The Company and its subsidiaries own certain real estate investment properties. Following the sale of 2,739 acres of timber property during 2013, the Company owns approximately 211 acres of real estate in Coffee County in Alabama. There was no timber revenue during 2013 compared to $87,000 during 2012. There were no gains on timber sales during 2013 compared to $71,000 in 2012. The Company had realized gains from the sale of timber property of $3,308,000 during 2013.
The property and casualty segment consists of the consolidated operations of two subsidiaries, National Security Fire and Casualty Company and its wholly owned subsidiary, Omega One Insurance Company. There is no material differentiation between the products underwritten by NSFC and Omega as both underwrite primarily dwelling personal lines coverage. The Property and Casualty segment has premium in-force in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee. We ceased writing business in the state of Texas in late 2012 and had no business in force in the state at December 31, 2013.
All of our insurance companies have been assigned ratings by A.M. Best Co (Best). On November 20, 2013, Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. Best maintained the negative outlook on both of NSFC's ratings. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The outlook for all of these ratings is stable. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a negative outlook.
The two primary segments in which we report insurance operations are the personal lines property and casualty segment (NSFC) and the life, accident and health insurance segment (NSIC). Due to the small amount of earned premium revenue produced by Omega and the fact that Omega is a wholly owned subsidiary of NSFC underwriting similar lines of business, all references to NSFC in the remainder of this management discussion and analysis will include the insurance operations of both NSFC and Omega. Our income is principally derived from net underwriting profits and investment income. Net underwriting profit is principally derived from earned premiums received less claims paid, sales commissions to agents, costs of underwriting and insurance taxes and fees. Investment income includes interest and dividend income and gains and losses on investment holdings.
Realized capital gains were $4,439,000 in 2013 compared to $2,790,000 for the same period last year. The $1,649,000 increase in year over year realized capital gains was primarily due to the September 2013 sale of 2,739 acres of investment real estate consisting of timber property in Alabama. Capital gains in 2012 were primarily associated with the sale of debt and equity investments held by the insurance subsidiaries.
Shareholders' equity as of December 31, 2013 was $33,472,000 up $3,245,000 compared to $30,227,000 as of December 31, 2012. Book value per share increased $1.17 per share for the period ended December 31, 2013 to $13.42 per share compared to $12.25 per share at December 31, 2012. The primary reason for the increase in book value per share was the significant turnaround in net income due to both improved operating results in the insurance subsidiaries and the increase in equity due to the realized capital gain on the sale of timber property mentioned previously.
The Company ended 2013 with net premiums earned totaling $52,366,000 compared to $51,815,000 for the same period last year. Premium revenue is generated from our two operating segments: P&C segment and life segment. The P&C segment accounts for approximately 87% of total premium revenue while our life segment contributes the remaining 13%. The P&C segment operates in personal lines insurance products primarily generating premium revenue from dwelling fire and homeowners coverages. Our life segment produces premium revenue primarily from whole life, accident and critical illness insurance policies.
The following tables provide a summary of premium revenue by segment and line of business for the year ended December 31, 2013 and 2012:
Major categories of realized investment gains and losses are summarized as follows:
Amortization of deferred policy acquisition costs (DAC) and commissions totaled $10,716,000 compared to $11,267,000 for the same period last year; a decrease of $551,000. A change in terms of agent contingent commission contracts in the P&C segment coupled with a decrease in first year commissions in the life segment were the primary reasons for the decrease in DAC and commission expenses in 2013 compared to 2012.
General and administrative expenses decreased $311,000, ending 2013 at $8,443,000 compared to $8,754,000 for the same period last year. General expenses were 16.1% of earned premium revenue in 2013 compared to 16.9% of
earned premium revenue in 2012. The decline in general expenses in 2013 compared to 2012 was primarily the result of a reduction in costs associated with actuarial fees and continued company wide cost reduction measures. Management continues to focus on this area as we seek ways to maximize efficiency and reduce costs by streamlining processes and cross-training employees across both insurance segments of the Company.
