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 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", "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, the following discussion generally covers the change in financial condition, results of operations and cash flows for the year ended December 31, 2020 compared to the year ended December 31, 2019 and should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and Notes which accompany this report. Please refer to our note regarding forward looking statements on page 4 of this report.
•The Life segment accounted for 8.5% of gross premium revenue in 2020. The Life segment is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.
The Life segment operations are conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. All references to NSIC or life segment in the remainder of this management discussion and analysis will refer to the combined life, accident and health insurance operations.
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 subject to review and approval by the insurance department for the respective state in which the rates will apply.
The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On December 12, 2020, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.
For the year ended December 31, 2020, the Company had a net loss of $8,619,000, $3.41 loss per share, compared to a net income of $4,067,000, $1.61 income per share, for the year ended December 31, 2019. The year to date pretax loss from operations, in 2020, totaled $12,641,000 compared to a pretax income from operations of $1,525,000 in 2019. The primary reason for the significant loss in 2020, compared to the same period in 2019, was a $15,332,000 increase in policyholder benefits; primarily driven by a significant increase in catastrophe claims in the P&C segment. Results for 2020 were also impacted by investment gains of $1,623,000 compared to investment gains of $3,055,000 in 2019.
Financial results for the year ended December 31, 2020 and 2019, based on U.S generally accepted accounting principles, were as follows:
The P&C segment ended 2020 with a GAAP basis combined ratio of 126.1%. Reported catastrophe losses, net of reinsurance recoveries, totaled $24,196,000 and added 43.5 percentage points to the combined ratio. In comparison, the P&C segment ended 2019 with a GAAP basis combined ratio of 100.1% with $6,623,000 in reported catastrophe losses increasing the combined ratio by 12.1 percentage points. Partially offsetting the increase in reported catastrophe losses, in 2020, was a reduction in reported fire losses of $1,820,000. Reported fire losses totaled $12,172,000, in 2020, and added 21.9 percentage points to the 2020 combined ratio. In comparison, in 2019, reported fire losses totaled $13,992,000 and added 25.6 percentage points to the 2019 combined ratio. In addition, non-catastrophe wind and hail losses were down $1,267,000 in 2020 compared to 2019. Reported non-catastrophe wind and hail losses, in 2020, totaled $7,866,000 and added 14.1 percentage points to the 2020 combined ratio. In comparison, non-catastrophe wind and hail losses reported during 2019 totaled $9,133,000 and added 16.7 percentage points to the 2019 combined ratio.
Total assets as of December 31, 2020 were $150,540,000 compared to $153,934,000 at December 31, 2019. Asset growth in 2020 was hindered by catastrophe losses in the P&C segment and was the primary reason for the 2.2% decrease in total assets at December 31, 2020 compared to total assets at December 31, 2019.
Premium revenues and operating income for the life segment for the year ended December 31, 2020 and 2019 are summarized below:
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019:
The table below provides investment gains and losses for the year ended December 31, 2020 and 2019:
NSIC net investment gains, for the year ended December 31, 2020, were $567,000 compared to net investment gains of $861,000 for the same period last year; a decrease of $294,000. Net investment gains and losses are highly dependent on numerous internal and external factors including but not limited to market conditions, tax position and liquidity needs of the Company and can vary significantly from period to period. A primary factor contributing to the decrease in net investment gains, in 2020, was an decrease in the change in value of equity securities held for investment to a gain of $104,000 compared to a gain of $589,000 in the prior year. Another factor contributing to the lower investment gains, in 2020, was a $233,000 realized gain, in 2019, primarily from our minority stake in privately held Trinity Bancorp, which merged with privately held River Financial Corporation, in October of 2019, in a cash and stock transaction.
Other income was $1,242,000 in 2020 compared to $853,000 for the same period last year; an increase of $389,000. Other income consists primarily of adjuster fees paid to NSIC from the P&C segment. As a percent of net earned premium, other income was 21.8% in 2020 and 14.5% in 2019. The primary reason for the increase in other income, in 2020 compared to 2019, was an increase in claims from storm activity in the P&C segment leading to an increase in adjuster fees paid from NSFC to NSIC.
Claims were $5,215,000 through December 31, 2020 compared to $5,027,000 through December 31, 2019; an increase of $188,000 or 3.7%. The primary reason for the increase was elevated claim payments, in 2020, due to an increase in ordinary life related claims.
