms of the quota share agreement with Employers Mutual. The reinsurance
subsidiary pays an annual override commission to Employers Mutual for this
protection, which amounted to $3,429,148 in 2002. The reinsurance subsidiary
also pays for 100 percent of the outside reinsurance protection Employers
Mutual purchases to protect itself from catastrophic losses on the assumed
reinsurance business. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary and amounted to $3,247,969 in 2002.
BEST'S RATING
The most recent Best's Property Casualty Key Rating Guide gives the
reinsurance subsidiary an "A-" (Excellent) policyholders' rating. Best's
ratings are based upon factors of concern to policyholders and insurance
agents and are not necessarily directed toward the protection of investors.
OUTSTANDING LOSSES AND SETTLEMENT EXPENSES
The reinsurance subsidiary's reserve information is included in the
property and casualty loss reserve development for 2002. See "Property and
Casualty Insurance Subsidiaries and Reinsurance Subsidiary - Outstanding
Losses and Settlement Expenses."
<PAGE>
PROPERTY AND CASUALTY INSURANCE SUBSIDIARIES AND REINSURANCE SUBSIDIARY
- -----------------------------------------------------------------------
Employers Mutual provides various services to all of its subsidiaries and
affiliates. Such services include data processing, claims, financial,
actuarial, auditing, marketing and underwriting. Employers Mutual allocates a
portion of the cost of these services to the subsidiaries that do not
participate in the pooling agreement based upon a number of criteria,
including usage and number of transactions. The remaining costs are charged
to the pooling agreement and each pool participant shares in the total cost in
accordance with its pool participation percentage. Costs allocated to the
Company by Employers Mutual for services provided to the holding company and
its subsidiaries that do not participate in the pooling agreement amounted to
$1,765,179, $2,040,822 and $1,674,704 in 2002, 2001 and 2000, respectively.
Costs allocated to the Company through the operation of the pooling agreement
amounted to $56,897,066, $51,041,812 and $46,796,784 in 2002, 2001 and 2000,
respectively.
STATUTORY COMBINED RATIOS
The following table sets forth the statutory combined ratios of the
Company's insurance subsidiaries and the property and casualty insurance
industry averages for the five years ended December 31, 2002. The combined
ratios below are the sum of the following: the loss ratio, calculated by
dividing losses and settlement expenses incurred by net premiums earned, and
the expense ratio, calculated by dividing underwriting expenses incurred by
net premiums written and policyholder dividends by net premiums earned.
Generally, if the combined ratio is below 100 percent, a company has an
underwriting profit; if it is above 100 percent, a company has an underwriting
loss.
Year ended December 31,
--------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Property and casualty insurance
Loss ratio ................... 69.8% 83.0% 82.2% 83.6% 83.5%
Expense ratio ................ 31.2 28.5 30.8 32.0 33.3
------ ------ ------ ------ ------
Combined ratio ............. 101.0% 111.5% 113.0% 115.6% 116.8%
====== ====== ====== ====== ======
Reinsurance
Loss ratio ................... 70.7% 86.6% 86.1% 83.1% 75.4%
Expense ratio ................ 31.6 29.1 29.1 30.6 31.1
------ ------ ------ ------ ------
Combined ratio ............. 102.3% 115.7% 115.2% 113.7% 106.5%
====== ====== ====== ====== ======
Total insurance operations
Loss ratio ................... 70.0% 83.8% 83.0% 83.5% 81.9%
Expense ratio ................ 31.3 28.6 30.5 31.7 32.9
------ ------ ------ ------ ------
Combined ratio ............. 101.3% 112.4% 113.5% 115.2% 114.8%
====== ====== ====== ====== ======
Property and casualty insurance
industry averages (1)
Loss ratio ................... 79.6% 88.5% 81.5% 78.6% 76.3%
Expense ratio ................ 26.1 27.5 28.9 29.2 29.4
------ ------ ------ ------ ------
Combined ratio ............. 105.7% 116.0% 110.4% 107.8% 105.7%
====== ====== ====== ====== ======
(1) As reported by A.M. Best Company. The ratio for 2002 is an estimate; the
actual combined ratio is not currently available.
The 2001 expense ratios and combined ratios for "property and casualty
insurance" and "total insurance operations" are distorted by $13,884,000 of
additional written premiums that were recorded in 2001 in connection with a
change in the recording of installment-based insurance policies. Excluding
this adjustment, the expense ratios would have been 30.2 percent and 30.0
percent, respectively, and the combined ratios would have been 113.2 percent
and 113.8 percent, respectively.
<PAGE>
REINSURANCE CEDED
The following table presents amounts due to the Company from reinsurers
for losses and settlement expenses and prepaid reinsurance premiums as of
December 31, 2002:
2002
Amount Percent Best's
recoverable of total rating
----------- -------- ------
Wisconsin Compensation Rating Bureau .. $ 3,797,448 27.1% (1)
National Workers' Compensation
Reinsurance Pool .................... 2,003,320 14.3 (1)
General Reinsurance Corporation ....... 1,723,130 12.3 A++
Hartford Steam Boiler Insp. & Ins. .... 883,109 6.3 A+
PXRE Reinsurance Company .............. 508,533 3.6 A
XL Reinsurance America ................ 459,721 3.3 A+
Hartford Fire Insurance Company ....... 426,556 3.0 A+
SCOR Reinsurance Company .............. 382,242 2.7 A
American Re-Insurance Company ......... 381,273 2.7 A++
Minnesota Workers' Comp Reins Assoc ... 374,220 2.7 (2)
Other Reinsurers ...................... 3,085,483 22.0
----------- -----
Total ........................... $14,025,035(3) 100.0%
=========== =====
(1) Amounts recoverable reflect the property and casualty insurance
subsidiaries' pool participation percentage of amounts ceded to these
organizations by Employers Mutual in connection with its role as "service
carrier." Under these arrangements, Employers Mutual writes business for
these organizations on a direct basis and then cedes 100 percent of the
business to these organizations. Credit risk associated with these
amounts is minimal as all companies participating in these organizations
are responsible for the liabilities of such organizations on a pro rata
basis.
(2) Not rated.
(3) The total amount recoverable at December 31, 2002 represented $1,214,512
in paid losses and settlement expenses, $10,367,624 in unpaid losses
and settlement expenses and $2,442,899 in unearned premiums.
<PAGE>
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred for the three years ended December 31, 2002 is
presented below.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Premiums written:
Direct ........................ $235,596,547 $272,027,823 $249,896,499
Assumed from nonaffiliates .... 3,985,370 1,898,509 1,220,442
Assumed from affiliates ....... 320,940,551 299,990,245 244,762,032
Ceded to nonaffiliates ........ (11,089,041) (11,189,227) (8,347,822)
Ceded to affiliates ........... (235,596,547) (272,027,823) (249,896,499)
------------ ------------ ------------
Net premiums written ........ $313,836,880 $290,699,527 $237,634,652
============ ============ ============
Premiums earned:
Direct ........................ $241,939,466 $255,764,274 $245,078,165
Assumed from nonaffiliates .... 3,501,616 1,786,132 1,194,835
Assumed from affiliates ....... 304,462,790 274,352,821 237,946,894
Ceded to nonaffiliates ........ (10,921,373) (10,859,095) (7,683,287)
Ceded to affiliates ........... (241,939,466) (255,764,274) (245,078,165)
------------ ------------ ------------
Net premiums earned ......... $297,043,033 $265,279,858 $231,458,442
============ ============ ============
Losses and settlement expenses
incurred:
Direct ........................ $165,218,514 $221,314,633 $208,604,970
Assumed from nonaffiliates .... 2,876,808 1,336,824 400,360
Assumed from affiliates ....... 206,614,356 227,650,959 194,017,734
Ceded to nonaffiliates ........ (2,433,308) (7,069,033) (4,896,420)
Ceded to affiliates ........... (165,218,514) (221,314,633) (208,604,970)
------------ ------------ ------------
Net losses and settlement
expenses incurred ......... $207,057,856 $221,918,750 $189,521,674
============ ============ ============
Effective January 1, 2001, the Company began recording the full-term
written premium at the inception of insurance policies that are billed on an
installment basis. Previously, such amounts were recorded as each installment
became due. As a result, written premiums assumed from affiliates for 2001
increased $13,884,423. Earned premiums were not affected by this change, as
unearned premiums were increased by the same amount.
OUTSTANDING LOSSES AND SETTLEMENT EXPENSES
The Company maintains reserves for losses and settlement expenses with
respect to both reported and unreported claims. The amount of reserves for
reported claims is primarily based upon a case-by-case evaluation of the
specific type of claim, knowledge of the circumstances surrounding each claim
and the policy provisions relating to the type of loss. Reserves on assumed
reinsurance business are the amounts reported by the ceding company.
The amount of reserves for unreported claims is determined on the basis
of statistical information for each line of insurance with respect to the
probable number and nature of claims arising from occurrences that have not
yet been reported. Established reserves are closely monitored and are
frequently recomputed using a variety of formulas and statistical techniques
for analyzing actual claim costs, frequency data and other economic and social
factors.
<PAGE>
The Company does not discount reserves. Inflation is implicitly provided
for in the reserving function through analysis of cost trends, reviews of
historical reserving results and projections of future economic conditions.
Large ($100,000 and over) incurred and reported gross reserves are reviewed
regularly for adequacy. In addition, long-term and lifetime medical claims
are periodically reviewed for cost trends and the applicable reserves are
appropriately revised.
Loss reserves are estimates at a given time of what the insurer expects
to pay on incurred losses, based on facts and circumstances then known.
During the loss settlement period, which may be many years, additional facts
regarding individual claims become known, and accordingly, it often becomes
necessary to refine and adjust the estimates of liability on a claim.
Settlement expense reserves are intended to cover the ultimate cost of
investigating claims and defending lawsuits arising from claims. These
reserves are established each year based on previous years experience to
project the ultimate cost of settlement expenses. To the extent that
adjustments are required to be made in the amount of loss reserves each year,
settlement expense reserves are correspondingly revised.
Changes in reserves for losses and settlement expenses are reflected in
operating results in the year such changes are recorded.
Despite the inherent uncertainties of estimating insurance company loss
and settlement expense reserves, management believes that the Company's
reserves are being calculated in accordance with sound actuarial practices
and, based upon current information, that the Company's reserves for losses
and settlement expenses at December 31, 2002 are adequate.
<PAGE>
The following table sets forth a reconciliation of beginning and ending
reserves for losses and settlement expenses of the property and casualty
insurance subsidiaries and the reinsurance subsidiary. Amounts presented are
on a net basis, with a reconciliation of beginning and ending reserves to the
gross amounts presented in the consolidated financial statements.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Gross reserves at beginning of year $314,518,588 $286,489,028 $266,514,024
Ceded reserves at beginning of year (11,848,597) (11,224,797) (10,260,815)
------------ ------------ ------------
Net reserves at beginning of year .. 302,669,991 275,264,231 256,253,209
------------ ------------ ------------
Incurred losses and
settlement expenses
- ---------------------
Provision for insured events
of the current year ............ 200,059,798 216,752,003 191,425,036
Increase (decrease) in provision
for insured events of prior
years .......................... 6,998,058 5,166,747 (1,903,362)
------------ ------------ ------------
Total incurred losses and
settlement expenses ...... 207,057,856 221,918,750 189,521,674
------------ ------------ ------------
Payments
- --------
Losses and settlement expenses
attributable to insured events
of the current year ............ 81,124,276 94,983,112 82,912,082
Losses and settlement expenses
attributable to insured events
of prior years ................. 107,744,442 99,529,878 87,598,570
------------ ------------ ------------
Total payments ............. 188,868,718 194,512,990 170,510,652
------------ ------------ ------------
Net reserves at end of year ........ 320,859,129 302,669,991 275,264,231
Ceded reserves at end of year ...... 10,367,624 11,848,597 11,224,797
------------ ------------ ------------
Gross reserves at end of year ...... $331,226,753 $314,518,588 $286,489,028
============ ============ ============
<Page>
The following table shows the calendar year development of loss and
settlement expense reserves of the property and casualty insurance
subsidiaries and the reinsurance subsidiary. Amounts presented are on a net
basis with (i) a reconciliation of the net loss and settlement expense
reserves to the gross amounts presented in the consolidated financial
statements and (ii) disclosure of the gross re-estimated loss and settlement
expense reserves and the related re-estimated reinsurance receivables.
Reflected in this table is (1) the change in the pooling agreement
whereby effective January 1, 1993 the voluntary reinsurance business written
by Employers Mutual is no longer subject to cession to the pool members, (2)
the commutation of two reinsurance contracts under the reinsurance
subsidiary's quota share agreement in 1993, (3) the gross-up of reserve
amounts associated with the National Workers' Compensation Reinsurance Pool at
December 31, 1993, (4) the reinsurance subsidiary's commutation of all
outstanding reinsurance balances ceded to Employers Mutual under catastrophe
and aggregate excess of loss reinsurance treaties related to accident years
1991 through 1993 in 1994, and (5) the increase in the reinsurance
subsidiary's quota share assumption of Employers Mutual's assumed reinsurance
business from 95 percent to 100 percent in 1997. The table has been restated
to reflect the addition of Hamilton Mutual to the pooling agreement effective
January 1, 1997 and the addition of Farm and City to the pooling agreement
effective January 1, 1998.
In evaluating the table, it should be noted that each cumulative
redundancy (deficiency) amount includes the effects of all changes in reserves
for prior periods. Conditions and trends that have affected development of
the liability in the past, such as a time lag in the reporting of assumed
reinsurance business, the high rate of inflation associated with medical
services and supplies and the reform measures implemented by several states to
control administrative costs for workers' compensation insurance, may not
necessarily occur in the future. Accordingly, it may not be appropriate to
project future development of reserves based on this table.
During the last three years the Company has experienced adverse
development in the provision for insured events of prior years. The majority
of this adverse development has come from the property and casualty insurance
subsidiaries, although the reinsurance subsidiary has experienced similar
declines. The adverse development in the property and casualty insurance
segment is primarily attributed to an increase in IBNR reserves, the
establishment of $2,100,000 of additional IBNR asbestos reserves, a
revaluation of individual claim liabilities in select lines of business, a
revaluation of formula based settlement expense reserves and an increase in
paid settlement expenses. The adverse development in the reinsurance segment
is attributed to construction defect claims arising from a reinsurance pool
that the reinsurance subsidiary participates in. The company has historically
experienced favorable development in its reserves and its reserving practices
have not changed; however, the amount of development experienced will
fluctuate from year to year as individual claims are settled and new
information becomes available on open claims.
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------------------------------------------------
(Dollars in thousands) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Statutory reserves for losses
and settlement expenses ...... $180,797 182,072 191,514 196,293 191,892 205,606 230,937 257,201 276,103 303,643 321,945
Reclassification of reserve
amounts associated with the
National Workers' Compensation
Reinsurance Pool ............. 11,364 - - - - - - - - - -
Retroactive restatement of
reserves in conjunction with
admittance of new participants
into the pooling agreement ... 5,314 5,248 6,603 6,809 7,018 3,600 - - - -
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Statutory reserves after
reclassification ............. 197,475 187,320 198,117 203,102 198,910 209,206 230,937 257,201 276,103 303,643 321,945
GAAP adjustments ............... (2,026) (2,405) (2,479) (3,098) (3,186) (858) (890) (948) (839) (973) (1,086)
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Reserves for losses and
settlement expenses .......... 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 320,859
Paid (cumulative) as of:
One year later ............... 78,000 60,162 57,247 62,012 59,856 62,949 77,699 87,599 99,530 107,744 -
Two years later .............. 109,985 89,153 88,831 92,626 92,191 99,870 119,620 138,701 156,337 - -
Three years later ............ 127,885 107,372 106,691 112,985 113,343 122,455 147,561 173,840 - - -
Four years later ............. 137,783 116,856 118,705 124,450 126,507 136,975 167,529 - - - -
Five years later ............. 143,876 123,843 126,384 132,044 135,321 148,708 - - - - -
Six years later .............. 148,518 128,931 130,977 137,522 143,105 - - - - - -
Seven years later ............ 151,895 132,036 134,923 143,044 - - - - - - -
Eight years later ............ 154,160 135,007 139,263 - - - - - - - -
Nine years later ............. 156,276 137,630 - - - - - - - - -
Ten years later .............. 158,358 - - - - - - - - - -
Reserves reestimated as of:
End of year .................. 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 320,859
One year later ............... 197,008 179,527 179,818 183,760 188,579 197,271 224,313 254,350 280,431 309,668 -
Two years later .............. 192,318 170,653 173,162 182,285 185,465 194,287 225,288 256,111 288,465 - -
Three years later ............ 186,730 166,778 172,118 179,797 181,392 193,505 227,010 260,715 - - -
Four years later ............. 186,133 166,133 170,570 176,176 180,686 192,824 229,336 - - - -
Five years later ............. 186,319 165,548 167,763 175,465 179,898 195,910 - - - - -
Six years later .............. 186,095 163,406 166,764 174,695 181,567 - - - - - -
Seven years later ............ 184,174 161,985 166,280 176,012 - - - - - - -
Eight years later ............ 183,821 160,459 167,889 - - - - - - - -
Nine years later ............. 181,840 162,578 - - - - - - - - -
Ten years later .............. 184,146 - - - - - - - - - -
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Cumulative redundancy
(Deficiency) ................. $ 11,303 22,337 27,749 23,992 14,157 12,438 711 (4,462) (13,201) (6,998) -
======== ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Gross loss and settlement
expense reserves
- end of year (A) ............ $220,703 202,370 209,785 212,231 209,521 221,378 245,610 266,514 286,489 314,519 329,158
Reinsurance receivables ........ 25,254 17,455 14,147 12,227 13,797 13,030 15,563 10,261 11,225 11,849 10,368
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net loss and settlement expense
reserves - end of year ....... $195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 318,790
======== ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Gross re-estimated reserves
- latest (B) ................. $206,364 178,021 181,813 190,493 198,257 210,400 244,577 270,710 299,749 320,604 331,227
Re-estimated reinsurance
receivables - latest ......... 22,218 15,443 13,924 14,481 16,690 14,490 15,241 9,995 11,284 10,936 10,368
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net re-estimated reserves
- latest ..................... $184,146 162,578 167,889 176,012 181,567 195,910 229,336 260,715 288,465 309,668 320,859
======== ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Gross cumulative redundancy
(deficiency) (A-B) ........... $ 14,339 24,349 27,972 21,738 11,264 10,978 1,033 (4,196) (13,260) (6,085) -
======== ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
Asbestos and Environmental Claims
The Company has exposure to asbestos and environmental related claims
associated with the insurance business written by the parties to the pooling
agreement and the reinsurance business assumed from Employers Mutual by the
reinsurance subsidiary.
Estimating loss and settlement expense reserves for asbestos and
environmental claims is very difficult due to the many uncertainties
surrounding these types of claims. These uncertainties exist because the
assignment of responsibility varies widely by state and claims often emerge
long after a policy has expired, which makes assignment of damages to the
appropriate party and to the time period covered by a particular policy
difficult. In establishing reserves for these types of claims, management
monitors the relevant facts concerning each claim, the current status of the
legal environment, the social and political conditions and the claim history
and trends within the Company and the industry.
During 2002, the Company re-evaluated the estimated ultimate losses for
direct asbestos and environmental exposures. Based on this re-evaluation, the
Company reallocated $752,000 of bulk IBNR reserves and $324,000 of settlement
expense reserves to these exposures. In addition, the company took a
proactive approach to evaluate the adequacy of its asbestos reserves and
commissioned a "ground-up" study to better quantify its exposure to asbestos
liabilities. This study concluded that the Company's exposure for direct
asbestos claims ranged from $1,000,000 to $5,100,000, with a point estimate of
$3,000,000 at December 31, 2002. Based on this study, the Company elected to
increase the IBNR reserves carried for direct asbestos exposures by $2,100,000
at December 31, 2002, to $3,000,000. The study and its results assume no
improvement in the current asbestos litigation environment; however, federal
legislation currently being considered could reduce the ultimate losses from
asbestos litigation below the levels currently being projected for the
industry.
Based upon current facts, management believes the reserves established
for asbestos and environmental related claims at December 31, 2002 are
adequate. Although future changes in the legal and political environment may
result in adjustments to these reserves, management believes any adjustments
will not have a material impact on the financial condition or results of
operations of the Company.
<PAGE>
The following table presents asbestos and environmental related losses
and settlement expenses incurred and reserves outstanding for the Company:
Year ended December 31,
--------------------------------
2002 2001 2000
---------- ---------- ----------
Losses and settlement expenses incurred:
Asbestos:
Property and casualty insurance ........ $2,377,631 $ 64,451 $ 518,480
Reinsurance ............................ (25,001) (9,167) (135,695)
---------- ---------- ----------
2,352,630 55,284 382,785
---------- ---------- ----------
Environmental:
Property and casualty insurance ........ 774,489 (120,610) 96,828
Reinsurance ............................ 21,479 20,615 167,238
---------- ---------- ----------
795,968 (99,995) 264,066
---------- ---------- ----------
Total losses and settlement
expenses incurred ................ $3,148,598 $ (44,711)$ 646,851
========== ========== ==========
Loss and settlement expense reserves:
Asbestos:
Property and casualty insurance ........ $2,982,809 $ 719,590 $ 715,472
Reinsurance ............................ 533,687 566,477 589,518
---------- ---------- ----------
3,516,496 1,286,067 1,304,990
---------- ---------- ----------
Environmental:
Property and casualty insurance ........ 1,175,541 454,460 711,690
Reinsurance ............................ 834,906 824,988 812,572
---------- ---------- ----------
2,010,447 1,279,448 1,524,262
---------- ---------- ----------
Total loss and settlement expense
reserves ......................... $5,526,943 $2,565,515 $2,829,252
========== ========== ==========
EMPLOYEES
- ---------
EMC Insurance Group Inc. and its subsidiaries have no employees. The
Company's business activities are conducted by the 2,165 employees of
Employers Mutual. EMC Insurance Group Inc., EMC Reinsurance Company and
Underwriters, LLC are charged their proportionate share of salary and employee
benefit costs based on time allocations. Costs not allocated to these
companies and other subsidiaries of Employers Mutual outside the pooling
agreement are charged to the participants in the pooling agreement. The
property and casualty insurance subsidiaries share the costs charged to the
pooling agreement in accordance with their pool participation percentages.
See "Property and Casualty Insurance - Pooling Agreement."
REGULATION
- ----------
The Company's insurance subsidiaries are subject to extensive regulation
and supervision by their state of domicile, as well as those states in which
they do business. The purpose of such regulation and supervision is primarily
to provide safeguards for policyholders rather than to protect the interests
of stockholders. The insurance laws of the various states establish
regulatory agencies with broad administrative powers, including the power to
grant or revoke operating licenses and to regulate trade practices,
investments, premium rates, deposits of securities, the form and content of
financial statements and insurance policies, accounting practices and the
maintenance of specified reserves and capital for the protection of
policyholders.
Premium rate regulation varies greatly among jurisdictions and lines of
insurance. In most states in which the Company's subsidiaries write
insurance, premium rates for their lines of insurance are subject to either
prior approval or limited review upon implementation. States require rates
for property and casualty insurance that are adequate, not excessive, and not
unfairly discriminatory.
<PAGE>
The Company's insurance subsidiaries are required to file detailed annual
reports with the appropriate regulatory agency in each state where they do
business based on applicable statutory regulations, which differ from
generally accepted accounting principles. Their businesses and accounts are
subject to examination by such agencies at any time. Since EMC Insurance
Group Inc. and Employers Mutual are domiciled in Iowa, the State of Iowa
exercises principal regulatory supervision, and Iowa law requires periodic
examination. The Company's insurance subsidiaries are subject to examination
by state insurance departments on a periodic basis, as applicable law
requires.
In 1998, the National Association of Insurance Commissioners (NAIC)
adopted a comprehensive Codification of Statutory Accounting Principles
(Codification) to replace the Accounting Practices and Procedures Manual as
the NAIC's primary guidance on statutory accounting. Codification is intended
to provide a consistent and comprehensive basis of statutory accounting for
all insurance companies and became effective in most states, including the
states of domicile of the Company's insurance subsidiaries, on January 1,
2001. The adoption of Codification resulted in changes to the accounting
practices that the Company's insurance subsidiaries use to prepare their
statutory financial statements. One of the more significant changes was the
recording of deferred income taxes. As a result of the adoption of
Codification, the statutory surplus of the Company's insurance subsidiaries
increased by approximately $9,110,000 on January 1, 2001.
State laws governing insurance holding companies also impose standards on
certain transactions with related companies, which include, among other
requirements, that all transactions be fair and reasonable and that an
insurer's surplus as regards policyholders be reasonable and adequate in
relation to its liabilities. Under Iowa law, dividends or distributions made
by registered insurers are restricted in amount and may be subject to approval
from the Iowa Commissioner of Insurance. "Extraordinary" dividends or
distributions are subject to prior approval and are defined as dividends or
distributions made within a 12 month period which exceed the greater of 10
percent of statutory surplus as regards policyholders as of the preceding
December 31, or net income of the preceding calendar year on a statutory
basis. North Dakota imposes similar restrictions on the payment of dividends
and distributions. At December 31, 2002, $16,784,451 was available for
distribution in 2003 to the Company without prior approval. See note 6 of
Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.
The NAIC utilizes a risk-based capital model to help state regulators
assess the capital adequacy of insurance companies and identify insurers that
are in, or are perceived as approaching, financial difficulty. This model
establishes minimum capital needs based on the risks applicable to the
operations of the individual insurer. The risk-based capital requirements for
property and casualty insurance companies measure three major areas of risk:
asset risk, credit risk and underwriting risk. Companies having less
statutory surplus than required by the risk-based capital requirements are
subject to varying degrees of regulatory scrutiny and intervention, depending
on the severity of the inadequacy. At December 31, 2002, the Company's
insurance subsidiaries had total adjusted statutory capital of $140,323,534,
which is well in excess of the minimum risk-based capital requirement of
$35,865,587.
<PAGE>
ITEM 2. PROPERTIES.
- ------- -----------
The Company does not own any real property. Lease costs of the Company's
office facilities in Bismarck, North Dakota, which total approximately
$332,000 annually, are included as expenses under the pooling agreement.
Expenses of office facilities owned and leased by Employers Mutual are borne
by the parties to the pooling agreement, less the rent received from the space
used and paid for by non-insurance subsidiaries and outside tenants. See
"Property and Casualty Insurance - Pooling Agreement" under Item 1 of this
Form 10-K.
ITEM 3. LEGAL PROCEEDINGS.
- ------- ------------------
The Company and Employers Mutual and its other subsidiaries are parties
to numerous lawsuits arising in the normal course of the insurance business.
The Company believes that the resolution of these lawsuits will not have a
material adverse effect on its financial condition or its results of
operations. The companies involved have reserves that are believed adequate
to cover any potential liabilities arising out of all such pending or
threatened proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ----------------------------------------------------
None.
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
- ------- -------------------------------------------------
STOCKHOLDER MATTERS.
--------------------
The "Stockholder Information" section from the Company's Annual Report to
Stockholders for the year ended December 31, 2002, which is included as
Exhibit 13(d) to this Form 10-K, is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA.
- ------- ------------------------
The "Selected Financial Data" section from the Company's Annual Report to
Stockholders for the year ended December 31, 2002, which is included as
Exhibit 13(a) to this Form 10-K, is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- ---------------------------------------------------------------
RESULTS OF OPERATIONS.