The company had no litigation settlement costs for the year ended December 31, 2013 compared to $13,328,000 for the same period last year. This line item reflects cost associated with Mobile Attic litigation which was settled in 2012.
The Company had an income tax expense of $1,665,000 in 2013 compared to an income tax benefit totaling $4,393,000 in 2012. Income tax expense in 2013 was composed of current taxes totaling $92,000 and deferred taxes totaling $1,573,000. The income tax benefit in 2012 was composed of current tax expense of $527,000 and a deferred tax benefit totaling $4,920,000. The utilization of net operating loss carryforwards associated with prior year operating losses limited current tax expense on a consolidated basis.
The Company ended 2013 with net income of $5,658,000 compared to a net loss of $6,671,000 for the same period last year. The increase in net earned premiums and decline in claims in 2013 both contributed to underwriting profits and therefore, were the primary reasons for the net income in the current year. The litigation settlement and $3,400,000 in pretax Hurricane Isaac losses mentioned above were the primary reasons for the net loss in 2012.
NSIC premium accounted for 12.6% of total consolidated net premium revenue for 2013. Net premium revenue in NSIC was $6,591,000 at December 31, 2013 compared to $6,609,000 for the same period last year; a decrease of 0.3%. The $18,000 decrease in net premium revenue was primarily due to a 2% reduction in net premium revenue from the traditional life insurance line of business in 2013 compared to 2012. While net premium revenue from our accident and health products increased 4% in 2013 compared to 2012, and partially offset the decline, total NSIC net premium revenue was down 0.3%.
Net investment income was virtually unchanged at $2,032,000 for the year ended December 31, 2013 compared to $1,993,000 for the same period last year. Investment income in NSIC is generated from securities held in our investment portfolio as well as mortgage and policy loan interest. Life segment invested assets were up in 2013 compared to 2012 leading to the slight increase in net investment income.
Deferred policy acquisition cost amortization and commission expenses increased $56,000 for the year ended December 31, 2013 at $1,462,000 compared to $1,406,000 for the same period last year; an increase of 4%. The slight increase in deferred acquisition cost was primarily due less cost being capitalized as a component of deferred acquisition cost due to a reduction in new product sales.
For the year ended December 31, 2013 and 2012, insurance taxes, licenses and fees were $232,000 and $218,000, respectively. As a percent of earned premium, insurance taxes, licenses and fees were comparable at 3.5% in 2013 and 3.3% in 2012.
Property and casualty operations constitute our largest segment composing 87.4% and 87.2% of our total consolidated premium revenue in 2013 and 2012, respectively. Premium revenues and operating income for the P&C segment for the year ended December 31, 2013 and 2012 are summarized below:
Property and casualty segment premium revenue for 2013 was $45,775,000 compared to $45,206,000 for the same period last year; an increase of 1.3%. The primary reason for the increase in 2013 compared to 2012 was an 8.0% increase in gross premium revenue in our dwelling fire program. However, this increase was partially offset by revenue reductions associated with the elimination of our ocean marine program in 2013 and auto program during 2012.
Net investment income totaled $1,637,000 in 2013 compared to $2,107,000 in 2012; a decrease of $470,000. The primary reason for the 2013 decline in year to date investment income was a decrease in value of company owned life insurance. The change in COLI value accounted for 73.2% of the total decrease in P&C segment net investment income in 2013 compared to 2012.
The table below provides a recap of P&C segment gross reported losses and LAE by catastrophe event and non-catastrophe wind and hail losses and LAE for the year ended December 31, 2013 and 2012 (dollars in thousands):
Non-catastrophe wind and hail claims reported in 2013 totaled $6,031,000 compared to non-catastrophe wind and hail claims reported in 2012 totaling $7,949,000; a decline of $1,918,000 or 24.1%. During 2013, the P&C segment had 2,252 non-cat wind and hail claims reported (an average of $2,700 per claim) compared to 2,800 claims reported during 2012 (an average of $2,800 per claim). Non-cat wind and hail claims reported during 2013 accounted for 23% of total incurred losses and LAE in the current year. Non-cat wind and hail claims reported during 2012 accounted for 27.6% of total incurred losses and LAE in the prior year.