General and administrative expenses were down slightly at $1,923,000, in 2020, compared to $1,948,000, in 2019. As a percent of earned premium, general and administrative expenses were 33.7% and 33.2% at December 31, 2020 and 2019, respectively. The $25,000 decrease in general and administrative expenses, in 2020 compared to 2019, was primarily due to a decline in actuarial and consulting fees of $39,000.
Interest expense was $41,000 for the year ended December 31, 2020 compared to $43,000 for the year ended December 31, 2019. Interest expense in NSIC is associated with interest payments on insurance policies with a deposit fund. Deposit fund balances declined in 2020 leading to the slight reduction in interest expense.
Pretax income for the P&C segment for the year ended December 31, 2020 and 2019 is summarized below:
The primary source of premium revenue growth in the P&C segment was primarily the states of Alabama and Georgia. Premium revenue in Alabama increased 7.6%, in 2020, while policy counts decreased 1.7% compared to December 31, 2019. Increased rates were implemented in Alabama which lead to the year over year increase in premium revenue in the state. In addition, Georgia premium revenue increased 6.8% in 2020, while policy counts decreased 4.4%. The implementation of increased rates was the primary reason for the increase in premium revenue in Georgia, in 2020, compared to the same period last year.
The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from cat events. To summarize our catastrophe reinsurance structure, under the catastrophe reinsurance program in 2020, the Company retained the first $4,000,000 in losses from a first event and $2 million in losses from a second event.
The table below provides the major categories of investment income, primarily dividend and interest income, for the year ended December 31, 2020 and 2019:
Other income was comparable at $582,000 for the year ended December 31, 2020, compared to $575,000 in 2019; an increase of $7,000. 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 1.1% in both 2020 and 2019.
Policyholder claims in the property and casualty segment were $49,425,000 in 2020, compared to $33,979,000 for the same period last year; an increase of $15,446,000 or 45.5%. Claims as a percentage of premium earned was 89.7% in 2020 compared to 62.9% in 2019. The primary reason for the increase in claims was a $17,573,000
Hurricane Dorian (Cat 1954) and Tropical Storm Olga (Cat 1963), in 2019, totaled $2,772,000 and accounted for 41.9% of all reported catastrophe event claims through December 31, 2019. Hurricane Barry, Hurricane Dorian and Tropical Storm Olga added 5.1 percentage points to the 2019 P&C segment combined ratio.
Reported fire losses in 2020 were down $1,820,000 or 13.0% compared to fire losses reported during 2019. The P&C segment had 416 fire losses reported in 2020 totaling $12,172,000 compared to 481 claims reported in 2019 totaling $13,992,000. The average cost per claim was $29,300 for fire losses reported in 2020 compared to $29,100 for fire losses reported in 2019. Fire losses reported during 2020 added 21.9 percentage points to the P&C segment combined ratio while fire losses reported during 2019 added 25.6 percentage points to the P&C segment combined ratio.
Insurance taxes, licenses and fees were $2,268,000 through December 31, 2020, compared to $2,185,000 for the same period last year. As a percentage of net premiums earned, insurance taxes, licenses and fees were 4.1% for the year ended December 31, 2020, compared to 4.0% for year ended December 31, 2019. The primary reason for the increase in taxes, licenses and fees, in 2020, compared to 2019, was the 2.2% increase in P&C segment gross written premium, in 2020, compared to 2019.
For the year ended December 31, 2020, the Company had a pretax loss of $11,962,000 compared to pretax income of $3,804,000 for the same period in 2019. The $15,766,000 decrease was primarily due to the $17,573,000 increase in catastrophe claims, in 2020 compared to 2019.
•The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premium revenue.
•The underwriting expense ratio, which measures underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premium revenue.
Revenue for non-insurance operations primarily consists of interest on investments and other income. Other income is composed of management service fees from subsidiaries which are eliminated upon consolidation. General and administrative expenses totaled $892,000 in 2020 compared to $1,128,000 for the same period last
year. 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 was a decrease in the liability for unfunded non-qualified deferred compensation plans. Total interest expense associated with short-term and long-term borrowings of NSG was $823,000 for the year ended December 31, 2020 and $1,122,000 for the same period in 2019. The Company entered into two interest rates swaps during 2020 to reduce the rate of interest paid on its trust preferred securities. See Note 8 to the Consolidated Financial Statements for additional information about the interest rate swaps. A reduction in debt outstanding was also a factor in the decline in interest expense.