----------------------
The "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section from the Company's Annual Report to
Stockholders for the year ended December 31, 2002, which is included as
Exhibit 13(b) to this Form 10-K, is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
- -------- -----------------------------------------------------------
The information under the caption "Market Risk" in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section from the Company's Annual Report to Stockholders for the year ended
December 31, 2002, which is included as Exhibit 13(b) to this Form 10-K, is
incorporated herein by reference.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
- ------- --------------------------------------------
The consolidated financial statements from the Company's Annual Report to
Stockholders for the year ended December 31, 2002, which is included as
Exhibit 13(c) to this Form 10-K, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
- ------- ------------------------------------------------
ACCOUNTING AND FINANCIAL DISCLOSURE.
------------------------------------
None.
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------- ---------------------------------------------------
See the information under the caption "Election of Directors" in the
Company's Proxy Statement in connection with its Annual Meeting to be held on
May 20, 2003, which information is incorporated herein by reference.
The following sets forth information regarding all executive officers of
the Company.
NAME AGE POSITION
Bruce G. Kelley 49 President and Chief Executive Officer of the
Company and of Employers Mutual since 1992.
Treasurer of Employers Mutual from 1996 until
2000 and the Company from 1996 until February
2001. He was President and Chief Operating
Officer of the Company and Employers Mutual
from 1991 to 1992 and was Executive Vice
President of the Company and Employers Mutual
from 1989 to 1991. He has been employed by
Employers Mutual since 1985.
William A. Murray 56 Executive Vice President and Chief Operating
Officer of the Company and Employers Mutual
since 2001. He was Resident Vice President
and Branch Manager of Employers Mutual from
1992 until 2001. He has been employed by
Employers Mutual since 1985.
Ronald W. Jean 53 Executive Vice President for Corporate
Development of the Company and Employers
Mutual since 2000. He was Senior Vice
President - Actuary of the Company and
Employers Mutual from 1997 until 2000. He
was Vice President - Actuary of the Company
and Employers Mutual from 1985 until 1997.
He has been employed by Employers Mutual
since 1979.
John D. Isenhart 65 Senior Vice President of the Company since
1997 and of Employers Mutual since 1992.
He has been employed by Employers Mutual
since 1963.
Raymond W. Davis 57 Senior Vice President - Investments of the
Company and Employers Mutual since 1998.
Treasurer of the Company since 2001 and of
Employers Mutual since 2000. He was Vice
President - Investments of the Company and of
Employers Mutual from 1985 until 1998. He
has been employed by Employers Mutual since
1979.
<PAGE>
NAME AGE POSITION
Donald D. Klemme 57 Senior Vice President - Administration and
Secretary of the Company since 1998. Senior
Vice President - Administration of Employers
Mutual since 1998. He was Vice President -
Administration and Secretary of the Company
from 1996 until 1998 and was Vice President -
Director of Internal Audit prior to that. He
has been employed by Employers Mutual since
1972.
David O. Narigon 50 Senior Vice President - Claims of the Company
and of Employers Mutual since 1998. He was
Vice President - Claims of the Company from
1988 until 1998. He has been employed by
Employers Mutual since 1983.
Mark E. Reese 45 Vice President of the Company and Employers
Mutual since 1996 and Chief Financial Officer
of the Company and Employers Mutual since
1997. He has been employed by Employers
Mutual since 1984.
Section 16(a) Beneficial Ownership Reporting Compliance
During 2002, there were two occasions when Form 4 was not filed on a
timely basis for directors of Employers Mutual Casualty Company. In both
instances, the information was inadvertently sent late to the Company and the
filings were not made on a timely basis. Mr. Lanning Macfarland, Jr. sold
2,000 shares in March and Dr. John Kelley sold 6,782 shares in May. The Form
4 on these two transactions were filed nine days and eleven days late,
respectively. The Company has taken the appropriate steps that should prevent
this from happening in the future.
ITEM 11. EXECUTIVE COMPENSATION.
- -------- -----------------------
See the information under the caption "Compensation of Management" in the
Company's Proxy Statement in connection with its Annual Meeting to be held on
May 20, 2003, which information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
- -------- ------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS.
----------------------------
See the information under the captions "Security Ownership of Certain
Beneficial Owners" and "Security Ownership of Management and Directors" in the
Company's Proxy Statement in connection with its Annual Meeting to be held on
May 20, 2003, which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- -------- -----------------------------------------------
See the information under the caption "Certain Relationships and Related
Transactions" in the Company's Proxy Statement in connection with its Annual
Meeting to be held on May 20, 2003, which information is incorporated herein
by reference.
<PAGE>
ITEM 14. CONTROLS AND PROCEDURES.
- -------- ------------------------
Within the 90 days prior to the filing date of this report, the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are functioning effectively to provide reasonable
assurance that the Company can meet its disclosure obligations. Since the
date of the most recent evaluation of the Company's internal controls by the
Chief Executive Officer and Chief Financial Officer there have been no
significant changes in the Company's internal controls or in other factors
that could significantly affect these controls.
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
- -------- -----------------------------------------------------------------
(a) List of Financial Statements and Schedules.
1. Financial Statements
Page
------
Report of Ernst & Young LLP, Independent Auditor ............ 29*
Report of KPMG LLP, Independent Auditor ..................... 30*
Consolidated Balance Sheets, December 31, 2002 and 2001 ..... 31*
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000 ......................... 33*
Consolidated Statements of Comprehensive Income for the
Years ended December 31, 2002, 2001 and 2000 ............. 34*
Consolidated Statements of Stockholders' Equity for the
Years ended December 31, 2002, 2001 and 2000 ............. 35*
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 ......................... 36*
Notes to Consolidated Financial Statements .................. 38-65*
* Refers to the respective page of the financial information insert
of EMC Insurance Group Inc.'s 2002 Annual Report to Stockholders.
The Consolidated Financial Statements and Independent Auditors'
Reports, which are included as Exhibit 13(c), are incorporated by
reference. With the exception of the portions of such Annual Report
specifically incorporated by reference in this Item and Items 5, 6,
7, 7A and 8, such Annual Report shall not be deemed filed as part of
this Form 10-K or otherwise subject to the liabilities of Section 18
of the Securities Exchange Act of 1934.
2. Schedules Form 10-K
Page
------
Report of Ernst & Young LLP, Independent Auditors,
On Schedules .............................................. 33
Report of KPMG LLP, Independent Auditors, On Schedules ...... 34
Schedule I - Summary of Investments - Other Than
Investments in Related Parties ............... 35
Schedule II - Condensed Financial Information of Registrant 36
Schedule III - Supplementary Insurance Information .......... 39
Schedule IV - Reinsurance .................................. 40
Schedule VI - Supplemental Information Concerning
Property-Casualty Insurance Operations ..... 41
All other schedules have been omitted for the reason that the items
required by such schedules are not present in the consolidated
financial statements, are covered in the notes to the consolidated
financial statements or are not significant in amount.
<PAGE>
3. Management contracts and compensatory plan arrangements
Exhibit 10(b). 2002 Senior Executive Compensation Bonus Program.
Exhibit 10(d). 1982 Employers Mutual Casualty Company Incentive
Stock Option Plan, as amended.
Exhibit 10(e). Deferred Bonus Compensation Plans.
Exhibit 10(f). 2002 Executive Bonus Program - EMC Reinsurance
Company.
Exhibit 10(h). Employers Mutual Casualty Company Excess Retirement
Benefit Agreement.
Exhibit 10(i). Employers Mutual Casualty Company 1993 Employee
Stock Purchase Plan.
Exhibit 10(j). 1993 Employers Mutual Casualty Company Incentive
Stock Option Plan, as amended.
Exhibit 10(k). Employers Mutual Casualty Company Non-Employee
Director Stock Option Plan.
Exhibit 10(l). Employers Mutual Casualty Company Supplemental
Executive Retirement Plan.
Exhibit 10(m). EMCC Option It! Deferred Bonus Compensation Plan.
Exhibit 10(n). EMCC Board of Directors Option It! Deferred
Compensation Plan.
Exhibit 10(o). Employers Mutual Casualty Company Excess Deferral
Plan.
Exhibit 10(p). 2003 Employers Mutual Casualty Company Incentive
Stock Option Plan.
(b) Reports on Form 8-K.
None
(c) Exhibits.
3. Articles of incorporation and bylaws:
(a) Articles of Incorporation of the Company, as amended.
(Incorporated by reference to the Company's Form 10-K
for the calendar year ended December 31, 1998.)
(b) By-Laws of the Company, as amended. Incorporated by
reference to the Company's Form 10-K for the calendar
year ended December 31, 2001.)
10. Material contracts.
(a) Quota Share Reinsurance Contract between Employers Mutual
Casualty Company and EMC Reinsurance Company. (Incorporated by
reference to the Company's Form 10-K for the calendar year ended
December 31, 2000.)
(b) 2002 Senior Executive Compensation Bonus Program.
(c) EMC Insurance Companies reinsurance pooling agreements
between Employers Mutual Casualty Company and certain of its
affiliated companies, as amended. (Incorporated by reference
to the Company's Form 10-K for the calendar year ended December
31, 1998.)
(d) 1982 Employers Mutual Casualty Company Incentive Stock Option
Plan, as amended. (Incorporated by reference to the Company's
Form 10-K for the calendar year ended December 31, 1998.)
(e) Deferred Bonus Compensation Plans. (Incorporated by reference
to the Company's Form 10-K for the calendar year ended December
31, 1998.)
(f) 2002 Executive Bonus Program - EMC Reinsurance Company.
<PAGE>
(g) EMC Insurance Group Inc. Amended and Restated Dividend
Reinvestment and Common Stock Purchase Plan. (Incorporated by
reference to Registration No. 33-34499.)
(h) Employers Mutual Casualty Company Excess Retirement Benefit
Agreement. (Incorporated by reference to the Company's
Form 10-K for the calendar year ended December 31, 1998.)
(i) Employers Mutual Casualty Company 1993 Employee Stock Purchase
Plan. (Incorporated by reference to Registration No. 33-49335.)
(j) 1993 Employers Mutual Casualty Company Incentive Stock Option
Plan. (Incorporated by reference to Registration Nos.33-49337
and 333-45279.)
(k) Employers Mutual Casualty Company Non-Employee Director Stock
Option Plan. (Incorporated by reference to Registration No.
33-49339.)
(l) Employers Mutual Casualty Company Supplemental Executive
Retirement Plan. (Incorporated by reference to the Company's
Form 10-K for the calendar year ended December 31, 2000.)
(m) EMCC Option It! Deferred Bonus Compensation Plan. (Incorporated
by reference to the Company's Form 10-K for the calendar year
ended December 31, 2001.)
(n) EMCC Board of Directors Option It! Deferred Compensation Plan.
(Incorporated by reference to the Company's Form 10-K for the
calendar year ended December 31, 2001.)
(o) Employers Mutual Casualty Company Excess Deferral Plan.
(Incorporated by reference to the Company's Form 10-K for the
calendar year ended December 31, 2001.)
(p) 2003 Employers Mutual Casualty Company Incentive Stock Option
Plan. (Incorporated by reference to Registration No.
333-103722.)
13. Annual Report to Security Holders.
(a) Selected Financial Data from the Company's 2002 Annual Report to
Stockholders.
(b) Management's Discussion and Analysis of Financial Condition and
Results of Operations from the Company's 2002 Annual Report to
Stockholders.
(c) Consolidated Financial Statements from the Company's 2002
Annual Report to Stockholders.
(d) Stockholder Information from the Company's 2002 Annual Report to
Stockholders.
21. Subsidiaries of the Registrant.
23. Consent of Experts and Counsel.
(a) Consent of Ernst & Young LLP, Independent Auditors.
(b) Consent of KPMG LLP, Independent Auditors.
<PAGE>
24. Power of Attorney.
99.1 Certification of President and Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Vice President and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(d) Financial statements required by Regulation S-X which are excluded from
the Annual Report to Stockholders by Rule 14a-3(b)(1).
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, on March 27,
2003.
EMC INSURANCE GROUP INC.
/s/ Bruce G. Kelley
-----------------------
Bruce G. Kelley
President and
Chief Executive Officer
/s/ Mark E. Reese
-----------------------
Mark E. Reese
Vice President - Chief Financial Officer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 27, 2003.
/s/ Mark E. Reese
------------------------
George C. Carpenter III*
Director
/s/ Mark E. Reese
------------------------
E. H. Creese*
Director
/s/ Mark E. Reese
------------------------
David J. Fisher*
Director
/s/ Bruce G. Kelley
------------------------
Bruce G. Kelley
Director
/s/ Mark E. Reese
------------------------
George W. Kochheiser*
Chairman of the Board
/s/ Mark E. Reese
------------------------
Raymond A. Michel*
Director
/s/ Mark E. Reese
------------------------
Fredrick A. Schiek*
Director
* by power of attorney
<PAGE>
CERTIFICATIONS
I, Bruce G. Kelley, certify that:
1. I have reviewed this annual report on Form 10-K of EMC Insurance
Group Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report.
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 27, 2003
---------------
/s/ Bruce G. Kelley
-----------------------------
Bruce G. Kelley, President
and Chief Executive Officer
<PAGE>
CERTIFICATIONS
I, Mark Reese, certify that:
1. I have reviewed this annual report on Form 10-K of EMC Insurance Group
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report.
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 27, 2003
--------------
/s/ Mark E. Reese
-----------------------------
Mark E. Reese, Vice President
and Chief Financial Officer
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS, ON SCHEDULES
We have audited the consolidated financial statements of EMC Insurance
Group Inc. and Subsidiaries as of December 31, 2002 and 2001, and for the
years then ended, and have issued our report thereon dated February 25, 2003
(included elsewhere in this Annual Report on Form 10-K). Our audits also
included the financial statement schedules listed in Item 15(a)2 of this
Annual Report on Form 10-K. These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on
our audits. The financial statement schedules as of December 31, 2000 and for
the year then ended were audited by other auditors whose report dated February
27, 2001, expressed an opinion that such financial statement schedules, when
considered in relation to the consolidated financial statements taken as a
whole, presented fairly, in all material respects, the information set forth
therein.
In our opinion, the 2002 and 2001 financial statement schedules referred
to above, when considered in relation to the 2002 and 2001 basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
February 25, 2003
Des Moines, Iowa
<PAGE>
REPORT OF KPMG LLP, INDEPENDENT AUDITORS, ON SCHEDULES
The Board of Directors and Stockholders
EMC Insurance Group Inc.:
Under date of February 27, 2001, we reported on the consolidated
balance sheet of EMC Insurance Group In. and Subsidiaries as of December 31,
2000 and the related consolidated statements of income, comprehensive income,
stockholders' equity and cash flows for the year then ended, as
contained in Part II, Item 8 of the annual report on Form 10-K for the year
2000. In connection with our audit of the aforementioned consolidated
financial statements, we also audited the related consolidated financial
statement schedules listed in Part IV, Item 15(a)2. These financial statement
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statement schedules
based on our audit.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Des Moines, Iowa
February 27, 2001
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule I - Summary of Investments -
Other Than Investments in Related Parties
December 31, 2002
Amount at
which shown
Fair in the
Type of investment Cost value balance sheet
------------------ ------------ ------------ -------------
Securities held-to-maturity:
Fixed maturities:
United States Government
and government agencies
and authorities .............. $ 49,956,691 $ 56,147,115 $ 49,956,691
Mortgage-backed securities ..... 5,076,984 5,491,922 5,076,984
------------ ------------ ------------
Total fixed maturity
securities ............. 55,033,675 61,639,037 55,033,675
------------ ------------ ------------
Securities available-for-sale:
Fixed maturities:
United States Government
and government agencies
and authorities .............. 110,033,485 111,381,047 111,381,047
States, municipalities and
political subdivisions ....... 81,425,249 87,116,088 87,116,088
Mortgage-backed securities ..... 12,594,103 13,641,956 13,641,956
Debt securities issued by
foreign governments .......... 6,483,656 7,587,710 7,587,710
Public utilities ............... 46,979,003 49,106,908 49,106,908
Corporate securities ........... 202,329,432 217,022,257 217,022,257
------------ ------------ ------------
Total fixed maturity
securities ............. 459,844,928 485,855,966 485,855,966
------------ ------------ ------------
Equity securities:
Common stocks
Banks, trusts and insurance
companies .................. 5,059,135 5,545,442 5,545,442
Industrial, miscellaneous and
all other .................. 32,884,895 28,593,543 28,593,543
Non-redeemable preferred
stocks ..................... 500,000 458,000 458,000
------------ ------------ ------------
Total equity securities .. 38,444,030 34,596,985 34,596,985
------------ ------------ ------------
Other long-term investments ........ 3,057,000 3,057,000 3,057,000
Short-term investments ............. 29,650,230 29,650,230 29,650,230
------------ ------------ ------------
Total investments ...... $586,029,863 $614,799,218 $608,193,856
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule II - Condensed Financial Information of Registrant
Condensed Balance Sheets
December 31,
--------------------------
2002 2001
------------ ------------
ASSETS
Investment in common stock of
subsidiaries (equity method) .................. $154,552,425 $137,738,931
Fixed maturity investments:
Securities available-for-sale, at fair value .. 1,676,455 1,556,475
Short-term investments .......................... 1,455,824 988,555
Cash ............................................ 58,676 227,541
Accrued investment income ....................... 42,088 41,333
Income taxes recoverable ........................ 212,502 3,259
Deferred income taxes ........................... 12,764 103,490
------------ ------------
Total assets ............................... $158,010,734 $140,659,584
============ ============
LIABILITIES
Accounts payable ................................ $ 227,207 $ 163,416
Indebtedness to related party ................... 15,163 38,545
------------ ------------
Total liabilities .......................... 242,370 201,961
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value,
authorized 20,000,000 shares;
issued and outstanding, 11,399,050 shares
in 2002 and 11,329,987 shares in 2001 ......... 11,399,050 11,329,987
Additional paid-in capital ...................... 67,270,591 66,013,203
Accumulated other comprehensive income .......... 14,218,330 7,507,672
Retained earnings ............................... 64,880,393 55,606,761
------------ ------------
Total stockholders' equity ................. 157,768,364 140,457,623
------------ ------------
Total liabilities and stockholders' equity $158,010,734 $140,659,584
============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule II - Condensed Financial Information of Registrant, Continued
Condensed Statements of Income
Years ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
REVENUES
Dividends received from subsidiaries .. $ 6,250,016 $ 5,525,096 $ 6,375,104
Investment income ..................... 113,843 194,326 345,597
Realized investment gains ............. 5,313 - 536
----------- ----------- -----------
6,369,172 5,719,422 6,721,237
Operating expenses .................... 436,688 438,687 401,527
----------- ----------- -----------
Income before income tax benefit
and equity in undistributed net
income (loss) of subsidiaries ..... 5,932,484 5,280,735 6,319,710
Income tax benefit .................... (101,747) (110,263) (4,399)
----------- ----------- -----------
Income before equity in undistributed
net income (loss) of subsidiaries 6,034,231 5,390,998 6,324,109
Equity in undistributed net income
(loss) of subsidiaries .............. 10,067,507 (7,497,130) (3,995,078)
----------- ----------- -----------
Net income (loss) ....... $16,101,738 $(2,106,132) $ 2,329,031
=========== =========== ===========
Condensed Statements of Comprehensive Income
Years ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Net income (loss) .................. $ 16,101,738 $ (2,106,132) $ 2,329,031
------------ ------------ ------------
Other Comprehensive Income:
Unrealized holding gains arising
during the period, net of
deferred income tax expense .... 4,845,443 962,453 11,708,349
Reclassification adjustment for
losses (gains) included in net
income (loss), net of income tax
(benefit) expense .............. 2,053,481 (506,701) (1,031,166)
Adjustment for minimum pension
liability, net of deferred
income tax benefit ............. (188,266) - -
------------ ------------ ------------
Other comprehensive income ....... 6,710,658 455,752 10,677,183
------------ ------------ ------------
Total comprehensive income
(loss) ..................... $ 22,812,396 $ (1,650,380) $ 13,006,214
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule II - Condensed Financial Information of Registrant, Continued
Condensed Statements of Cash Flows
Years ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Net cash provided by
operating activities ................ $ 5,988,850 $ 5,316,361 $ 6,371,690
----------- ----------- -----------
Cash flows from investing activities
Disposals of fixed maturity
securities held-to-maturity ....... - - 2,000,000
Maturities of fixed maturity
securities available-for-sale ..... 1,505,313 - -
Purchases of fixed maturity
securities available-for-sale ..... (1,694,104) - -
Net (purchases) sales of short-term
investments ...................... (467,269) 1,169,110 (1,820,140)
----------- ----------- -----------
Net cash (used) provided by
investing activities ........... (656,060) 1,169,110 179,860
----------- ----------- -----------
Cash flows from financing activities
Issuance of common stock ........... 1,326,451 502,007 242,265
Dividends paid to stockholders ..... (6,828,106) (6,787,320) (6,771,440)
----------- ----------- -----------
Net cash used in financing
activities ..................... (5,501,655) (6,285,313) (6,529,175)
----------- ----------- -----------
Net (decrease) increase in cash ....... (168,865) 200,158 22,375
Cash at beginning of year ............. 227,541 27,383 5,008
----------- ----------- -----------
Cash at end of year ................... $ 58,676 $ 227,541 $ 27,383
=========== =========== ===========
Income taxes (received) paid .......... $ (2,253) $ (6,588) $ 189
Interest (received) paid .............. $ - $ (123) $ -
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule III - Supplementary Insurance Information
For Years Ended December 31, 2002, 2001 and 2000
Deferred Loss and
policy settlement
acquisition expense Unearned
Segment costs reserves premiums
------- ----------- ------------ ------------
Year ended December 31, 2002:
Property and casualty insurance $21,181,714 $229,876,996 $ 98,723,419
Reinsurance ................... 3,745,147 101,349,757 17,023,395
Parent company ................ - - -
----------- ------------ ------------
Consolidated ............. $24,926,861 $331,226,753 $115,746,814
=========== ============ ============
Year ended December 31, 2001:
Property and casualty insurance $18,536,512 $221,986,108 $ 86,532,102
Reinsurance ................... 2,827,016 92,532,480 12,850,074
Parent company ................ - - -
----------- ------------ ------------
Consolidated ............. $21,363,528 $314,518,588 $ 99,382,176
=========== ============ ============
Year ended December 31, 2000:
Property and casualty insurance $13,777,831 $209,365,347 $ 65,228,769
Reinsurance ................... 1,858,922 77,123,681 8,449,645
Parent company ................ - - -
----------- ------------ ------------
Consolidated ............. $15,636,753 $286,489,028 $ 73,678,414
=========== ============ ============
Losses and
Net settlement
Premium investment expenses
Segment revenue income incurred
------- ------------ ----------- ------------
Year ended December 31, 2002:
Property and casualty insurance $225,013,076 $23,517,163 $156,152,022
Reinsurance ................... 72,029,957 9,147,127 50,905,834
Parent company ................ - 113,843 -
------------ ----------- ------------
Consolidated ............. $297,043,033 $32,778,133 $207,057,856
============ =========== ============
Year ended December 31, 2001:
Property and casualty insurance $203,392,845 $22,457,799 $168,344,370
Reinsurance ................... 61,887,013 8,317,505 53,574,380
Parent company ................ - 194,326 -
------------ ----------- ------------
Consolidated ............. $265,279,858 $30,969,630 $221,918,750
============ =========== ============
Year ended December 31, 2000:
Property and casualty insurance $184,985,620 $20,787,679 $149,518,346
Reinsurance ................... 46,472,822 7,873,040 40,003,328
Parent company ................ - 345,597 -
------------ ----------- ------------
Consolidated ............. $231,458,442 $29,006,316 $189,521,674
============ =========== ============
Amortization
of deferred
policy Other
acquisition underwriting Premiums
Segment costs expenses written (1)
------- ------------ ------------ ------------
Year ended December 31, 2002:
Property and casualty insurance $ 49,057,682 $ 20,447,874 $237,633,602
Reinsurance ................... 16,669,334 6,481,098 76,203,278
Parent company ................ - - -
------------ ------------ ------------
Consolidated ............. $ 65,727,016 $ 26,928,972 $313,836,880
============ ============ ============
Year ended December 31, 2001:
Property and casualty insurance $ 42,062,510 $ 17,990,128 $224,412,085
Reinsurance ................... 13,624,505 4,749,785 66,287,442
Parent company ................ - - -
------------ ------------ ------------
Consolidated ............. $ 55,687,015 $ 22,739,913 $290,699,527
============ ============ ============
Year ended December 31, 2000:
Property and casualty insurance $ 40,675,773 $ 15,439,286 $190,104,541
Reinsurance ................... 10,612,706 3,040,206 47,530,111
Parent company ................ - - -
------------ ------------ ------------
Consolidated ............. $ 51,288,479 $ 18,479,492 $237,634,652
============ ============ ============
(1) Written premiums for 2001 include $13,884,423 of additional premiums
from a change in the recording of installment-based policies.
See note 11 of Notes to Consolidated Financial Statements which is
included as Exhibit 13(c) of this Form 10-K.
<PAGE>
<TABLE>
<CAPTION>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule IV - Reinsurance
For years ended December 31, 2002, 2001 and 2000
Percentage
Ceded to Assumed of amount
Gross other from other Net assumed
amount companies companies amount to net
------------ ------------ ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 2002:
Consolidated earned premiums ........... $241,939,466 $252,860,839 $307,964,406 $297,043,033 103.7%
============ ============ ============ ============ =====
Year ended December 31, 2001:
Consolidated earned premiums ........... $255,764,274 $266,623,369 $276,138,953 $265,279,858 104.1%
============ ============ ============ ============ =====
Year ended December 31, 2000:
Consolidated earned premiums ........... $245,078,165 $252,761,452 $239,141,729 $231,458,442 103.3%
============ ============ ============ ============ =====
</TABLE>
<TABLE>
<CAPTION>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Schedule VI - Supplemental Insurance Information Concerning
Property-Casualty Insurance Operations
For Years Ended December 31, 2002, 2001 and 2000
Discount,
Deferred Reserves for if any,
policy losses and deducted Net
Consolidated property- acquisition settlement from Unearned Earned investment
casualty entities costs expenses reserves premiums premiums income
- ---------------------- ----------- ------------ -------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 2002: $24,926,861 $331,226,753 $ -0- $115,746,814 $297,043,033 $32,664,290
=========== ============ ======== ============ ============ ===========
Year ended December 31, 2001: $21,363,528 $314,518,588 $ -0- $ 99,382,176 $265,279,858 $30,775,304
=========== ============ ======== ============ ============ ===========
Year ended December 31, 2000: $15,636,753 $286,489,028 $ -0- $ 73,678,414 $231,458,442 $28,660,719
=========== ============ ======== ============ ============ ===========
Losses and Amortization
settlement expenses of deferred Paid
incurred related to policy losses and
Consolidated property- Current Prior acquisition settlement Premiums
casualty entities Year Years costs expenses Written (1)
- ---------------------- ------------ ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 2002: $200,059,798 $ 6,998,058 $ 65,727,016 $188,868,718 $313,836,880
============ =========== ============ ============ ============
Year ended December 31, 2001: $216,752,003 $ 5,166,747 $ 55,687,015 $194,512,990 $290,699,527
============ =========== ============ ============ ============
Year ended December 31, 2000: $191,425,036 ($ 1,903,362) $ 51,288,479 $170,510,652 $237,634,652
============ =========== ============ ============ ============
</TABLE>
(1) Written premiums for 2001 include $13,884,423 of additional premiums
from a change in the recording of installment-based policies.
See note 11 of Notes to Consolidated Financial Statements which is
included as Exhibit 13(c) of this Form 10-K.
