The Company and its subsidiaries own certain real estate investment properties. The Company owns approximately 211 acres of real estate in Coffee County in Alabama. We also own, through our subsidiary NSFC, approximately 85 acres of undeveloped commercial real estate in Greenville, Alabama. We sell undeveloped lots from this development, and the development has no depreciable improvements. The Company incurred impairment losses totaling $552,000 on investment real estate in 2014.
Capitalized along with the Greenville property are site preparation costs, including clearing, filling and leveling of land. There are no improvements such as paving, parking lots or fencing that would be recorded as land improvements and depreciated over the appropriate useful life.
The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) and its subsidiaries. We are a “smaller reporting company” under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general, the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the two year period ended December 31, 2015.
is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1992.
The property and casualty segment consists of the consolidated operations of two subsidiaries, National Security Fire and Casualty Company and its wholly owned subsidiary, Omega One Insurance Company. There is no material differentiation between the products underwritten by NSFC and Omega as both underwrite primarily dwelling personal lines coverage. The Property and Casualty segment has premium in-force in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.
All of the insurance subsidiaries are Alabama domiciled insurance companies; therefore, the Alabama Department of Insurance is the primary insurance regulator. However, each subsidiary is subject to regulation by the respective insurance regulators of each state in which it is licensed to transact business. Insurance rates charged by each of the insurance subsidiaries are typically reviewed and approved by each insurance department for the respective state in which the rates will apply.
All of our insurance companies have been assigned ratings by A.M. Best Co (Best). On February 10, 2016, Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The outlook for all of these ratings is stable. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a stable outlook. The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On November 23, 2015, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.
Financial results for the year ended December 31, 2015 and 2014 were as follows:
The property and casualty segment composed 89.4% of total net earned premium revenue in 2015 compared to 88.7% in 2014. The P&C segment is primarily composed of dwelling fire and homeowners lines of business. The life segment composed 10.6% of net earned premium revenue in 2015 compared to 11.3% in 2014 with revenue produced from life, accident and supplemental health insurance products. While reading this discussion regarding segment information, reference is made to Note 15 to the Consolidated Financial Statements which provides additional segment related information.
From a revenue standpoint, our life segment is the smaller of our insurance segments contributing 10.6% of total insurance net earned premium revenue in 2015 and 11.3% in 2014. Premium revenues and operating income for the life segment for the year ended December 31, 2015 and 2014 are summarized below (amounts in thousands):
While NSIC composes only 10.6% of premium revenue, the segment makes up 38.5% of consolidated assets. The majority of these assets consist of fixed income investments. Due to the continued low interest rate environment, net investment income was down slightly at $1,913,000 for the year ended December 31, 2015 compared to $1,925,000 for the same period last year. Management believes the portfolio is well positioned to take advantage of a rising rate environment; however, continued low interest rates could lead to continued moderate declines in interest income.
Claims were $4,687,000 through December 31, 2015 compared to $5,403,000 through December 31, 2014; a decrease of $716,000 or 13.3%. NSIC experienced a decrease in both ordinary life and industrial life related claims in 2015 compared to the same period last year.
Deferred policy acquisition cost amortization and commission expenses decreased $192,000 for the year ended December 31, 2015 at $1,189,000 compared to $1,381,000 for the same period in 2014; a decline of 13.9%. As a percent of net premiums earned, policy acquisition cost amortization and commission expense was 18.9% compared to 21.7% in 2014. A decline in the rate of new business production was the primary reason for the decline in policy acquisition costs.
primary contributing factor to reductions in NSIC's general and administrative expenses as employees become cross trained and operational areas become more streamlined.
For the year ended December 31, 2015 and 2014, insurance taxes, licenses and fees were $180,000 and $311,000, respectively. As a percent of earned premium, insurance taxes, licenses and fees were 2.9% in 2015 and 4.9% in 2014. The primary reason for the increase in 2014 taxes, licenses and fees compared to 2015 were fees paid related to our periodic Alabama Department of Insurance examination which took place over most of the year in 2014.
The reduction in catastrophe reinsurance cost significantly contributed to the improvement in underwriting margins in our property and casualty segment. The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. Our catastrophe retention remained unchanged at $4 million in 2015 and we maintain catastrophe reinsurance coverage with an upper limit of $72.5 million. Our catastrophe reinsurance also covers the cost of a second event up to the same $72.5 million upper limit, again with a $4 million retention. In our reinsurance structure, management attempts to limit the impact on pretax earnings of a single modeled 100 year cat event to no more than $4 million and the primary models utilized indicate that the Company's upper limit of reinsurance is adequate to cover up to approximately a 250 year event (an event with an estimated probability of occurrence of 0.4% in a given year). It is noted, however, that hurricane models are subject to significant risks and uncertainties and are continuously evolving. Catastrophe models are only a tool to estimate the impact of catastrophe events. The Company also has risk associated with multiple smaller catastrophe events that individually may not exceed our $4 million retention.
Other income was $620,000 in 2015 compared to $550,000 for the same period in 2014; a $70,000 increase. Other income consists primarily of fees related to the issuance of our property insurance policies as well as other miscellaneous income. As a percent of net earned premium other income was 1.2% 2015 compared to 1.1% in 2014.
