Operating results 1996 1995 1994 1993 1992 ------- ------ ------- ------- ------
Net income per share before extraordinary items ......$ 0.58 $ 0.09 $ 1.57 $ 1.47 $ 1.61 Extraordinary gain ............ 0.00 0.00 0.00 0.11 0.00 ------- ------- -------- ------- ------- $ 0.58 $ 0.09 $ 1.57 $ 1.58 $ 1.61 ======= ======= ======== ======= =======
Net change in unrealized capital gains (net of tax)$ 968 $ 2,726 ($ 3,030) $ 850 $ 937
Life and Accident and Health Insurance Operations: Premium income was $4.4 million in 1996, down 9.5% from $4.9 million in 1995, as a result of decreased sales of both, life insurance, and accident and health insurance. The primary reason for the decrease is due to reductions in field agents and losses of significant amounts of business in Mississippi. Premium income was down 5% for 1995 compared to 1994. The primary reason for this decrease was due to a reduction of more than 25% in the life insurance sales force during 1994 and early 1995. As it is becoming increasingly difficult to hire and maintain high quality home service agents, the Life Company expects to make some changes in its method of selling new life insurance products in the near future.
As a result of the decrease in the life insurance sales force, general expenses before litigation and sales commissions fell slightly in 1996 compared to 1995. Sales commissions dropped 17% from $1.34 million in 1994 to $1.12 million in 1995. General expenses before litigation costs decreased 6.7% in 1996 compared to 1995 primarily due to decreased legal expenses and insurance expenses. General expenses before litigation cost in 1995 declined $137,000 compared to 1994, a 7% decrease.
Pretax earnings were much improved in 1996 at $1.07 million compared to $(178,000) in 1995. The primary reason for the improvement was that litigation expenses decreased by over $1.5 million. Pretax earnings of $(178,000) in 1995 compared to $639,000 in 1994, reflected a decrease in realized investment gains, and a continued hostile legal environment. Litigation expenses totaled $2.32 million and $2.22 million in 1995 and 1994 respectively.
a. The loss and loss expense ratio, which measurers losses and loss adjustment expenses incurred as a percentage of premiums earned.
b. The underwriting expense ratio, which measurers underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premiums written during the year.
1996 1995 1994 ---- ---- ---- Loss and LAE Ratio 79.8% 82.8% 64.2% Underwriting Expense Ratio 30.9% 31.4% 28.0% ----- ----- ----- Combined Ratio 110.7% 114.2% 92.2%
The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $11.2 million at December 31, 1996 and 1995. The mortgage-backed bonds are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments cause those securities to have different actual maturities than that expected at the time of purchase. Securities that are purchased at a premium to par value and prepay faster than expected will incur a reduction in yield or loss. Securities that are purchased at a discount to par value and prepay faster than expected will generate an increase in yield or gain. The degree to which a security is susceptible to either gains or losses is influenced by the difference between amortized cost and par value, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure.
The Company limits the extent of its credit risk by purchasing securities that are backed by stable collateral, the majority of the assets are guaranteed by U.S. government sponsored entities. Also, substantially all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higherrisk mortgage backed bonds. To reduce the risk of loss of principal should prepayments exceed expectations, the Company does not purchase mortgage backed securities at significant premiums over par value.
The National Security Group's consolidated statement of cash flows indicate that operating activities provided (used) cash of $1.45 million, $(3.6) million, $1 million in 1996, 1995, and 1994 respectively. Those statements also classify the other sources and uses of cash by investing activities, and financing activities and disclose the amount of cash available at the end of the year to meet the Company's obligations.
Except as discussed in Note 11 to the consolidated financial statements, the Company is aware of no known trends, events, or uncertainties reasonably likely to have a material effect in its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect.