<PAGE>
EMC Insurance Group Inc. and Subsidiaries
Index to Exhibits
Exhibit
number Item Page number
-------- ---- -----------
10(b) 2002 Senior Executive Compensation
Bonus Program. 43
10(f) 2002 Executive Bonus Program - EMC
Reinsurance Company 48
13(a) Selected Financial Data. 50
13(b) Management's Discussion and Analysis
of Financial Condition and Results
of Operations. 51-76
13(c) Consolidated Financial Statements and
Supplementary Data. 77-114
13(d) Stockholder Information. 115
21 Subsidiaries of the Registrant. 116
23(a) Consent of Ernst & Young LLP, Independent
Auditors. 117
23(b) Consent of KPMG LLP, Independent Auditors. 118
24 Power of Attorney. 119
99.1 Certification of President and Chief
Executive Officer. 120
99.2 Certification of Vice President and Chief
Financial Officer. 121
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10
<SEQUENCE>3
<FILENAME>exhibit10b.txt
<DESCRIPTION>2002 SENIOR EXECUTIVE COMPENSATION BONUS PROGRAM
<TEXT>
EXHIBIT 10(b)
-------------
2002 SENIOR EXECUTIVE COMPENSATION BONUS PROGRAM
The Senior Executive Bonus Program is a measure of the three areas often
looked at when comparing results of different companies or in comparing
current company results from one year to the next.
PURPOSE
1. To provide a motivational tool in the form of compensation to help
executives focus on specific organizational goals to improve profits,
surplus and service in all areas of the corporation.
2. To maintain competitive advantage in terms of recruitment and retention
of senior executives.
3. To provide a plan based on EMC results and industry results, to provide
a better measure of performance.
4. Reward superior results more appropriately.
5. Provide a maximum bonus difficult to attain so there is incentive to
strive for better results.
6. To provide a measure of safety to the company so that senior officers'
total compensation is reduced if company performance declines.
GENERAL BONUS CALCULATION
The bonus plan uses production, surplus growth and the combined ratio, all
valid measures of performance, as follows:
1. EMC WRITTEN PREMIUM - Compares consolidated written premium to a goal
that is established each year.
2. CHANGE IN SURPLUS
3. COMBINED RATIO - Compares EMC combined ratio to a target ratio
established by the Committee each year. Also compares EMC's combined
ratio to that of the industry.
Fifty percent of any bonus would be based on the industry estimate
published in January by A.M. Best and paid at that time. The remaining
fifty percent would be paid when final numbers are released by A.M. Best
(generally in March).
ALL CALCULATIONS ARE ROUNDED TO THE NEAREST ONE TENTH OF ONE PERCENT.
The factors in each of the formulas are subject to change each year with final
approval by the Senior Executive Compensation and Incentive Stock Option
Committee.
WRITTEN PREMIUM
This component is based on actual net written premium growth compared to a
consolidated written premium goal established each year and approved by the
Committee.
Achieving goal results in a bonus contribution of plus 7.5 percent of salary.
This changes by 1.5 percent for each 1.0 percent variation from goal, subject
to a maximum contribution of plus 15.0 percent and a minimum contribution of
minus 15.0 percent.
The written premium component is determined as follows:
Percent of actual change, minus goal, plus 5.0, times 1.50.
Example 1: The goal equals 8.5 percent premium growth.
- ---------- The actual change equals 7.5 percent premium growth.
7.5 percent minus 8.5 percent equals minus 1 plus 5.0, equals 4.0 times 1.50
equals 6.0. The contribution in this example of written premium towards the
total bonus is equal to 6.0 percent.
Example 2: The goal equals 5.7 percent premium growth. The actual change
- ---------- equals minus 1.3 percent premium growth.
Minus 1.3 percent minus 5.7 percent equals minus 7.0 plus 5.0 equals minus 2.0
times 1.50 equals minus 3.0.
Example 3: The goal equals 4.7 percent premium growth.
- ---------- The actual change equals 9.8 percent premium growth.
9.8 percent minus 4.7 percent equals 5.1 percent plus 5.0 equals 10.1 times
1.50 equals 15.2 percent. The contribution in this example of written premium
towards the total bonus equals plus 15.0 percent.
(This component not to exceed plus or minus 15.0 percent of total bonus.)
SURPLUS
The component of surplus is based on the actual change in surplus. Each one
percent change in surplus represents a change in bonus equal to 1.00 percent
of salary subject to a maximum of 25.0 percent and a minimum of minus 20.0
percent.
The surplus component is determined as follows:
Percent surplus change times multiplier of 1.00.
Example 1: Change in surplus equals plus 4.6 percent.
- ---------- Contribution towards total bonus from surplus component equals
4.6 percent times 1.00 equals 4.6 percent.
Example 2: Change in surplus equals a minus 2.4 percent. Contribution
- ---------- towards total bonus from surplus component equals minus 2.4
percent times 1.00 equals minus 2.4 percent.
Example 3: Change in surplus equals a plus 10.7 percent. Contribution
- ---------- towards total bonus from surplus component equals 10.7 percent
times 1.00 equals 10.7 percent.
COMBINED RATIO
The component for combined ratio is based on EMC's consolidated combined ratio
relative to a target combined ratio on a trade basis, adjusted by a comparison
of the EMC combined ratio to that of the industry.
The target combined ratio for 2002 is 103.0 percent. Current actuarial
calculations estimate that a combined ratio of 103.0 percent produces a return
on statutory surplus of 12.5 percent after taxes. This considers income from
all sources including investment return on surplus and assumes a premium to
surplus ratio of two to one.
The formula uses a target ratio of 103.0 percent which is subject to Committee
approval each year. For each 1.0 percent change in the combined ratio, the
bonus contribution changes 5.0 percent subject to a maximum contribution of
plus 65.0 percent and a minimum contribution of minus 40.0 percent.
First determine EMC's relationship to the industry by subtracting EMC's
combined ratio from that of the industry.
The initial Industry estimate published in December or January by A.M. Best
will be the number used in the calculation. Adjusments will be made as
required when A.M. Best releases final numbers, generally in March.
If the result is a positive number, subtract result (not to exceed 3.0
percent) from EMC's combined ratio to obtain adjusted combined ratio.
Subtract adjusted combined ratio from target combined ratio, add 6.0, multiply
by 5.00 to equal the bonus produced by the combined ratio component.
If the result is a negative number or 0.0, no adjustment is necessary and the
EMC combined ratio is the adjusted combined ratio. Subtract the adjusted
combined ratio from the target combined ratio, add 6.0, multiply by 5.00 to
equal the bonus produced by the combined ratio component.
The combined ratio formula is determined as follows:
103.0 minus the adjusted combined ratio plus 6.0 times 5.00.
Example 1: Industry ratio equals 101.6 percent.
- ---------- EMC ratio equals 97.1 percent.
Adjustment * 101.6 minus 97.1 equals 3.0 (maximum
adjustment allowed).
Adjusted ratio * 97.1 minus 3.0 equals 94.1 percent. Target
ratio equals 103.0 percent.
103.0 percent minus 94.1 percent equals 8.9 plus 6 equals 14.9
times 5.00 equals 74.5 percent. (Capped at 65.0)
The contribution towards total bonus from the combined ratio component equals
65.0 percent.
Example 2: Industry ratio equals 101.6 percent.
- ---------- EMC ratio equals 100.1 percent.
Adjustment * 101.6 minus 100.1 equals 1.5 percent.
Adjusted ratio * 100.1 minus 1.5 equals 98.6 percent.
Target ratio equals 103.0 percent.
103.0 percent minus 98.6 percent equals 4.4 percent plus 6.0
equals 10.4 percent times 5.00 equals 52.0 percent.
The contribution towards the total bonus from the combined ratio component
equals 52.0 percent.
Example 3: Industry ratio equals 101.6 percent.
- ---------- EMC ratio equals 110.1 percent.
Adjustment - None (If EMC performance is worse than the
industry average, use the EMC ratio in the formula).
Adjusted ratio * 110.1.
Target ratio equals 103.0 percent.
103.0 percent minus 110.1 percent equals minus 7.1 plus 6.0
equals minus 1.1 times 5.00 equals minus 5.5.
The contribution towards the total bonus from the combined ratio component
equals minus 5.5 percent.
Assuming each example represents one year, the bonus for the three years would
be as follows:
Component Example 1 Example 2 Example 3
Written Premium 6.0% -3.0% 15.0%
Surplus 4.6% -2.4% 10.7%
Combined Ratio 65.0% 52.0% -5.5%
----- ----- -----
Total Bonus 75.6% 46.6% 20.2%
* Maximum bonus for Vice President is 75.0 percent.
This represents the bonus for Vice Presidents. Factors would be
applied as follows to arrive at the bonus calculations for Senior Vice
Presidents, Executive Vice President, and President.
Position Example 1 Example 2 Example 3
Vice President 75.0% 46.6% 20.2%
Senior VP Multiply by 1.10 82.5% 51.3% 22.2%
Executive VP Multiply by 1.20 90.0% 55.9% 24.2%
President Multiply by 1.30 97.5% 60.6% 26.3%
MAXIMUM BONUS
For Vice Presidents, the total bonus is the sum of the three components
subject to a maximum of 75 percent of salary.
Maximum Bonus
For Vice Presidents, the percent of salary is 75.0 %
For Senior Vice Presidents, multiply the bonus
percentage by 1.10. 82.5 %
For Executive Vice President, multiply the bonus
percentage by 1.20. 90.0 %
For President, multiply the bonus percentage by
1.30. 97.5 %
EXECUTIVES ELIGIBLE FOR BONUS
Vice Presidents Senior VP Executive VP President
Mark E. Reese John D. Isenhart Ronald W. Jean Bruce G. Kelley
Richard W. Hoffmann David O. Narigon William A. Murray
Douglas J. Zmolek Raymond W. Davis
Steven C. Peck Donald D. Klemme
A. Beech Turner Kevin Hovick
Richard L. Gass
Jeffrey T. Dahms
PLAN ADMINISTRATION
1. An executive must be on the payroll a minimum of six months
before he/she is eligible for a bonus payment.
2. An executive terminating employment with the companies before
the established date for the payment of bonuses will not be
paid a bonus.
3. Executives retiring or becoming deceased or disabled before
the established date for the payment of bonuses will receive
a bonus on the basis of the portion of the year he/she was on
the payroll.
4. If an executive becomes a member of the Policy Committee at
some time during the year, they will receive a prorata bonus
for that portion of the year they are a member.
5. If an executive is promoted during the year and/or given a
salary increase, the bonus will be prorated on the basis of
the position and/or the salaries paid for the specific
position.
6. Deductions for federal and state income taxes, and FICA, if
applicable, will be made from each bonus on the basis of IRS
regulations.
7. Before any bonuses are paid, a member of Ernst & Young
Auditing Firm will determine that the calculations are
correct according to the bonus plan document.
8. The Executive Compensation Committee may, at its discretion
adjust the bonus calculation for unusual or extenuating
circumstances that unfairly impact the results.
9. The EMC Employee Contingent Salary Plan provides that
employees eligible under a separate "bonus" program will
receive the larger of the "bonus" and the "contingent salary"
for the plan year. In the unlikely event the "contingent
salary" is larger than the "senior executive bonus" the
Executive Compensation Committee may, at its discretion,
approve payment of the "contingent salary" in lieu of the
"senior executive bonus".
10. If there is a disagreement or misunderstanding of the basis
for the bonus or in the calculation in the amounts, the
decision of the Senior Executive Compensation and Incentive
Stock Option Committee will be final.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10
<SEQUENCE>4
<FILENAME>exhibit10f.txt
<DESCRIPTION>2002 EXECUTIVE BONUS PROGRAM - EMC REINSURANCE
<TEXT>
EXHIBIT 10(f)
-------------
2002 EXECUTIVE BONUS PROGRAM
EMC RE
PURPOSES AND BENEFITS:
1. To improve profits, surplus and service in EMC Reinsurance Company.
2. To recognize the effort and contribution to profit by a senior
executive of the company.
3. To cause an executive under this Plan to improve the earnings of the
company - not to be a profit sharing program.
4. Applicable to the officer who is listed below:
Ronnie D. Hallenbeck
GENERAL PROGRAM:
Any bonus payment earned under this program will be paid to the executive in
"4" above about April 15, or as soon as all information is available for the
operating year on which to base payments. If there is a disagreement or
misunderstanding of the basis for the bonus or in the calculation of the
amounts, the decision of the Chief Executive Officer will be final.
UNDERWRITING BONUS BASIS:
Bonus basis is keyed to the adjusted combined loss and expense ratio of EMC Re
computed according the formula below. Calculations will be to the nearest
1/10th of 1%.
Step One: The actual combined trade ratio is adjusted by the profit or loss
incurred by EMCC under the occurrence cap protection.
Step Two: The adjusted combined trade ratio from Step One is compared to that
of the reinsurance industry as published by the Reinsurance Association of
America. If it is greater than the RAA combined, no further adjustment is
made. If it is lower than the RAA combined ratio, the adjusted combined trade
ratio is reduced by the difference, subject to a maximum reduction of three
points.
Step Three: If the adjusted combined ratio from Steps One and Two is greater
than 108.0, no bonus is payable. For every point by which the combined ratio
is less than 108.0, 12.5% of the bonus potential is earned so that the maximum
bonus is earned if the adjusted combined ratio is less than or equal to 100.0.
The adjusted combined loss and expense ratio of the company as defined for
purposes of calculation under this plan may be modified by reserve adjustments
or corrections only by approval of the Senior Executive Compensation
Committee.
NOTE: Potential bonus under this plan is 35% of base annual salary for the
program year.
ADMINISTRATION:
1. An executive must have been on the payroll a minimum of six months
before he or she is eligible for a bonus payment.
2. An executive leaving the Companies before the established date for the
payment of bonuses will not be paid a bonus.
3. An executive retiring or becoming deceased or disabled before the
established date for the payment of bonuses will receive a bonus on the
basis of the portion of the year he or she is on the payroll.
4. If an executive is promoted during the year and given a salary increase,
the bonus will be pro-rated on the basis of the salaries paid for the
specific position.
5. Deductions for Federal and State income taxes and FICA, if applicable,
will be made from each bonus on the basis of IRS regulations.
6. As a general rule, no bonus will be paid if there is not an increase
in surplus for the year; however, even in the event of no increase in
surplus, before making a recommendation to pay or not pay a bonus, the
Senior Officers Compensation Committee will take into consideration
a number of factors that have a direct relationship to surplus. Examples
of factors to be considered would be the following:
a) The direction and degree that surplus has moved in the property and
casualty reinsurance industry as a whole.
b) The existence or absence of an excessive number and the dollar size,
of natural catastrophes.
c) The Company's reserving policy and the experience of the adequacy
or inadequacy thereof.
c) Trends in the equity and fixed income markets as reflected by the
major market indexes.
d) The nature of securities transactions; the reasoning for them and
the short and long-term effects thereof.
f) Dividends paid to EMC Group above $1,000,000.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>5
<FILENAME>exhibit13a.txt
<DESCRIPTION>SELECTED FINANCIAL DATA
<TEXT>
<TABLE>
SELECTED FINANCIAL DATA. EXHIBIT 13(a)
- ------------------------ -------------
<CAPTION>
Year ended December 31,
--------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
($ in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data
Insurance premiums
earned ................... $297,043 $265,280 $231,459 $211,098 $194,244 $177,218 $165,191 $162,266 $164,829 $156,438 $147,410
Investment income, net ..... 32,778 30,970 29,006 25,761 24,859 23,780 24,007 23,204 21,042 20,936 21,586
Realized investment (losses)
gains .................... (3,159) 800 1,558 277 5,901 4,100 1,891 1,043 520 684 384
Other income ............... 866 774 1,473 2,194 1,701 1,023 904 1,005 1,128 668 701
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total revenues ........ 327,528 297,824 263,496 239,330 226,705 206,121 191,993 187,518 187,519 178,726 170,081
Losses and expenses ........ 305,636 303,366 262,431 245,321 223,031 189,318 171,324 163,202 168,842 169,707 169,106
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------
Income (loss) before income
tax expense (benefit) .... 21,892 (5,542) 1,065 (5,991) 3,674 16,803 20,669 24,316 18,677 9,019 975
Income tax expense (benefit) 5,790 (3,436) (1,264) (5,187) (2,339) 3,586 5,635 6,967 5,171 1,885 759
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from:
Continuing operations ... 16,102 (2,106) 2,329 (804) 6,013 13,217 15,034 17,349 13,506 7,134 216
Accounting changes ...... - - - - - - - - - 2,621 -
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) .... $ 16,102 $ (2,106)$ 2,329 $ (804)$ 6,013 $ 13,217 $ 15,034 $ 17,349 $ 13,506 $ 9,755 $ 216
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Net income (loss) per common
share - basic and diluted:
Continuing operations $ 1.42 $ (.19)$ .21 $ (.07)$ .53 $ 1.18 $ 1.37 $ 1.62 $ 1.29 $ .70 $ .02
Accounting changes .... - - - - - - - - - .26 -
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total ................ $ 1.42 $ (.19)$ .21 $ (.07)$ .53 $ 1.18 $ 1.37 $ 1.62 $ 1.29 $ .96 $ .02
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Premiums earned by segment:
Property and casualty
insurance .............. $225,013 $203,393 $184,986 $167,265 $155,523 $143,113 $128,516 $126,440 $127,573 $123,114 $120,795
Reinsurance .............. 72,030 61,887 46,473 43,833 38,721 34,105 36,675 35,826 37,256 33,324 26,615
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total ................ $297,043 $265,280 $231,459 $211,098 $194,244 $177,218 $165,191 $162,266 $164,829 $156,438 $147,410
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Balance Sheet Data
Total assets ............... $674,864 $671,565 $601,560 $542,395 $496,046 $459,110 $430,328 $412,881 $387,370 $368,936 $372,807
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Stockholders' equity ....... $157,768 $140,458 $148,393 $141,916 $163,938 $162,346 $148,729 $136,889 $116,727 $109,634 $100,911
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Other Data
Average return on equity ... 10.8% (1.5)% 1.6% (.5)% 3.7% 8.5% 10.5% 13.7% 11.9% 9.3% .2%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Book value per share ....... $ 13.84 $ 12.40 $ 13.14 $ 12.60 $ 14.26 $ 14.30 $ 13.42 $ 12.66 $ 11.03 $ 10.63 $ 9.98
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Dividends paid per share ... $ .60 $ .60 $ .60 $ .60 $ .60 $ .60 $ .57 $ .53 $ .52 $ .52 $ .52
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Property and casualty
insurance subsidiaries
aggregate pool percentage 23.5% 23.5% 23.5% 23.5% 23.5% 22% 22% 22% 22% 22% 22%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Reinsurance subsidiary quota
share percentage ......... 100% 100% 100% 100% 100% 100% 95% 95% 95% 95% 95%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Closing stock price ....... $ 17.87 $ 17.15 $ 11.75 $ 9.13 $ 12.75 $ 13.25 $ 12.00 $ 13.75 $ 9.50 $ 9.50 $ 8.50
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Net investment yield
(pre-tax) ................ 5.92% 6.31% 6.47% 5.96% 6.02% 6.15% 6.54% 6.65% 6.59% 6.83% 7.50%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Cash dividends to
closing stock price ...... 3.4% 3.5% 5.1% 6.6% 4.7% 4.5% 4.8% 3.9% 5.5% 5.5% 6.1%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Common shares outstanding .. 11,399 11,330 11,294 11,265 11,496 11,351 11,084 10,814 10,577 10,317 10,112
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Statutory trade combined
ratio .................... 101.3% 112.4% 113.5% 115.2% 114.8% 106.2% 103.6% 99.6% 101.3% 106.3% 113.9%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
Amounts previously reported in prior consolidated financial statements have
been reclassified to conform to current presentation.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>6
<FILENAME>exhibit13b.txt
<DESCRIPTION>MANAGEMENT'S DISCUSSION AND ANALYSIS
<TEXT>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL EXHIBIT 13(b)
- ------------------------------------------------- -------------
CONDITION AND RESULTS OF OPERATIONS
- -----------------------------------
The following discussion and analysis of EMC Insurance Group Inc. and its
subsidiaries' financial condition and results of operations should be read in
conjunction with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements included elsewhere herein.
OVERVIEW
EMC Insurance Group Inc., a 79.9 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 75.8
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.
Employers Mutual and all of its subsidiaries (including the Company) and an
affiliate, are referred to as the "EMC Insurance Companies."
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. The aggregate
participation of the Company's property and casualty insurance subsidiaries is
23.5 percent. 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 investment
and income tax activities of the reinsurance subsidiary are not subject to the
quota share agreement.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. The override commission rate is charged at 4.50 percent of written
premiums. The reinsurance subsidiary also pays for 100 percent of the outside
reinsurance protection Employers Mutual purchases to protect itself from
catastrophic losses on the assumed reinsurance business, excluding
reinstatement premiums. This cost is recorded as a reduction to the premiums
received by the reinsurance subsidiary.
CRITICAL ACCOUNTING POLICIES
The following accounting policies are considered by management to be
critically important in the preparation and understanding of the Company's
financial statements and related disclosures. The assumptions utilized in the
application of these accounting policies are complex and require a significant
amount of subjective judgment.
Loss and settlement expense reserves
Processes and assumptions for establishing loss and settlement expense
reserves
Liabilities for losses are based upon case-basis estimates of reported
losses and estimates of incurred but not reported ("IBNR") losses. For direct
insurance business, the Company's IBNR reserves are estimates of liability for
accidents that have occurred, but have not yet been reported to the Company.
For assumed reinsurance business, IBNR reserves are also used to record
anticipated increases in reserves for claims that have previously been
reported. An estimate of the expected expenses to be incurred in the
settlement of the claims provided for in the loss reserves is established as
the liability for settlement expenses.
Property and Casualty Insurance Segment
- ---------------------------------------
The Company's claims department establishes case loss reserves for direct
business. Branch claims personnel establish case reserves for individual
claims, with mandatory home office claims department review of reserves that
exceed a specified threshold. This reserving process implicitly assumes a
stable inflationary and legal environment. Most of the IBNR reserves for
direct business are established through an actuarial analysis of IBNR claims
that have emerged after the end of recent calendar years compared to the
corresponding calendar year earned premiums (adjusted for changes in rate
level adequacy). The methodology used in estimating these formula IBNR
reserves assumes consistency in claims reporting patterns and immaterial
changes in loss development patterns due to loss cost trends. From this
analysis, IBNR factors are derived for each line of business and are applied
to the latest twelve months of earned premiums to generate the formula IBNR
reserves. The IBNR factors at year-end 2002 were selected to generate IBNR
reserves near the midpoint of the range of actuarial reserve indications,
after consideration of anticipated salvage and subrogation recoveries. No one
point estimate within the range of actuarial reserve indications was
considered better than another; therefore, management targeted the midpoint of
the range as its best estimate of the required reserves.
Ceded reserves are derived by applying the ceded contract terms to the
direct reserves. For excess of loss contracts (excluding the catastrophe
contract), this is accomplished by applying the ceded contract terms to the
case reserves of the ceded claims. For the catastrophe excess of loss
contract, ceded reserves are calculated by applying the contract terms to both
the aggregate case reserves on claims stemming from catastrophes and the
estimate of IBNR reserves developed for each individual catastrophe. For
quota share contracts, ceded reserves are calculated as the quota share
percentage multiplied by both case and IBNR reserves on the direct business.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The methodology used for reserving settlement expenses is based on an
analysis of historical ratios of paid expenses to paid losses. Assumptions
underlying this methodology include stability in the mix of business,
consistent claims processing procedures, immaterial impact of loss cost trends
on development patterns, and consistent legal defense strategies. Based on
this actuarial analysis, expense factors are derived for each line of
business, which are applied to loss reserves to generate the expense reserves.
The factors at year-end 2002 were selected to target an expense reserve level
near the midpoint of the range of reserve indications arising from the
actuarial analysis. No one point estimate within the range of reserve
indications arising from the actuarial analysis was considered better than
another; therefore, management targeted the midpoint of the range as its best
estimate of the required reserves.
Reinsurance Segment
- -------------------
The reinsurance book of business is comprised of two major components.
The first is Home Office Reinsurance Assumed Department ("HORAD"), which is
the reinsurance business that is underwritten by Employers Mutual. The second
is the Mutual Reinsurance Bureau pool ("MRB"), which is a voluntary pool in
which Employers Mutual participates. For the HORAD component, Employers
Mutual records the case and IBNR reserves reported by the ceding companies.
Bulk IBNR reserves are established based on an actuarial reserve analysis.
Due to the time lag in the reporting of assumed reinsurance business and the
relatively low volume of data generally available at the end of the first
three quarters, the loss ratio method is used to estimate ultimate loss
experience for those periods. Reported reinsurance results are analyzed
throughout the year and, when appropriate, modifications are made to the
reserves established by the loss ratio method. During the fourth quarter,
with a full year of reported data, the Company uses other actuarial projection
methods to evaluate anticipated loss experience and further adjustments are
made to the carried reserves if deemed appropriate.
The primary actuarial methods used to project ultimate policy year losses
are paid development, incurred development and Bornhuetter-Ferguson, a
recognized actuarial methodology. The assumptions underlying the various
projection methods include stability in the mix of business, consistent claims
processing procedures, immaterial impact of loss cost trends on development
patterns, consistent case reserving practices, and appropriate Bornhuetter-
Ferguson expected loss ratio selections. At year-end 2002, the carried HORAD
reserves were in the upper quarter of the range of actuarial reserve
indications. This conservative selection reflects the fact that there are
inherent uncertainties involved in establishing reserves for assumed
reinsurance business. Such uncertainties include the fact that a reinsurance
company generally has less knowledge than the ceding company about the
underlying book of business and the ceding company's reserving practices.
For MRB, Employers Mutual records the case and IBNR reserves reported to
it by the management of the pool, along with a relatively small IBNR reserve
to cover a one-month reporting lag. To verify the adequacy of the reported
reserves, an actuarial evaluation of MRB's reserves is performed at each year-
end. As of December 31, 2002, this evaluation indicated that the carried MRB
reserves were in the upper quarter of the range of actuarial reserve
indications. The Company considers this conservative reserving practice to be
appropriate in light of the inherent uncertainties associated with assumed
reinsurance business noted above.
Expense reserves for both the HORAD and MRB books of business are
developed through the application of expense reserve factors to carried loss
reserves. The factors are derived from an analysis of paid expenses to paid
losses. Assumptions described for the property and casualty insurance segment
apply to the reinsurance expense reserving process.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Asbestos, environmental and other uncertain exposures
- -----------------------------------------------------
Asbestos and environmental losses paid by the Company have averaged only
$200,000 per year over the past five years. During 2002, the Company re-
evaluated the estimated ultimate losses for asbestos exposures. Based on this
re-evaluation, the Company reallocated $200,000 of bulk IBNR reserves and
$100,000 of settlement expense reserves to direct asbestos exposures. In
addition, the Company took a proactive approach to evaluate the adequacy of
its asbestos reserves and commissioned a "ground-up" study to better quantify
its exposure to asbestos liabilities. This study concluded that the Company's
exposure for direct asbestos claims ranged from $1,100,000 to $5,100,000, with
a point estimate of $3,000,000. Based on the results of this study, the
Company elected to increase the IBNR reserves carried for direct asbestos
exposures by $2,100,000 at December 31, 2002, to $3,000,000. The study and
its results assume no improvement in the current asbestos litigation
environment; however, federal legislation currently being considered could
reduce the ultimate losses from asbestos litigation below the levels currently
being projected for the industry.