General and administrative expenses totaled $5,683,000 in 2013 compared to $6,262,000 in 2012; a 9.2% decrease. The primary reason for the $579,000 decline in general and administrative expenses was a reduction in costs associated with actuarial fees and continued company wide cost reduction measures.
Insurance taxes, licenses and fees were $1,614,000 through December 31, 2013 compared to $1,628,000 for the same period last year. Insurance taxes, licenses and fees were down slightly at 3.5% of premium revenue in 2013 compared to 3.6% in 2012.
The P&C segment ended 2013 with pretax net income of $6,266,000 compared to pretax income of $2,552,000 for the same period last year. The $3,714,000 increase in pretax income primarily consisted of a $2,592,000 decline in claims coupled with a $569,000 increase in net premiums earned. In addition, the P&C segment had decreases in commissions and general expenses totaling $410,000 and $579,000, respectively compared to the same period last year.
Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, and adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi or Louisiana could cause the combined ratio to fluctuate materially from prior years. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe; however, prohibitive catastrophe reinsurance costs associated with maintaining lower deductibles prevent us from further mitigating hurricane risks.
During 2013, the P&C segment experienced a decrease of 10 percentage points in the combined ratio compared to 2012. The primary reason for the decrease was a $2,592,000 decline in incurred losses coupled with a $569,000 increase in net earned premium in 2013 compared to 2012. Reported non-catastrophe wind and hail related claims added 13.2 percentage points to the current year loss ratio and 17.6 percentage points to the prior year loss ratio. Cat events increased the loss ratio by 9.5 percentage points in both 2013 and 2012. While cat events are unpredictable and beyond the control of management, measures have been taken to improve underwriting results in the P&C segment. Management also continues to evaluate rate adequacy, exposure concentrations and risk management strategies in order to improve underwriting profitability and reduce earnings volatility.
General and administrative expenses totaled $726,000 in 2013 compared to $519,000 for the same period last year; a 39.9% increase. 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 increase in general expenses were increases in interest costs related to deferred compensation plans and director fees.
Litigation settlement and defense costs incurred by NSG during 2012 totaled $13,328,000 and was directly related to the settlement of the previously disclosed Mobile Attic litigation matter. There were no additional costs related to this settlement in 2013. However, interest on a promissory note executed to finance the settlement accounted for most of the $382,000 increase in interest expense for the year. Total interest expense associated with short-term and long-term borrowings of NSG was $1,609,000 for the period ended December 31, 2013 and $1,227,000 for the same period last year.
At December 31, 2013, the Company's holdings in debt securities amounted to 80.2% of total investments and 59.9% of total assets. The Company utilizes the ratings of various Nationally Recognized Statistical Rating Organizations when classifying fixed maturity investments by quality rating. The most significant shift in quality ratings occurring in 2011 was the downgrade of US Government debt by S&P from their highest rating of AAA to AA+. Moody's and Fitch continued to carry US Government debt at their highest rating throughout 2012. Due to the split ratings of the major rating agencies, US Government and agency debt is shown in the table below in the category of AAA/AA+.
The amortized cost and aggregate fair values of investments in securities at December 31, 2013 and December 31, 2012 are as follows (dollars in thousands):
At December 31, 2013, 3.07% 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 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 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, 2013, the Company realized no other-than-temporary impairments.
