The Company’s subsidiaries own certain real estate investment properties. We own approximately 2,950 acres of undeveloped timberland in Pike, Coffee and Covington counties in Alabama. The only depreciable improvements on this land include a small pavilion with current accumulated depreciation of $18,000. The timber is accounted for as a natural resource and depleted in accordance with applicable accounting standards, which identify total costs as including acquisition costs, exploration costs, development costs, production costs and support equipment and facilities cost. We include in total costs timberland purchases and reforestation costs and other costs associated with the planting and growing of timber, such as site preparation, growing or purchases of seedlings, planting, fertilization, herbicide application and the thinning of tree stands to improve growth. We allocate total cost of the timberland over periods benefited by means of depletion.
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 NSG) 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, 2009.
Results of Operations for Years Ended December 31, 2009 and 2008
Policyholder benefit expenses decreased 19.9%, ending 2009 at $35,839,000 compared to $44,746,000 for the same period last year. The primary reason for the $8,907,000 decline was the reduction in claim activity in the P&C segment. During 2009, we did not incur any hurricane losses in any of our coverage areas while in 2008 we incurred net losses from Hurricane Gustav and Hurricane Ike totaling $4,032,000 and $3,539,000 respectively. Furthermore, catastrophe losses from tornado and windstorm activity were less frequent in 2009 leaving the P&C segment with losses from these events totaling $2,328,000 compared to $4,916,000 in 2008.
Interest expense decreased $21,000 in 2009 compared to 2008. The largest portion of interest expense relates to our non-insurance operations. Additional information regarding the long-term debt generating the interest expense can be found in Note 9 to the consolidated financial statements.
The Company incurred income tax expenses totaling $1,252,000 compared to an income tax benefit of $2,610,000 in 2008. The tax benefit from 2008 was fully recovered through the utilization of net operating loss carry backs applied to tax years 2007 and 2006.
Due to the decrease in storm activity as well as profitable underwriting results, the Company ended 2009 with net income totaling $4,224,000 compared to a net loss in 2008 of $5,204,000. The P&C and Life segments contributed $5,151,000 and $464,000, respectively to net income in 2009, while we incurred a net loss of $1,391,000 from non-insurance operations.
The property and casualty segment composed 87.92% of total premium revenue in 2009 compared to 87.64% in 2008. The property and casualty segment is primarily composed of dwelling fire, allied lines and homeowners lines of business. The life segment composed 12.08% of premium revenue in 2009 compared to 12.36% in 2008 with revenue produced primarily from life insurance products.
NSIC ended 2009 with premium revenue of $7,199,000 compared to $6,956,000 for the same period last year; an increase of 3.5%. The increase in premium revenue was primarily due to an increase of 11% in premiums in the independent agent’s method of distribution compared to 2008. Premium revenue in the home service agent method of distribution declined 4.6% compared to 2008. The decline in premium revenue related to the home service agents distribution method was primarily the result of a shift in our primary focus to the independent agent distribution method.
Policyholder benefit expenses decreased $96,000 ending 2009 at $4,931,000 compared to $5,027,000 for the same period last year. The reduction in policyholder benefits was primarily attributable to a $167,000 reduction in benefit payments under accident and health contracts.
The Life segment incurred income tax expenses totaling $497,000 compared to an income tax benefit of $120,000 in 2008. Income tax expense as a percent of pretax income increased due to an increase in deferred taxes. The current tax benefit from 2008 was fully recovered through the utilization of net operating loss carry backs applied to tax years 2007 and 2006.
NSIC ended 2009 with year to date net income of $464,000 compared to a year to date net loss of $859,000 for the same period last year. The primary factor contributing to the increase in net income was the lack of impairment losses in the investment portfolio. Net realized capital gains totaled $234,000 in 2009 compared to net realized capital losses, primarily associated with other than temporary impairments, of $1,423,000 in 2008. A much improved investment climate was the primary factor contributing to the turnaround in realized capital gains.