Since 1989, the Company has consistently included an asbestos exclusion
in liability policies issued for most lines of business. The exclusion
prohibits liability coverage for "bodily injury", "personal injury" or
"property damage" (including any associated clean-up obligations) arising out
of the installation, existence, removal or disposal of asbestos or any
substance containing asbestos fibers. Therefore, the Company's present
asbestos exposures are primarily limited to commercial policies issued prior
to 1989. At present, the Company is defending several hundred asbestos bodily
injury lawsuits under express reservation of rights in a number of states for
injuries caused by asbestos containing products allegedly "mined, milled,
manufactured, and/or distributed" by the Company's past and present
policyholders. The plaintiffs in these cases suffer latent injuries, which
can take years to detect. As a result, courts have allowed the trigger of
more than one policy period (and carrier) to apply to these claims. The
Company's policyholders that have been named as defendants in these asbestos
lawsuits are peripheral defendants (i.e., small contractors, insulators, and
electrical and building supply companies). Three policyholders (Lennox,
Packing and Insulation Corp. and its contract installer, PIC), dominate the
Company's asbestos claims. To date, actual losses paid have been minimal due
to the plaintiffs' failure to identify an asbestos-containing product to which
they were exposed that is associated with the Company's policyholders.
Defense costs, on the other hand, have typically increased due to the
increased number of parties involved in the litigation and the length of time
required to obtain a favorable result in the litigation on behalf of the
policyholder. Whenever possible, the Company has participated in cost sharing
agreements with other liability carriers to reduce overall asbestos claim
expenses.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company's direct environmental claims have been defined as "any loss
or potential loss (including third party claims) related directly or
indirectly to the remediation of a site arising from past operations or waste
disposal." Examples include, but are not limited to: chemical waste;
hazardous waste treatment, storage and/or disposal facilities; industrial
waste disposal facilities; landfills; superfund sites; toxic waste spills; and
underground storage tanks. Widespread use of pollution exclusions since 1970
in virtually all lines of business, except personal lines, has resulted in
limited exposure to environmental claims. Absolute pollution exclusions have
been used since the 1980's. The Company's exposure to environmental claims is
therefore limited primarily to accident years preceding the 1980s. The pre-
1980's exposures include municipality exposures for closed landfills, small
commercial businesses involved with disposing waste at landfills or leaking
underground storage tanks. During 2002, the Company re-evaluated the
estimated ultimate losses for direct environmental exposures. Based on this
re-evaluation, the Company reallocated $600,000 of bulk IBNR reserves and
$200,000 of settlement expense reserves to direct environmental exposures. No
additional IBNR reserves were established for these exposures.
The Company's exposure to asbestos and environmental claims through
assumed reinsurance is very limited due to the fact that the Company's
reinsurance subsidiary entered into the reinsurance marketplace in the early
1980s after much attention had already been brought to these issues. The
Company has taken action to commute one reinsurance contract during the first
quarter of 2003 that has some asbestos and environmental reserves associated
with it. The "ground-up" study recently completed on the Company's asbestos
exposures did not identify any additional exposures associated with the
reinsurance business assumed by the Company.
At December 31, 2002, the Company carried asbestos and environmental
reserves for direct insurance and assumed reinsurance business totaling
$5,600,000, which represents 1.7% of total loss and settlement expense
reserves. The asbestos and environmental reserves include $600,000 of case
reserves, $3,800,000 of IBNR reserves and $1,200,000 of bulk settlement
expense reserves.
The Company's direct product liability claims are considered to be highly
uncertain exposures due to the many uncertainties inherent in determining the
loss, and the significant periods of time that can elapse between the
occurrence of the loss and the ultimate settlement of the claim. The majority
of the Company's product liability claims arise from small to medium sized
manufacturers, contractors, petroleum distributors, and mobile home and auto
dealerships. No specific claim trends are evident from the Company's
manufacturer and contractor policies, as the claims activity on these policies
is generally isolated and can be severe. Claims involving petroleum products
can range from small to severe, and are generally isolated and tend to occur
when the product is placed into use. Specific product coverage is provided to
the Company's mobile home and auto dealership policyholders, and the claims
from these policies tend to be relatively small. No trends are currently
evident that would adversely affect the Company's product liability book of
business.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company's assumed casualty excess reinsurance is also considered to
be a highly uncertain exposure due to the significant periods of time that can
elapse during the settlement of the underlying claims and the fact that a
reinsurance company generally has less knowledge than the ceding company about
the underlying book of business and the ceding company's reserving practices.
While the Company's reinsurance subsidiary is predominantly a property
reinsurer, it does write some casualty excess business that includes most of
the standard casualty lines of business. Casualty excess business that is
written is generally considered to be either working layer (exposed to loss on
a policy limit basis) or clash (reinsurance attaches above the typical
original policy limits that are provided). The working layer casualty excess
reinsurance is written for smaller companies, while clash casualty excess is
provided to all sizes of companies. No contracts are currently written for
specialty casualty lines such as medical malpractice or for-profit directors
and officers.
Following is a schedule of claims activity for asbestos, environmental,
products liability and casualty excess reinsurance for 2002, 2001 and 2000.
Property and casualty
insurance segment Reinsurance segment
--------------------------- --------------------------
Settlement Settlement
($ in thousands) Case IBNR expense Case IBNR expense
- ---------------- ------- ------- ------- ------- ------- --------
Reserves at 12/31/02
Asbestos ...........$ 451 $ 1,693 $ 839 $ 80 $ 454 $ -
Environmental ......$ 14 $ 839 $ 322 $ 49 $ 786 $ -
Products 1 .........$ 2,314 $ 1,856 $ 2,000 $ - $ - $ -
Casualty excess 2 ..$ - $ - $ - $13,393 $21,472 $ 1,385
Reserves at 12/31/01
Asbestos ...........$ 353 $ 147 $ 220 $ 86 $ 480 $ -
Environmental ......$ 11 $ 312 $ 131 $ 52 $ 773 $ -
Products 1 .........$ 1,890 $ 1,230 $ 1,364 $ - $ - $ -
Casualty excess 2 ..$ - $ - $ - $15,040 $21,034 $ 1,575
Reserves at 12/31/00
Asbestos ...........$ 317 $ 194 $ 205 $ 93 $ 496 $ -
Environmental ......$ 177 $ 312 $ 223 $ 53 $ 760 $ -
Products 1 .........$ 2,010 $ 937 $ 1,078 $ - $ - $ -
Casualty excess 2 ..$ - $ - $ - $11,164 $21,916 $ 914
Paid during 2002
Asbestos ...........$ 18 $ 97 $ 8 $ -
Environmental ......$ 44 $ 10 $ 12 $ -
Products 1 .........$ 577 $ 586 $ - $ -
Casualty excess 2 ..$ - $ - $ 5,019 $ 498
Paid during 2001
Asbestos ...........$ 11 $ 49 $ 13 $ 1
Environmental ......$ 109 $ 27 $ 8 $ -
Products 1 .........$ 967 $ 562 $ - $ -
Casualty excess 2 ..$ - $ - $ 4,436 $ 534
Paid during 2000
Asbestos ...........$ 7 $ 56 $ 28 $ -
Environmental ......$ 39 $ 71 $ 65 $ -
Products 1 .........$ 592 $ 490 $ - $ -
Casualty excess 2 ..$ - $ - $ 3,457 $ 398
1 Products includes the portion of asbestos and environmental claims
reported above that are non-premises/operations claims
2 Casualty excess includes the asbestos and environmental
claims reported above
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Environ-
Asbestos mental Products
-------- -------- --------
Open claims, 12/31/02 ... 306 6 1,080
Reported in 2002 ........ 123 - 781
Disposed of in 2002 ..... 83 3 260
Open claims, 12/31/01 ... 266 9 559
Reported in 2001 ........ 104 1 454
Disposed of in 2001 ..... 95 8 371
Open claims, 12/31/00 ... 257 16 476
Reported in 2000 ........ 155 5 258
Disposed of in 2000 ..... 114 7 278
Variability of loss and settlement expense reserves
The Company does not determine a range of estimates for all components of
the loss and settlement expense reserves at the time those reserves are
established. However, at each year-end an actuarially determined range of
estimates is developed for the major components of the loss and settlement
expense reserves. All reserves are reviewed, except for the involuntary
workers' compensation pools, for which reliance is placed on a reserve opinion
received from the National Council on Compensation Insurance certifying the
reasonableness of those reserves. Shown below are the actuarially determined
ranges of reserve estimates as of December 31, 2002, along with the carried
reserves. The last two columns display the estimated after-tax impact on
earnings if the reserves were moved to the high endpoint and the low endpoint
of the ranges.
After-Tax Impact
Range of Reserve Estimates on Earnings
-------------------------- ------------------
Reserves Reserves
($ in thousands) High Low Carried at High at Low
-------- -------- -------- -------- --------
Property and casualty
insurance segment .........$243,390 $207,392 $229,877 $ (8,783) $ 14,615
Reinsurance segment ......... 105,493 86,216 101,350 (2,693) 9,837
-------- -------- -------- -------- --------
$348,883 $293,608 $331,227 $(11,476) $ 24,452
======== ======== ======== ======== ========
Changes in loss and settlement expense reserve estimates of prior periods
For the property and casualty insurance segment, the December 31, 2002
estimate of loss and settlement expense reserves for accident years 2001 and
prior increased $4,600,000 from the estimate at December 31, 2001. This
increase represents 2.1% of the December 31, 2001 carried reserves and is
primarily attributable to three sources: direct IBNR reserves, involuntary
pools and contingent salary plan reserves. With regard to direct IBNR
reserves, the methodology utilized to establish these reserves assumes
consistency in claims reporting patterns. However, in recent years emerged
IBNR losses have increased as a percentage of earned premiums. As a result of
these actuarial indications, the Company strengthened direct IBNR reserves by
$3,600,000 in 2002, $1,700,000 of which was allocated to accident years 2001
and prior. In addition, the Company established $2,100,000 of additional IBNR
asbestos reserves at December 31, 2002 based on the results of a recently
completed study of the Company's asbestos exposures, all of which was
allocated to accident years 2001 and prior. As previously noted, the Company
books the reserves reported by the management of the involuntary pools and in
2002 these bookings resulted in modest upward development of $400,000.
Finally, Employers Mutual implemented a contingent salary plan in 2002 and
$400,000 of the reserve established for this plan at December 31, 2002 was
allocated to settlement expenses for accident years 2001 and prior.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the reinsurance segment, the December 31, 2002 estimate of loss and
settlement expense reserves for accident years 2001 and prior increased
$2,400,000 from the estimate at December 31, 2001. This increase represents
2.6% of the December 31, 2001 carried reserves. Virtually all of the increase
arose from the MRB pool, for which the Company books the reserves established
and reported by the pool. The carried MRB reserves at December 31, 2001 were
above the midpoint of the actuarial range of estimates. However, reported
losses and settlement expenses during pool year 2002 exceeded by approximately
$1,200,000 the amounts predicted by the actuarial analysis. In addition,
management of the MRB pool increased the IBNR reserves for prior years by
$300,000. Finally, the losses and settlement expenses reported during January
2002 exceeded by $800,000 the IBNR reserve established at December 31, 2001 to
cover the one-month reporting lag.
Deferred policy acquisition costs and related amortization
Deferred policy acquisition costs are used to match the expenses incurred
in the production of insurance business to the income earned on this business.
This adjustment is necessary because statutory accounting principals require
that expenses incurred in the production of insurance business be expensed
immediately, while premium income is recognized ratably over the terms of the
underlying insurance policies.
Amortization of deferred policy acquisition costs is calculated as the
difference between the beginning and ending amounts of deferred policy
acquisition costs plus the amount of costs deferred during the current year.
Deferred policy acquisition costs and related amortization are calculated
separately for the property and casualty insurance segment and the reinsurance
segment. The method followed in computing deferred policy acquisition costs
limits the amount of such deferred costs to their estimated realizable value,
which gives effect to the premium to be earned, related investment income,
losses and settlement expenses and certain other costs expected to be incurred
as the premium is earned. Deferred policy acquisition costs were not subject
to limitation at December 31, 2002, and management does not anticipate future
limitations to be likely due to the improving premium rate environment in both
the insurance and reinsurance marketplaces.
Deferred income taxes
The realization of the deferred income tax asset is based upon
projections that indicate that a sufficient amount of future taxable income
will be earned to utilize the tax deductions that will reverse in the future.
These projections are based on the Company's history of producing significant
amounts of taxable income, the improving premium rate environment for both the
property and casualty insurance segment and the reinsurance segment and loss
and expense control initiatives that have been implemented during the last two
years. In addition, management has formulated tax-planning strategies that
could be implemented to generate taxable income if needed. Should the
projected taxable income and tax planning strategies not provide sufficient
taxable income to recover the deferred tax asset, a valuation allowance would
be required.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three years ended December 31, 2002 are as follows:
($ in thousands) 2002 2001 2000
-------- -------- --------
Premiums earned .......................... $297,043 $265,280 $231,459
Losses and settlement expenses ........... 207,058 221,919 189,522
Acquisition and other expenses ........... 95,633 80,251 71,401
-------- -------- --------
Underwriting loss ........................ (5,648) (36,890) (29,464)
Net investment income .................... 32,778 30,970 29,006
Interest expense ......................... (1,639) (11) -
Other expense ............................ (440) (411) (35)
-------- -------- --------
Operating income (loss) before income
tax expense (benefit) .................. 25,051 (6,342) (493)
Realized investment (losses) gains ....... (3,159) 800 1,558
-------- -------- --------
Income (loss) before income tax
expense (benefit) ...................... 21,892 (5,542) 1,065
Income tax expense (benefit) ............. 5,790 (3,436) (1,264)
-------- -------- --------
Net income (loss) ........................ $ 16,102 $ (2,106) $ 2,329
======== ======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $200,060 $216,752 $191,425
Increase (decrease) in provision for
insured events of prior years ........ 6,998 5,167 (1,903)
-------- -------- --------
Total losses and settlement expenses $207,058 $221,919 $189,522
======== ======== ========
Catastrophe and storm losses ............. $ 8,304 $ 22,947 $ 8,604
======== ======== ========
The Company increased its December 31, 2002 reserves for direct asbestos
exposures by $2,069,000 as a result of a "ground-up" study commissioned by the
Company to better quantify its exposure to asbestos liabilities. The Company
does not have a significant amount of exposure to asbestos claims; however,
the recent increase in litigation against "peripheral defendants" prompted the
Company to commission an independent study to better understand its exposures
in this evolving legal environment. The consulting actuarial firm
commissioned to conduct this study is highly respected for its expertise in
performing this type of evaluation. The study was completely voluntary and at
the discretion of the Company.
Operating results before income taxes improved dramatically in 2002 from
the results reported in 2001 and 2000. This improvement is attributed to
improved premium rate adequacy, focused underwriting initiatives and a
significant decline in catastrophe and storm losses. The Company has been
successful in executing a corporate operating plan that is focused on
improving profitability. Although significant improvements were achieved in
pricing and loss experience in 2001, they were masked by an unusually large
amount of storm losses. The initiatives implemented in recent years have
resulted in improved profitability for 2002, and this trend is expected to
continue in 2003.
Premium rate levels improved during 2002, continuing a trend that began
in 1999. During this time period, implemented rate increases have grown
progressively larger each year, reflecting an industry-wide movement toward
adequate premium rate levels. During 2002, premium rate increases ranging
from five to eighteen percent were implemented in most lines of business. As
a result, premium rate levels for most lines of business are now at, or near,
adequate levels for the first time in nearly a decade. Although management
expects to implement additional rate increases during 2003, these increases
are not expected to be as large as those implemented in 2002 and will likely
be targeted toward specific territories and lines of business.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Premiums earned increased 12.0 percent in 2002, 14.6 percent in 2001 and
9.6 percent in 2000. The increase in 2002 premiums is primarily attributed to
rate increases that were implemented during the last two years in the property
and casualty business, as well as growth and improved pricing in the assumed
reinsurance business. Despite rising premium rates, retention levels have
remained fairly constant, evidence of the movement of the insurance industry
towards more adequate rate levels. The Company continues to be selective in
the insurance risks that it accepts and has been able to price both new and
renewal business at more adequate levels. The significant growth reported in
2001 earned premiums was achieved through a combination of implemented rate
increases and increased exposures.
Losses and settlement expenses decreased 6.7 percent in 2002 after
increasing 17.1 percent in 2001 and 7.1 percent 2000. The decrease for 2002
is primarily related to a significant decline in catastrophe and storm losses
from the unusually large amount experienced in 2001, when active weather
patterns produced a record amount of storm losses. Other factors contributing
to this improvement include the implementation of more stringent underwriting
standards, a substantial decrease in loss frequency and a decline in large
losses. For the second consecutive year, losses and settlement expenses were
negatively impacted by adverse development on prior years' reserves. The
Company has historically experienced favorable development in its reserves and
its reserving practices have not changed; however, the amount of development
experienced will fluctuate from year to year as individual claims are settled
and new information becomes available on open claims. The adverse development
reported for 2002 includes $2,069,000 associated with the increase in asbestos
reserves noted above.
Acquisition and other expenses increased 19.2 percent in 2002, 12.4
percent in 2001 and 7.0 percent in 2000. These increases are primarily
attributed to the higher premium levels reported for these years. Additional
factors contributing to the large increase for 2002 include an increase in
contingent commission expense and policyholder dividends resulting from the
significant improvement in underwriting results, the discontinuation of an
assigned risk program during 2001 that produced commission income, an increase
in employee benefit costs and $379,000 of commission expense stemming from
increased participation in a reinsurance pool. The increase for 2001 was
limited by the increase in deferred policy acquisition costs that resulted
from the change in the recording of installment-based premiums. The increase
in 2000 was limited by an $824,000 decline in contingent commission expense in
the reinsurance subsidiary. Acquisition and other expenses for 2001 and 2000
include approximately $135,000 of goodwill amortization expense. In
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets", which became effective January 1, 2002, the
Company's carried goodwill is no longer subject to amortization and must
instead be tested for impairment on a periodic basis.
Net investment income increased 5.8 percent in 2002, 6.8 percent in 2001
and 12.6 percent in 2000. The Company experienced a significant increase in
fixed maturity security investments during 2002 due to the issuance of
$25,000,000 of surplus notes to Employers Mutual in December 2001 and
$11,000,000 of surplus notes to Employers Mutual in June 2002; however, this
increase in invested assets has not produced a significant increase in
investment income due to the declining interest rate environment. In
addition, the Company experienced a significant amount of call activity in its
portfolio of fixed maturity securities during 2001 due to the large decline in
interest rates. Proceeds from this call activity, and from maturing
securities, were reinvested at lower current interest rates, resulting in a
lower rate of return in 2002. The increase for 2001 is primarily attributed
to a higher average invested balance in fixed maturity securities. The large
increase in 2000 reflects both a higher average invested balance in fixed
maturity securities and an increase in the average rate of return earned on
the fixed maturity portfolio.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company incurred $1,639,000 of interest expense on its surplus notes
in 2002 and $11,000 in 2001. This interest expense did not have a material
impact on the Company's operating results as the proceeds of the surplus notes
were invested in government agencies and corporate bonds and earned a similar
amount of interest income.
The realized investment losses of 2002 primarily reflect a $3,821,000
"other than temporary" security impairment write-down of the Company's
investment in MCI Communications Corporation bonds. The realized investment
gains for 2001 reflect $563,000 from the Company's equity portfolio, net of
$310,000 of realized losses associated with the sale of Enron stock, with the
remainder coming primarily from calls on taxable fixed maturity securities.
The realized investment gains of 2000 reflect $531,000 from the disposal of
tax-exempt fixed maturity securities, $531,000 from the disposal of other
fixed maturity securities and $496,000 from the Company's equity portfolio.
The Company reported income tax expense in 2002 compared to an income tax
benefit for both 2001 and 2000. This change in tax status primarily reflects
the substantial improvement in pre-tax operating results experienced in 2002.
Due to the significant improvement in 2002 operating results, the Company was
able to utilize its entire net operating loss carry forward from calendar
years 2001 and 2000. Due to a change in the composition of the Company's
investment portfolio, tax-exempt interest has declined from $4,922,000 in 2000
to $4,314,000 in 2001 and $4,119,000 in 2002. The income tax benefit for 2000
reflects a $470,000 benefit from the elimination of an accrual that had been
carried for potential tax examination adjustments and $775,000 of expense
associated with required changes in the tax accounting methods used to
recognize audit-based premiums and installment premiums.
On November 26, 2002, President Bush signed into law the Terrorism Risk
Insurance Act of 2002 ("TRIA"). TRIA provides a Federal backstop on losses
from certified terrorism events from foreign sources and is effective until
December 31, 2004, with a one-year optional extension. Coverage includes most
direct commercial lines of business, including coverage for losses from
nuclear, biological, and chemical weapons. Each insurer has a deductible
amount, which is calculated as a percentage of the prior year's direct earned
premiums, and a ten percent retention. The percentage used in the deductible
calculation increases from seven percent in 2003 to ten percent in 2004 and,
if extended, to fifteen percent in 2005. TRIA caps losses at $100 billion
annually, after which there is no coverage beyond the deductible. Terrorism
exclusions in effect on direct policies in the covered lines of business were
nullified upon passage of TRIA and, as provided for under TRIA, the Company
was required to contact all of its commercial policyholders and inform them of
the premium amount for acts of terrorism coverage. Management views this
legislation as being favorable to both the Company and the industry. Though
it is still too early to know what impact TRIA will have, it is anticipated
that it will assist the industry in providing reasonably priced coverage for
terrorist events in both the insurance and reinsurance markets. For the
Company, the TRIA deductible will be approximately $13,000,000 in 2003. The
March 1, 2003 renewal of Employers Mutual's reinsurance coverage for terrorism
claims saw a broadening of coverage with limits corresponding to the TRIA
deductible (approximately $55,000,000 for the EMC Insurance Companies). The
contract terms provide for 70 percent coverage of $45,000,000 of terrorism
losses in excess of $10,000,000, with an occurrence limit of $23,500,000.
Coverage now includes all commercial lines of business losses from both
certified and non-certified terrorist events, and nuclear, biological and
chemical weapons.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Losses from mold related claims continue to hamper the insurance industry
as a whole, but are not considered to be significant exposures to the Company.
The Company is using exclusionary endorsements and sub-limits to control mold
losses. In addition, an improved understanding of these types of claims has
resulted in prompt attention to water damage losses.
In response to the declining interest rate environment, Employers Mutual
has changed several key assumptions utilized in the preparation of the
actuarial valuation reports for its pension and postretirement benefit plans
during the last several years. Key assumption changes include a reduction in
the discount rate from 7.75 percent in 2000 to 7.0 percent in 2001 and 6.5
percent in 2002 and a reduction in the assumed long-term rate of return on
plan assets from 8.5 percent in 2000 and 2001 to 8.0 percent in 2002. In
addition, due to the continued escalation in the price of prescription drugs,
the assumed health care cost trend rate utilized in the postretirement benefit
plan valuation report was increased from 9 percent to 12 percent in 2002. As
a result of these assumption changes, and a decline in the market value of the
pension plan assets, the funded status of these plans has declined over the
last three years.
At December 31, 2002, the pension plan's unfunded accumulated benefit
obligation (equal to the accumulated benefit obligation minus the fair value
of the plan's assets) exceeded the accrued pension liability carried in the
financial statements, necessitating the establishment of an additional minimum
liability. When an additional minimum liability is established, an intangible
asset is recognized equal to the lesser of the additional minimum liability or
the plan's unrecognized prior service costs. At December 31, 2002, the plan's
unrecognized prior service cost was less than the additional minimum
liability. The difference between the additional minimum liability and the
intangible asset is reflected in stockholders' equity as other comprehensive
loss, net of deferred income tax benefits.
Pension liabilities reflected in the Company's financial statements
totaled $2,488,000 (including $1,701,000 of additional minimum liability) at
December 31, 2002 and $570,000 at December 31, 2001. At December 31, 2002,
the Company's financial statements also reflect an intangible asset associated
with the pension plan of $1,411,000, resulting in $290,000 of other
comprehensive loss. Postretirement benefit liabilities reflected in the
Company's financial statements totaled $7,527,000 and $6,967,000 at December
31, 2002 and 2001, respectively.
The assumption changes noted above have also resulted in an increase in
the expenses associated with these retirement plans. Pension expense amounted
to $1,406,000, $1,060,000 and $691,000 in 2002, 2001 and 2000, respectively,
and is expected to increase approximately 55 percent in 2003. Postretirement
benefit expense amounted to $1,487,000, $1,214,000 and $1,138,000 in 2002,
2001 and 2000, respectively, and is expected to increase approximately 34
percent in 2003.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Prior to 2002, the Company had concluded that it was not subject to the
accounting requirements of Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations, since
it receives the current fair value for any common stock issued under Employers
Mutual's stock option plans. As a result, the Company was recognizing as
compensation expense its pool participation share of the stock option expense
recorded by Employers Mutual for these plans. During 2002, the Company
concluded that it is subject to the accounting requirements of APB 25 and,
accordingly, should not be recognizing compensation expense from Employers
Mutual's stock option plans since the exercise price of the options is equal
to the fair value of the stock at the date of grant. Accordingly, during 2002
the Company reversed the accrual for stock option expense allocated to it by
Employers Mutual, resulting in $349,000 of pre-tax income. Pre-tax
compensation expense recognized in the Company's financial statements for the
years 2001 and 2000 amounted to $355,000 and $67,000, respectively. Since
these amounts are not material, the financial statements for those years have
not been restated.
As previously noted, the Company currently has $36,000,000 of
surplus notes issued to Employers Mutual. In December of 2001, three of the
Company's property and casualty insurance subsidiaries issued an aggregate of
$25,000,000 of surplus notes with an interest rate of 5.38 percent to
Employers Mutual. On June 27, 2002, the Company's reinsurance subsidiary
issued $11,000,000 of surplus notes with an interest rate of 5.25 percent to
Employers Mutual. These surplus notes were issued in response to statutory
capital adequacy concerns raised by certain rating agencies because the
statutory surplus position of the Company's insurance and reinsurance
subsidiaries had declined over the last three years due to unfavorable
operating results and the payment of dividends to the parent company. It
should be noted that surplus notes are considered to be a component of surplus
for statutory reporting purposes because the notes have no maturity date and
all payments of interest and principal must be approved in advance by the
insurance commissioner of the state of domicile of the issuing insurance
company; however, under generally accepted accounting principals, surplus
notes are considered to be debt and are reported as a liability in the
Company's financial statements.
Effective January 1, 2001, the Company began recording the full-term
written premium and related commission expense at the inception of insurance
policies that are billed on an installment basis. Previously, such amounts
were recorded as each installment became due. As a result, written premiums
and unearned premiums increased $13,884,000, invested assets increased
$11,881,000 and the Company incurred $1,706,000 of commission expense and
$297,000 of premium tax expense. These expenses were offset by a $3,054,000
increase in deferred policy acquisition costs, resulting in $1,051,000 of non-
recurring income.