There were no material changes in credit quality mix in 2020 as we continue to focus on investing in high quality investment grade securities. Also, tight credit spreads throughout 2020 limited the rewards of investing in lower quality issues.
As shown in the tables above, the Company experienced an increase in unrealized gains in fixed maturity securities in 2020 compared to 2019. The increase is primarily driven by the decline in interest rates and tightening of corporate bond spreads in the fixed maturity investment portfolio.
A number of factors influence portfolio allocation within each of the insurance subsidiaries. Within the property and casualty subsidiaries, due to the relatively short-term nature of segment liabilities, fixed income investments tend to be of shorter duration, with average maturities of less than five years. Also, due to higher levels of potential volatility of policy liabilities (severe weather related losses), a greater emphasis is placed upon overall liquidity of investments. In contrast, within the life insurance subsidiary, policy liabilities tend to be more stable and of significantly longer duration. In order to match the longer duration of liabilities, investments in the life insurance portfolio tend to have longer maturities, and higher average book yields. Also, less emphasis is placed upon short-term liquidity in the life subsidiary due to more predictable cash needs.
declines in market value of fixed income securities in a rising interest rate environment. Management currently maintains the life insurance portfolio in the intermediate duration range of 6.0 to guard against the adverse impact of rising rates. However, due to the necessity of matching the longer duration of life policy liabilities as closely as possible in order to pass regulatory cash flow testing and avoid significant interest rate speculation in the asset liability matching process, some volatility in market value of the portfolio in a rising rate environment cannot be avoided.
At December 31, 2020, 6.5% of total investments in the fixed income portfolio were classified as below investment grade. In evaluating whether or not the equity loss positions were other-than-temporary impairments, management evaluated financial information on each company and, where available, reviewed analyst reports from independent sources. Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments. Management has evaluated each security in a significant unrealized loss position. For the year ended December 31, 2020, the Company realized $180,000 in other-than-temporary impairments related to fixed maturities.
The amortized cost and aggregate fair value of debt securities at December 31, 2020, 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 or prepayment penalties.
As discussed earlier, the majority of our longer duration securities are investments made to match longer duration liabilities in the life segment or are investments in mortgage backed securities, primarily government agency. Due to the amortizing nature and the ability to prepay mortgage backed securities, actual maturities tend to be significantly shorter than contractual maturities.
Average current yield on investments in 2020 remained unchanged compared to 2019. The total return on investments in 2020 was 6.6% compared to 10.2% in 2019. Increases in market value of fixed maturity investments due to declines in market interest rates was a primary driver of total return on investments in 2020. A gain on our
company owned life insurance investment coupled with interest rate driven increases in value of our fixed maturity investments available for sale were the primary factors driving the higher total return in 2019 compared 2020.
Due to regulatory restrictions, the majority of the Company's cash is required to be invested primarily in investment-grade securities to provide protection for policyholders. The liabilities of the property and casualty insurance subsidiaries are of various terms, and therefore, those subsidiaries invest in securities with various effective maturities spread over periods usually not exceeding 10 years with an average portfolio duration typically of less than 5 years. The liabilities of the life insurance subsidiary are typically of a longer duration, and therefore, a higher percentage of securities in the life insurance subsidiary are invested for periods exceeding 10 years.
The liquidity requirements for the Company are primarily met by funds generated from operations of the life insurance and property and casualty insurance subsidiaries. All operations and virtually all investments are maintained by the insurance subsidiaries. Premium and investment income as well as maturities and sales of invested assets provide the primary sources of cash for both the life and property/casualty businesses, while applications of cash are applied by both businesses to the payment of policy benefits, the cost of acquiring new business (principally commissions), operating expenses, purchases of new investments, and in the case of life insurance, policy loans.