The ratios of Total Adjusted Capital to Authorized Control Level RBC for The National Security Group's life/health and property/casualty insurance subsidiaries are all in excess of eight to one at December 31, 1996.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $10.1 million and $12.1 million at December 31, 1996 and 1995, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 8.31 and 10.4 at December 31, 1996 and 1995 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $24.1 million and $23.9 million at December 31, 1996 and 1995, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 8.3 and 10.6 at December 31, 1996 and 1995 respectively. Accordingly, National Security Fire & Casualty Company meets the minimum RBC requirements.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $5.2 million and $5.2 million at December 31, 1996 and 1995, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 10.7 and 90.11 at December 31, 1996 and 1995 respectively. Accordingly, Omega One Insurance Company meets the minimum RBC requirements.
Consolidated Statements of Income - Years Ended December 31, 1996, 1995, and 1994...................... 19
Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1996, 1995, and 1994...................... 21
Report of Independent Certified Public Accountants on Financial Statement Schedules...................................... 34
Schedule I. Summary of Investments - December 31, 1996 and 1995.... 35
Schedule V. Supplementary Insurance Information - December 31, 1996, 1995, and 1994.................................. 40
Schedule VI. Reinsurance - Years Ended December 31, 1996, 1995, and 1994...................... 41
We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Birmingham, Alabama February 14, 1997 Dudley, Hopton-Jones, Sims & Freeman PLLP
Investments Effective January 1, 1994, the Company and its subsidiaries adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). This statement, among other things, requires investment securities (bonds, notes, common stock and preferred stocks) to be divided into one of three categories: held-to-maturity, available-for-sale, and trading.
The initial effect of adopting SFAS 115 at January 1, 1994 is reported as a $32,000 increase in net unrealized appreciation on securities available-for-sale, net of deferred taxes.
Earnings Per Share Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding was 2,339,848 in 1996 and 2,337,090 in 1995 and $2,339,848 in 1994. (See Note 12).
Proceeds from the maturity or call of held-to-maturity securities during 1996 and 1995 were $5,773,992 and $2,237,576, respectively. Gross gains of $29,565 and $22,667 and gross losses of $342 and $4,926 for 1996 and 1995, respectively, were realized on those maturities or calls.
(Dollars in thousands) Year ended December 31, 1996 1995 1994 ---- ---- ---- Fixed maturities............................$ 3,112 $ 3,336 $ 3,112 Equity securities........................... 559 663 721 Mortgage loans on real estate............... 39 45 52 Investment real estate...................... 13 17 19 Policy loans................................ 37 34 38 Other, principally short-term investments... 230 234 139 -------- -------- ------- 3,990 4,329 4,081 Less: Investment expenses.................. (55) (18) (80) -------- -------- ------- Net investment income.......................$ 3,935 $ 4,311 $ 4,001 ======== ======== =======
Year ended December 31, 1996 1995 1994 ---- ---- ---- Net realized investment gains: Fixed maturities..........................$ 12 $ 56 $ 57 Other, principally equity securities...... 1,827 1,594 1,663 -------- -------- ------- $ 1,839 $ 1,650 $ 1,720 ======== ======== =======
An analysis of the net increase (decrease) in unrealized appreciation on available-for-sale securities follows:
Year ended December 31, 1996 1995 1994 ---- ---- ---- Net increase (decrease) in unrealized appreciation on available-for-sale securities before deferred income tax....$ 1,340 $ 3,356 $( 3,509) Deferred income tax ....................... (372) (630) 479 -------- -------- -------
Net increase (decrease) in unrealized appreciation on available-for-sale securities...............................$ 968 $ 2,726 $( 3,030) ======== ======== =======
Federal income tax rate applied to pre-tax income..........$ 551 $ 94 $ 1,588 Special deductions allowed small life insurance companies.. - - ( 348) Dividends received deduction and tax-exempt interest.......( 256) (261) ( 291) Other, net.................................................( 30) 229 48 ------ ----- ------
Federal income tax expense.................................$ 265 $ 62 $ 997 ==== ===== =====
Deferred policy acquisition costs 226 $( 59) $( 33) Policy liabilities ( 17) ( 76) ( 29) Unearned premiums ( 87) ( 21) 87 General insurance expenses ( 268) ( 3) ( 24) Claim liabilities ( 38) - ( 36) Other 28 176 ( 212) ------ ------ ------ $( 156) $ 17 $( 247) ===== ====== ====== Under pre-1984 life insurance company tax laws, a portion of NSIC's gain from operations was not subject to current income taxation, but was accumulated for tax purposes in a memorandum account designated "policyholders' surplus". The aggregate balance in this account, $3,720,000 at December 31, 1995, would be taxed at current rates only if distributed to shareholders or if the account exceeded a prescribed minimum. The Deficit Reduction Act of 1984 eliminated additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have not been provided on amounts designated as policyholders' surplus. The deferred tax liability not recognized is approximately $1,270,000 at December 31, 1996.