Production of premium revenue in the P&C segment is primarily driven by our dwelling fire, allied lines and homeowner lines of business. The following table provides net premiums earned by line of business:
Net investment income totaled $3,125,000 in 2009 compared to $2,852,000 in 2008; an increase of $273,000. The increase in investment income in the P&C segment was primarily attributable to the change in value of the company owned life insurance (COLI) investment.
Other income, which primarily consists of billing, payment and policy fees related to our property and automobile business decreased $286,000 from 2008. The decline in dwelling fire premium revenue led to a reduction in billing fees which caused the decrease in other income for 2009 compared to the same period last year.
We routinely evaluate our claims frequency and severity statistics in order to better understand the nature of our risks and aid in the loss reserve liability evaluation process. Claims frequency is a measure of the number of claims incurred during a measurement period regardless of amount. Claims severity is a measure of the average dollar amount of claims during a measurement period. During 2009, tornado and storm related frequency was significantly below levels we experienced throughout 2008. Non-hurricane catastrophe losses totaled $2,328,000 in 2009 compared to $4,916,000 in 2008. The severity of claims related to catastrophes affecting the P&C companies during 2009 totaled approximately $2500 per claim. The severity of claims related to the nineteen non-hurricane catastrophes affecting the P&C companies during 2008 totaled approximately $2,400 per claim while the average severity of claims related to Hurricanes Gustav and Ike totaled $2,900 and $3,400, respectively.
The P&C segment continued to be involved in litigation pertaining to claims from Hurricane Katrina which impacted our coverage areas in Louisiana and Mississippi in August 2005. During 2008, the claims associated with Hurricane Katrina exceeded the $37,500,000 million upper limit of the reinsurance agreement in affect during 2005. As of December 31, 2009, cumulative claims related to Hurricane Katrina exceeded the reinsurance upper limit by $1,574,000. Although the reinsurance for this catastrophe has been exhausted and the ultimate outcome of these claims is unknown, the company believes it maintains adequate reserves for the open claims based on information available at the present time. Additional adverse development related to the claims in litigation is possible and therefore these claims are carefully monitored on a continuous basis. Adverse development related to the 53 remaining open Katrina claims increased 2009 incurred losses by $579,000.
There was no significant change in deferred policy acquisition costs which totaled $3,397,000 in 2009 (6.48% of premium revenue) compared to $3,312,000 in 2008 (6.72% of premium revenue). Deferred policy acquisition cost consists of amortization of previously capitalized distribution costs, primarily commissions.
During 2009, the P&C segment experienced improved results primarily due to the reduction in tornado and storm related losses as well as the lack of hurricane activity during the year. The $2,328,000 in losses incurred from non-hurricane catastrophes during 2009 added 4.4 percentage points to our combined ratio. In comparison, tornado and windstorm losses totaling $4,903,000 incurred in the first half of 2008 added 9.9 percentage points to the combined ratio. Losses, net of reinsurance recoveries, from Hurricane Gustav totaled $4,032,000 and added 8.2 percentage points to the 2008 combined ratio. Losses, net of reinsurance recoveries, from Hurricane Ike totaled $3,539,000 and added 7.2 percentage points to the 2008 combined ratio.
The non-insurance operations of the Company consist of our parent company, The National Security Group, Inc. The National Security Group has no material sources of revenue and relies almost entirely on dividends and fees from subsidiaries to pay expenses. Dividends are eliminated upon consolidation of the subsidiaries in the audited financials included herein. The expenses of the group consist of expenses associated with the public listing of our stock, taxes and fees, and directors’ fees. The most significant expense of the group is interest expense associated with $12,372,000 in debt. This debt is composed of two trust preferred securities offerings, the first being $9,279,000 issued in the December 2005 and the second being $3,093,000 issued in June 2007. The primary use for these proceeds was to add capital to the property and casualty subsidiaries. Total interest expense for the Group associated with these borrowings in 2009 was $1,077,000 compared to $1,085,000 in 2008.
