Net premiums earned .......... $28,451 $31,156 $26,654 $24,372 $26,289 Net investment income ........ 4,351 4,204 3,935 4,311 4,001 Net realized investment gains ...................... 4,117 2,720 1,839 1,650 1,720 Other income ................. 385 695 582 505 400 ------- ------- ------- ------- ------- Total revenues ............... $37,304 $38,775 $33,010 $30,838 $32,410 ======= ======= ======= ======= =======
Net Income ................... $ 930 $ 2,998 $ 1,356 $ 214 $ 3,674 ======= ======= ======= ======= =======
Net income per share ......... $ 0.42 $ 1.28 $ 0.58 $ 0.09 $ 1.57 ======= ======= ======= ======= =======
Dividends per share ........... $ 0.77 $ 0.70 $ 0.65 $ 0.61 $ 0.57
Net change in unrealized capital gains (net of tax) ($ 351) $ 4,556 $ 968 $ 2,726 ($3,030)
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997:
Consolidated net income for The National Security Group (The Company) was $930,000 in 1998 compared to $2.998 million in 1997. On a per share basis earnings were $0.42 in 1998 compared to $1.28 in 1997. The decrease in net income was due to poor operating results in The Company's property/casualty subsidiaries operations. The operating results of the subsidiaries are discussed in further detail in the sections that follow. Realized capital gains in 1998 were $4.1 million compared to $2.7 million in 1997. Consolidated revenues were $37.3 million in 1998 compared to 38.8 million in 1997. Revenues were down 4% for the year due to a decrease in property and casualty insurance premiums.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996:
Premium revenues: 1998 % 1997 % 1996 % ------- ----- ------ ----- ----- ---- Life and accident and health insurance $ 3,837 13.5 $ 3,991 12.8 $ 4,433 16.6 Property and casualty insurance 24,614 86.5 27,165 87.2 22,221 83.4 ------- ----- ------ ---- ------- ----- $28,451 100.0 $31,156 100.0 $26,654 100.0
Pretax earnings in 1998 were $2.5 million compared to $2.2 million in 1997. The increase in pretax earnings was primarily due to a decrease in agents commissions and litigation expenses. Premium income was $3.8 million in 1998 compared to $4.0 million in 1997. Premium income appears to be stabilizing after a rapid decline over the past five years.
Pretax earnings in 1997 of $2.2 million were significantly better than 1996 earnings of $1.1 million. The primary factor contributing to the improvement in earnings was a reduction in litigation expenses. In 1997 litigation expenses were only $80,000 compared to $760,000 in 1996. Also contributing to the increase in earnings was realized capital gains which increased over $400,000 in 1997 compared to 1996. Premium income, which totaled $4.0 million in 1997, is down from $4.4 million in 1996. The reduction in premium income is due to a reduction in the number of sales agents. The number of sales agents has declined by 69% over the last five years to the current total of 31.
Pretax losses were $1.0 million in 1998 compared to pretax income of $1.6 million in 1997. Several catastrophe losses and a litigation settlement during 1998 had a major impact on the results of property and casualty insurance operations.
NSFC also settled a long standing lawsuit in 1998 which decreased pretax earnings by over $2.0 million. This settlement is discussed in further detail in Note 11 of the financial statements.
The results of these ratios for the past three years were: 1998 1997 1996 ----- ----- ---- Loss and LAE Ratio ...................... 87.0% 79.3% 79.8% Underwriting Expense Ratio .............. 31.6% 31.0% 30.9% ----- ----- ----- Combined Ratio .......................... 118.6% 110.3% 110.7%
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, strict underwriting of risks, and adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi, Louisiana, or Texas could cause the combined ratio to fluctuate materially from prior years. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe.
The combined ratio for 1997 compared to 1996 did not improve due to increased losses in the private passenger automobile programs. The low value dwelling program loss ratio improved greatly in 1997 but was offset by the increase in automobile losses. The primary reason for the high combined ratio for 1996 was higher than normal incurred losses in the low value dwelling program in the first quarter of 1996. These losses were attributable to the colder than normal winter which led to more fire losses and several tornado producing storms which hit the Southeastern United States.
