Consolidated net income for The National Security Group (The Company) was $4.09 million in 2003 compared to $908,000 in 2002. On a per share basis earnings were $1.66 in 2003 compared to $.37 in 2002. Realized capital gains in 2003 were $1.42 million compared to $1.17 million in 2002. Pre-tax earnings were $5.7 million in 2003 compared to $1.2 million in 2002, a tenfold increase. A much improved property and casualty combined ratio in the property and casualty subsidiaries was the primary factor contributing to the significant increase in the segments pre-tax earnings. The improvement in the property and casualty combined ratio is discussed further in the segment information presented below. The life, accident and health insurance segment experienced a 50% decline in pre-tax earnings primarily due to litigation related cost, which is discussed further in Note O to the consolidated financial statements.
A 50% owned subsidiary contributed negatively to net income in the amount $29,000 in 2003. This subsidiary, The Mobile Attic, Inc., is in the business of leasing portable storage containers through independent dealers in Alabama, Florida, and Tennessee.
The operating results of the subsidiaries are discussed in further detail in the sections that follow.
Consolidated net income for The National Security Group (The Company) was $908,000 in 2002 compared to $4.130 million in 2001. On a per share basis earnings were $.37 in 2002 compared to $1.67 in 2001. Adverse underwriting results in the property/casualty insurance segment were the primary factor contributing to the decline in earnings for 2002 compared to 2001. Information related to the adverse underwriting results is discussed further in the property and casualty insurance segment in the paragraphs that follow. Realized capital gains in 2002 were $1.168 million and $1.64 million in 2001. Consolidated revenues were $39.1 million in 2002 compared to $32.8 million in 2001.
Commission expense increased 5.7% in 2003 compared to 2002. The continuing increases in new sales through independent agents and a change in the home service agents commission contract were the primary factors contributing to the increase in commission. Independent agents typically receive much higher commission rates in the early years of a policy compared to employee agents in the home service market, which typically receive a lower and more level commission over a longer number of years. With premium growth generated exclusively through independent agents, commission expense will rise at a faster rate than premium growth until a more significant block of insurance business rolls into subsequent years at lower commission rates.
Commission expenses increased due to the continued increase in new business production. Life insurance commissions are front loaded, meaning that significantly higher commission rates are paid in the early years of a policy and decrease significantly particularly after the first two years of the policy.
Net income before income tax was $5.72 million in 2003 compared to $ 518,000 in 2002. Pre-tax income increased significantly over 2002. Results for 2002 were negatively impacted by adverse claims experience from hurricane losses in the fourth quarter of 2002 and an increased severity of losses on new business issued were the primary reasons for the significant decrease in income. Results for 2003 were much improved due to decreases in both severity and frequency of losses. Prior year growth also helped 2003 results as a larger book of renewal business helped significantly reduce NSFC loss ratios.
A measure used to analyze a property/casualty insurer’s underwriting performance is the statutory combined ratio. It is the sum of two ratios:
The combined ratio for 2003 compared to 2002 decreased 16.6 percentage points. The loss and LAE component of the combined ratio decreased 15.5 percentage points. The lack of any major catastrophes during 2003 resulted in the decrease in the combined ratio. The expense ratio declined 1.1 percentage points during 2003. The 2003 combined ratio of the property and casualty subsidiaries was much improved due to an absence of significant catastrophe related losses and a significant decrease in frequency and severity of fire related losses. As discussed last year a primary objective for us in 2004 was to focus on maintaining a manageable level of growth while reducing the loss and LAE ratio. We will continue to be proactive in managing our books of business with a primary focus on underwriting profitability.
The Company’s leasing operations are conducted through its 50% owned subsidiary, Mobile Attic, Inc. The investment in Mobile Attic is accounted for under the Equity Method in the Consolidated Financial Statements of the Company. Mobile Attic was incorporated in August of 2001 and is a joint venture with a manufacturing partner, Cash Brothers Leasing of Elba, Alabama.