The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 2009, the company’s holdings in debt securities amounted to 74.9% of total investments and 58% of total assets. The following is a breakdown of the bond portfolio quality according to the nationally recognized rating organization equivalents of Standard and Poor’s:
Management has evaluated each security in a significant unrealized loss position. For the year ended December 31, 2009, $443,000 in OTTI were realized by the Company compared to $2,973,000 in 2008. Of the remaining securities in loss positions, Management believes based on current information, that no ultimate loss will be realized on the securities. Most unrealized losses in the fixed income portfolio are interest rate and market driven as opposed to credit quality driven. The Company has no material direct exposure to sub-prime mortgage loans and less than 3.5% of the fixed income investment portfolio is rated below investment grade. With respect to equity securities in a loss position, Management evaluated financial information on each company and reviewed analyst reports from at least two 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 remaining securities in an accumulated loss position in the portfolio were temporary impairments.
The amortized cost and aggregate fair values of investments in securities at December 31, 2009 and December 31, 2008 are as follows:
The insurance subsidiaries’ fixed maturity securities include residential mortgage-backed securities (RMBS) of $21.2 million and $22 million at amortized value at December 31, 2009 and 2008 respectively. We own no commercial mortgage backed securities. We also have no material direct exposure in sub-prime mortgage loans in our private label RMBS portfolio.
As for the composition of the RMBS portfolio, agency mortgage backed securities compose 52% and 69% of the RMBS portfolio at December 31, 2009 and 2008, respectively. The remainder of the RMBS portfolio is composed of private label mortgage backed securities. These securities consist primarily of conventional 15 and 30 year loans with an average borrower FICO score of 740. We own no mortgage backed securities with direct exposure to subprime loans and less than 1% of the RMBS portfolio is composed of loans subject to rate resets. Three securities in the private label mortgage backed security portfolio is rated below investment grade and it composes less than 1% of total invested assets.
The total return on investments consists of return of current interest and dividend payments (current yield components) plus realized and unrealized appreciation or depreciation in asset market values. Due to improvement in overall market stability in 2009, we experienced a significant improvement in investment market values. This improvement in market values of long term holdings, along with increased allocation of new investments in corporate debt securities during the depressed market in early 2009, led to an 11.5% total return on our investment portfolio in 2009. The total return in 2009 was a significant turnaround from the 4.5% negative total return experienced in 2008. Significant reductions in market values of portfolio holdings due to a meltdown in credit markets were the primary driver of the negative total return experienced in 2008.
As of December 31, 2009, the maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows:
The National Security Group’s consolidated statement of cash flows indicates that cash flow provided from operating activities was $8,723,000 in 2009 compared to net uses from operating activities of $5,892,000 in 2008. An improvement in underwriting results in our property and casualty insurance operations in 2009 was the primary source of operating cash flow in 2009. In 2008, the adverse impact of hurricanes Gustav and Ike was the primary contributor to increased uses of cash in operating activities.
The consolidated statement of cash flows also reflects a decrease in cash used in financing activities of $(1,477,000) and $(3,085,000), respectively. Cash flows from financing activities in 2009 reflect the revision in the Company’s dividend policy in which quarterly dividends were reduced from 22.5 cents per share, per quarter to 15 cents per share, per quarter. A short-term loan was also repaid in 2008.
1 Long-term debt, consisting of two separate issues of trust preferred securities, is assumed to be settled at contractual maturity. Interest on long-term debt is calculated using the interest rates in effect at December 31, 2009 for each issue. Interest on long-term debt is accrued and settled quarterly. Therefore, the timing and amount of interest payments may vary from the calculated value included in the table above. These calculations do not take into account any potential prepayments. For additional information regarding long-term debt and interest on long-term debt, please see Note 9, Notes Payable and Long-term Debt, in the notes to consolidated financial statements.
2 The anticipated payout of property and casualty claim reserves, which includes loss and loss adjustment expenses, are based upon historical payout patterns. Both the timing and amount of these payments may vary from the payment indicated.
Except as discussed in Note 16 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.