The operating results reported for 2000 include earnings of $1,517,000
associated with a change in the property and casualty insurance segment's
estimate of additional premium income expected on policies, primarily workers'
compensation, subject to audit. This change in estimate was prompted by
additional research that was conducted in connection with a required change in
the tax accounting method used for recognizing audit-based premiums.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three years ended December 31, 2002 are as follows:
($ in thousands) 2002 2001 2000
-------- -------- --------
Premiums earned .......................... $225,013 $203,393 $184,986
Losses and settlement expenses ........... 156,152 168,344 149,519
Acquisition and other expenses ........... 72,483 61,877 57,748
-------- -------- --------
Underwriting loss ........................ (3,622) (26,828) (22,281)
Net investment income .................... 23,517 22,458 20,788
Realized (losses) gains .................. (2,154) 681 1,242
Interest expense ......................... (1,345) (11) -
Other income (expense) ................... (3) (51) 286
-------- -------- --------
Income (loss) before income taxes ........ $ 16,393 $ (3,751) $ 35
======== ======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $151,507 $167,152 $152,360
Increase (decrease) in the provision
for insured events of prior years .... 4,645 1,192 (2,841)
-------- -------- --------
Total losses and settlement expenses $156,152 $168,344 $149,519
======== ======== ========
Catastrophe and storm losses ............. $ 8,055 $ 15,813 $ 7,945
======== ======== ========
Premiums earned increased 10.6 percent in 2002, 10.0 percent in 2001 and
10.6 percent in 2000, primarily as a result of rate increases that were
implemented during the last three years. Premium rate levels for property and
casualty insurance improved during 2002 as average rate level increases
ranging from five to eighteen percent were implemented in most lines of
business. Premium rate increases have grown progressively larger during the
last three years as a result of the industry's movement toward premium rate
adequacy; however, this trend is not expected to continue in 2003 as the
Company's premium rate levels for most lines of business are now considered to
be at, or near, adequate levels. The Company does expect to implement
additional rate increases during 2003, but they will generally be smaller than
those implemented in 2002 and will likely be targeted toward specific
territories and lines of business. It should be noted that it takes a
considerable amount of time for implemented rate increases to have a
noticeable impact on underwriting results due to the timing of policy renewals
and the fact that premiums are earned ratably over the terms of the underlying
policies. Due to this delay, premiums earned in 2003 are expected to continue
to show strong growth as the rate increases obtained in 2002 become earned.
In addition to the rate increases noted above, the growth in premium income
for 2001 and 2000 reflects an increase in the exposure base of the commercial
lines of business, which resulted from an improved retention rate on renewal
business and a steady amount of new business. The premium income amount for
2000 also includes $1,727,000 of income associated with a change in the
estimate of the amount of additional premium income expected on policies,
primarily workers' compensation, subject to audit.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Losses and settlement expenses decreased 7.2 percent in 2002 after
increasing 12.6 percent in 2001 and 6.4 percent in 2000. The primary factor
contributing to this improvement was a significant decline in catastrophe and
storm losses from the unusually large amount experienced during storm plagued
2001. Other factors contributing to this improvement include more stringent
underwriting standards, a substantial decline in loss frequency and a decline
in large losses. Offsetting these improvements were an increase in overall
loss severity and a second consecutive year of adverse development on prior
years' reserves. The adverse development reported for 2002 includes
$2,069,000 of additional asbestos reserves established in response to the
findings of an independent study conducted on the Company's asbestos
exposures. Additional factors contributing to the increase in adverse
development for 2002 include a strengthening of IBNR reserves, adverse
development reported by involuntary pool associations and the establishment of
reserves associated with Employers Mutual's new contingent salary plan and
other bonus plans. The property and casualty insurance subsidiaries have
historically experienced favorable development in their reserves and reserving
practices have not changes; however, the amount of development experienced
will fluctuate from year to year as individual claims are settled and
additional information becomes available on open claims.
Acquisition and other expenses increased 17.1 percent in 2002, 7.2
percent in 2001 and 8.3 percent in 2000, primarily due to the increase in
premium income noted above. The large increase for 2002 also reflects an
increase in contingent commission expense and policyholder dividends as a
result of the improved underwriting results. The increase for 2001 includes
$688,000 of estimated guaranty fund assessments stemming from the Reliance
Insurance Company insolvency, but was limited by the increase in deferred
policy acquisition costs associated with the change in the recording of
installment-based policies.
Underwriting results improved dramatically in 2002 when compared to
recent years. This improvement is attributed to a significant increase in
overall premium rate adequacy, the implementation of more stringent
underwriting standards, a significant decline in catastrophe and storm losses
and a substantial decrease in loss frequency. The improvements that have been
achieved in premium rate adequacy will continue to have an increasingly
positive impact on future operating results, but the unpredictable nature of
catastrophe and storm losses will remain. Underwriting for profitability is
always stressed, but has become even more critical in light of the declining
stock markets and the low interest rate environment. Both new and renewal
business is being closely scrutinized to ensure that there is potential for an
underwriting profit.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Reinsurance
Operating results for the three years ended December 31, 2002 are as follows:
($ in thousands) 2002 2001 2000
-------- -------- --------
Premiums earned ............................ $ 72,030 $ 61,887 $ 46,473
Losses and settlement expenses ............. 50,906 53,575 40,003
Acquisition and other expenses ............. 23,150 18,374 13,653
-------- -------- --------
Underwriting loss .......................... (2,026) (10,062) (7,183)
Net investment income ...................... 9,147 8,318 7,873
Realized (losses) gains .................... (1,010) 119 315
Interest expense ........................... (294) - -
Other income ............................... - 78 80
-------- -------- --------
Operating income (loss) before income taxes $ 5,817 $ (1,547) $ 1,085
======== ======== ========
Incurred losses and settlement expenses:
Insured events of the current year ....... $ 48,553 $ 49,600 $ 39,065
Increase in the provision for insured
events of prior years .................. 2,353 3,975 938
-------- -------- --------
Total losses and settlement expenses $ 50,906 $ 53,575 $ 40,003
======== ======== ========
Catastrophe losses ......................... $ 249 $ 7,134 $ 659
======== ======== ========
Premiums earned increased 16.4 percent in 2002, 33.2 percent in 2001 and
6.1 percent in 2000. The increase for 2002 is attributed to rate increases
implemented during the January 2002 renewal season, increased participation in
a reinsurance pool and growth in a marine syndicate account; however, this
increase was tempered by the recognition in 2001 of approximately $2,001,000
of reinstatement premiums associated with the World Trade Center catastrophe
and an increase of approximately $1,350,000 in the estimate of earned but not
reported premiums. During 2002, the estimate of reinstatement premiums
associated with the World Trade Center catastrophe was reduced by
approximately $677,000 (reflecting a decrease in Employers Mutual's estimate
of the loss), and the estimate of earned but not reported premiums was reduced
by approximately $1,085,000 due to the loss of several accounts and the
voluntary withdrawal from Israeli proportional business. The Company lost
several accounts in 2002 due to the 2001 decline in Employers Mutual's A.M.
Best rating from "A" (Excellent) to "A-" (Excellent) and a decline in
Employers Mutual's surplus level at December 31, 2001. Some of the lost
business was replaced by several new working layer programs, which typically
have smaller profit margins but offer greater loss predictability. In
addition to the amounts recorded for reinstatement premiums and earned but not
reported premiums, the large increase for 2001 reflects the addition of
several new contracts (including a large marine syndicate account), growth in
the exposure base of existing contracts and modest rate increases. The
increase for 2000 reflects growth in the exposure base of existing contracts
and the addition of several new contracts.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Large premium rate increases have been common since the September 2001
terrorist attack on the World Trade Center. During 2002, significant rate
increases were placed on excess of loss contracts, and both excess of loss
contracts and pro-rata contracts benefited from industry-wide rate increases
being implemented at the primary company level. This escalating rate
environment attracted an influx of new capital into the reinsurance
marketplace during 2002. As a result, premium rate increases moderated during
the January 2003 renewal season. The only exception was for contracts with
poor loss experience, which received exceptionally large rate increases.
Losses and settlement expenses decreased 5.0 percent in 2002 after
increasing 33.9 percent in 2001 and 9.9 percent in 2000. The decrease for
2002 is primarily the result of a significant decline in catastrophe losses
from the elevated level experienced in 2001, which included Midwest wind and
hail storms, flood losses from tropical storm Allison, surety bond losses
associated with the Enron bankruptcy, and losses from the terrorist attack on
the World Trade Center. The improved results of 2002 also reflect more
favorable weather conditions and decreased casualty losses. The reinsurance
subsidiary has experienced adverse development on prior years' reserves for
the last three years. The majority of the development for 2002 and 2001 is
attributed to a reinsurance pool that has experienced a high level of
construction defect claims on an account that was discontinued on December 31,
1999. The adverse development reported for 2000 was primarily associated with
reserves established for 1999 European storms. Results for 2000 also reflect
an increase in loss severity on several aggregate treaties and property
contracts, and an increase in loss frequency in the workers' compensation line
of business.
Acquisition and other expenses increased 26.0 percent in 2002, 34.6
percent in 2001 and 1.5 percent in 2000, primarily as a result of the increase
in premium income noted above. The amounts reported for 2002 also reflect an
increase in contingent commission expense that resulted from good loss
experience on certain reinsurance contracts and $379,000 of commission expense
associated with increased participation in the reinsurance pool noted above.
The relatively small increase for 2000 is attributed to two transactions that
produced an $824,000 decline in contingent commission expense. The first
transaction was the receipt of $420,000 of profit share commission income
associated with the outside reinsurance protection that the reinsurance
subsidiary pays for to protect Employers Mutual from catastrophic losses on
its assumed book of business. The second transaction was a $404,000 decline
in contingent commission expense that was recognized by a reinsurance pool
that the reinsurance subsidiary participates in.
The improvement in the underwriting results of the reinsurance segment
for 2002 is primarily attributed to improved rate adequacy, lower catastrophe
losses, a decline in the amount of adverse development experienced on prior
years' reserves and a decline in casualty losses. The reinsurance subsidiary
was able to implement significant rate increases in 2002, which, when coupled
with increased retentions and coverage exclusions, helped push premium rates
to near adequate levels at year-end. Premium rate level increases are
expected to moderate in 2003; however, underwriting results will continue to
benefit from the large increases in rates and changes in terms implemented in
2002, as well as from continued improvement in premium rates on the underlying
direct insurance business. In addition to pricing its reinsurance premiums at
more adequate rates, Employers Mutual continues to work toward improving
profitability on the assumed book of business by accepting larger shares of
coverage on desirable programs, utilizing relationships with reinsurance
intermediaries and monitoring exposures.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Parent Company
The parent company reported operating losses before income taxes of
$323,000, $244,000 and $56,000 in 2002, 2001 and 2000, respectively. The
decrease in operating results is primarily due to a decline in investment
income, which is attributed to a decrease in both interest rates and the
average invested asset balance beginning in 2001.
LOSS AND SETTLEMENT EXPENSE RESERVES
Loss and settlement expense reserves are the Company's largest liability.
Management continually reviews these reserves using a variety of statistical
and actuarial techniques to analyze claim costs, frequency and severity data,
and social and economic factors. Significant periods of time may elapse
between the occurrence of an insured loss, the reporting of the loss and the
settlement of the loss. During the loss settlement period, additional facts
regarding individual claims become known, and accordingly, it often becomes
necessary to refine and adjust the estimates of liability on a claim. Such
changes in estimates are reflected in operating results in the year the
changes are recorded.
The Company does not have a significant amount of exposure to asbestos
and environmental claims. Total reserves for asbestos and environmental
related claims, including the additional $2,069,000 established in response to
the recently completed study of the Company's asbestos exposures, amounted to
$5,527,000 at December 31, 2002. Approximately $1,368,000 of these reserves
are attributed to the reinsurance business assumed by the Company's
reinsurance subsidiary, with the remaining $4,159,000 attributed to the direct
insurance business written by the parties to the pooling agreement.
LIQUIDITY AND INVESTMENTS
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. At December 31, 2002, approximately 50 percent of the Company's fixed
maturity securities were in government or government agency issued securities.
A variety of maturities are maintained in the Company's portfolio to assure
adequate liquidity. The maturity structure of the fixed maturity investments
is also established by the relative attractiveness of yields on short,
intermediate and long-term securities. The Company does not invest in any
high-yield debt investments (commonly referred to as junk bonds.)
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
Despite this intent, the Company has historically classified a portion of its
fixed maturity investments as available-for-sale securities to provide
flexibility in the management of the portfolio. During the last three years,
all newly acquired fixed maturity investments have been classified as
available-for-sale securities to provide increased management flexibility.
The Company had unrealized holding gains, net of deferred taxes, on fixed
maturity securities available-for-sale totaling $16,907,000, $4,494,000 and
$3,107,000 at December 31, 2002, 2001 and 2000, respectively. The fluctuation
in the market value of these investments is primarily due to changes in the
interest rate environment during this time period. 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 its portfolio as changing conditions warrant.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of investment
income that supplements underwriting results and contributes to net earnings.
As these investments mature, or are called, 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.
The Company participates 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,
primarily cash, equal to 102 percent of the market value of the loaned
securities. At December 31, 2002, the securities lending program was
temporarily suspended to eliminate financial ratio concerns expressed by
certain regulatory authorities. This program will be continued, but will be
temporarily suspended at each subsequent year-end.
During 2002, the Company invested a net $2,077,000 into minor ownership
interests in limited partnerships and limited liability companies. The
Company does not hold any other non-traded securities.
During 2000, the Company sold approximately $14,000,000 of investments in
tax-exempt fixed maturity securities and reinvested the proceeds in taxable
fixed maturity securities.
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, interest and principal payments on debt, and investment purchases.
The Company generated positive cash flows from operations of $58,573,000
in 2002, $47,087,000 in 2001 and $21,519,000 in 2000. The amount for 2001
includes $11,881,000 received from Employers Mutual in connection with a
change in the recording of written premiums and commissions on policies billed
on an installment basis.
Employers Mutual reinvested 25 percent of its dividends in additional
shares of the Company's common stock during 2002. Prior to 2002, Employers
Mutual was reinvesting 100 percent of its dividends in additional shares of
the Company's common stock. For the first quarter of 2003, Employers Mutual
increased its dividend reinvestment percentage to 50 percent. As a result of
this dividend reinvestment activity, the Company expects to become an 80
percent owned subsidiary of Employers Mutual in 2003. At that time the
Company will begin filing a consolidated tax return with Employers Mutual and
its subsidiaries. Employers Mutual has indicated that it may continue to
participate in the dividend reinvestment plan in the future; however, its
reinvestment percentage will likely be reduced to a level necessary to
maintain the 80 percent ownership threshold.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Investment Impairments and Considerations
At December 31, 2002, the Company had one fixed maturity security, MCI
Communications Corporation, that was determined to be "other than temporarily"
impaired. MCI Communications Corporation is owned by WorldCom Inc., whose
corporate bonds were downgraded to junk status in May 2002 when it reported
the detection of accounting irregularities. The MCI bonds are supported by
the assets of MCI; however, the magnitude of the WorldCom collapse cast doubt
on the prospect of collecting the entire amount of principal and interest
payments due the Company. As a result, on June 30, 2002 the Company
recognized $3,821,000 of realized loss when the carrying value of this
investment was reduced from an aggregate book value of $5,604,000 to the
current fair value of $1,783,000. The factors surrounding this "other than
temporary" impairment did not have any impact on the carrying value of any
other investments held by the Company. At December 31, 2002, the fair value
of the MCI bonds had partially recovered, resulting in $1,035,000 of pre-tax
unrealized gains.
At December 31, 2002, the Company had unrealized losses on held-to-
maturity and available-for-sale securities as presented in the table below.
The estimated fair value is based on quoted market prices, where available, or
on values obtained from independent pricing services. None of these
securities are considered to be in concentrations by either security type or
industry. The Company uses several factors to determine whether the carrying
value of an individual security has been impaired. Such factors include, but
are not limited to, the security's value and performance in the context of the
overall market, key corporate events and collateralization of fixed maturity
securities. Based on these factors, and the Company's ability and intent to
hold these securities until maturity, it was determined that the carrying
value of these securities was not impaired at December 31, 2002. Risks and
uncertainties inherent in the methodology utilized in this evaluation process
include interest rate risk, equity price risk and the overall performance of
the economy, all of which have the potential to adversely affect the value of
the Company's investments. Should a determination be made at some point in
the future that these unrealized losses are "other than temporary", the
Company's earnings would be reduced by approximately $6,072,000, net of tax;
however, the Company's financial position would not be affected due to the
fact that unrealized losses on available-for-sale securities are reflected in
the Company's financial statements as a component of stockholders' equity, net
of deferred taxes.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Gross
unrealized
losses
----------
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities and obligations of U.S.
government corporations and agencies .............$ -
Mortgage-backed securities ......................... -
----------
Total securities held-to-maturity .............. -
----------
Securities available-for-sale:
Fixed maturity securities:
U.S. treasury securities and obligations of U.S.
government corporations and agencies ............. 6,934
Obligations of states and political subdivisions ... 15,640
Mortgage-backed securities ......................... -
Debt securities issued by foreign governments ...... -
Public utilities ................................... 303,457
Corporate securities ............................... 3,695,933
----------
Total fixed maturity securities ................ 4,021,964
----------
Equity securities:
Common stocks ...................................... 5,277,079
Non-redeemable preferred stocks .................... 42,000
----------
Total equity securities ........................ 5,319,079
----------
Total securities available-for-sale ............ 9,341,043
----------
Total all securities ...........................$9,341,043
==========
Following is a schedule of the length of time securities have
continuously been in an unrealized loss position. Note that this is
calculated on the basis of the fair value of the securities at the end of
quarterly financial reporting periods.
Gross
Book Fair unrealized
value value loss
----------- ----------- -----------
Fixed maturity securities
available-for-sale:
Three months or less ...............$53,543,537 $53,187,557 $ 355,980
Over three months to six months .... - - -
Over six months to nine months ..... - - -
Over nine months to twelve months .. - - -
Over twelve months ................. 29,653,259 25,987,275 3,665,984
----------- ----------- -----------
$83,196,796 $79,174,832 $ 4,021,964
=========== =========== ===========
Equity securities:
Three months or less ...............$ 8,265,899 $ 7,483,847 $ 782,052
Over three months to six months .... 7,162,094 6,017,498 1,144,596
Over six months to nine months ..... 9,663,726 7,013,635 2,650,091
Over nine months to twelve months .. 2,503,725 1,910,943 592,782
Over twelve months ................. 2,165,280 2,015,722 149,558
----------- ----------- -----------
$29,760,724 $24,441,645 $ 5,319,079
=========== =========== ===========
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Following is a schedule of the maturity dates of fixed maturity
securities with unrealized losses at December 31, 2002. Note that this
schedule includes only fixed maturity securities available-for-sale, as the
Company does not have any fixed maturity securities held-to-maturity with
unrealized losses.
Gross
Book Fair unrealized
value value loss
----------- ----------- -----------
Due in one year or less ................$44,969,470 $44,962,537 $ 6,933
Due after one year through five years .. - - -
Due after five years through ten years . 4,959,434 3,727,645 1,231,789
Due after ten years .................... 33,267,892 30,484,650 2,783,242
----------- ----------- -----------
$83,196,796 $79,174,832 $ 4,021,964
=========== =========== ===========
Following is a schedule of fixed maturity securities available-for-sale
that are non-investment grade and have unrealized losses at December 31, 2002.
As previously noted, the Company does not invest in junk bonds. The non-
investment grade securities held by the Company are the result of rating
downgrades that occurred subsequent to their purchase. The percentages
displayed are of the fair values of these securities to the total fair value
of fixed maturity securities available-for-sale, and of the unrealized losses
on these securities to the total gross unrealized losses on fixed maturity
securities available-for-sale. This schedule does not include fixed maturity
securities held-to-maturity due to the fact that none of these securities have
unrealized losses or are below investment grade at December 31, 2002. This
schedule also does not include the Company's MCI bonds, which carry a Moody's
Bond Rating of CA, due to the fact that these bonds were written-down to their
fair value in the second quarter of 2002 and have since partially recovered,
resulting in unrealized gains of $1,035,000 as of December 31, 2002. Although
the fair value of the American Airlines and United Airlines bonds are
relatively low in relation to their book values and are classified as non-
investment grade, these bonds are collateralized by aircraft with an appraised
value sufficient to recover the Company's investment. Based on this
collateralization and the Company's ability and intent to hold these
securities to maturity, these securities were not considered to be impaired
at December 31, 2002.
Percent Percent
Moody's of of gross
bond Carrying Unrealized market unrealized
rating value Loss value losses
------ ---------- ---------- ------ ----------
US West Communications .. BA $4,235,000 $ 397,487 0.9% 9.9%
American Airlines ....... BA $2,513,181 $1,115,175 0.5% 27.7%
United Airlines ......... BA $ 791,825 $1,171,929 0.2% 29.1%
---------- ---------- ------ ----------
$7,540,006 $2,684,591 1.6% 66.7%
========== ========== ====== ==========
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Following is a schedule of gross realized losses recognized in 2002 along
with the associated book values and sales prices aged according to the length
of time the underlying securities were in an unrealized loss position. This
schedule only includes realized losses from common stock disposals, as there
were no realized losses recognized from disposals of preferred stocks or fixed
maturity securities (an insignificant amount of losses were recognized on
fixed maturity securities as a result of corporate actions such as calls, pay-
downs, redemptions, etc.). The Company's equity portfolio is managed on a
"tax-aware" basis, which generally results in sales of securities at a loss to
offset sales of securities at a gain, thus minimizing the Company's income tax
expense. Fixed maturity securities are generally held until maturity.
Gross
Book Sales realized
value price loss
----------- ----------- -----------
90 days or less in unrealized loss .....$ 4,870,141 $ 3,912,673 $ 957,468
Over 90 to 180 days in unrealized loss . 8,703,374 5,708,373 2,995,001
Over 180 to 270 days in unrealized loss 2,008,110 1,198,588 809,522
Over 270 to 365 days in unrealized loss 166,979 104,031 62,948
Over 365 days in unrealized loss ....... 240,258 122,046 118,212
----------- ----------- -----------
$15,988,862 $11,045,711 $ 4,943,151
=========== =========== ===========
MARKET RISK
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective 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 December
31, 2002 would result in a corresponding pre-tax decrease in the fair value of
the fixed maturity portfolio of approximately $25,608,000, or 4.4 percent. In
addition, a hypothetical one percent decrease in interest rates at December
31, 2002 would result in a corresponding decrease in pre-tax income over the
next twelve months of approximately $1,101,000, 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 Company's fixed maturity
portfolio at December 31, 2002 was 4.05 years.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 have been
consistently higher over longer time frames. The Company invests in a
diversified portfolio of readily marketable equity securities. A hypothetical
10 percent decrease in the S&P 500 index as of December 31, 2002 would result
in a corresponding pre-tax decrease in the fair value of the Company's equity
portfolio of approximately $2,963,000.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At December 31, 2002, the portfolio of long-
term fixed maturity securities consists of 15.7 percent U.S. Treasury, 13.4
percent government agency, 3.2 percent mortgage-backed, 14.8 percent
municipal, and 52.9 percent corporate securities. At December 31, 2001, the
portfolio of long-term fixed maturity securities consisted of 8.3 percent U.S.
Treasury, 7.3 percent government agency, 6.8 percent mortgage-backed, 15.7
percent municipal, and 61.9 percent corporate securities.
Fixed maturity securities held by the Company generally have an
investment quality rating of "A" or better by independent rating agencies.
The following table shows the composition of the Company's fixed maturity
securities, by rating, as of December 31, 2002.
Securities Securities
held-to-maturity available-for-sale
(at amortized cost) (at fair value)
--------------------- ---------------------
Amount Percent Amount Percent
------------ ------- ------------ -------
Rating:
AAA ..................... $ 55,033,675 100.0% $180,346,751 37.1%
AA ...................... - - 99,711,104 20.5
A ....................... - - 144,304,899 29.7
BAA ..................... - - 51,135,706 10.5
BA ...................... - - 7,540,006 1.6
CA ...................... - - 2,817,500 .6
------------ ------- ------------ -------
Total fixed maturities $ 55,033,675 100.0% $485,855,966 100.0%
============ ======= ============ =======
Ratings for preferred stocks and fixed maturity securities with initial
maturities greater than one year are assigned by Moody's Investor's Services,
Inc. Moody's rating process seeks to evaluate the quality of a security by
examining the factors that affect returns to investors. Moody's ratings are
based on quantitative and qualitative factors, as well as the economic, social
and political environment in which the issuing entity exists. The
quantitative factors include debt coverage, sales and income growth, cash
flows and liquidity ratios. Qualitative factors include management quality,
access to capital markets and the quality of earnings and balance sheet items.
Ratings for securities with initial maturities less than one year are based on
an evaluation of the underlying assets or the credit rating of the issuer's
parent company.
Prepayment risk refers to the changes in prepayment patterns that can
shorten or lengthen the expected timing of 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 December 31, 2002, the effective duration of the mortgage-
backed securities is 0.2 years with an average life and current yield of 1.2
years and 7.6 percent, respectively. At December 31, 2001, the effective
duration of the mortgage-backed securities was 2.6 years with an average life
and current yield of 4.6 years and 7.3 percent, respectively.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
CAPITAL RESOURCES
Insurance company operations require capital to support premium writings.
The Company believes that its insurance company subsidiaries have sufficient
capital to support their expected premium writings in 2003 after the issuance
of the $36,000,000 of surplus notes to Employers Mutual.
As previously noted, all payments of interest and principal on the
surplus notes must be approved in advance by the insurance commissioner of the
state of domicile of the respective insurance company. Interest payments are
due January 1 of each year and, like the principal amount of the notes, can
only be paid out of surplus earnings of the respective companies. At December
31, 2002, the Company's subsidiaries had received approval for the payment of
interest accrued on their surplus notes during 2001 and 2002.
The National Association of Insurance Commissioners (NAIC) maintains
certain risk-based capital standards for property and casualty insurance
companies. Risk-based capital requirements attempt to measure minimum
statutory capital needs based upon the risks in a company's mix of products
and investment portfolio. At December 31, 2002, the Company's insurance
subsidiaries had total adjusted statutory capital of $140,324,000, which is
well in excess of the minimum risk-based capital requirement of $35,866,000.
A major source of cash flows for the Company is dividend payments from
its insurance subsidiaries. State insurance regulations restrict the maximum
amount of dividends insurance companies can pay without prior regulatory
approval. See note 6 of Notes to Consolidated Financial Statements for
additional information regarding dividend restrictions. The Company received
$6,250,000, $5,525,000 and $6,375,000 of dividends from its insurance
subsidiaries and paid cash dividends to its stockholders totaling $6,828,000,
$6,787,000 and $6,771,000 in 2002, 2001 and 2000, respectively.
As of December 31, 2002, the Company had no material commitments for
capital expenditures.
IMPACT OF INFLATION
Inflation has a widespread effect on the Company's results of operations,
primarily through increased losses and settlement expenses. The Company
considers inflation, including social inflation that reflects an increasingly
litigious society and increasing jury awards, when setting reserve amounts.
Premiums are also affected by inflation, although they are often restricted or
delayed by competition and the regulatory rate-setting environment.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which is effective for
fiscal years ending after December 31, 2002. SFAS 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation, and the effect of the method used on
reported results. The Company has adopted the disclosure requirements of SFAS
148 and elected to continue to follow the recognition and measurement
principles of APB 25.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In July 2001, the FASB issued SFAS No. 141, "Business Combinations", and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and establishes specific criteria for the recognition of
intangible assets separately from goodwill. SFAS 142 addresses accounting
for intangible assets, eliminates the amortization of goodwill and provides
specific steps for testing the impairment of goodwill. SFAS 142 was
effective for fiscal years beginning after December 15, 2001; however, the
amortization provisions apply to goodwill and intangible assets acquired after
June 30, 2001. Other than the requirement to eliminate the amortization of
the Company's carried goodwill, which amounted to $135,000 per year, adoption
of these statements did not have an impact on the operating results of the
Company.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which is effective for fiscal
years beginning after December 15, 2001. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS 144 requires that one accounting model be
used for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions. Adoption of this statement
did not have any effect on the operating results of the Company.
DEVELOPMENTS IN INSURANCE REGULATION
In 1998, in a move to provide a consistent and comprehensive basis of
statutory accounting for all insurance companies, the NAIC adopted a
comprehensive Codification of Statutory Accounting Principles (Codification).