The Company's subsidiaries maintain repurchase agreements for cash held on deposit under which the policy requires 102% (100% minimum) of the fair value of the securities purchased to be maintained as collateral. The repurchase investments are limited to government securities that are highly liquid and therefore, the investment is reflected on the balance sheet as a cash equivalent. Due to a combination of the 102% collateral requirement and short term interest rates hovering near zero, we realize virtually no interest income from repurchase agreements/short term investments. However, repurchase agreements utilizing government agency securities do provide deposit protection for short term cash held in excess of FDIC deposit limits. The Company does not have any reverse repurchase agreements.
Virtually all invested assets of the Company are held in the insurance subsidiaries. As of December 31, 2013, the contractual maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows (dollars in thousands):
While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 5.6% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.
3 Future life insurance obligations consist primarily of estimated future contingent benefit payments and surrender benefits on policies inforce at December 31, 2013. These estimated payments are computed using assumptions for future mortality, morbidity and persistency. In contrast to this table, the majority of NSIC’s obligations is recorded on the balance sheet at the current account values and do not incorporate an expectation of future market growth, interest crediting or future deposits. Therefore, the estimated future life insurance obligations presented in this table significantly exceed the liabilities recorded in the Company’s consolidated balance sheet. Due to the significance of the assumptions used, the actual amount and timing of such payments may differ significantly from the estimated amounts. Management believes that current assets, future premiums and investment income will be sufficient to fund all future life insurance obligations.
Contractual obligations reflected in the table above include the issuance of $9,279,000 in subordinated debentures completed on December 15, 2005. The subordinated debentures mature December 15, 2035. It is anticipated that principal payments will not be made before maturity. Also included in long-term debt is the issuance of $3,093,000 in subordinated debentures on June 21, 2007. This issue matures June 15, 2037 and may be prepaid at any time. Also included in long-term debt held by the Company is a line of credit in the amount of $500,000 obtained in September 2012. The line of credit is secured by real estate and had $350,000 drawn at December 31, 2013. In July 2012, the Company executed an installment note in the amount of $13,000,000 to finance the settlement obligation related to the Mobile Attic litigation. As of December 31, 2013, a total of $9,333,000 was outstanding with $1,166,000 included in short-term notes payable.
The Company's liquidity requirements are primarily met by funds provided from operations of the insurance subsidiaries. The Company receives funds from its subsidiaries through payment of dividends, management fees, reimbursements for federal income taxes and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used to pay stockholder dividends, interest on debt, corporate administrative expenses, federal income taxes, and for funding investments in the subsidiaries. The Company maintains minimal liquidity in order to maximize liquidity within the insurance subsidiaries in order to support ongoing insurance operations. The Company has no separate source of revenue other than dividends and fees from the insurance subsidiaries. Also, dividends from the insurance subsidiaries are subject to regulatory restrictions and, therefore, are limited depending on capital levels and earnings of the subsidiaries.
As discussed previously, improved underwriting results in the P&C segment resulted in much improved operating results following losses from CAT 46 in 2011 and Hurricane Isaac in 2012. While improved operations have allowed the P&C companies to work towards restoring capital levels, it is still necessary to remain cautious and protect subsidiary capital. The Company has implemented various changes to reduce capital/surplus strain in the P&C subsidiaries and help protect capital levels from substantial further erosion resulting from a major catastrophic event. These changes include a combination of reduction in underwriting leverage and an increase in catastrophe reinsurance protection. A summary of each change follows:
We have incurred substantial losses from catastrophe events over the past eight years. These events have driven up catastrophe reinsurance cost and forced our catastrophe reinsurance deductible up from $2 million in 2005 to the current $4 million. As our cat retention has increased, we have attempted to achieve higher margins in our insurance rate structure in order to compensate for the additional risk of the higher catastrophe reinsurance retention but with limited success due to regulatory constraints primarily because this additional retention was not a "hard dollar" cost in our expense structure. So, since we were limited in our ability to increase margins for this additional retained risk the Company continues to place additional reinsurance cover in the form of reinsurance premium protection (RPP). The RPP cover serves to reduce our risk from a major catastrophe and strengthen our capital position. The additional RPP cover reduces our modeled 100 year event net cost (net of reinsurance recoveries) from approximately $9 million (pretax) to an estimated $4.5 million (pretax). A 100 year event is defined as an event that has approximately a 1% probability of occurring in a given year. This additional cover added $1,304,000 to our cat reinsurance cost in 2013.