An operating line of credit was obtained by the holding company in December of 2009 to allow flexibility with respect to cash management at the holding company level.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $9.6 million and $8.4 million at December 31, 2009 and 2008, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 12.2 and 11.4 at December 31, 2009 and 2008, respectively. Accordingly, National Security Insurance Company exceeds the minimum RBC requirements.
Our consolidated financial statements are based upon the development and application of accounting policies that require management to make significant estimates and assumptions. Accounting policies may be based on (including but not limited to) GAAP authoritative literature, statutory authoritative literature, regulations and industry standards. The Company’s financial results would be directly impacted by changes in assumptions and judgments used to select and apply our accounting policies. It is management’s opinion that the following are some of the more critical judgment areas in regards to the application of our accounting policies and their effect on our financial condition and results of operations.
NSFC and Omega generally reinsure with third parties any liability in excess of $225,000 on any single policy. In addition, the property and casualty segment holds a catastrophe contract which covers losses related to a catastrophic event with multiple policyholders affected. In the event a catastrophe exceeds the $3.5 million retention stated in the contract, reinsurers will reimburse the company 95% (5% co-pay) of gross losses and loss adjustment expenses paid up to $ 17.5 million (layer one and layer two of the contract). If losses exceed $ 17.5 million, the contract allows for 100% reimbursement of losses and loss adjustment expenses up to $72.5 million. Any losses above the $72.5 million upper limit are the responsibility of our company. The contract in place during 2009 also allowed one reinstatement for coverage under the contract for a second catastrophic event if needed. The contract provided protection up to at least a 100 year “near term” event as depicted in catastrophe modeling results. The “near term” catastrophe modeling results reflect a predicted increase in storm activity given the current weather pattern and various factors projected to impact our weather patterns in the near term.
At December 31, 2009, the estimated reinsurance recoverable recorded was $784,000 compared to $4,146,000 for the same period last year. The Company does not anticipate any issues with collection of the recorded amount.
At December 31, 2009 and 2008, the Company recorded $10,210,000 and $9,825,000, respectively, as an asset for DAC in the financial statements. We do not foresee any issues related to recoverability of these capitalized costs. For more information regarding deferred policy acquisition costs, please see Note 1 to our financial statements.
At December 31, 2009, there is no evidence to suggest to management that any deferred tax asset is unrealizable. For more information regarding deferred income taxes, please see Note 8 to our financial statements.
At December 31, 2009 and 2008, the recorded liability for loss and loss and adjustment expense was $12,646,000 and $14,436,000, respectively. The decline in reserves is directly attributable to the absence of hurricanes during 2009. 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 10 to our financial statements.
In April 2009, a new accounting standard was issued which amends the recognition guidance for other-than-temporary impairments (OTTI) of debt securities and expands the financial statement disclosures for OTTI on debt and equity securities.
This new accounting standard states that an OTTI write-down of debt securities, where fair value is below amortized cost, is triggered in circumstances where (1) an entity has the intent to sell a security, (2) it is more-likely-than-not that the entity will be required to sell the security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more-likely-than-not the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more-likely-than-not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income.
This new accounting standard requires that companies record, as of the beginning of the interim period of adoption, a cumulative-effect adjustment to reclassify the noncredit component of a previously recognized OTTI loss from retained earnings to other comprehensive income if the company does not intend to sell the security and it is more-likely-than-not that the company will not be required to sell the security before recovery of its amortized cost basis. The adoption had no impact on our financial position or results of operations. The Company had no cumulative-effect adjustment upon adoption at the beginning of the second quarter.
In June 2009, a new accounting standard was issued related to the accounting for transfers of financial assets, which updates accounting for securitizations and special-purpose entities. The new accounting standard is a revision of previously issued accounting standards related to accounting for transfers and servicing of financial assets and extinguishments of liabilities, and will require additional information regarding financial asset transfers, including securitization transactions, and the presence of continuing exposure around the risks related to transferred financial assets. In addition, the new accounting standard removes the concept of a qualifying special-purpose entity and changes the requirements for de-recognizing financial assets. The new accounting standard was effective January 1, 2010. We do not expect the implementation of this new accounting standard to have a significant impact on our financial statements.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement and financial statement schedules presentation. We believe that our audit provide a reasonable basis for our opinion.