Direct........$ 4,451 $ 4,483 $ 31,920 $ 27,299 Assumed....... - - 1 - Ceded......... 51 51 8,422 5,077 ------ ------- ------- ------- Net...........$ 4,400 $ 4,432 $ 23,499 $ 22,222 ====== ======= ======= =======
NOTE 8 - REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS: The amount of dividends paid from NSIC to the Company in any year may not exceed, without prior approval of regulatory authorities, the greater of 10% of statutory surplus as of the end of the preceding year, or the statutory net gain from operations for the preceding year. At December 31, 1996, NSIC's retained earnings unrestricted for the payment of dividends in 1997 amounted to $802,097. NSFC is similarly restricted in the amount of dividends payable to the Company; dividends may not exceed the greater of 10% of statutory surplus as of the end of the preceding year, or net investment income for the preceding year. As a result, dividends from NSFC to the Company are limited to $2,406,122 in 1997.
Under applicable Alabama insurance alws and regulations, NSFC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $100,000.
NOTE 11 - CONTINGENCIES: The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Company's subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief. The frequency of these lawsuits has increased significantly over the past 36 months, particularly in Alabama where the Company conducts the majority of its business. Certain of these actions are filed in jurisdictions in Alabama where local juries have returned large punitive damage verdicts against insurance companies and financial institutions with, in many cases, the punitive damage award bearing little or no relation to the actual damages. It is not feasible to predict or determine the ultimate outcome of these matters.
We have audited in accordance with generally accepted auditing standards, the financial statements of The National Security Group, Inc. as of December 31, 1995 and 1994 and for the years then ended included in this Form 10-K, and have issued our report thereon dated February 16, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules as of December 31, 1996 and 1995 and for the years then ended have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
December 31, 1996 1995 ---- ---- Assets Cash ............................................ $ 155 $ 61 Investment in subsidiaries (equity method) eliminated upon consolidation ............... 39,975 39,905 Other assets .................................... 318 161 ------ ------ Total Assets ............................. $40,448 $40,127 ====== ====== Liabilities and Shareholders' Equity Accrued general expenses ........................ $ 808 $ 353
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS) For the Years Ended December 31, 1996 1995 1994 ----- ------ ----- Cash flows from operating activities: Net income ................................. $ 1,356 $ 214 $ 3,674 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed loss (income) of subsidiaries............... 19 1,424 (2,293) Provision for amortization .............. 22 12 22 Decrease (Increase) in other assets...... (157) 64 (92) (Decrease) Increase in other liabilities. 433 (43) (5) ----- ------ ------ Net cash provided by operating activities 1,673 1,671 1,306 ----- ------ ------ Cash flows from financing activities: Purchase of treasury stock .......... (70) (222) 0 Cash dividends ...................... (1,509) (1,427) (1,334) ----- ------ ------ Net cash used in financing activities (1,579) (1,649) (1,334) ----- ------ ------ Net increase (decrease) in cash and cash equivalents 94 22 (28)
Cash and due from banks at beginning of year 61 39 67 ----- ------ ------ Cash and due from banks at end of year $ 155 $ 61 $ 39 ===== ====== ======