Policyholder benefits and settlement expenses in the property and casualty segment were $29,461,000 in 2015 compared to $25,479,000 for the same period in 2014; an increase of $3,982,000 or 15.6%. The primary reason for the increase was a rise in reported losses and loss adjustment expenses (LAE) from cat events in 2015 compared to 2014.
The primary source of the overall increase in reported losses and LAE from cat events in 2015 was Cat 93 which occurred in early October. This cat event primarily impacted the state of South Carolina and accounted for 29.3% of the total reported losses and LAE claims from cat events for 2015 . In addition, we had 755 claims reported for Cat 93 accounting for 42.2% of total reported claims from cat events in 2015.
Commission expense for 2015 was $7,572,000 (14.2% of premium revenue) compared to $7,103,000 (14.1% of premium revenue) for the same period in 2014. The primary reason for the $469,000 increase in commission expense during 2015 compared to 2014 was a 2.5% increase in gross written premium.
Insurance taxes, licenses and fees were $1,906,000 through December 31, 2015 compared to $1,826,000 for the same period in 2014. Insurance taxes, licenses and fees were 3.6% of premium revenue in 2015 and 2014.
Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, catastrophe reinsurance costs, severe thunderstorm frequency and the ability to obtain adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi or Louisiana could cause the combined ratio to fluctuate materially from year to year. In addition, most of the states that we write business are prone to severe thunderstorm and tornado activity with significant variations in the level of activity from year to year. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe; however, the geography of our coverage area, frequency of smaller catastrophe events and prohibitive
cost of maintaining lower catastrophe deductibles and/or catastrophe aggregate coverage prevents us from further mitigating catastrophe risks.
During 2015, the P&C segment experienced an increase of 3.61 percentage points in the combined ratio compared to 2014. The primary reason for the increase was a $3,982,000 increase in claims in 2015 compared to 2014. Reported claims from cat events increased the 2015 combined ratio by 10.1 percentage points. In 2014 claims from cat events increased the 2014 combined ratio by 5.2 percentage points. While catastrophe events are unpredictable and beyond the control of management, management has sought to increase margins through efficiency measures and improved rate optimization. We believe that these efforts, while not eliminating volatility, will improve our ability to better absorb the impact of a major catastrophe or increased frequency of smaller catastrophe events. Management also continues to improve rate adequacy, reduce significant exposure concentrations and implement other risk management strategies in order to further improve underwriting profitability and reduce earnings volatility.
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014:
Revenue for non-insurance operations primarily consists of interest on investments. General and administrative expenses totaled $368,000 in 2015 compared to $484,000 for the same period last year; a 23.9% decline. The expenses of NSG are primarily associated with the public listing of our stock, taxes and fees, and directors' fees. The most significant item impacting the decline in general expenses were declines in interest costs related to deferred compensation plans and legal fees. Total interest expense associated with short-term and long-term borrowings of NSG was $1,318,000 for the period ended December 31, 2015 and $1,455,000 for the same period last year. The decline in interest expense is related to a reduction in debt outstanding.
The amortized cost and aggregate fair values of investments in securities at December 31, 2015 and December 31, 2014 are as follows (dollars in thousands):
As shown in the tables above, the Company experienced an overall increase in fixed income investments in 2015 compared to the portfolio composition at December 31, 2014. Most of the increase within the fixed income portfolio was due to increase in asset backed securities and corporate debt securities. The increase in fixed income investments was driven by positive cash flow from operations which provided additional funds to invest.
The Company's subsidiaries maintain repurchase agreements for cash held on deposit under which insurance regulations dictates that our policy requires 102% (100% minimum) of the fair value of the securities purchased to be maintained as collateral. The repurchase investments are limited to government securities that are highly liquid and therefore, the investment is reflected on the balance sheet as a cash equivalent. Due to a combination of the 102% collateral requirement and short term interest rates hovering near zero, we realize virtually no interest income from repurchase agreements/short term investments. However, repurchase agreements utilizing government agency securities do provide deposit protection for short term cash held in excess of FDIC deposit limits. The Company does not have any reverse repurchase agreements.
Virtually all invested assets of the Company are held in the insurance subsidiaries. As of December 31, 2015, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows (dollars in thousands):
As discussed above, changing interest rates can have a significant impact on the market value of fixed income securities. Fixed income securities classified as available-for-sale increase the liquidity resources of the Company as they can be sold at any time to pay claims or meet other Company obligations. However, these securities are required to be carried at market value with net of tax accumulated unrealized gains and losses directly impacting shareholder's equity.
The Company, primarily through its insurance subsidiaries, had $6,763,000 in cash and cash equivalents at December 31, 2015, compared to $6,426,000 at December 31, 2014. Cash provided by operating activities increased cash by $6,880,000 during year ended December 31, 2015 and was the primary contributor to the increase in cash compared to the previous year end. For the year ended December 31, 2014, cash provided by operating activities totaled $9,833,000. Operating cash flow generated in the property and casualty segment was the primary contributor to cash provided by operating activities in both years.