Codification became effective in most states, including the states of domicile
of the Company's insurance subsidiaries, on January 1, 2001, and replaced the
then current Accounting Practices and Procedures Manual as the NAIC's primary
guidance on statutory accounting. The adoption of Codification resulted in
changes to the accounting practices that the Company's insurance subsidiaries
were using to prepare their statutory financial statements. One of the more
significant changes was the recording of deferred income taxes. As a result
of the adoption of Codification, the statutory surplus of the Company's
insurance subsidiaries increased by approximately $9,110,000 on January 1,
2001.
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; rate competition; changes in interest rates and the performance
of financial markets; the adequacy of loss and settlement expense reserves,
including asbestos and environmental claims; terrorist activities and federal
solutions to make available insurance coverage for acts of terrorism; timely
collection of amounts due under ceded reinsurance contracts; rating agency
actions; and other risks and uncertainties inherent in the Company's business.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>7
<FILENAME>exhibit13c.txt
<DESCRIPTION>CONSOLIDATED FINANCIAL STATEMENTS
<TEXT>
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. EXHIBIT 13(c)
- ------------------------------------------- -------------
Management's Responsibility for Financial Reporting
The management of EMC Insurance Group Inc. and Subsidiaries is
responsible for the preparation, integrity and objectivity of the accompanying
financial statements, as well as other financial information in this report.
The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and include amounts that
are based on management's estimates and judgments where necessary.
The Company's financial statements have been audited by Ernst & Young
LLP, independent certified public accountants. Management has made available
to Ernst & Young LLP all of the Company's financial records and related data,
as well as the minutes of the stockholders' and directors' meetings.
Furthermore, management believes that all representations made to Ernst &
Young LLP during its audit were valid and appropriate. Their report appears
elsewhere in this annual report.
Management of the Company has established and continues to maintain a
system of internal controls that are designed to provide assurance as to the
integrity and reliability of the financial statements, the protection of
assets from unauthorized use or disposition, and the prevention and detection
of fraudulent financial reporting. The system of internal controls provides
for appropriate division of responsibility. Certain aspects of these systems
and controls are tested periodically by the Company's internal auditors.
Management considers the recommendations of its internal auditors and the
independent auditors concerning the Company's internal controls and takes the
necessary actions that are cost-effective in the circumstances to respond
appropriately to the recommendations presented. Management believes that as
of December 31, 2002, the Company's system of internal controls was adequate
to accomplish the above objectives.
The Audit Committee of the Board of Directors, composed solely of outside
directors, met during the year with management and the independent auditors to
review and discuss audit findings and other financial and accounting matters.
The independent auditors and the internal auditors have free access to the
Audit Committee, with and without management present, to discuss the results
of their audit work.
/s/ Bruce G. Kelley /s/ Mark E. Reese
- ----------------------- -----------------------
Bruce G. Kelley Mark E. Reese
President and Vice President and
Chief Executive Officer Chief Financial Officer
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
EMC Insurance Group Inc.
We have audited the accompanying consolidated balance sheets of EMC
Insurance Group Inc. and Subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows of EMC Insurance Group Inc. and
Subsidiaries for the year ended December 31, 2000 were audited by other
auditors whose report dated February 27, 2001 expressed an unqualified opinion
on those statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the 2002 and 2001 financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of EMC Insurance Group Inc. and Subsidiaries at December 31, 2002 and 2001 and
the consolidated results of their operations and their cash flows for the
years then ended, in conformity with accounting principles generally accepted
in the United States.
/s/Ernst & Young LLP
February 25, 2003
Des Moines, Iowa
<PAGE>
Report of KPMG LLP, Independent Auditors
The Board of Directors and Stockholders
EMC Insurance Group Inc.:
We have audited the accompanying consolidated statements of income,
comprehensive income, stockholders' equity and cash flows of EMC Insurance
Group Inc. and Subsidiaries for the year ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audits in accordance with auditing standards generally
accepted in The United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of EMC Insurance Group Inc. and Subsidiaries for the year ended December
31, 2000, in conformity with accounting principles generally accepted in The
United States of America.
/s/ KPMG LLP
Des Moines, Iowa
February 27, 2001
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2002 2001
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $61,639,037 and $35,502,755) ..... $ 55,033,675 $ 33,572,602
Securities available-for-sale, at fair value
(amortized cost $459,844,928 and $384,410,393) 485,855,966 390,214,177
Fixed maturity securities on loan:
Securities held-to-maturity, at amortized cost
(fair value $0 and $35,962,133) ............. - 32,505,305
Securities available-for-sale, at fair value
(amortized cost $0 and $27,325,968) ......... - 28,436,008
Equity securities available-for-sale, at fair
value (cost $38,444,030 and $28,686,321) ...... 34,596,985 33,322,767
Other long-term investments, at cost ............ 3,057,000 -
Short-term investments, at cost ................. 29,650,230 17,724,458
------------ ------------
Total investments ........................... 608,193,856 535,775,317
Balances resulting from related party transactions
with Employers Mutual:
Reinsurance receivables ...................... 11,582,136 14,501,336
Prepaid reinsurance premiums ................. 2,442,899 2,275,231
Intangible asset, defined benefit
retirement plan ............................ 1,411,716 -
Other assets ................................. 1,331,816 1,170,655
Cash .............................................. (119,097) 558,073
Accrued investment income ......................... 9,179,555 8,659,008
Accounts receivable (net of allowance for
uncollectible accounts of $7,297 and $573,502) .. 772,944 1,081,024
Income taxes recoverable .......................... 213,504 100,614
Deferred policy acquisition costs ................. 24,926,861 21,363,528
Deferred income taxes ............................. 13,986,172 18,328,807
Goodwill, at cost less accumulated amortization
of $2,616,234 and $2,616,234 .................... 941,586 941,586
Securities lending collateral ..................... - 66,809,518
------------ ------------
Total assets ............................... $674,863,948 $671,564,697
============ ============
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2002 2001
------------ ------------
LIABILITIES
Balances resulting from related party transactions
with Employers Mutual:
Losses and settlement expenses .............. $331,226,753 $314,518,588
Unearned premiums ........................... 115,746,814 99,382,176
Other policyholders' funds .................. 1,035,622 472,952
Surplus notes payable ....................... 36,000,000 25,000,000
Indebtedness to related party ............... 3,304,539 2,684,418
Employee retirement plans ................... 10,014,349 6,967,484
Other liabilities ........................... 19,767,507 15,271,938
Securities lending obligation ..................... - 66,809,518
------------ ------------
Total liabilities ......................... 517,095,584 531,107,074
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value,
authorized 20,000,000 shares;
issued and outstanding, 11,399,050 shares
in 2002 and 11,329,987 shares in 2001 ........... 11,399,050 11,329,987
Additional paid-in capital ........................ 67,270,591 66,013,203
Accumulated other comprehensive income ............ 14,218,330 7,507,672
Retained earnings ................................. 64,880,393 55,606,761
------------ ------------
Total stockholders' equity .................. 157,768,364 140,457,623
------------ ------------
Total liabilities and stockholders' equity .. $674,863,948 $671,564,697
============ ============
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
All balances presented below, with the exception of investment income,
realized investment (losses) gains and income tax expense (benefit), are the
result of related party transactions with Employers Mutual.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
REVENUES
Premiums earned .................... $297,043,033 $265,279,858 $231,458,442
Investment income, net ............. 32,778,133 30,969,630 29,006,316
Realized investment (losses) gains (3,159,201) 800,582 1,557,870
Other income ....................... 865,819 774,169 1,473,113
------------ ------------ ------------
327,527,784 297,824,239 263,495,741
------------ ------------ ------------
LOSSES AND EXPENSES
Losses and settlement expenses ..... 207,057,856 221,918,750 189,521,674
Dividends to policyholders ......... 2,977,154 1,823,970 1,632,961
Amortization of deferred
policy acquisition costs ......... 65,727,016 55,687,015 51,288,479
Other underwriting expenses ........ 26,928,972 22,739,913 18,479,492
Interest expense ................... 1,638,716 11,055 -
Other expenses ..................... 1,306,034 1,185,415 1,508,523
------------ ------------ ------------
305,635,748 303,366,118 262,431,129
------------ ------------ ------------
Income (loss) before income
tax expense (benefit) ...... 21,892,036 (5,541,879) 1,064,612
------------ ------------ ------------
INCOME TAX EXPENSE (BENEFIT)
Current .......................... 5,061,093 (142,405) (307,677)
Deferred ......................... 729,205 (3,293,342) (956,742)
5,790,298 (3,435,747) (1,264,419)
------------ ------------ ------------
Net income (loss) ............ $ 16,101,738 $ (2,106,132) $ 2,329,031
============ ============ ============
Net income (loss) per common share
- basic and diluted .............. $ 1.42 $ (.19) $ .21
============ ============ ============
Average number of shares outstanding
- basic and diluted .............. 11,375,779 11,312,063 11,284,885
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Net income (loss) .................. $ 16,101,738 $ (2,106,132) $ 2,329,031
------------ ------------ ------------
OTHER COMPREHENSIVE INCOME
Unrealized holding gains
arising during the period,
before deferred income tax
expense ........................ 7,454,522 1,645,082 15,872,363
Deferred income tax expense ...... 2,609,079 682,629 4,164,014
------------ ------------ ------------
4,845,443 962,453 11,708,349
------------ ------------ ------------
Reclassification adjustment for
losses (gains) included in net
income (loss), before income
tax (benefit) expense .......... 3,159,201 (779,540) (1,562,372)
Income tax (benefit) expense ..... (1,105,720) 272,839 531,206
------------ ------------ ------------
2,053,481 (506,701) (1,031,166)
------------ ------------ ------------
Adjustment for minimum pension
liability ...................... (289,639) - -
Deferred income tax benefit ...... (101,373) - -
------------ ------------ ------------
(188,266) - -
------------ ------------ ------------
Other comprehensive income ... 6,710,658 455,752 10,677,183
------------ ------------ ------------
Total comprehensive income
(loss) ..................... $ 22,812,396 $ (1,650,380) $ 13,006,214
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Year ended December 31,
------------ ------------ ------------
2002 2001 2000
------------ ------------ ------------
COMMON STOCK
Beginning of year .................. $ 11,329,987 $ 11,294,220 $ 11,265,232
Issuance of common stock through
stock option plans ............... 69,063 35,767 28,988
------------ ------------ ------------
End of year ........................ 11,399,050 11,329,987 11,294,220
------------ ------------ ------------
ADDITIONAL PAID-IN CAPITAL
Beginning of year .................. 66,013,203 65,546,963 65,333,686
Issuance of common stock through
stock option plans ............... 1,257,388 466,240 213,277
------------ ------------ ------------
End of year ........................ 67,270,591 66,013,203 65,546,963
------------ ------------ ------------
ACCUMULATED OTHER COMPREHENSIVE
INCOME
Beginning of year .................. 7,507,672 7,051,920 (3,625,263)
Minimum pension liability .......... (188,266) - -
Unrealized gains on
available-for-sale securities .... 6,898,924 455,752 10,677,183
------------ ------------ ------------
End of year ........................ 14,218,330 7,507,672 7,051,920
------------ ------------ ------------
RETAINED EARNINGS
Beginning of year .................. 55,606,761 64,500,213 68,942,622
Net income (loss) .................. 16,101,738 (2,106,132) 2,329,031
Cash dividends on common stock
($.60 per share in 2002, 2001 and
2000) ............................ (6,828,106) (6,787,320) (6,771,440)
------------ ------------ ------------
End of year ........................ 64,880,393 55,606,761 64,500,213
------------ ------------ ------------
Total stockholders' equity ....... $157,768,364 $140,457,623 $148,393,316
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................... $16,101,738 $(2,106,132) $ 2,329,031
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Balances resulting from related
party transactions with
Employers Mutual:
Losses and settlement
expenses .................. 16,708,165 28,029,560 19,975,004
Unearned premiums ........... 16,364,638 13,822,959 8,687,285
Other policyholders' funds .. 562,670 (255,701) (364,601)
Indebtedness of related party 620,121 6,484,089 (7,686,230)
Employee retirement plans ... 2,475,961 118,972 80,293
Reinsurance receivables ..... 2,919,200 (2,575,981) (795,990)
Prepaid reinsurance premiums (167,668) (330,132) (664,535)
Amortization of deferred
income .................... - (78,212) (80,619)
Deferred policy acquisition costs (3,563,333) (5,726,775) (2,017,561)
Accrued investment income ....... (520,547) (1,313,645) (458,424)
Accrued income taxes:
Current ....................... (112,890) 635,297 801,089
Deferred ...................... 729,205 (3,293,342) (956,742)
Realized investment losses
(gains) ....................... 3,159,201 (800,582) (1,557,870)
Accounts receivable ............. 308,084 (807,010) 3,019,523
Other, net ...................... 2,988,881 3,403,024 1,209,447
----------- ----------- -----------
42,471,688 37,312,521 19,190,069
Balances resulting from related
party transactions with
Employers Mutual:
Cash provided by the property
and casualty insurance
subsidiaries' change in
recording of full-term
premium amount on policies
billed on an installment
basis ....................... - 11,880,803 -
----------- ----------- -----------
Net cash provided by
operating activities .... $58,573,426 $47,087,192 $21,519,100
----------- ----------- -----------
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities of fixed maturity
securities held-to-maturity .... $ 11,074,685 $ 49,692,313 $ 11,529,551
Purchases of fixed maturity
securities available-for-sale .. (231,511,754) (166,403,259) (52,060,772)
Disposals of fixed maturity
securities available-for-sale .. 180,717,143 44,693,688 27,499,407
Purchases of equity securities
available-for-sale ............. (43,930,432) (26,769,001) (23,203,788)
Disposals of equity securities
available-for-sale ............. 33,884,190 27,388,659 23,451,046
Purchase of other long-term
investments .................... (4,057,004) - -
Disposals of other long-term
investments .................... 1,000,004 - -
Net (purchases) sales of
short-term investments ......... (11,925,773) 5,663,568 (3,223,821)
------------ ------------ ------------
Net cash used in investing
activities ............. (64,748,941) (65,734,032) (16,008,377)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Balances resulting from related
party transactions with
Employers Mutual:
Issuance of common stock ..... 1,326,451 502,007 242,265
Dividends paid to
Employers Mutual ........... (5,423,042) (5,275,938) (5,013,592)
Issuance of surplus notes .... 11,000,000 25,000,000 -
Dividends paid to stockholders ... (1,405,064) (1,511,382) (1,757,848)
------------ ------------ ------------
Net cash provided (used) in
financing activities .... 5,498,345 18,714,687 (6,529,175)
------------ ------------ ------------
Net (decrease) increase in cash .... (677,170) 67,847 (1,018,452)
Cash at beginning of year .......... 558,073 490,226 1,508,678
------------ ------------ ------------
Cash at end of year ................ $ (119,097) $ 558,073 $ 490,226
============ ============ ============
Income taxes paid (recovered) ...... $ 4,755,010 $ (778,316) $ (1,108,766)
Interest paid (received) ........... $ 19,232 $ (79,232) $ (23,722)
See accompanying Notes to Consolidated Financial Statements
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
EMC Insurance Group Inc., a 79.9 percent owned subsidiary of Employers
Mutual Casualty Company (Employers Mutual), is an insurance holding company
with operations in property and casualty insurance and reinsurance. Both
commercial and personal lines of insurance are written, with a focus on
medium-sized commercial accounts. About one-half of the premiums written are
in Iowa and contiguous states. 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 subsidiaries include EMCASCO Insurance Company, Illinois
EMCASCO Insurance Company, Dakota Fire Insurance Company, Farm and City
Insurance Company, EMC Reinsurance Company and EMC Underwriters, LLC.
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States (GAAP), which
differ in some respects from those followed in reports to insurance regulatory
authorities. All significant inter-company balances and transactions have
been eliminated.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
differ from those estimates.
Property and Casualty Insurance and Reinsurance Operations
Property and casualty insurance premiums are recognized as revenue
ratably over the terms of the respective policies. Unearned premiums are
calculated on the daily pro rata method. Both domestic and foreign assumed
reinsurance premiums are recognized as revenues ratably over the terms of the
contract period. Amounts paid as ceded reinsurance premiums are reported as
prepaid reinsurance premiums and amortized over the remaining contract period
in proportion to the amount of reinsurance protection provided. Reinsurance
reinstatement premiums are recognized in the same period as the loss event
that gave rise to the reinstatement premiums.
Certain costs of acquiring new business, principally commissions, premium
taxes and other underwriting expenses that vary with and are directly related
to the production of business have been deferred. Such deferred costs are
being amortized as premium revenue is recognized. The method followed in
computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value, which gives effect to the premium
to be earned, related investment income, losses and settlement expenses and
certain other costs expected to be incurred as the premium is earned.
Certain commercial lines of business, primarily workers' compensation,
are eligible for policyholder dividends in accordance with provisions of the
underlying insurance policies. Net written premiums subject to policyholder
dividends represented approximately 49 percent of the Company's total net
written premiums in 2002. Policyholder dividends are accrued over the terms
of the underlying policies.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Liabilities for losses are based upon case-basis estimates of reported
losses, estimates of unreported losses based upon prior experience adjusted
for current trends, and estimates of losses expected to be paid under assumed
reinsurance contracts. Liabilities for settlement expenses are provided by
estimating expenses expected to be incurred in settling the claims provided
for in the loss reserves. Changes in estimates are reflected in current
operating results (see note 4).
Ceded reinsurance amounts with nonaffiliated reinsurers relating to
reinsurance receivables for paid and unpaid losses and settlement expenses and
prepaid reinsurance are reported on the balance sheet on a gross basis.
Amounts ceded to Employers Mutual relating to the affiliated reinsurance
pooling agreement (see note 2) have not been grossed up because the contracts
provide that receivables and payables may be offset upon settlement.
The liabilities for losses and settlement expenses are considered
adequate to cover the ultimate net cost of losses and claims incurred to date.
Since the provisions are necessarily based on estimates, the ultimate
liability may be more or less than such provisions.
Investments
Securities classified as held-to-maturity are purchased with the intent
and ability to be held to maturity and are carried at amortized cost.
Unrealized holding gains and losses on securities held-to-maturity are not
reflected in the financial statements. All other securities have been
classified as securities available-for-sale and are carried at fair value,
with unrealized holding gains and losses reported as accumulated other
comprehensive income in stockholders' equity, net of deferred income taxes.
Other long-term investments represent minor ownership interests in limited
partnerships and limited liability companies and are carried at cost. Short-
term investments represent money market funds and are carried at cost.
The Company's carrying value for investments is reduced to its estimated
realizable value if a decline in the fair value is deemed "other than
temporary." Such reductions in carrying value are recognized as realized
losses and are charged to income. Premiums and discounts on debt securities
are amortized over the life of the security as an adjustment to yield using
the effective interest method. Realized gains and losses on disposition of
investments are included in net income. The cost of investments sold is
determined on the specific identification method using the highest cost basis
first. Included in investments at December 31, 2002 and 2001 are securities
on deposit with various regulatory authorities as required by law amounting to
$12,648,887 and $12,448,310, respectively.
The Company participates in a securities lending program whereby certain
fixed maturity securities from the investment portfolio are loaned to other
institutions for a short period of time. The Company requires initial
collateral equal to 102 percent of the market value of the loaned securities.
The collateral is invested by the lending agent, in accordance with the
Company's guidelines, and generates fee income for the Company that is
recognized ratably over the time period the security is on loan. The
securities on loan to others are segregated from the other invested assets on
the Company's balance sheet. In accordance with the relevant accounting
literature, the collateral held by the Company is accounted for as a secured
borrowing and is recorded as an asset on the Company's balance sheet with a
corresponding liability reflecting the Company's obligation to return this
collateral upon the return of the loaned securities. The securities lending
program was temporarily suspended at December 31, 2002 to eliminate financial
ratio concerns expressed by certain regulatory authorities.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Income Taxes
The Company files a consolidated Federal income tax return with its
subsidiaries. Consolidated income taxes/benefits are allocated among the
entities based upon separate tax liabilities. The Company expects to become
an 80 percent owned subsidiary of Employers Mutual in 2003. At that time the
Company will begin filing a consolidated tax return with Employers Mutual and
its subsidiaries.
Deferred income taxes are provided for temporary differences between the
tax basis of assets and liabilities and the reported amounts of those assets
and liabilities for financial reporting purposes. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Income tax expense provisions increase or decrease in
the same period in which a change in tax rates is enacted. A valuation
allowance is established to reduce deferred tax assets to their net realizable
value if it is "more likely than not" that a tax benefit will not be realized.
Stock Based Compensation
The Company has no stock based compensation plans of its own; however,
Employers Mutual has several stock plans that utilize the common stock of the
Company. The Company receives the current fair value for any shares issued
under these plans. Under the terms of the pooling agreement (see note 2),
stock option expense is allocated to the Company as determined on a statutory
basis of accounting; however, for these GAAP basis financial statements the
Company accounts for the stock option plans using the intrinsic value method
of accounting as prescribed by Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Under the provisions of APB 25, no compensation expense is recognized from the
operation of Employers Mutual's stock option plans since the exercise price of
the options is equal to the fair value of the stock on the date of grant.
Prior to 2002, the Company had concluded that it was not subject to the
accounting requirements of APB 25 since it receives the current fair value for
any common stock issued under Employers Mutual's stock option plans. As a
result, the Company was recognizing as compensation expense its pool
participation share of the stock option expense recorded by Employers Mutual
for these plans. During 2002, the Company concluded that it is subject to the
accounting requirements of APB 25 and, accordingly, should not be recognizing
compensation expense from Employers Mutual's stock option plans as discussed
above. Accordingly, during 2002 the Company reversed the accrual for stock
option expense allocated to it by Employers Mutual, resulting in $349,273 of
pre-tax income. Pre-tax compensation expense recognized in the Company's
financial statements for the years 2001 and 2000 amounted to $354,703 and
$66,943, respectively. Since these amounts are not material, the financial
statements for those years have not been restated.
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which is effective for
fiscal years ending after December 15, 2002. SFAS 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation, and the effect of the method used on
reported results. The Company has adopted the disclosure requirements of SFAS
148 and elected to continue to follow the recognition and measurement
principles of APB 25.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table illustrates the effect on net income (loss) and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS 123 to Employers Mutual's stock option plans:
2002 2001 2000
----------- ----------- ----------
Net income (loss), as reported $16,101,738 $(2,106,132) $2,329,031
Add: Compensation expense
recognized in net income (loss) - 230,557 44,182
Deduct: Total stock-based
employee compensation expense
determined under fair value
method for all awards, net of
related tax effects .......... 18,992 16,287 14,410
----------- ----------- ----------
Pro forma net income (loss) .... $16,082,746 $(1,891,862) $2,358,803
=========== =========== ==========
Net income (loss) per share:
Basic and diluted - As reported $1.42 $(0.19) $0.21
Basic and diluted - Pro forma $1.41 $(0.17) $0.21
The weighted average fair value of options granted amounted to $3.28,
$1.59 and $.83 for 2002, 2001 and 2000, respectively. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-
pricing model with the following weighted-average assumptions used for the
grants:
2002 2001 2000
------ ------ ------
Dividend yield .......................... 3.28% 5.22% 6.49%
Expected volatility ..................... .218 .215 .159
Risk-free interest rate ................. 4.37% 4.78% 6.14%
Expected life (years) ................... 5 5 5
Net Income (loss) Per Share - Basic and Diluted
The Company's basic and diluted net income (loss) per share are computed
by dividing net income (loss) by the weighted average number of common shares
outstanding during each year. As previously noted, the Company receives the
current fair value for any shares issued under Employers Mutual's stock plans.
As a result, the Company had no potential common shares outstanding during
2002, 2001 and 2000 that would have been dilutive to net income (loss) per
share.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Goodwill
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets." SFAS 142 eliminated the amortization of
goodwill, which represents the excess of cost over the fair value of net
assets acquired subsidiaries, and provides specific steps for testing the
impairment of goodwill. The initial adoption of SFAS 142 did not have an
impact on the operating results of the Company. The annual impairment test
was completed inthe fourth quarter of 2002 and goodwill was not deemed to be
impaired.
Prior to January 1, 2002, goodwill was being amortized on a straight-line
basis over 25 years. The Company reviewed the recoverability of the
unamortized balance of goodwill on a periodic basis using projected cash
flows. Goodwill amortization expense amounted to approximately $135,000
($87,000 after tax) per year. Due to the immaterial amounts involved, the
Company has not presented prior year net income or earnings per share
information that has been adjusted to exclude this expense.
Reclassifications
Certain amounts previously reported in prior years' consolidated
financial statements have been reclassified to conform to current year
presentation.
2. AFFILIATION AND TRANSACTIONS WITH AFFILIATES
Property and Casualty Insurance 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. The aggregate
participation of the Company's property and casualty insurance subsidiaries is
23.5 percent. 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 pooling agreement is continuous, but may be amended or
terminated at the end of any calendar year as to any one or more parties.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Reinsurance Subsidiary
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 investment
and income tax activities of the reinsurance subsidiary are not subject to the
quota share agreement.
Premiums assumed by the reinsurance subsidiary from Employers Mutual
amounted to $76,203,278, $66,287,442 and $47,530,111 in 2002, 2001 and 2000,
respectively. It is customary in the reinsurance business for the assuming
company to compensate the ceding company for the acquisition expenses incurred
in the generation of the business. Commissions paid by the reinsurance
subsidiary to Employers Mutual amounted to $18,117,058, $15,892,684 and
$10,795,106 in 2002, 2001 and 2000, respectively.
The reinsurance subsidiary pays an annual override commission to
Employers Mutual in connection with the $1,500,000 cap on losses assumed per
event. Total override commission paid to Employers Mutual amounted to
$3,429,148, $2,982,935 and $2,138,855 in 2002, 2001 and 2000, respectively.
Employers Mutual retained losses and settlement expenses under this agreement
totaling $1,186,598 in 2002, $14,442,561 in 2001 and $373,847 in 2000. The
reinsurance subsidiary also pays for 100 percent of the outside reinsurance
protection Employers Mutual purchases to protect itself from catastrophic
losses on the assumed reinsurance business, excluding reinstatement premiums.
This cost is recorded as a reduction to the premiums received by the
reinsurance subsidiary and amounted to $3,247,969, $2,495,794 and $2,122,248
in 2002, 2001 and 2000, respectively.
Services Provided by Employers Mutual
Employers Mutual provides various services to all of its subsidiaries and
affiliates. Such services include data processing, claims, financial,
actuarial, auditing, marketing and underwriting. Employers Mutual allocates a
portion of the cost of these services to the subsidiaries that do not
participate in the pooling agreement based upon a number of criteria,
including usage and number of transactions. The remaining costs are charged
to the pooling agreement and each pool participant shares in the total cost in
accordance with its pool participation percentage. Costs allocated to the
Company by Employers Mutual for services provided to the holding company and
its subsidiaries that do not participate in the pooling agreement amounted to
$1,765,179, $2,040,822 and $1,674,704 in 2002, 2001 and 2000, respectively.
Costs allocated to the Company through the operation of the pooling agreement
amounted to $56,897,066, $51,041,812 and $46,796,784 in 2002, 2001 and 2000,
respectively.
Investment expenses are based on actual expenses incurred by the Company
plus an allocation of other investment expenses incurred by Employers Mutual,
which is based on a weighted average of total invested assets and number of
investment transactions. Investment expenses allocated to the Company by
Employers Mutual amounted to $559,136, $494,142 and $462,068 in 2002, 2001 and
2000, respectively.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. REINSURANCE
The parties to the pooling agreement cede insurance business to other
insurers in the ordinary course of business for the purpose of limiting their
maximum loss exposure through diversification of their risks. In its
consolidated financial statements, the Company treats risks to the extent they
are reinsured as though they were risks for which the Company is not liable.