Mobile Attic is in the business of leasing portable storage containers to individual and commercial customers through an independent dealer network primarily in Alabama, but also operating in Florida and Tennessee. At December 31, 2003 Mobile Attic had available approximately 3,000 storage containers for lease and thirteen independent dealers. The portable storage containers are eight feet wide and eight feet tall and are available in lengths of 8, 16, 20, and 40 feet. Independent dealers market these portable storage containers primarily to household customers in need of a convenient alternative to fixed location mini-storage, commercial customers in need of secure storage facilities at job sites, and retail customers for storage of seasonal inventory.
As of January 1, 1994, the Company adopted Financial Accounting Standards Board Statement 115 and reclassified a portion of its fixed maturity securities portfolio as “available-for-sale,” with the remainder being classified as “held-to-maturity.” With that reclassification, the fixed maturity securities classified as “available-for-sale” are carried at fair value and changes in fair values, net of related income taxes, are charged or credited to shareholders’ equity (see Note E to the consolidated financial statements).
Liquidity and Capital Resources: Due to regulatory restrictions, the majority of the Company’s cash is required to be invested in investment-grade securities to provide ample protection for policyholders. The liabilities of the insurance subsidiaries are of various terms and, therefore, those subsidiaries invest in securities with various maturities spread over periods usually not exceeding 10 years.
The National Security Group’s consolidated statement of cash flows indicate that operating activities provided cash of $10.7 million, $4.3 million, $2.9 million in 2003, 2002, and 2001 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.
The Company has notes payable of $3.1 million at December 31, 2003. The notes payable are to be repaid in quarterly installments over five years.
As disclosed in note L to the consolidated financial statements, in 2003, the amount that The National Security Group’s insurance subsidiaries can transfer in the form of dividends to the parent company is limited to $1.1 million in the life insurance subsidiary and $2.0 million in the property/casualty insurance subsidiary. However, that condition poses no short-term or long-term liquidity concerns for the parent company.
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003. 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 audits.
Income Before Income Taxes and Equity in Income of Affiliate 5,669
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2003 -
Investment real estate, at book value (accumulated depr.: 2003 - $17; 2002 -$17) 1,564
Receivable from agents, less allowance for credit losses (2002-$176; 2001-$176) 2,602
Net realized gains on investments (1,416 ) (1,163 ) (1,640 )
Net cash (used in) provided by investing activities (8,875 ) (4,961 ) (927 )
Net cash used in financing activities (1,861 ) (150 ) (1,345 )
NSIC is licensed in the states of Alabama, Georgia, Mississippi, Texas, South Carolina and Florida and was organized in 1947 to provide life and burial insurance policies to the home service market. Premiums sold and serviced by company agents primarily include industrial life, larger ordinary life, accident and health, limited hospital, cancer and low valued life insurance. NSFC operates in various property and casualty lines, the most significant of which are low valued dwelling property, home service fire, nonstandard automobile physical damage and liability, nonstandard commercial, ocean marine and inland marine. Omega operates in property and casualty lines, the most significant of which is commercial auto liability.
In the normal course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage contracts. NSIC retains a maximum of $30,000 of coverage per individual life. The cost of reinsurance is amortized over the contract period of the reinsurance.
The Company expenses advertising costs as incurred. Advertising costs were $89,000 for the year ended December 31, 2003 ($101,000 and $110,000 for the years ended December 31, 2002 and 2001, respectively).
The Company maintains cash depository accounts which, at times, may exceed federally insured limits. These amounts represent actual account balances held by financial institutions at the end of the period, and unlike the balance reported in the financial statements, the account balances do not reflect timing delays inherent in reconciling items such as outstanding checks and deposits in transit. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. At December 31, 2003, the Company’s uninsured cash balances totaled $289,000.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities, and must be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 was effective for certain contracts entered into or modified by the company after June 30, 2003. The Company adopted SFAS No. 149 effective July 1, 2003 with no material impact on its financial condition or results of operations.
In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Financial instruments that are within the scope of the statement, which previously were often classified as equity, must now be classified as liabilities. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise generally effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have a material effect on the Company’s results of operations or financial position.
Summarized financial information for the Company's investment in Mobile Attic, Inc., accounted for by the equity method, follows:
NSIC - including realized capital gains of $287, $356 and $652,
For 2003, gross gains of $2,266,000 ($1,412,000 for 2002 and $1,785,000 for 2001) and gross losses of $858,000 ($318,000 for 2002 and $324,000 for 2001) were realized on sales of available-for-sale-securities.