Virtually all invested assets of the Company are held in the insurance subsidiaries. As of December 31, 2020, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows:
It should be noted that the above table represents maturities based on stated/contractual maturity. Due to call and prepayment features inherent in some fixed maturity securities, actual repayment, or effective maturities, will differ from stated maturities. The Company routinely evaluates the impact of changing interest rates on the projected maturities of bonds in the portfolio and actively manages the portfolio in order to minimize the impact of interest rate risk. However, due to other factors, both regulatory and those associated with good investment management practices associated with asset/liability matching, we do have exposure to changes in market values of securities due to changes in interest rates. Currently, a 100 basis point immediate increase in interest rates would generate approximately a $3,826,000, or 4.7%, decline in the market value of fixed maturity investments. Alternatively, a 100 basis point decrease in interest rates will generate approximately $3,638,000, or 4.5%, increase in market value of fixed income investments. Management has attempted, to the extent possible, to reduce risk in a rising rate environment. However, due to asset/liability matching requirements, particularly in the life subsidiary portfolio, interest rate risk can not be eliminated and exposure to market volatility can cause some variability in our accumulated other comprehensive income, total return on investments, total shareholders' equity and book value per share.
At December 31, 2020, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $45,366,000, down $8,095,000, compared to $53,461,000 at December 31,
2019. During the year ended December 31, 2020, shareholders' equity was decreased by a net loss of $8,619,000, increased by comprehensive income due to changes in value of fixed maturity securities of $1,580,000 and decreased by a comprehensive loss of $438,000 related to change in value of interest rate swaps. Equity was also increased by common stock issued of $25,000. Equity was reduced $36,000 by the purchase of 2,509 common stock shares held as treasury stock and by cash dividends paid totaling $607,000.
The Company, primarily through its insurance subsidiaries, had $19,887,000 in cash and cash equivalents at December 31, 2020, compared to $11,809,000 at December 31, 2019. Cash used in operating activities decreased cash by $13,890,000 during the year ended December 31, 2020. The decrease in cash from operating activities was primarily related to the net loss for the period which was triggered by an increase in claims and claims related expenses in the P&C segment from spring storms during the second quarter and hurricane losses during the third and fourth quarters. Cash provided by operating activities increased cash by $5,373,000 for the year ended December 31, 2019. The increase in cash from operating activities was driven by refunds of federal income tax overpayment along with changes in other assets and reinsurance recoveries. Net cash provided by investing activities totaled $23,083,000 for the year ended December 31, 2020, compared to $1,656,000 in 2019. The increase in cash from investing activities was related to maturities, some increases in prepayments on mortgage backed securities and sales of investments to maintain adequate liquidity to settle P&C segment hurricane claims. Net cash provided by investing activities in 2019 primarily consisted of maturities of investments in which reinvestment was delayed in order to increase liquidity during hurricane season. Net cash used in financing activities totaled $1,115,000 for the year ended December 31, 2020, compared to $896,000 for the same period last year. During the year ended December 31, 2020, the Company paid $607,000 in dividends to shareholders.
Contractual obligations reflected in the table above include the issuance of $9,129,000 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 $3,035,000 in subordinated debentures on June 21, 2007. This issue matures June 15, 2037 and may be prepaid at any time. Also reflected in the table above is a $1,500,000 unsecured loan renewed in December 2019. The unsecured loan matures in November 2023.
In estimating the time interval for payment of property and casualty claim reserves, the Company utilized historical payment patterns. By the nature of the insurance contracts under which these liabilities exist, there can be no certainty that actual payments will fall in the periods indicated above. However, management believes that current liquidity and capital resources are sufficient to pay these obligations as they come due. Also, due to the relatively short-tail nature of the majority of the Company's property and casualty claim liabilities, management can conclude with a reasonable level of confidence that historical patterns indicate that approximately 97.5% of claim liabilities at the end of a given year are settled within the following two year period. See Note 9 for additional details on payout patterns.
Our P&C segment is the primary source of dividends to the holding company. Consideration of insurance subsidiary growth opportunities, regulatory capital adequacy, rating agency impact and holding company debt reduction, among other items, are factors that influence our subsidiary dividend requirements. While we have made significant progress in recent years, continued strengthening capital levels in the insurance subsidiaries and reduction of debt remains a top priority. However, a decline in regulatory capital in our P&C subsidiary in 2020 due to increased catastrophe loss frequency will limit our ability to prepay any debt obligations beyond what is required for at least the next two years.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $7,083,000 and $11,430,000 at December 31, 2020 and 2019, and a ratio of regulatory total adjusted capital to authorized control level RBC of 12.7 and 20.1 at December 31, 2020 and 2019, respectively. Accordingly, Omega One Insurance Company exceeds the minimum RBC requirements.