The accompanying consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries: National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO). NSFC includes a wholly-owned subsidiary - Omega One Insurance Company (Omega) . The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany transactions and accounts have been eliminated.
The Company’s life, accident and health insurance segment, composing nearly 12% of consolidated revenues, is licensed in six states. However, over 75% of segment revenue is generated in the states of Alabama and Georgia. Consequently, changes in the legal, regulatory or economic environment could adversely impact the Company.
Realized gains and losses on the sale of investments available-for-sale are determined using the specific-identification method and include write downs on available-for-sale investments considered to have other than temporary declines in market value.
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 income statement 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 a realized loss in the income statement, and the amount related to all other factors, which is recognized in other comprehensive income.
Mortgage loans and policy loans are stated at the unpaid principal balance of such loans.
Interest rate swaps - The estimated fair value of the interest rate swaps is based on valuations received from financial institution counterparties.
Property and equipment is carried at cost less accumulated depreciation and includes expenditures that substantially increase the useful lives of existing property and equipment. Significant costs incurred for internally developed software are capitalized and amortized over estimated useful lives of 3 years. Maintenance, repairs, and minor renovations are charged to expense as incurred. Upon sale or retirement of property and equipment, the costs 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 3-8 years
for electronic data processing equipment and furniture and fixtures. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Layers 1-3 cover events occurring from January1-December 31 of the contract year. The Company placed the fourth layer in July allowing an interim review of exposure and projected storm patterns for the current contract year. The fourth layer covers events occurring from July 1-June 30 of the contract year. All significant reinsurers under the program carry A.M. Best ratings of A- (Excellent) or higher.
In the normal course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage contracts. NSIC retains a maximum of $50,000 of coverage per individual life. The cost of reinsurance is amortized over the contract period of the reinsurance.
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, 2009 the single largest balance due from one agent totaled $525,000.
Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet their obligation could result in losses to the insurance subsidiaries. Allowances for losses are established if amounts are believed to be uncollectible. At December 31, 2009 and 2008, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At December 31, 2009, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.
securitization transactions, and the presence of continuing exposure around the risks related to transferred financial assets. In addition, the new accounting standard removes the concept of a qualifying special-purpose entity and changes the requirements for de-recognizing financial assets. The new accounting standard was effective January 1, 2010. We do not expect the implementation of this new accounting standard to have a significant impact on our financial statements.
In June 2009, new consolidation guidance was issued which replaces the quantitative-based risks and rewards calculation for determining whether an enterprise is the primary beneficiary in a variable interest entity with an approach that is primarily qualitative, requires ongoing assessments whether an enterprise is the primary beneficiary of a variable interest entity, and requires additional disclosure about an enterprise’s involvement in variable interest entities. This guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of this guidance to have a material impact on our financial statements.
In August 2009, the FASB issued ASU 2009-05 “Measuring Liabilities at Fair Value” (“ASU 2009-05”). ASU 2009-05 updated ASC Section 820-10 (“Fair Value Measurements”) to provide additional guidance on how to measure liabilities at fair value for which a quoted price in an active market is not available. In this situation a company can either use the quoted price of an identical liability when traded as an asset or the quoted price of similar liabilities when traded as assets. As of December 31, 2009, the only liability measured at fair value was an interest rate swap discussed in Note 7. The new guidance was effective for the company on October 1, 2009. The implementation of the new guidance did not have a significant impact on our financial statements.
In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,300,000 of variable rate subordinated debentures issued by the Company. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE’s. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 9, are reported in the accompanying Consolidated Balance Sheets as a component of long-term debt. The Company’s equity investments in the Trust total $279,000 and are included in Other Assets.
In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $3,093,000 unsecured junior subordinated deferrable interest debentures. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $2,995,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE’s. The Trust is not consolidated because the Company is not the primary beneficiary of the Trust. The Subordinated Debentures, disclosed in Note 9, are reported in the accompanying Consolidated Balance
The amortized cost and aggregate fair value of debt securities at December 31, 2009, 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.