During the first quarter of 2003 the Company transferred certain corporate bonds from the SFAS 115 classification of held-to-maturity to available-for -sale. This decision was made due to circumstances considered by the Company to be both unusual and nonrecurring, which could not have been reasonably anticipated. With interest rates at four decade lows and corporate bond spreads extremely tight relative to Treasuries, the Company intends to sell certain (primarily corporate) bonds which were previously held in the SFAS 115 classification of held-to-maturity. The proceeds of these bonds will be reinvested primarily in agency securities and in the process raise the overall credit quality of the portfolio. The net carrying amount of the securities transferred was $9,833,000 and unrealized gains (net of tax) on these securities totaled $467,000 at the transfer date.
The gross unrealized investment losses and related fair value for securities available for sale at December 31, 2003 were as follow:
The appropriate income tax effects of changes in temporary differences are as follows:
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, 2003, 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 income tax liability not recognized is approximately $1,270,000 at December 31, 2003.
The Company’s insurance operations participate in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term. Property and casualty reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of reinsurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurers and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize their exposure to significant losses from reinsurance insolvencies. At December 31, 2003, reinsurance receivables with a carrying value of $765,000 ($220,000 at December 31, 2002) and prepaid reinsurance premiums of $496,000 ($343,000 at December 31, 2002) were associated with a single reinsurer. The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2003, 2002 and 2001 were approximately $580,000, $374,000, and $989,000, respectively
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, 2003, NSIC’s retained earnings unrestricted for the payment of dividends in 2004 amounted to $1,019,000.
At December 31, 2003, securities with market values of $3,606,000 ($3,564,000 at December 31, 2002) were deposited with various states pursuant to statutory requirements.
In the event of any liquidation, dissolution or distribution of the assets of the Company remaining after the payments to the holders of the Preferred Stock of the full preferential amounts to which they may be entitled as provided in the resolution or resolutions creating any series thereof, the remaining assets of the Company shall be divided and distributed among the holders of both classes of common stock, except as may otherwise be provided in any such resolution or resolutions.
The Company and its subsidiaries operate primarily in the insurance industry. Premium revenues and operating income by industry segment for the years ended December 31, 2003, 2002 and 2001 are summarized below:
Capital expenditures during the year ended December 31, 2003, were $645,000 for the individual life and accident and health insurance segment, $118,000 for the property and casualty insurance segment and $88,000 for other segments.
At December 31, 2003, the Company guaranteed the $13 million lines of credit of its affiliate, Mobile Attic, Inc. The Company is paid a guaranty fee based on the average balance of the line of credit. In 2003, the Company received $114,000 ($15,000 in 2002) in guaranty fees. The term of the guarantee is two years. Credit risk represents the accounting loss that would be recognized at the reporting date if Mobile Attic, Inc. failed to perform completely as contracted. The credit risk of $13 million assumes that no amounts could be recovered from other parties.
NSFC was named a defendant in a Washington County, Alabama action alleging fraud and bad faith in connection with a claim for wind damage to a mobile home. This action was settled in January 2004 under terms which required that the amount be kept confidential. The amount of this settlement has been reflected in the financial statements for the period ending December 31, 2003.
Cash paid for interest during 2003 was $204,000 ($261,000 in 2002 and $241,000 in 2001). Cash paid for income taxes in 2003 was $400,000 ($76,000 in 2002 and $800,000 in 2001). In 2002, noncash investing activity consisted of the conversion of a $725,000 note receivable to an equity investment.
Under the date of February 26, 2004, we reported on the balance sheets of The National Security Group, Inc. as of December 31, 2003 and 2002, and the related statements of income, shareholders’ equity and cash flows for each of the years in the three year period ended December 31, 2003, which are included in this Form 10-K. In connection with our audit of the aforementioned financial statements, we also audited the related financial statement schedules listed in the accompanying index. 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.
Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Information of the Registrant does not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles. It is, therefore, suggested that this Condensed Financial Information be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Registrant’s Annual Report as referenced in Form 10-K, Part II, Item 8, page 22.