Insurance ceded by the pool participants does not relieve their primary
liability as the originating insurers. Employers Mutual evaluates the
financial condition of the reinsurers of the parties to the pooling agreement
and monitors concentrations of credit risk arising from similar geographic
regions, activities or economic characteristics of the reinsurers to minimize
exposure to significant losses from reinsurer insolvencies.
As of December 31, 2002, reinsurance ceded to two nonaffiliated
reinsurers aggregated $5,800,768, which represents a significant portion of
the total prepaid reinsurance premiums and reinsurance receivables for losses
and settlement expenses. These amounts reflect the property and casualty
insurance subsidiaries' pool participation percentage of amounts ceded by
Employers Mutual to these organizations in connection with its role as
"service carrier". Under these arrangements, Employers Mutual writes business
for these organizations on a direct basis and then cedes 100 percent of this
business to these organizations. Credit risk associated with these amounts is
minimal, as all companies participating in these organizations are responsible
for the liabilities of such organizations on a pro rata basis.
The effect of reinsurance on premiums written and earned, and losses and
settlement expenses incurred, for the three years ended December 31, 2002 is
presented below.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Premiums written
Direct ......................... $235,596,547 $272,027,823 $249,896,499
Assumed from nonaffiliates ..... 3,985,370 1,898,509 1,220,442
Assumed from affiliates
(note 11) .................... 320,940,551 299,990,245 244,762,032
Ceded to nonaffiliates ......... (11,089,041) (11,189,227) (8,347,822)
Ceded to affiliates ............ (235,596,547) (272,027,823) (249,896,499)
------------ ------------ ------------
Net premiums written ......... $313,836,880 $290,699,527 $237,634,652
============ ============ ============
Premiums earned
Direct ......................... $241,939,466 $255,764,274 $245,078,165
Assumed from nonaffiliates ..... 3,501,616 1,786,132 1,194,835
Assumed from affiliates ........ 304,462,790 274,352,821 237,946,894
Ceded to nonaffiliates ......... (10,921,373) (10,859,095) (7,683,287)
Ceded to affiliates ............ (241,939,466) (255,764,274) (245,078,165)
------------ ------------ ------------
Net premiums earned .......... $297,043,033 $265,279,858 $231,458,442
============ ============ ============
Losses and settlement expenses
incurred
Direct ......................... $165,218,514 $221,314,633 $208,604,970
Assumed from nonaffiliates ..... 2,876,808 1,336,824 400,360
Assumed from affiliates ........ 206,614,356 227,650,959 194,017,734
Ceded to nonaffiliates ......... (2,433,308) (7,069,033) (4,896,420)
Ceded to affiliates ............ (165,218,514) (221,314,633) (208,604,970)
------------ ------------ ------------
Net losses and settlement
expenses incurred .......... $207,057,856 $221,918,750 $189,521,674
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
4. LIABILITY FOR LOSSES AND SETTLEMENT EXPENSES
The following table sets forth a reconciliation of beginning and ending
reserves for losses and settlement expenses of the Company. Amounts presented
are on a net basis, with a reconciliation of beginning and ending reserves to
the gross amounts presented in the consolidated financial statements.
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Gross reserves at beginning of year $314,518,588 $286,489,028 $266,514,024
Ceded reserves at beginning of year (11,848,597) (11,224,797) (10,260,815)
------------ ------------ ------------
Net reserves at beginning of year .. 302,669,991 275,264,231 256,253,209
------------ ------------ ------------
Incurred losses and
settlement expenses
Provision for insured events
of the current year ............ 200,059,798 216,752,003 191,425,036
Increase (decrease) in provision
for insured events of prior
years .......................... 6,998,058 5,166,747 (1,903,362)
------------ ------------ ------------
Total incurred losses and
settlement expenses ...... 207,057,856 221,918,750 189,521,674
------------ ------------ ------------
Payments
Losses and settlement expenses
attributable to insured events
of the current year ............ 81,124,276 94,983,112 82,912,082
Losses and settlement expenses
attributable to insured events
of prior years ................. 107,744,442 99,529,878 87,598,570
------------ ------------ ------------
Total payments ............. 188,868,718 194,512,990 170,510,652
------------ ------------ ------------
Net reserves at end of year ........ 320,859,129 302,669,991 275,264,231
Ceded reserves at end of year ...... 10,367,624 11,848,597 11,224,797
------------ ------------ ------------
Gross reserves at end of year ...... $331,226,753 $314,518,588 $286,489,028
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Underwriting results of the Company are significantly influenced by
estimates of loss and settlement expense reserves. Changes in reserve
estimates are reflected in operating results in the year such changes are
recorded. The Company experienced adverse development on prior years'
reserves in both the property and casualty insurance segment and the
reinsurance segment during 2002, which contributed to the increase in losses
and settlement expenses. For the property and casualty insurance segment, the
December 31, 2002 estimate of loss and settlement expense reserves for
accident years 2001 and prior increased $4,645,194 from the estimate at
December 31, 2001. This increase represents 2.1% of the December 31, 2001
carried reserves and is primarily attributable to three sources: direct IBNR
reserves, involuntary pools and contingent salary plan reserves. With regard
to direct IBNR reserves, the methodology utilized to establish these reserves
assumes consistency in claims reporting patterns. However, in recent years
emerged IBNR losses have increased as a percentage of earned premiums. As a
result of these actuarial indications, the Company strengthened direct IBNR
reserves by $3,564,000 in 2002, $1,697,000 of which was allocated to accident
years 2001 and prior. In addition, the Company established $2,068,705 of
additional IBNR asbestos reserves at December 31, 2002 based on the results of
a recently completed study of the Company's asbestos exposures, all of which
was allocated to accident years 2001 and prior. As previously noted, the
Company books the reserves reported by the management of the involuntary pools
and in 2002 these bookings resulted in modest upward development of $353,000.
Finally, Employers Mutual implemented a contingent salary plan in 2002 and
$376,000 of the reserve established for this plan at December 31, 2002 was
allocated to settlement expenses for accident years 2001 and prior.
For the reinsurance segment, the December 31, 2002 estimate of loss and
settlement expense reserves for accident years 2001 and prior increased
$2,352,864 from the estimate at December 31, 2001. This increase represents
2.6% of the December 31, 2001 carried reserves. Virtually all of the increase
arose from the MRB pool, for which the Company books the reserves established
and reported by the pool. The carried MRB reserves at December 31, 2001 were
above the midpoint of the actuarial range of estimates. However, reported
losses and settlement expenses during pool year 2002 exceeded by approximately
$1,249,792 the amounts predicted by the actuarial analysis. In addition,
management of the MRB pool increased the IBNR reserves for prior years by
$345,800. Finally, the losses and settlement expenses reported during January
2002 exceeded by $762,000 the IBNR reserve established at December 31, 2001 to
cover the one-month reporting lag.
The Company has historically experienced favorable development in its
reserves and its reserving practices have not changed; however, the amount of
development experienced will fluctuate from year to year as individual claims
are settled and new information becomes available on open claims.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS
The Company has exposure to asbestos and environmental related claims
associated with the insurance business written by the parties to the pooling
agreement and the reinsurance business assumed from Employers Mutual by the
reinsurance subsidiary. These exposures are not considered to be significant.
Asbestos and environmental losses paid by the Company have averaged only
$219,000 per year over the past five years. During 2002, the Company re-
evaluated the estimated ultimate losses for direct asbestos and environmental
exposures. Based on this re-evaluation, the Company reallocated $752,000 of
bulk IBNR reserves and $324,303 of settlement expense reserves to these
exposures. In addition, the Company took a proactive approach to evaluate the
adequacy of its asbestos reserves and commissioned a "ground-up" study to
better quantify its exposure to asbestos liabilities. This study concluded
that the Company's exposure for direct asbestos claims ranged from $1,000,000
to $5,100,000, with a point estimate of $3,000,000. Based on this study, the
Company elected to increase the IBNR reserves carried for direct asbestos
exposures by $2,068,705 at December 31, 2002, to $2,985,402. The study and
its results assume no improvement in the current asbestos litigation
environment; however, federal legislation currently being considered could
reduce the ultimate losses from asbestos litigation below the levels currently
being projected for the industry. Reserves for asbestos and environmental
related claims for direct insurance and assumed reinsurance business totaled
$5,526,943 and $2,565,515 at December 31, 2002 and 2001, respectively.
Estimating loss and settlement expense reserves for asbestos and
environmental claims is very difficult due to the many uncertainties
surrounding these types of claims. These uncertainties exist because the
assignment of responsibility varies widely by state and claims often emerge
long after the policy has expired, which makes assignment of damages to the
appropriate party and to the time period covered by a particular policy
difficult. In establishing reserves for these types of claims, management
monitors the relevant facts concerning each claim, the current status of the
legal environment, the social and political conditions, and the claim history
and trends within the Company and the industry.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
6. STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The Company's insurance subsidiaries are required to file financial
statements with state regulatory authorities. The accounting principles used
to prepare these statutory financial statements follow prescribed or permitted
accounting practices that differ from GAAP. Prescribed statutory accounting
principles include state laws, regulations and general administrative rules
issued by the state of domicile as well as a variety of publications and
manuals of the National Association of Insurance Commissioners (NAIC).
Permitted accounting practices encompass all accounting practices not
prescribed, but allowed by the state of domicile. The Company's insurance
subsidiaries had no permitted accounting practices during 2002, 2001 and 2000.
Statutory surplus of the Company's insurance subsidiaries was
$140,323,534 and $128,735,605 at December 31, 2002 and 2001, respectively.
Statutory net income (loss) of the Company's insurance subsidiaries was
$13,729,028, ($8,289,542) and ($1,599,085) for 2002, 2001 and 2000,
respectively.
The NAIC utilizes a risk-based capital model to help state regulators
assess the capital adequacy of insurance companies and identify insurers that
are in, or are perceived as approaching, financial difficulty. This model
establishes minimum capital needs based on the risks applicable to the
operations of the individual insurer. The risk-based capital requirements for
property and casualty insurance companies measure three major areas of risk:
asset risk, credit risk and underwriting risk. Companies having less
statutory surplus than required by the risk-based capital requirements are
subject to varying degrees of regulatory scrutiny and intervention, depending
on the severity of the inadequacy. At December 31, 2002, the Company's
insurance subsidiaries had total adjusted statutory capital of $140,323,534,
which is well in excess of the minimum risk-based capital requirement of
$35,865,587.
Retained earnings of the Company's insurance subsidiaries available for
distribution as dividends are limited by law to the statutory unassigned
surplus of each of the subsidiaries as of the previous December 31, as
determined in accordance with accounting practices prescribed by insurance
regulatory authorities of the state of domicile of each subsidiary. Subject
to this limitation, the maximum dividend that may be paid within a 12 month
period without prior approval of the insurance regulatory authorities is
restricted to the greater of 10 percent of statutory surplus as regards
policyholders as of the preceding December 31, or net income of the preceding
calendar year on a statutory basis. At December 31, 2002, $16,784,451 was
available for distribution to the Company in 2003 without prior approval.
In 1998, the NAIC adopted a comprehensive Codification of Statutory
Accounting Principles (Codification) to replace the Accounting Practices and
Procedures Manual as the NAIC's primary guidance on statutory accounting.
Codification is intended to provide a consistent and comprehensive basis of
statutory accounting for all insurance companies and became effective in most
states, including the states of domicile of the Company's insurance
subsidiaries, on January 1, 2001. The adoption of Codification resulted in
changes to the accounting practices that the Company's insurance subsidiaries
use to prepare their statutory financial statements. One of the more
significant changes was the recording of deferred income taxes. As a result
of the adoption of Codification, the statutory surplus of the Company's
insurance subsidiaries increased by approximately $9,110,000 on January 1,
2001.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. SEGMENT INFORMATION
The Company's operations consist of a property and casualty insurance
segment and a reinsurance segment. The property and casualty insurance
segment writes both commercial and personal lines of insurance, with a focus
on medium sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are managed
separately due to differences in the insurance products sold and the business
environment in which they operate. The accounting policies of the segments
are described in note 1, Summary of Significant Accounting Policies.
Summarized financial information for the Company's segments is as
follows:
Property
Year ended and casualty Parent
December 31, 2002 insurance Reinsurance company Consolidated
- ----------------- ------------ ------------ ------------ ------------
Premiums earned ......... $225,013,076 $ 72,029,957 $ - $297,043,033
Underwriting loss ....... (3,621,656) (2,026,309) - (5,647,965)
Net investment income ... 23,517,163 9,147,127 113,843 32,778,133
Realized (losses) gains (2,154,246) (1,010,268) 5,313 (3,159,201)
Interest expense ........ (1,345,153) (293,563) - (1,638,716)
Other income ............ 865,819 - - 865,819
Other expenses .......... (869,346) - (436,688) (1,306,034)
------------ ------------ ------------ ------------
Income (loss) before
income tax expense
(benefit) ........... $ 16,392,581 $ 5,816,987 $ (317,532)$ 21,892,036
============ ============ ============ ============
Assets .................. $490,583,702 $181,401,782 $158,010,734 $829,996,218
Eliminations ............ - - (154,552,425)(154,552,425)
Reclassifications ....... - (579,845) - (579,845)
------------ ------------ ------------ ------------
Net assets ......... $490,583,702 $180,821,937 $ 3,458,309 $674,863,948
============ ============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Property
Year ended and casualty Parent
December 31, 2001 insurance Reinsurance company Consolidated
- ----------------- ------------ ------------ ------------ ------------
Premiums earned ......... $203,392,845 $ 61,887,013 $ - $265,279,858
Underwriting loss ....... (26,828,133) (10,061,657) - (36,889,790)
Net investment income ... 22,457,799 8,317,505 194,326 30,969,630
Realized gains .......... 681,349 119,233 - 800,582
Interest expense ........ (11,055) - - (11,055)
Other income ............ 695,957 78,212 - 774,169
Other expenses .......... (746,728) - (438,687) (1,185,415)
------------ ------------ ------------ ------------
Loss before income
tax benefit ......... $ (3,750,811)$ (1,546,707)$ (244,361)$ (5,541,879)
============ ============ ============ ============
Assets .................. $514,376,179 $157,360,388 $140,659,584 $812,396,151
Eliminations ............ - - (137,738,931)(137,738,931)
Reclassifications........ - (3,092,523) - (3,092,523)
------------ ------------ ------------ ------------
Net assets ......... $514,376,179 $154,267,865 $ 2,920,653 $671,564,697
============ ============ ============ ============
Year ended
December 31, 2000
- -----------------
Premiums earned ......... $184,985,620 $ 46,472,822 $ - $231,458,442
Underwriting loss ....... (22,280,746) (7,183,418) - (29,464,164)
Net investment income ... 20,787,679 7,873,040 345,597 29,006,316
Realized gains .......... 1,242,233 315,101 536 1,557,870
Other income ............ 1,392,494 80,619 - 1,473,113
Other expenses .......... (1,106,996) - (401,527) (1,508,523)
------------ ------------ ------------ ------------
Income (loss) before
income tax (benefit)
expense ............. $ 34,664 $ 1,085,342 $ (55,394)$ 1,064,612
============ ============ ============ ============
8. INVESTMENTS
Investments of the Company's insurance subsidiaries are subject to the
insurance laws of the state of their incorporation. These laws prescribe the
kind, quality and concentration of investments that may be made by insurance
companies. In general, these laws permit investments, within specified limits
and subject to certain qualifications, in federal, state and municipal
obligations, corporate bonds, preferred and common stocks and real estate
mortgages. The Company believes that it is in compliance with these laws.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The amortized cost and estimated fair value of securities
held-to-maturity and available-for-sale as of December 31, 2002 and 2001 are
as follows. The estimated fair value is based on quoted market prices, where
available, or on values obtained from independent pricing services.
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ------------ ------------
December 31, 2002
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 49,956,691 $ 6,190,424 $ - $ 56,147,115
Mortgage-backed
securities ........... 5,076,984 414,938 - 5,491,922
------------ ----------- ----------- ------------
Total securities
held-to-maturity $ 55,033,675 $ 6,605,362 $ - $ 61,639,037
============ =========== =========== ============
Securities available-for-
sale:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $110,033,485 $ 1,354,496 $ (6,934)$111,381,047
Obligations of states
and political
subdivisions ......... 81,425,249 5,706,479 (15,640) 87,116,088
Mortgage-backed
securities ........... 12,594,103 1,047,853 - 13,641,956
Debt securities issued
by foreign governments 6,483,656 1,104,054 - 7,587,710
Public utilities ....... 46,979,003 2,431,362 (303,457) 49,106,908
Corporate securities ... 202,329,432 18,388,758 (3,695,933) 217,022,257
------------ ----------- ----------- ------------
Total fixed maturity
securities ....... 459,844,928 30,033,002 (4,021,964) 485,855,966
------------ ----------- ----------- ------------
Equity securities:
Common stocks .......... 37,944,030 1,472,034 (5,277,079) 34,138,985
Non-redeemable
preferred stocks ..... 500,000 - (42,000) 458,000
------------ ----------- ----------- ------------
Total equity
securities ....... 38,444,030 1,472,034 (5,319,079) 34,596,985
------------ ----------- ----------- ------------
Total securities
available-for-sale $498,288,958 $31,505,036 $(9,341,043)$520,452,951
============ =========== =========== ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
------------ ----------- ----------- ------------
December 31, 2001
Securities held-to-maturity:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 57,443,480 $ 4,938,670 $ - $ 62,382,150
Mortgage-backed
securities ........... 8,634,427 448,311 - 9,082,738
------------ ----------- ----------- ------------
Total securities
held-to-maturity $ 66,077,907 $ 5,386,981 $ - $ 71,464,888
============ =========== =========== ============
Securities available-for-
Sale:
Fixed maturity securities:
U.S. treasury securities
and obligations of
U.S. government
corporations and
agencies ............. $ 53,080,155 $ 171,555 $ (80,651)$ 53,171,059
Obligations of states
and political
subdivisions ......... 77,746,658 2,528,902 (510,260) 79,765,300
Mortgage-backed
securities ........... 24,993,733 1,234,960 - 26,228,693
Debt securities issued
by foreign governments 6,481,973 662,892 - 7,144,865
Public utilities ....... 59,510,559 578,124 (1,182,696) 58,905,987
Corporate securities ... 189,923,283 5,741,902 (2,230,904) 193,434,281
------------ ----------- ----------- ------------
Total fixed maturity
securities ....... 411,736,361 10,918,335 (4,004,511) 418,650,185
------------ ----------- ----------- ------------
Equity securities:
Common stocks .......... 27,689,811 6,190,284 (1,492,393) 32,387,702
Non-redeemable
preferred stocks ..... 996,510 6,055 (67,500) 935,065
------------ ----------- ----------- ------------
Total equity
securities ....... 28,686,321 6,196,339 (1,559,893) 33,322,767
------------ ----------- ----------- ------------
Total securities
available-for-sale $440,422,682 $17,114,674 $(5,564,404)$451,972,952
============ =========== =========== ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The amortized cost and estimated fair value of fixed maturity securities
at December 31, 2002, by contractual maturity, are shown below. Expected
maturities may differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
Estimated
Amortized fair
cost value
------------ ------------
Securities held-to-maturity:
Due in one year or less ................... $ - $ -
Due after one year through five years ..... 43,973,773 49,782,810
Due after five years through ten years .... 4,985,531 5,313,205
Due after ten years ....................... 997,387 1,051,100
Mortgage-backed securities ................ 5,076,984 5,491,922
------------ ------------
Totals ................................ $ 55,033,675 $ 61,639,037
============ ============
Securities available-for-sale:
Due in one year or less ................... $ 55,668,261 $ 55,717,130
Due after one year through five years ..... 24,992,053 26,572,980
Due after five years through ten years .... 105,727,344 116,605,900
Due after ten years ....................... 260,863,167 273,318,000
Mortgage-backed securities ................ 12,594,103 13,641,956
------------ ------------
Totals ................................ $459,844,928 $485,855,966
============ ============
The mortgage-backed securities shown in the above table include
$17,059,099 of securities issued by government corporations and agencies and
$611,988 of collateralized mortgage obligations (CMOs). CMOs are securities
backed by mortgages on real estate, which come due at various times. The
Company has attempted to minimize the prepayment risks associated with
mortgage-backed securities by not investing in "principal only" and "interest
only" CMOs. The CMOs that the Company has invested in are designed to reduce
the risk of prepayment by providing predictable principal payment schedules
within a designated range of prepayments. Investment yields may vary from
those anticipated due to changes in prepayment patterns of the underlying
collateral.
A summary of realized investment gains and losses is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ---------- ----------
Fixed maturity securities
held-to-maturity: (1)
Gross realized investment gains ... $ - $ 21,042 $ 536
Gross realized investment losses .. - - (5,038)
Fixed maturity securities
available-for-sale: (2)
Gross realized investment gains ... 960,705 235,515 1,074,068
Gross realized investment losses .. (3,831,374) (19,039) (7,237)
Equity securities
available-for-sale:
Gross realized investment gains ... 4,654,622 4,050,256 3,911,717
Gross realized investment losses .. (4,943,154) (3,487,192) (3,416,176)
----------- ---------- ----------
Totals .......................... $(3,159,201) $ 800,582 $1,557,870
=========== ========== ==========
(1) Investment gains and losses realized on fixed maturity securities
held-to-maturity are the result of calls and prepayments.
(2) Investment losses realized on fixed maturity securities available-
for-sale for the year ended December 31, 2002 include "other than temporary"
security impairment write-downs totaling $3,821,466.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2000, the Company sold approximately $14,000,000 of investments in
tax-exempt fixed maturity securities available-for-sale and reinvested the
proceeds into taxable fixed maturity securities available-for-sale that pay a
higher interest rate. This change in asset allocation was implemented to
increase the Company's after-tax rate of return on its investment portfolio.
Realized investment gains from the disposal of these tax-exempt fixed maturity
securities amounted to $531,352.
A summary of net investment income is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Interest on fixed maturities .......... $31,909,946 $29,507,515 $27,857,760
Dividends on equity securities ........ 605,079 551,066 494,941
Interest on short-term investments .... 690,046 1,425,167 1,114,717
Interest on long-term investments ..... 103,763 - -
Fees from securities lending .......... 120,489 132,905 96,709
----------- ----------- -----------
Total investment income ........... 33,429,323 31,616,653 29,564,127
Investment expenses ................... (651,190) (647,023) (557,811)
----------- ----------- -----------
Net investment income ............. $32,778,133 $30,969,630 $29,006,316
=========== =========== ===========
A summary of net changes in unrealized holding gains (losses) on
securities available-for-sale is as follows:
Year ended December 31,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Fixed maturity securities ......... $ 19,097,214 $ 2,206,640 $ 12,246,089
Applicable deferred income tax
expense ......................... 6,684,025 819,396 4,163,670
------------ ------------ ------------
Total fixed maturity securities 12,413,189 1,387,244 8,082,419
------------ ------------ ------------
Equity securities ................. (8,483,491) (1,341,098) 2,063,902
Applicable deferred income tax
(benefit) expense ............... (2,969,226) (409,606) 701,728
------------ ------------ ------------
Total equity securities ....... (5,514,265) (931,492) 1,362,174
------------ ------------ ------------
Deferred income tax valuation
allowance ....................... - - (1,232,590)
------------ ------------ ------------
Total available-for-sale
securities .................. $ 6,898,924 $ 455,752 $ 10,677,183
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. INCOME TAXES
Temporary differences between the consolidated financial statement
carrying amount and tax basis of assets and liabilities that give rise to
significant portions of the deferred income tax asset at December 31, 2002
and 2001 are as follows:
Year ended December 31,
-------------------------
2002 2001
----------- -----------
Loss reserve discounting .......................... $15,730,089 $15,487,210
Unearned premium reserve limitation ............... 7,993,385 6,520,646
Postretirement benefits ........................... 2,364,160 2,187,059
Other policyholders' funds payable ................ 362,468 165,533
Net operating loss carry forward .................. - 3,481,087
Minimum tax credit ................................ 1,730,815 2,158,360
Impairment losses on investments .................. 1,337,513 -
Other, net ........................................ 1,789,128 457,464
----------- -----------
Total deferred income tax asset ............. 31,307,558 30,457,359
----------- -----------
Deferred policy acquisition costs ................. (8,724,401) (7,477,235)
Net unrealized holding gains ...................... (7,757,397) (4,042,595)
Other, net ........................................ (839,588) (608,722)
----------- -----------
Total deferred income tax liability ......... (17,321,386) (12,128,552)
----------- -----------
Net deferred income tax asset ............. $13,986,172 $18,328,807
=========== ===========
Based upon anticipated future taxable income and consideration of all
other available evidence, management believes that it is "more likely than
not" that the Company's net deferred income tax asset will be realized.
The actual income tax expense (benefit) for the years ended December 31,
2002, 2001 and 2000 differed from the "expected" tax expense (benefit) for
those years (computed by applying the United States federal corporate tax rate
of 35 percent (34 percent for 2000) to income (loss) before income tax expense
(benefit)) as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Computed "expected" tax expense
(benefit) ........................... $ 7,662,213 $(1,939,658) $ 361,968
Increases (decreases) in
tax resulting from:
Tax-exempt interest income ........ (1,441,502) (1,509,839) (1,673,566)
Change in accrual of prior year
taxes ........................... - - (470,000)
Other, net ........................ (430,413) 13,750 517,179
----------- ----------- -----------
Income tax expense (benefit)..... $ 5,790,298 $(3,435,747) $(1,264,419)
=========== =========== ===========
Comprehensive income tax expense (benefit) included in the consolidated
financial statements for the years ended December 31, 2002, 2001 and 2000 is
as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Income tax expense (benefit) on:
Operations .......................... $ 5,790,298 $(3,435,747) $(1,264,419)
Unrealized holding gains (losses) on
revaluation of securities
available-for-sale ................ 3,714,799 409,790 3,632,808
Minimum pension liability ........... (101,373) - -
----------- ----------- -----------
Comprehensive income tax
expense (benefit) ............. $ 9,403,724 $(3,025,957) $ 2,368,389
=========== =========== ===========
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. SURPLUS NOTES
On June 27, 2002, the Company's reinsurance subsidiary issued a surplus
note in the amount of $11,000,000 to Employers Mutual. The surplus note bears
an annual interest rate of 5.25 percent and does not have a maturity date.
Payment of interest and repayment of principal can only be repaid out of the
reinsurance subsidiary's statutory surplus earnings and is subject to approval
by the Iowa Insurance Commissioner. The surplus note is subordinate and
junior in right of payment to all obligations or liabilities of the
reinsurance subsidiary. Interest expense on this surplus note amounted to
$293,563 for 2002.
On December 28, 2001, three of the Company's property and casualty
insurance subsidiaries issued surplus notes totaling $25,000,000 to Employers
Mutual. The surplus notes bear an annual interest rate of 5.38 percent and do
not have a maturity date. Payment of interest and repayment of principal can
only be repaid out of the issuing company's statutory surplus earnings and is
subject to approval by the Insurance Commissioner of the issuing company's
state of domicile. The surplus notes are subordinate and junior in right of
payment to all obligations or liabilities of the issuing company. Interest
expense on these surplus notes amounted to $1,345,153 for 2002 and $11,055 for
2001.