Our securities available-for-sale consists of fixed maturity and equity securities which are recorded at fair value in the accompanying consolidated balance sheets. The change in the fair value of these investments, unless deemed to be other than temporarily impaired, is recorded as a component of other comprehensive income.
Level 2 assets include certain of our marketable debt and equity instruments with quoted market prices that are traded in less active markets or priced using a quoted market price for similar instruments. Level 2 assets also include marketable equity instruments with security-specific restrictions that would transfer to the buyer, marketable debt instruments priced using indicator prices which represent non-binding market consensus prices that can be corroborated by observable market quotes, as well as derivative contracts and debt instruments priced using inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Marketable debt instruments in this category generally include commercial paper, bank time deposits, repurchase agreements for fixed-income instruments, and a majority of floating-rate notes, corporate bonds, and municipal bonds.
The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2009:
NOTE 6 - FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES - CONTINUED
The Company is exposed to certain risks in the normal course of its business operations. The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings. This risk is managed through the use of interest rate swaps which are designated as cash flow hedges. For cash flow hedges, the effective portion of the gain or loss on the interest rate swap is included as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings. The Company does not hold or issue derivatives that are not designated as hedging instruments. Please see Note 9 for additional information about the interest rate swaps.
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, $2,520,000 at December 31, 2009, 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 $857,000 at December 31, 2009
The $9,279,000 of subordinated debentures is due in 2035 and $3,093,000 of subordinated debentures is due in 2037.
The Company’s interest rate swaps include provisions requiring the Company to post collateral when the derivative is in a net liability position. The Company has posted collateral of $469,000. Please see Note 6 for additional information about the interest rate swaps.
The 2009 decline in the provision for claims and claim adjustment expenses arising from claims in the current year and the ending reinsurance recoverable on unpaid losses are attributable to the absence of hurricane losses during the year. The decrease in provision for claims and claim adjustment expenses for prior years (net of reinsurance recoveries) for 2008 is primarily due to reductions in incurred but not reported loss reserves on dwelling property lines of business.
The Company has a geographic exposure to catastrophe losses in certain areas of the country. 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, 2009, the Company’s estimate of unpaid losses and adjustment expenses for hurricane related claims incurred in prior years totaled $787,000 before reinsurance ($758,000 in 2008). Because the Company has exhausted its catastrophe coverage limits available for Hurricane Katrina any additional development will not be covered by reinsurance. The Company maintains case reserves of $519,000 for losses in excess of catastrophe reinsurance ($594,000 in 2008).
At December 31, 2009, the largest reinsurance recoverable of a single reinsurer was $95,000 ($607,000 in 2008). The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2009 and 2008 were approximately $-0- and $12,582,000, respectively. The Company incurred no losses from covered events occurring in 2009. Amounts reported as ceded incurred losses in 2009 were related to development of losses from prior year catastrophes.
An amendment changing the number of authorized shares of common stock from 10,000,000 to 3,000,000 was approved by the shareholders at the 2009 Annual Meeting on May 14, 2009.
The Company and its subsidiaries operate primarily in the insurance industry. Selected balance sheet information by industry segment for the years ended December 31, 2009 and 2008 is summarized below:
The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Company’s subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief.
auditors in the preparation of Mobile Attic’s financial statements. The Court has subsequently granted the Company’s motion to intervene and the action is in the initial stages of discovery. No amount has been accrued in these financial statements since the outcome of this matter is uncertain and the amount of liability, if any, cannot be determined.
Cash paid for interest during 2009 was $1,077,000 ($1,085,000 in 2008). Cash received from income taxes in 2009 was $796,000 compared to cash paid for income taxes in 2008 was $500,000.
There were no subsequent events requiring adjustment to the condensed consolidated financial statements.
Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial
statements prepared in accordance with generally accepted accounting principles. It is, therefore, suggested
that this Condensed Financial Information be read in conjunction with the Consolidated Financial Statements