Net cash used in investing activities totaled $4,835,000 for the period ended December 31, 2015, compared to $4,974,000 for the same period last year. The reinvestment of maturities of fixed income securities was the primary cash related investment activity during the year ended December 31, 2015. For the period ended December 31, 2014, the investment of positive cash flow from operations was the primary contributor to cash used in investing activities of $4,974,000.
The Company had a total of $17,358,000 of long-term debt outstanding as of December 31, 2015, compared to $18,715,000 at December 31, 2014, which includes $12,372,000 in trust preferred securities issued by the Company in addition to the installment note.
The following table reflects the anticipated cash flows associated with our short- and long-term contractual obligations and commitments as of December 31, 2015 (dollars in thousands):
Contractual obligations reflected in the table above include the issuance of $9,279,000 in subordinated debentures completed on December 15, 2005. The subordinated debentures mature December 15, 2035. It is anticipated that principal payments will not be made before maturity. Also included in long-term debt is the issuance of $3,093,000 in subordinated debentures on June 21, 2007. This issue matures June 15, 2037 and may be prepaid at any time. Also included in long-term debt held by the Company is a line of credit in the amount of $700,000 which matures in March 2018. The line of credit had $700,000 drawn at December 31, 2015. In July 2012, the Company executed an installment note in the amount of $13,000,000 to finance the settlement obligation related to the Mobile Attic litigation. As of December 31, 2015, a total of $5,142,000 was outstanding with $857,000 included in short-term notes payable.
Dividends paid from the insurance subsidiaries are subject to regulatory restrictions and prior approval of the Alabama Department of Insurance. As disclosed in Note 12 to the audited Consolidated Financial Statements included in our 2015 Annual Report on Form 10-K, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company during 2016 is statutorily limited to $1,510,000 in the life insurance subsidiary and $3,445,000 in the property/casualty insurance subsidiary. Dividends are limited to the greater of net income (operating income for life subsidiary) or 10% of statutory capital, and regulators consider dividends paid within the preceding twelve months when calculating the available dividend capacity. Therefore, all of the above referenced dividend capacity will not be available for consideration of payment until dividends paid in the preceding twelve months have been considered on a rolling basis. The Company also has to continuously evaluate other factors such as subsidiary operating performance, subsidiary capital requirements and potential impact by rating agencies in making decisions on how much capital can be released from insurance subsidiaries for payment of dividends to NSG. These factors are considered along with the goal of growing year over year statutory surplus in the subsidiaries, and these considerations along with previous adverse impacts on regulatory surplus, will likely lead to dividend payments to NSG substantially below the above referenced regulatory maximums. The Company received $2,000,000 in dividends from its subsidiaries during the year ended December 31, 2015.
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 5 to 1 at December 31, 2015.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $13.9 million and $12.9 million at December 31, 2015 and 2014, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 17.9 and 17.4 at December 31, 2015 and 2014, respectively. Accordingly, National Security Insurance Company exceeds the minimum RBC requirements.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $34.5 million and $32.3 million at December 31, 2015 and 2014, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 5.2 and 4.9 at December 31, 2015 and 2014, respectively. Accordingly, National Security Fire & Casualty Company exceeds the minimum RBC requirements.
NSFC and Omega generally reinsure with third parties any liability in excess of $250,000 on any single policy. During 2015, the property and casualty segment maintained a catastrophe contract, which covered losses related to a catastrophic event with multiple policyholders affected. In the event a catastrophe exceeded the $4 million company retention stated in the contract, reinsurers would reimburse the company 100% of gross losses up to the upper limits of the reinsurance agreement, which was $72.5 million in 2015 and 2014. Any losses above the $72.5 million upper limit are the responsibility of our Company. The contract in place during 2015 also allowed one reinstatement for coverage under the contract for a second catastrophic event if needed.
The property and casualty subsidiaries utilize our actual in force policy data modeled utilizing two different industry accepted catastrophe models to structure catastrophe reinsurance and determine upper limits of catastrophe reinsurance agreements. Based on modeling results utilized in 2015 and 2014, the Company was reinsured at approximately a 250 year event level. While this estimate is subject to some uncertainty and model risk, the models indicate that we maintain catastrophe reinsurance upper limits to cover an event that has less than a 0.5% probability of occurring in a given year.
There is a possibility that the actual amounts recovered from reinsurers could be materially less than the estimates recorded. This possibility could result in a material adverse impact on our financial condition and results of operations. Reinsurers may dispute claims under reinsurance treaties, such as the calculated amount of reinsurance recoverable. Management does not anticipate any issues with recoverability of reinsurance balances based on current evaluations of collectability. For more information regarding reinsurance, see the Notes to our Consolidated Financial Statements.
At December 31, 2015 and 2014, the recorded liability for loss and loss adjustment expense was $9,645,000 and $8,321,000, respectively, a $1,324,000 increase. The increase in property and casualty benefit and loss reserves is due to an increase in fourth quarter storm activity in 2015 compared to prior year. We believe the estimate of unpaid losses and loss adjustment expenses to be sufficient based on currently available information and a review of our historical reserving practices. For more information regarding loss and loss adjustment expense, see Note 9 to our Consolidated Financial Statements.