11. INSTALLMENT BASIS PREMIUMS
Effective January 1, 2001, the Company began recording the full-term
written premium and related commission expense at the inception of insurance
policies that are billed on an installment basis. Previously, such amounts
were recorded as each installment became due. As a result, written premiums
and unearned premiums increased $13,884,423, invested assets increased
$11,880,803 and the Company incurred $1,706,181 of commission expense and
$297,439 of premium tax expense. These expenses were offset by a $3,054,573
increase in deferred policy acquisition costs, resulting in $1,050,953 of non-
recurring income.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. EMPLOYEE RETIREMENT PLANS
Employers Mutual has various benefit plans, including a defined benefit
retirement plan and two postretirement benefit plans. Although the Company
has no employees of its own, under the terms of the pooling agreement as
described in note 2, the Company is responsible for its pool participation
share of Employers Mutual's benefit plan expenses and related benefit plan
prepaid assets and liabilities. Accordingly, the Company's consolidated
balance sheets reflect such benefit plan assets and liabilities, including a
minimum pension liability at December 31, 2002.
Employers Mutual's defined benefit retirement plan covers substantially
all of its employees. The plan is funded by employer contributions and
provides benefits under two different formulas, depending on an employee's age
and date of service. Benefits generally vest after five years of service.
It is Employers Mutual's policy to fund pension costs according to regulations
provided under the Internal Revenue Code. Assets held in the plan are a mix
of equity, debt and guaranteed interest securities and real estate funds.
Employers Mutual also offers postretirement benefit plans, which provide
certain health care and life insurance benefits for retired employees.
Substantially all of its employees may become eligible for those benefits if
they reach normal retirement age and have attained the required length of
service while working for Employers Mutual or its subsidiaries. The health
care postretirement plan requires contributions from participants and contains
certain cost sharing provisions such as coinsurance and deductibles. The life
insurance plan is noncontributory. The benefits provided under both plans are
subject to change.
Employers Mutual maintains two Voluntary Employee Beneficiary Association
(VEBA) trusts, which accumulate funds for the payment of postretirement health
care and life insurance benefits. Contributions to the VEBA trusts are used
to fund the accumulated postretirement benefit obligation, as well as pay
current year benefits. Assets held in the VEBA trusts are primarily invested
in life insurance products purchased from Employers Modern Life Company, a
subsidiary of Employers Mutual.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table sets forth the funded status of the Employers Mutual
defined benefit retirement plan and postretirement benefit plans as of
December 31, 2002 and 2001, based upon a measurement date of November 1, 2002
and 2001, respectively:
Defined benefit plan Postretirement plans
------------------------- --------------------------
2002 2001 2002 2001
------------ ----------- ------------ ------------
Change in projected
benefit obligation:
Benefit obligation at
beginning of year ...$ 98,008,250 $88,601,838 $ 46,759,000 $ 34,715,000
Service cost .......... 5,299,831 4,885,731 2,964,000 2,299,000
Interest cost ......... 6,576,584 6,640,491 3,223,000 2,644,000
Actuarial loss ........ 6,769,141 5,242,814 14,954,000 8,406,000
Benefits paid ......... (4,960,786) (8,069,721) (1,591,000) (1,305,000)
Amendments ............ 97,049 707,097 - -
------------ ----------- ------------ ------------
Projected benefit
obligation at end
of year ......... 111,790,069 98,008,250 66,309,000 46,759,000
------------ ----------- ------------ ------------
Change in plan assets:
Fair value of plan
assets at beginning
of year ............. 83,408,910 95,116,686 5,937,000 3,353,000
Actual return on plan
assets .............. (1,240,498) (3,638,055) 326,000 214,000
Employer contributions 4,990,740 - 8,065,000 3,675,000
Benefits paid ......... (4,960,786) (8,069,721) (1,591,000) (1,305,000)
------------ ----------- ------------ ------------
Fair value of plan
assets at end
of year ......... 82,198,366 83,408,910 12,737,000 5,937,000
------------ ----------- ------------ ------------
Funded status ......... (29,591,703) (14,599,340) (53,572,000) (40,822,000)
Unrecognized net
actuarial loss ...... 21,963,572 7,209,026 21,438,000 6,442,000
Unrecognized prior
service costs ....... 4,899,114 5,586,284 - 535,000
Employer contributions - - - 4,090,000
------------ ----------- ------------ ------------
Net amount
recognized ......$ (2,729,017) $(1,804,030) $(32,134,000) $(29,755,000)
============ =========== ============ ============
Amounts recognized in
the statement of
financial position
consist of:
Accrued benefit
liability ....... $(8,633,268) $(1,804,030) $(32,134,000) $(29,755,000)
Intangible asset .. 4,899,114 - - -
Accumulated other
comprehensive
income .......... 1,005,137 - - -
----------- ----------- ------------ ------------
Net amount
recognized .. $(2,729,017) $(1,804,030) $(32,134,000) $(29,755,000)
=========== =========== ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The components of net periodic pension cost for the Employers Mutual
defined benefit retirement plan is as follows:
Year ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Service cost .......................... $ 5,299,831 $ 4,885,731 $ 4,599,973
Interest cost ......................... 6,576,584 6,640,491 6,097,377
Expected return on plan assets ........ (6,744,907) (7,836,882) (7,436,949)
Recognized net actuarial gain ......... - - (164,619)
Amortization of initial net asset ..... - - (755,787)
Amortization of prior service costs ... 784,219 781,043 563,914
----------- ----------- -----------
Net periodic pension benefit cost ... $ 5,915,727 $ 4,470,383 $ 2,903,909
=========== =========== ===========
The weighted average discount rate used to measure the projected benefit
obligation was 6.50 percent for 2002, 7.00 for 2001 and 7.75 percent for 2000.
The assumed long-term rate of return on plan assets was 8.00 percent for 2002
and 8.50 percent for 2001 and 2000. The rate of increase in future
compensation levels used in measuring the projected benefit obligation was
5.93 percent in 2002 and 5.96 percent in 2001 and 2000.
Pension liabilities reflected in the Company's financial statements
totaled $2,487,560 (including $1,701,355 of additional minimum liability) in
2002 and $570,096 in 2001. At December 31, 2002, the Company's financial
statements also reflect an intangible asset associated with the pension plan
of $1,411,716. The $289,639 difference between the additional minimum
liability and the intangible asset is reflected as other comprehensive loss in
the Company's stockholders' equity. Pension expense allocated to the Company
amounted to $1,406,306, $1,060,259 and $691,007 in 2002, 2001 and 2000,
respectively.
The components of net periodic postretirement benefit cost for the
Employers Mutual postretirement benefit plans is as follows:
Year ended December 31,
--------------------------------------
2002 2001 2000
------------ ------------ ------------
Service cost ......................... $ 2,964,000 $ 2,299,000 $ 2,066,000
Interest cost ........................ 3,223,000 2,644,000 2,396,000
Expected return on assets ............ (518,000) (318,000) (140,000)
Amortization of net loss (gain) ...... 150,000 (1,000) (16,000)
Amortization of prior service costs .. 535,000 571,000 571,000
------------ ------------ ------------
Net periodic postretirement benefit
cost ............................. $ 6,354,000 $ 5,195,000 $ 4,877,000
============ ============ ============
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The assumed weighted average annual rate of increase in the per capita
cost of covered health care benefits (i.e. the health care cost trend rate)
for 2002 is 12.00 percent, and is assumed to decrease gradually to 5.00
percent in 2009 and remain at that level thereafter. The health care cost
trend rate assumption has a significant effect on the amounts reported. For
example, a one-percentage-point increase in the assumed health care cost trend
rate for each future year would increase the accumulated postretirement
benefit obligation as of December 31, 2002 by $11,362,000 and the aggregate of
the service and interest cost components of net periodic postretirement
benefit cost for the year ended December 31, 2002 by $1,254,000. A one-
percentage-point decrease in the assumed health care cost trend rate for each
future year would decrease the accumulated postretirement benefit obligation
as of December 31, 2002 by $9,014,000 and the aggregate of the service and
interest cost components of net periodic postretirement benefit cost for the
year ended December 31, 2002 by $977,000. The weighted average discount rate
used in determining the accumulated postretirement benefit obligation was 6.50
percent in 2002, 7.00 percent 2001 and 7.75 percent for 2000. The assumed
long-term rate of return on plan assets was 5.00 percent in 2002 and 6.00
percent for 2001 and 2000.
Postretirement benefit liabilities reflected in the Company's financial
statements totaled $7,526,789 in 2002 and $6,967,484 in 2001. Net periodic
postretirement benefit cost allocated to the Company for the years ended
December 31, 2002, 2001 and 2000 was $1,486,724, $1,214,255 and $1,138,231,
respectively.
The Company participates in several other retirement plans sponsored by
Employers Mutual, including a 401(k) Plan, an Executive Non Qualified Excess
Plan, an Excess Retirement Benefit Agreement and a Supplemental Executive
Retirement Plan. The Company's share of expenses for these plans amounted to
$703,555, $379,988 and $404,400 in 2002, 2001 and 2000, respectively.
13. STOCK PLANS
Stock Based Compensation
The Company has no stock based compensation plans of its own; however,
Employers Mutual has several stock plans which utilize the common stock of the
Company. Employers Mutual can provide the common stock required under its
plans by: 1) using shares of common stock that it currently owns; 2)
purchasing common stock on the open market; or 3) directly purchasing common
stock from the Company at the current fair value. Employers Mutual has
historically purchased common stock from the Company for use in its incentive
stock option plans and its non-employee director stock purchase plan.
Employers Mutual generally purchases common stock on the open market to
fulfill its obligations under its employee stock purchase plan.
Incentive Stock Option Plans
Employers Mutual maintains two separate stock option plans for the
benefit of officers and key employees of Employers Mutual and its
subsidiaries. A total of 600,000 shares have been reserved for the 1982
Employers Mutual Casualty Company Incentive Stock Option Plan (1982 Plan) and
a total of 500,000 shares of the Company's common stock were initially
reserved for issuance under the 1993 Employers Mutual Casualty Company
Incentive Stock Option Plan (1993 Plan). Effective January 30, 1998, an
additional 500,000 shares were registered under the 1993 Plan.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
There is a ten year time limit for granting options under the plans.
Options can no longer be granted under the 1982 Plan and the time period for
granting options under the 1993 Plan expired on December 31, 2002. Options
granted under the plans have a vesting period of two, three, four or five
years with options becoming exercisable in equal annual cumulative increments.
The Senior Executive Compensation and Stock Option Committee (the
"Committee") of Employers Mutual's Board of Directors (the "Board") is the
administrator of the plans. Option prices are determined by the Committee but
cannot be less than the fair value of the stock on the date of grant.
During 2002, 65,900 options were granted under the 1993 Plan to eligible
participants at a price of $18.30 and 98,864 options were exercised under the
plans at prices ranging from $14.32 to $22.66. A summary of the activity
under Employers Mutual's incentive stock option plans for 2002, 2001 and 2000
is as follows:
2002 2001 2000
------------------ ------------------ -----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- ------- --------
Outstanding,
beginning of year 723,378 $10.84 809,882 $10.71 595,255 $11.22
Granted ............. 65,900 18.30 10,700 11.38 265,775 9.25
Exercised ........... (98,864) 10.26 (85,377) 9.58 (47,748) 8.94
Expired ............. (11,657) 10.88 (11,827) 11.28 (3,400) 10.75
------- ------- -------
Outstanding,
end of year ....... 678,757 11.65 723,378 10.84 809,882 10.71
======= ======= =======
Exercisable,
end of year ....... 404,807 $11.35 407,108 $11.18 390,447 $10.82
======= ======= =======
December 31, 2002
----------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------- ---------------------
Weighted-
Weighted- average Weighted-
average remaining average
Range of option Number exercise contractual Number exercise
exercise prices outstanding price life exercisable price
- ---------------- ----------- -------- ----------- ----------- ---------
$ 8.81 - $10.00 340,496 $ 9.36 5.41 185,306 $ 9.45
11.38 - 12.69 145,613 12.38 5.26 109,333 12.38
13.25 - 18.30 192,648 15.16 5.30 110,168 13.51
------- -------
678,757 11.65 5.35 404,807 11.35
======= =======
Employee Stock Purchase Plan
A total of 500,000 shares of the Company's common stock have been
reserved for issuance under the Employers Mutual Casualty Company 1993
Employee Stock Purchase Plan. Any employee who is employed by Employers
Mutual or its subsidiaries on the first day of the month immediately preceding
any option period is eligible to participate in the plan. Participants pay 85
percent of the fair market value of the stock purchased, which is fully vested
on the date purchased. The plan is administered by the Board of Employers
Mutual and the Board has the right to amend or terminate the plan at any time;
however, no such amendment or termination shall adversely affect the rights
and privileges of participants with unexercised options. Expenses allocated
to the Company in connection with this plan totaled $6,817, $6,889 and $12,749
in 2002, 2001 and 2000, respectively.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
During 2002, a total of 11,716 options were exercised at prices of $14.95
and $15.10. Activity under the plan was as follows:
Year ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Shares available for purchase,
beginning of year ...................... 313,755 327,489 352,354
Shares purchased under plan .............. (11,716) (13,734) (24,865)
------- ------- -------
Shares available for purchase, end of year 302,039 313,755 327,489
======= ======= =======
Non-Employee Director Stock Purchase Plan
A total of 200,000 shares of the Company's common stock have been
reserved for issuance under the Employers Mutual Casualty Company Non-Employee
Director Stock Purchase Plan. All non-employee directors of Employers Mutual
and its subsidiaries who are not serving on the "Disinterested Director
Committee" of the Board as of the beginning of the option period are eligible
to participate in the plan. Each eligible director can purchase shares of
common stock at 75 percent of the fair value of the stock in an amount equal
to a minimum of 25 percent to a maximum of 100 percent of their annual cash
retainer. The plan will continue through the option period for options
granted at the 2002 annual meetings. The plan is administered by the
Disinterested Director Committee of the Board. The Board may amend or
terminate the plan at any time; however, no such amendment or termination
shall adversely affect the rights and privileges of participants with
unexercised options. During 2002, a total of 1,961 options were exercised at
a price of $12.24. Expenses allocated to the Company in connection with this
plan totaled $0, $5,819 and $5,916 in 2002, 2001 and 2000, respectively.
Activity under the plan was as follows:
Year ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Shares available for purchase,
beginning of year ...................... 143,158 143,158 152,190
Shares purchased under plan .............. (1,961) - (9,032)
------- ------- -------
Shares available for purchase, end of year 141,197 143,158 143,158
======= ======= =======
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Dividend Reinvestment Plan
The Company maintains a dividend reinvestment and common stock purchase
plan which provides stockholders with the option of reinvesting cash dividends
in additional shares of the Company's common stock. Participants may also
purchase additional shares of common stock without incurring broker
commissions by making optional cash contributions to the plan and may sell
shares of common stock through the plan. Since the third quarter of 1998, all
shares of common stock issued under the plan have been purchased in the open
market through the Company's transfer agent. On September 15, 2000, an
additional 1,000,000 shares of stock were registered for issuance under the
dividend reinvestment plan. Employers Mutual participated in the Dividend
Reinvestment Plan during 2002 by reinvesting 25 percent of its dividends in
additional shares of the Company's common stock. Prior to 2002, Employers
Mutual was reinvesting 100 percent of its dividends in additional shares of
the Company's common stock. Employers Mutual increased its dividend
reinvestment percentage to 50 percent in the first quarter of 2003 and expects
to surpass the 80 percent ownership threshold of the Company in 2003.
Employers Mutual has indicated that it may continue to participate in the
dividend reinvestment plan in the future; however, its reinvestment percentage
will likely be reduced to a level necessary to maintain the 80 percent
ownership threshold. Activity under the plan was as follows:
Year ended December 31,
-------------------------------
2002 2001 2000
------- ------- ---------
Shares available for purchase,
beginning of year .................. 501,230 880,679 399,629
Additional shares registered ......... - - 1,000,000
Shares purchased under plan .......... (84,331) (379,449) (518,950)
------- ------- ---------
Shares available for purchase,
end of year ........................ 416,899 501,230 880,679
======= ======= =========
Range of purchase prices ............. $15.38 $11.50 $ 7.50
to to to
$21.99 $17.25 $12.66
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash, indebtedness to related party and accounts
receivable approximate fair value because of the short maturity of these
instruments.
The estimated fair value for fixed maturities, equity securities and
short-term investments is based on quoted market prices, where available, or
on values obtained from independent pricing services (see note 8).
The carrying value of the surplus notes approximates their estimated fair
value since their interest rates approximate current interest rates for
comparable surplus notes.
Other long-term investments, consisting primarily of holdings in limited
partnerships and limited liability companies, are valued by the various fund
managers. In management's opinion, these values reflect fair value at
December 31, 2002.
The estimated fair value of the Company's financial instruments is
summarized below.
Carrying Estimated
amount fair value
------------ ------------
December 31, 2002
- -----------------
Assets:
Fixed maturity securities:
Held-to-maturity ............................ $ 55,033,675 $ 61,639,037
Available-for-sale .......................... 485,855,966 485,855,966
Equity securities available-for-sale .......... 34,596,985 34,596,985
Short-term investments ........................ 29,650,230 29,650,230
Other long-term investments ................... 3,057,000 3,057,000
Liabilities:
Surplus notes ................................. 36,000,000 36,000,000
December 31, 2001
- -----------------
Assets:
Fixed maturity securities:
Held-to-maturity ............................ $ 33,572,602 $ 35,502,755
Available-for-sale .......................... 390,214,177 390,214,177
Fixed maturity securities on loan:
Held-to-maturity ............................ 32,505,305 35,962,133
Available-for-sale .......................... 28,436,008 28,436,008
Equity securities available-for-sale .......... 33,322,767 33,322,767
Short-term investments ........................ 17,724,458 17,724,458
Liabilities:
Surplus notes ................................. 25,000,000 25,000,000
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
15. CONTINGENT LIABILITIES
The Company and Employers Mutual and its other subsidiaries are parties
to numerous lawsuits arising in the normal course of the insurance business.
The Company believes that the resolution of these lawsuits will not have a
material adverse effect on its financial condition or its results of
operations. The companies involved have reserves which are believed adequate
to cover any potential liabilities arising out of all such pending or
threatened proceedings.
The members of the pooling agreement have purchased annuities to fund
future payments that are fixed pursuant to specific claim settlement
provisions. The Company, under the current terms of the pooling agreement, is
contingently liable for 23.5 percent of these annuities (see note 2). The
Company is contingently liable to various claimants in the amount of $646,772
in the event that the issuing company would be unable to fulfill its
obligations.
16. UNAUDITED INTERIM FINANCIAL INFORMATION
Three months ended,
-----------------------------------------------------
March 31 June 30 September 30 December 31
----------- ----------- ------------ -----------
2002
- ----
Total revenues ........ $77,157,134 $78,582,787 $81,763,105 $90,024,758
=========== =========== =========== ===========
Income before income
tax expense ......... $ 5,470,323 $ 3,518,303 $ 5,971,780 $ 6,931,630
Income tax expense .... 1,780,446 573,617 1,670,595 1,765,640
----------- ----------- ----------- -----------
Net income ....... $ 3,689,877 $ 2,944,686 $ 4,301,185 $ 5,165,990
=========== =========== =========== ===========
Net income per share
- basic and diluted* $ .33 $ .26 $ .38 $ .45
=========== =========== =========== ===========
2001
- ----
Total revenues ........ $68,295,006 $71,307,822 $77,180,241 $81,041,170
=========== =========== =========== ===========
Income (loss) before
income tax expense
(benefit) ........... $ 2,677,827 $(5,025,762) $ (766,909) $(2,427,035)
Income tax expense
(benefit) ........... 612,674 (2,179,897) (703,381) (1,165,143)
----------- ----------- ----------- -----------
Net income (loss) $ 2,065,153 $(2,845,865) $ (63,528) $(1,261,892)
=========== =========== =========== ===========
Net income (loss) per
share
- basic and diluted* $ .18 $ (.25) $ (.01) $ (.11)
=========== =========== =========== ===========
2000
- ----
Total revenues ........ $61,144,637 $62,917,075 $66,792,907 $72,641,122
=========== =========== =========== ===========
Income (loss) before
income tax expense
(benefit) ........... $ 2,003,674 $ (293,962) $ 1,428,928 $(2,074,028)
Income tax expense
(benefit) ........... 386,504 (489,810) 224,712 (1,385,825)
----------- ----------- ----------- -----------
Net income (loss) $ 1,617,170 $ 195,848 $ 1,204,216 $ (688,203)
=========== =========== =========== ===========
Net income (loss) per
share
- basic and diluted* $ .14 $ .02 $ .11 $ (.06)
=========== =========== =========== ===========
* Since the weighted average shares for the quarters are calculated
independent of the weighted average shares for the year, quarterly net income
(loss) per share may not total to annual net income (loss) per share.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>8
<FILENAME>exhibit13d.txt
<DESCRIPTION>STOCKHOLDER INFORMATION
<TEXT>
STOCKHOLDER INFORMATION EXHIBIT 13(d)
- ----------------------- -------------
The Company's common stock trades on the NASDAQ National Market tier of
the NASDAQ Stock Market under the symbol EMCI.
The following table shows the high and low bid prices, as reported by
NASDAQ, and the dividends paid for each quarter within the two most recent
years.
2002 2001
--------------------------- ---------------------------
High Low Dividends High Low Dividends
------ ------ --------- ----- ------ ---------
1st Quarter $19.90 $15.95 $ .15 $13.13 $10.19 $ .15
2nd Quarter 23.50 15.00 .15 15.85 11.72 .15
3rd Quarter 17.20 13.25 .15 16.00 13.34 .15
4th Quarter 19.40 13.50 .15 18.75 13.01 .15
Close on Dec. 31 17.87 17.15
On February 28, 2003, there were approximately 1,208 registered
stockholders of the Company's common stock.
There are certain regulatory restrictions relating to the payment of
dividends by the Company's insurance subsidiaries (see note 6 of Notes to
Consolidated Financial Statements under Item 8 of this Form 10-K). It is the
present intention of the Company's Board of Directors to declare quarterly
cash dividends, but the amount and timing thereof, if any, is to be determined
by the Board of Directors at its discretion.
A dividend reinvestment and common stock purchase plan provides
stockholders with the option of receiving additional shares of common stock
instead of cash dividends. Participants may also purchase additional shares
of common stock without incurring broker commissions by making optional cash
contributions to the plan and may sell shares of common stock through the
plan. See note 13 of Notes to Consolidated Financial Statements under Item 8
of this Form 10-K. In 2002, Employers Mutual Casualty Company reinvested 25
percent of its dividends in additional shares of common stock under this plan,
Employers Mutual Casualty Company will increase its participation in the plan
from 25 percent to 50 percent for the first quarter of 2003 and expects to
surpass the 80 percent ownership threshold of EMC Insurance Group Inc. in
2003. Employers Mutual has indicated that it may continue to participate in
the dividend reinvestment plan in the future; however, its reinvestment
percentage will likely be reduced to a level necessary to maintain the 80
percent ownership threshold.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21
<SEQUENCE>9
<FILENAME>exhibit21.txt
<DESCRIPTION>SUBSIDIARIES OF THE REGISTRANT
<TEXT>
EXHIBIT 21
----------
EMC INSURANCE GROUP INC.
ORGANIZATIONAL CHART
...............................
: :
: EMC INSURANCE GROUP INC. :
:.............................:
:
:
:
:
......................:................................
: :
: :
Illinois EMCASCO Insurance Company EMC
Dakota Fire Insurance Company Reinsurance
Farm and City Insurance Company Company
EMCASCO Insurance Company
:
:
EMC Underwriters, LLC
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23
<SEQUENCE>10
<FILENAME>exhibit23a.txt
<DESCRIPTION>CONSENT OF ERNST & YOUNG LLP
<TEXT>
EXHIBIT 23(a)
-------------
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Form S-8 Nos. 2-93738, 33-49335, 33-49337, 33-49339, 333-45279
and 333-103722) pertaining to various employee benefit plan filings and in
the Registration Statement (Form S-3 No. 33-34499) of EMC Insurance Group
Inc. and in the related Prospectuses of our reports dated February 25, 2003
with respect to the consolidated financial statements and schedules of EMC
Insurance Group Inc. included in this Annual Report (Form 10-K) for the year
ended December 31, 2002.
/s/ Ernst & Young LLP
Des Moines, Iowa
March 24, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23
<SEQUENCE>11
<FILENAME>exhibit23b.txt
<DESCRIPTION>CONSENT OF KPMG LLP
<TEXT>
EXHIBIT 23(b)
-------------
CONSENT OF KPMG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
EMC Insurance Group Inc.:
We consent to incorporation by reference in Registration Statement Nos.
2-93738, 33-49335, 33-49337, 33-49339, 333-45279 and 333-103722 on Forms S-8
and No. 33-34499 on Form S-3 of EMC Insurance Group Inc. of our report dated
February 27, 2001, relating to the consolidated statements of income,
comprehensive income, stockholders' equity and cash flows and related
financial statement schedules of EMC Insurance Group Inc. and Subsidiaries as
of December 31, 2000, which appears in the December 31, 2002 annual report
on Form 10-K of EMC Insurance Group Inc.
/s/ KPMG LLP
Des Moines, Iowa
March 26, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-24
<SEQUENCE>12
<FILENAME>exhibit24.txt
<DESCRIPTION>POWER OF ATTORNEY
<TEXT>
EXHIBIT 24
----------
POWER OF ATTORNEY
KNOW EVERYONE BY THESE PRESENTS, that each director whose signature
appears below constitutes and appoints Mark E. Reese and Bruce G. Kelley,
jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities related to signing and filing
the Form 10-K (annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934) for the year ending December 31, 2002, and all other
related filings with the Securities and Exchange Commission, and hereby
ratifies and confirms all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
SIGNATURE TITLE
- --------- -----
/s/ George C. Carpenter III
- ---------------------------
George C. Carpenter III Director
/s/ E. H. Creese
- ---------------------------
E. H. Creese Director
/s/ David J. Fisher
- ---------------------------
David J. Fisher Director
/s/ Bruce G. Kelley
- ---------------------------
Bruce G. Kelley Director
/s/ George W. Kochheiser
- ---------------------------
George W. Kochheiser Chairman of the Board of
Directors
/s/ Raymond A. Michel
- ---------------------------
Raymond A. Michel Director
/s/ Fredrick A. Schiek
- ---------------------------
Fredrick A. Schiek Director
February 25, 2003
127
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99
<SEQUENCE>13
<FILENAME>exhibit991.txt
<DESCRIPTION>CERTIFICATION OF PRESIDENT AND CEO
<TEXT>
EXHIBIT 99.1
------------
CERTIFICATION OF PRESIDENT & CHIEF EXECUTIVE OFFICER PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the accompanying Annual Report of EMC Insurance
Group Inc. on Form 10-K for the period ending December 31, 2002, the
undersigned herby certifies, in accordance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his
capacity as an officer of EMC Insurance Group Inc. that:
(1) The report fully complies with the requirements of Section
13(a) or 15(d) of Securities Exchange Act of 1934, and
(2) The information contained in this report fairly presents, in
all material respects, the company's financial condition and
results of operations.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
-----------------------------------
Bruce G. Kelley
President & Chief Executive Officer
Date: March 27, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99
<SEQUENCE>14
<FILENAME>exhibit992.txt
<DESCRIPTION>CERTIFICATION OF VICE PRESIDENT AND CFO
<TEXT>
EXHIBIT 99.2
------------
CERTIFICATION OF VICE PRESIDENT AND CHIEF FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the accompanying Annual Report of EMC Insurance
Group Inc. on Form 10-K for the period ending December 31, 2002, the
undersigned herby certifies, in accordance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in his
capacity as an officer of EMC Insurance Group Inc. that:
(1) The report fully complies with the requirements of Section
13(a) or 15(d) of Securities Exchange Act of 1934, and
(2) The information contained in this report fairly presents, in
all material respects, the company's financial condition and
results of operations.
EMC INSURANCE GROUP INC.
Registrant
/s/ Mark Reese
--------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: March 27, 2003
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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