Risk management involves ceding risks to reinsurers for policies underwritten based on contractual agreements. The reinsurance purchased helps provide protection by individual loss or catastrophic event when claims exceed specified amounts. Although the reinsurance protects our Company in the event a loss exceeds retention limits specified in a particular reinsurance agreement; ultimate responsibility for claim settlement rests with our Company if any reinsurer defaults on payments due. We record an asset for reinsurance recoverable in the financial statements for amounts due from reinsurers and monitor the balances due by reinsurer to ensure the asset is ultimately going to be collectible. If we discover an amount due may not be received, we remove the balance and charge it to an allowance for doubtful accounts or charge it off to expense based on the information available at the time.
When a claim is made under a policy we have reinsured, we initially pay the full amount owed to the policyholder or claimant. Subsequently, we initiate the process to recover any amounts due from reinsurers in accordance with the terms of the applicable reinsurance contract.
During 2020, the property and casualty segment maintained a catastrophe reinsurance contract, which covered losses exceeding a retention related to a single catastrophic event. 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 2020 and 2019. Any losses above the $72.5 million upper limit are the responsibility of our Company. The contract in place during 2020 also allowed one reinstatement for coverage under the contract for a second catastrophic event with the same upper $72.5 million upper limit but with a reduced retention of $2 million due to placement of an aggregate Layer of coverage of $2 million in excess of a $2 million event minimum subject to a $2 million aggregate annual deductible.
reinsurance agreements. Historically, reinsurance has been maintained to meet at least a 250 year modeled event level. While this estimate is subject to some uncertainty and model risk, through obtaining coverage that meets at least a 250 year modeled event level, 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.
At December 31, 2020, there is no evidence to suggest to management that any deferred tax asset is unrealizable. For more information regarding deferred income taxes, see Note 7 to our Consolidated Financial Statements.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company. in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
•We obtained an understanding of the reserve estimation process through inquiry of management,
•We reviewed the reconciliations from the source data to the general ledger as performed by management,
•We used a specialist to assist us in evaluating the appropriates of the reserve balances recorded by management, and
The Company's life, accident and health insurance subsidiary, composing approximately 8.5% of consolidated direct written premium, is licensed in seven states. However, over 77% of life segment direct premium is generated in the
states of Alabama and Georgia. Consequently, changes in the legal, regulatory or economic environment in these states could adversely impact the Company.
For the year ended December 31, 2020, one agency individually produced greater than 5% of the Company's direct written premium.
•Securities available-for-sale are fixed maturity securities and equity securities not classified as either held-to-maturity or trading. These securities are reported at fair value. Substantially all of our fixed maturity and equity securities are classified as available-for-sale.
Changes in fair value of trading securities are reported in the consolidated statement of operations.
•it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis
•the Company does not expect to recover the entire amortized cost basis of the security
If the Company intends to sell the security or if it is more-likely-than-not the Company will be required to sell the security before recovery, an OTTI is recognized as a realized loss in the consolidated statement of operations equal to the difference between the security's amortized cost and its fair value. If the Company does not intend to sell the security or it is not more-likely-than-not that the Company will be required to sell the security before recovery, the OTTI is separated into an amount representing the credit loss, which is recognized as an investment loss in the consolidated statement of operations, and the amount related to all other factors, which is recognized in other comprehensive income.
The Company owns life insurance (COLI) contracts on certain management and supervisory employees each having a face amount of approximately $2,000,000 (including cash surrender value at the time of payment). The Company's original investment in currently inforce company owned life insurance is $4,082,000. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. The Company is the owner and principal beneficiary of these policies. The life insurance contracts are carried at their current cash surrender value. Cash surrender value at December 31, 2020 and December 31, 2019 was $4,998,000 and $4,655,000, respectively. Changes in cash surrender values are included in the consolidated statement of operations. The change in surrender value included in the consolidated statement of operations for the years ended December 31, 2020 and 2019 was an increase of $343,000 and an increase of $295,000, respectively. Proceeds from the COLI contracts are recorded when the benefits become payable under the terms of the policy and proceeds in excess of cash surrender value are recognized as a gain on company owned life insurance.