Asset Portfolio Review: The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 1998, the company's holdings in debt securities amounted to 58% of total investments and 49% of total assets. The following is a breakdown of the bond portfolio quality according to National Association of Insurance
Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the nationally recognized rating organization equivalents of Moody's and Standard and Poor's: SVO Equivalents % of Total SVO Class Moody's Standard and Poor's Bond Portfolio - --------- ------- ------------------- -------------- 1 Aaa to A3 AAA to A- 93.2 2 Baa to Baa3 BBB+ to BBB- 5.9 3 Ba1 to Ba3 BB+ to BB- 0.0 4 B1 to B3 B+ to B- 0.5 5 Caa to Ca CCC+ to C 0.4 6 C CI to D 0.0
The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $15.5 million and $14.1 million at December 31, 1998 and 1997 respectively. 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 National Security Group's consolidated statement of cash flows indicate that operating activities (used) provided cash of $(1.90 million), $7.48 million, $1.45 million in 1998, 1997, and 1996 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. An increase in claim payments was a primary use of cash in operating activities for 1998. A large decrease in reinsurance recoveries of $4 million are the major causes of a $6 million increase in cash provided from operations in 1997. The primary reason for the increase in cash provided by operating activities for 1996 was the increased cash flow from the new automobile programs.
The Company has notes payable of $3.0 million at December 31, 1998. A $700,000 note is payable in quarterly installments over five years, and a $2.3 million note matures in April of 1999. The Company expects to refinance this note at maturity with an extended repayment term of no less than five years.
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 four to one at December 31, 1998.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $14.5 million and $13.4 million at December 31, 1998 and 1997, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 9.5 and 8.5 at December 31, 1998 and 1997 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $25.0 million and $27.2 million at December 31, 1998 and 1997, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 9.1 and 8.4 at December 31, 1998 and 1997 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 $3.2 million and $4.4 million at December 31, 1998 and 1997, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 4.0 and 5.2 at December 31, 1998 and 1997 respectively. Accordingly, Omega One Insurance Company meets the minimum RBC requirements.
Consolidated Statements of Income - Years Ended December 31, 1998, 1997, and 1996......................... 20
Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997, and 1996......................... 23
Schedule I. Summary of Investments - December 31, 1998 and 1997........ 36
Schedule VI. Reinsurance - Years Ended December 31, 1998, 1997, and 1996......................... 42
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. 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.
Birmingham, Alabama Dudley, Hopton-Jones, Sims & Freeman PLLP February 19, 1999
BENEFITS AND EXPENSES Policyholder benefits paid or provided ...... 22,880 22,995 19,677 Amortization of deferred policy acquisition costs ........................ 1,856 1,488 995 Commissions ................................. 3,764 4,334 3,726 General insurance expenses .................. 6,261 5,229 5,515 Insurance taxes, licenses and fees .......... 1,194 1,258 1,367 Interest expense ............................ 243 111 109 -------- -------- -------- 36,198 35,415 31,389 ======== ======== ========
The fair values of debt and equity securities have been determined using values supplied by independent pricing services and are disclosed together with carrying amounts in Note 3.
As of December 31, 1998 and 1997, the fair value of policy loans approximated their carrying amount of $645,000 and $648,000, respectively.
Deferred Policy Acquisition Costs The costs of acquiring new insurance business are deferred and amortized over the lives of the policies. Deferred costs include commissions, other agency compensation and expenses, and other underwriting expenses directly related to the level of new business produced.
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 2,228,940 in 1998, 2,316,953 in 1997 and 2,337,931 in 1996.
Reclassifications Certain reclassifications have been made in the previously reported financial statements to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on the previously reported net income or shareholders' equity.
Effective January 1, 1998 the Company and its subsidiaries adopted Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, ("SFAS No. 131"). SFAS No. 131 requires that financial and descriptive information be disclosed for each reportable operating segment based on the management approach. The management approach focuses on financial information that a business enterprise's decision makers use to assess performance and make decisions about resource allocations. The statement also prescribes the enterprise-wide disclosures to be made about products, services, geographic areas and major customers. SFAS No. 131 is effective for annual financial statements issued for periods beginning after December 15, 1997, and for interim financial statements in the second year of application. The adoption of SFAS No. 131 did not have a material impact on the financial statements of the Company.
Effective January 1, 1998 the Company and its subsidiaries adopted Statement of Financial Accounting Standards No 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, ("SFAS No. 132"). SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits, eliminates certain disclosures and requires additional information on changes in benefit obligations and fair values of plan assets. SFAS No. 132 is effective for annual financial statements for periods beginning after December 15, 1997. Restatement of disclosures for previous periods is also required. The adoption of SFAS No 132 did not have a material impact on the financial statements of the Company.
