Income before income taxes in 2002 was $1,186,000 compared to $586,000 in 2001. A decrease in litigation related expenses boosted income before income tax by over $200,000. A decline in general expenses is the other significant item contributing to the increase in income before income taxes in 2002 compared to 2001.
Premium revenue increased to $5,396,000 in 2002 compared to $5,161,000 in 2001, an increase of 4.6%. Insurance sales through independent agent distribution channels increased over 40% in 2002 over prior year; while sales through NSIC’s traditional home service distribution channel declined by 4%. While management is pleased with new business production from the independent agents distribution channel, an increased focus is now being placed on increasing retention of new business. Increased retention and persistency will not only further increase premium growth in the independent agent distribution channel, but also reduce commission expense as a percent of premium because most commission paid on an insurance contract sold through independent agents is paid in the first two years the policy is in force.
Property and casualty premium revenues increased $7,039,000 for the year ended December 31, 2002 compared to the same period in 2001, an increase of over 35%. Increased marketing efforts certainly had a significant impact on the increase in premium revenue, but market changes also significantly influenced the influx of new business. Over the last two years many companies have become much more restrictive in their underwriting guidelines, or have completely exited some markets that we serve. As a result of these market changes we have seen a decrease in competition and an opportunity to significantly increase market share. However, as will be discussed in the paragraphs that follow, we will have to strictly monitor underwriting results and proactively manage growth in order to improve underwriting profitability.
NSFC incurred numerous total losses on business in force less than one year, mostly fire losses. 33% of all dwelling property losses incurred in 2002 were attributable to fire losses of over $25,000 per occurrence. Historically, fire losses are more numerous in the winter months of December and January, but a higher frequency of fire losses was experienced throughout the year. It is difficult to prove that these higher frequency losses were connected to any single cause, such as a colder than normal winter or lightning strikes, but with the overall economy in a downturn and personal bankruptcy at record highs in some of the states in which NSFC and Omega writes business, management believes that at least some of the losses could be attributable to arson, which is most cases is virtually impossible to prove. In an effort to stem the frequency of total fire losses, we have instituted additional underwriting standards in some states, such as providing proof of prior insurance coverage and closer evaluation of prior claims history. We will closely monitor underwriting results in 2003 and make further improvements and adjustments as deemed necessary to improve underwriting profitability.
The improved underwriting results in 2001 compared to 2000 were primarily attributable to the completion of the runoff period for several general agent programs that were started through out the 1990‘s. Adverse loss development on these programs led to higher underwriting losses in the late 1990‘s. These programs, primarily commercial and private passenger auto programs, were discontinued in 1999 and 2000.
The combined ratio for 2002 compared to 2001 increased seventeen percentage points. The loss and LAE component of the combined ratio increased over twenty percentage points. The previously discussed hurricane related losses and a higher loss ratio on new business is the primary reason for the significant increase in the combined ratio. On a positive note, the expense ratio declined over four percentage points in 2002 compared to 2001. While the large influx of new business had an adverse impact on the loss and LAE ratio, the increase in new business did enable us to begin to achieve some economies of scale and reduce the expense ratio significantly. A primary objective for us in 2003 will be to focus on maintaining a manageable level of growth while reducing the loss and LAE ratio. As discussed earlier in the Property and Casualty operations section of this report, we are proactively managing our risk to mitigate the continuing negative impact of adverse underwriting results on the Company.
The National Security Group's consolidated statement of cash flows indicate that operating activities provided (used) cash of $4,321,000, $2,913,000, $(442,000) in 2002, 2001, and 2000 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 $3.4 million at December 31, 2002. The notes payable are to be repaid in quarterly installments over five years.
Except as discussed in Note P to the consolidated financial statements, the Company is aware of no known trends, events, or uncertainties reasonably likely to have a material effect on its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect.
As disclosed in note M 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.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $20.2 million and $23.6 million at December 31, 2002 and 2001, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 5.3 and 7.0 at December 31, 2002 and 2001 respectively. Accordingly, National Security Fire & Casualty Company meets the minimum RBC requirements.
Receivable from agents, less allowance for credit losses (2002-$176; 2001-$176) 2,273
Change in accrued investment income (72 ) (57 ) (51 )
Net realized gains on investments (1,163 ) (1,593 ) (1,941 )
Net cash used in financing activities (150 ) (1,345 ) (1,862 )
Property and equipment is carried at cost less accumulated depreciation and includes expenditures that substantially increase the useful lives of existing property and equipment. Maintenance, repairs, and minor renovations are charged to expense as incurred. Upon sale or retirement of property and equipment, the cost and related accumulated depreciation are eliminated from the respective account and the resulting gain or loss is included in the results of operations. The Company provides for depreciation of property and equipment using the straight-line method designed to amortize costs over estimated useful lives. Estimated useful lives range up to 40 years for buildings and from 3-20 years for electronic data processing equipment and furniture and fixtures.
For purposes of reporting cash flows, cash includes cash-on-hand and demand deposits with banks.
Life insurance premiums are recognized as revenues when due. Property and casualty insurance premiums, less amounts ceded to reinsurers, are recognized on a pro rata basis over the terms of the policies. Reinsurance premiums assumed are recognized as reported by the ceding company.
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 were 2,466,600 (2,466,600 in 2001 and 2000).
The Company expenses advertising costs as incurred. Advertising costs were $101,000 for the year ended December 31, 2002 ($110,000 and $83,000 for the years ended December 31, 2001 and 2000, respectively).
In September 2000, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of this statement is not expected to have a material effect on the Company’s financial position or results of operations.
In July 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Company’s financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 revises SFAS No. 121 by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The adoption of this accounting standard did not have a material effect on the Company’s financial position or results of operations.
During the second quarter of 2000, Omega acquired 100% of the outstanding stock of Liberty Southern Insurance Company (LSIC) for a total cash purchase price of approximately $700,000. Effective December 31, 2000, all insurance related assets and liabilities of LSIC were transferred to Omega as the result of a novation. This transaction was approved by the Alabama Department of Insurance during a hearing relating to the acquisition of LSIC by Omega.
The above amounts exclude allocation of overhead from the Company. NSIC, NSFC and Omega are in compliance with statutory restrictions with regard to minimum amounts of surplus and capital. LSIC was liquidated on September 30, 2001.
Depreciation expense for the year ended December 31, 2002 was $206,000 ($197,000 for the year ended December 31, 2001 and $153,000 for the year ended December 31, 2000).
Total income tax expense varies from amounts computed by a pplying current federal income tax rates to income before income taxes. The reason for these differences and the approximate tax effects are as follows:
The tax effect of significant differences representing deferred assets and liabilities 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, 2002, 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, 2002.
As a result of changes in estimates of insured events in prior years, the provision of claims and claim adjustment expenses (net of reinsurance recoveries) decreased in 2002, 2001 and 2000 because of lower-than-anticipated losses in commercial and private passenger automobile lines of business.
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, 2002, NSIC’s retained earnings unrestricted for the payment of dividends in 2003 amounted to $1,089,472.
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, 2002, 2001 and 2000 are summarized below:
Under date of February 26, 2003, we reported on the balance sheets of The National Security Group, Inc. as of December 31, 2002 and 2001, and the related statements of income, shareholders’ equity and cash flows for each of the three year period ended December 31, 2002, 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.
Cash and due from banks at end of year $ 293
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 accountingprinciples. It is, therefore,suggested that this CondensedFinancial Information be read in conjunction with theConsolidated Financial Statements and Notes theretoincluded in the Registrant's Annual Report as referenced in Form 10-K, PartII, Item 8, page 23.