•Fixed income security fair values are based on quoted market prices when available. If not available, fair values are based on values obtained from investment brokers and independent pricing services.
•Multiple observable inputs are not available for some of our investments, primarily private placements and limited partnerships. Management values these investments either using non-binding broker quotes or pricing models that utilize market based assumptions that have limited observable inputs. These investments compose less than 1% of total assets.
Policy receivables and agents' balances are reported at net realizable value. Management determines the allowance for doubtful accounts based on historical losses and current economic conditions. On a continuing basis, management analyzes delinquent receivables, and once these receivables are determined to be uncollectible, they are written off through a charge against an existing allowance account or against earnings.
For purposes of reporting cash flows, cash includes cash-on-hand, demand deposits with banks and overnight investments consisting primarily of repurchase agreements.
Life insurance premiums are recognized as revenues when due. Property and casualty insurance premiums include direct writings plus reinsurance assumed less reinsurance ceded and are recognized on a pro-rata basis over the terms of the policies. Unearned premiums represent that portion of direct premiums written that are applicable to the unexpired terms of policy contracts in force and are reported as a liability. Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers and are reported as an asset.
The liability for unpaid claims represents the estimated liability for unpaid loss and loss adjustment expenses incurred but not yet reported under insurance contracts for loss events that have occurred on or before the balance sheet date. The liability for claims and related adjustment expenses are determined using case-basis evaluations and statistical analysis and represent estimates of the ultimate net cost of all losses incurred through December 31 of each year. Liability estimates are continually reviewed and adjusted as necessary; such adjustments are included in the period in which they are determined. Liability estimates are based on reports of losses from policyholders, individual case loss estimates, and estimates of losses incurred but not yet reported. Policyholder benefit and settlement expenses in the consolidated statement of operations include paid claims, settlement cost and changes in claim liability estimates. Loss and adjustment expenses charged to earnings are net of amounts recovered and estimates of recoverable amounts under ceded reinsurance contracts.
Certain 2019 amounts have been reclassified from the prior year consolidated financial statements to conform to the 2020 presentation.
Policy receivables are reported at unpaid balances. Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk. Receivables from agents, less provision for credit losses, are composed of balances due from independent agents. At December 31, 2020, the single largest balance due from one agent totaled $272,000.
In December 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance removes certain exceptions to general principles in the income tax guidance and amends existing guidance to improve consistent application. The guidance is effective for fiscal years beginning after December 15, 2020. The Company
In August 2018, the FASB issued guidance to improve the existing recognition, measurement, presentation and disclosure requirements for long-duration contracts issued by an insurance entity. The guidance improves timeliness of recognizing changes in the liability for future policy benefits and modifies the rate used to discount future cash flows. The guidance will simplify and improve accounting for certain market-based options or guarantees associated with deposit type contracts and simplify the amortization of deferred policy acquisition costs. The guidance also introduces certain financial statement presentation requirements, as well as significant additional quantitative and qualitative disclosures. The guidance is effective for fiscal years beginning after December 15, 2024 and interim periods within those fiscal years beginning after December 15, 2025. Early adoption is permitted. The Company is currently evaluating the impact of this new guidance. Due to the nature and extent of the changes required to the Company’s life insurance operations, the adoption of this standard is expected to have a material impact on the consolidated financial statements.
In March 2016, the FASB issued guidance that clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those years. The Company adopted this guidance on January 1, 2020. The adoption of this guidance did not have a material impact on its financial position or results of operations.
The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2020 are as follows:
The amortized cost and aggregate fair value of debt securities at December 31, 2020, by contractual maturity, are presented in the following table. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
There were no securities held-to-maturity with unrealized losses as of December 31, 2020.
An analysis of the net change in unrealized gains (losses) on available-for-sale securities follows:
primarily use prices and other relevant information generated by market transactions involving identical or comparable assets. The Company categorizes assets and liabilities carried at their fair value based upon a fair value hierarchy:
As of December 31, 2020, Level 3 fair value measurements of assets include $1,502,000 of equity securities in a local community bank whose value is based on an evaluation of the financial statements of the entity. The Company does not develop the unobservable inputs used in measuring fair value.
The table below presents a reconciliation for all assets and for all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2020:
Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2019 are summarized in the following table by the type of inputs applicable to the fair value measurements:
The table below presents a reconciliation for all assets and for all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2019:
For the year ended December 31, 2019, there were no assets or liabilities measured at fair values on a nonrecurring basis.