NOTE 3 - INVESTMENT SECURITIES: The amortized cost and aggregate fair values of investments in securities are as follows:
NOTE 3 - INVESTMENT SECURITIES: - CONTINUED The amortized cost and aggregate fair value of debt securities at December 31, 1998, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call prepayment penalties.
Gross gains of $4,009,429 and $2,392,684 and gross losses of $5,884 and $53,157 for 1998 and 1997, respectively, were realized on sales of available - for - sale securities.
Fixed maturities ........................ $ 3,503 $ 3,334 $ 3,112 Equity securities ....................... 682 654 559 Mortgage loans on real estate ........... 17 29 39 Investment real estate .................. 18 18 13 Policy loans ............................ 38 37 37 Other, principally short-term investments 136 222 230 ------- ------- ------- 4,394 4,294 3,990 Less: Investment expenses .............. (43) (90) (55) ------- ------- ------- Net investment income ................... $ 4,351 $ 4,204 $ 3,935 ======= ======= =======
NOTE 4 - NET INVESTMENT INCOME: - CONTINUED An analysis of the net increase (decrease) in unrealized appreciation on available-for-sale securities follows:
Deferred policy acquisition costs .................... $(1,412) $(1,434) Policy liabilities ................................... 463 519 Unearned premiums .................................... 440 442 Claim liabilities .................................... 569 530 General insurance expenses ........................... 710 931 Unrealized gains on securities available-for-sale .... (4,915) (5,066) ------- ------- Net deferred tax liabilities ......................... $(4,145) $(4,078) ------- -------
NOTE 5 - INCOME TAXES: - CONTINUED The approximate income tax effects of changes in temporary differences are as follows:
Deferred policy acquisition costs .......... $ (22) $ 70 $ 226 Policy liabilities ......................... 56 ( 3) (17) Unearned premiums .......................... 2 ( 2) (87) General insurance expenses ................. 222 (349) (268) Claim liabilities .......................... (39) (202) (38) Other ...................................... (136) 0 28 ----- ----- ----- $ (83) $(486) $(156) ===== ===== =====
(Dollars in Thousands) ---------------------------------- NSIC NSFC ---------------- ---------------- Written Earned Written Earned ------- ------ ------- -------- Direct ......... $ 3,886 $ 3,892 $ 26,085 $ 26,194 Assumed ........ 0 0 0 0 Ceded .......... (55) (55) (1,503) (1,580) -------- -------- -------- -------- Net ............ $ 3,831 $ 3,837 $ 24,582 $ 24,614 ======== ======== ======== ========
NOTE 7 - EMPLOYEE BENEFIT PLAN: In 1989, the Company and its subsidiaries established a retirement savings plan and transferred the assets from the defined contribution profit sharing plan into the new plan. All full-time employees who have completed one year of service at January 1 or July 1 are eligible to participate and all employee contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Contributions for 1998, 1997 and 1996 amounted to $61,000, $170,000, and $90,708, respectively. Contributions are at the Board of Directors' discretion subject to governmental limitations.
Securities with market values of $3,296,573 and $3,306,062, at December 31, 1998 and 1997, respectively, were deposited with various states pursuant to statutory requirements.
NOTE 9 - SHAREHOLDERS' EQUITY: Preferred Stock The Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference.
NOTE 13 - NOTES PAYABLE: At December 31, 1998, notes payable totaling $3,004,402 consisted of unsecured notes payable, bearing interest rates from 7% to 8%, due 1999.
Liabilities and Shareholders' Equity Accrued general expenses ........................ $ 871 $ 916 Notes Payable ................................... 3,004 0 ------- -------
Note 2-Cash Dividends from Subsidiaries Dividends of $2 million in 1998, $1.85 million in 1997 and $1.80 million in 1996 were paid to the Registrant by its subsidiaries.
At December 31, 1996: Life and accident and health insurance $ 2,700 $18,558 $ 0 $ 360 Property and casualty insurance ...... 1,313 0 10,398 19,087 ------- ------- ------- ------- Total ............................ $ 4,013 $18,558 $10,398 $19,447 ======= ======= ======= =======