The Company recognizes tax-related interest and penalties as a component of tax expense. The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is not subject to examinations by authorities related to its U.S. federal or state income tax filings for years prior to 2015. Tax returns have been filed through the year 2019.
Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The Company recognized a net deferred tax asset position of $706,000 at December 31, 2020 and a net deferred tax liability $96,000 at December 31, 2019.
Short-term debt and current portion of long-term debt consisted of the following as of December 31, 2020 and December 31, 2019:
The Company regularly updates its reserve estimates as new information becomes available and events occur that may impact the resolution of unsettled claims. Reserve estimation can be an inherently uncertain process and reserve estimates can be revised up or down depending on changes in circumstances. Changes in prior years' reserve estimates are reflected in the results of operations in the year such changes are determined.
The following table is a reconciliation of beginning and ending property and casualty reserve balances for claims and claim adjustment expense:
Claims and claim adjustment expense reserves before reinsurance recoverable at December 31, 2020 were up compared to the same period last year due to an increase in hurricane activity in the third and fourth quarter of 2020. The most significant event contributing to remaining claim reserves at December 31, 2020 was Hurricane Zeta which occurred in late October. The estimate for claims arising in prior years was reduced $687,000 in 2020 (reduced $1,333,000 in 2019) due to favorable loss development during the year on claims arising in prior years.
The Company has a geographic exposure to catastrophe losses in certain areas of the country, particularly the north-central Gulf of Mexico and the Georgia and South Carolina coast. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophe losses are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance. At December 31, 2020, the Company's estimate of unpaid losses and adjustment expenses for claims incurred in prior years related to catastrophes that exceeded our retention totaled $0 before reinsurance ($24,000 in 2019).
The claim development table that follows presents incurred and cumulative paid claims and adjustment expense by accident year. Information presented is undiscounted and net of reinsurance.
As shown in the table above depicting average annual payout of incurred claims, 88.7% of claims are settled within twelve months of the date of loss and cumulatively, 97.5% of claims are settled within two years of the date of loss. While reserves for reported but unpaid and incurred but not reported claims can ultimately prove to be excessive or deficient, the short duration of the Company's claim liabilities serves to lessen the uncertainty compared to longer tail lines of insurance. The Company has no material exposure to difficult to estimate long tail liabilities such as toxic waste cleanup, asbestos related illness or other environmental remediation exposures.
The Company and its subsidiaries have an established retirement savings plan (401K Plan). All full-time employees are eligible to participate, and all employer contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Company matching contributions for the year ended December 31, 2020 and 2019 amounted to $191,000 and $181,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limits.
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, 2020, NSIC's retained earnings unrestricted for the payment of dividends in the next twelve months amounted to $1,168,000.
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 income for the preceding year. At December 31, 2020, NSFC's retained earnings unrestricted for the payment of dividends in the next twelve months amounted to $3,650,000.
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. There is currently no Preferred Stock issued or outstanding.
The following table presents the amounts reclassified out of AOCI for the year ended December 31, 2020:
The following table presents the amounts reclassified out of AOCI for the year ended December 31, 2019:
The Company’s property and casualty insurance operations comprise one business segment. The property and casualty insurance segment primarily underwrites home insurance coverage with primary lines of business consisting of dwelling fire and extended coverage, homeowners (including mobile homeowners) and other liability.
The Company’s life and accident and health operations comprise the second business segment. The life and accident and health insurance segment consists of two lines of business: traditional life insurance and supplemental accident and health insurance.
The following table presents the Company’s gross and net premiums written for the property and casualty segment and the life and accident and health segment for the year ended December 31, 2020 and 2019, respectively:
The following table presents the Company’s gross and net premiums earned for the property and casualty segment and the life and accident and health segment for the year ended December 31, 2020 and 2019, respectively:
Cash paid for interest during the year ended December 31, 2020 was $765,000 ($1,185,000 in 2019). Cash paid for income taxes during the year ended December 31, 2020 was $244,000. Cash received from income taxes during the year ended December 31, 2019 was $921,000.
During the year ended December 31, 2020, non-cash changes in equity included $1,000 in common stock issued to Directors in lieu of cash compensation along with a corresponding $24,000 increase in additional paid-in capital.