In June 2012, we reached a settlement in the longstanding Mobile Attic litigation. Under the terms of the settlement agreement, the Company agreed to pay $13 million to the plaintiff. In order to manage the liquidity constraints, the settlement is in the form of an interest-bearing note with amounts to be paid over nine years with the ability to defer payments in years in which the Company's P&C subsidiaries incur cumulative catastrophe losses exceeding $3.5 million, thus allowing capital management flexibility in the P&C subsidiaries. Under the terms of the agreement, the
Cash to fund the remaining balance of the litigation settlement will come from two primary sources. First, the Holding Company has significant deferred tax assets associated with a net operating loss (NOL) carryforward generated by a combination of this settlement and defense costs incurred from the litigation. This NOL carryforward generated approximately $5 million in tax benefits a part of which have been used to offset the tax on realized gains from the sale of real estate by the holding company as well as to reduce the tax liability of the insurance subsidiaries for 2013. At December 31, 2013, approximately $2.5 million of this NOL carryforward remains. Second, dividends and management fees paid by the insurance subsidiaries will provide an additional source of proceeds to pay this obligation. Although not a preferred source of flexibility, the Company can also defer interest payments on the trust preferred securities to provide additional operating cash flow. In the event that the Company elects to defer interest payments, shareholder dividends will be suspended until interest payments are current.
We have taken and will continue to take corrective action as necessary to improve our profitability and capital position. Over the past decade we have experienced a significant reduction in equity capital due to the adverse effects of six major hurricanes, the financial market meltdown in 2008, continued historically low interest rates, an unprecedented tornado outbreak in April of 2011 and the Mobile Attic litigation. While we are beginning to see improvement and have put some major obstacles behind us, we are in a position where we believe it necessary to continue to preserve capital in the near term in order to put our Company in the best position to be successful moving forward. In order to maintain and improve our capital position, we will continue to monitor our dividend policy on a quarterly basis and should we encounter another significant adverse capital event we could take action which could include the suspension of shareholder dividends. Due to various factors discussed herein, we must remain flexible in our dividend policy until we achieve more consistent profitability and capital growth.
The ratios of Total Adjusted Capital to Authorized Control Level RBC for The National Security Group's life/health and property/casualty insurance subsidiaries are all in excess of 4.3 to 1 at December 31, 2013.
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 applicable reinsurance contract.
At December 31, 2013 and 2012, the Company recorded $8,776,000 and $9,097,000, 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, see Note 1 to our consolidated financial statements.
The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Company's assets and liabilities and operating loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or are settled. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period the new rate is enacted.
At December 31, 2013, 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.
At December 31, 2013 and 2012, the recorded liability for loss and loss adjustment expense was $8,734,000 and $11,214,000, respectively, a $2,480,000 decrease. The decline was primarily associated with the discontinuation of our non-standard auto programs and our ocean marine program coupled with a reduction in claim frequency during the fourth quarter of 2013 in our dwelling fire and homeowners insurance programs. We believe the estimate of unpaid losses and loss adjustment expenses to be sufficient based on currently available information and a review of our historical reserving practices. For more information regarding loss and loss adjustment expense, see Note 9 to our consolidated financial statements.
Liabilities for loss contingencies arising from, but not limited to, litigation, claims, assessments, fines and penalties are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Additional details with respect to contingencies are disclosed in Note 16 to the accompanying consolidated financial statements.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 audits 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 presentation. We believe that our audits provide a reasonable basis for our opinion.
NSIC is licensed in the states of Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas and was organized in 1947 to provide life and burial insurance policies to the home service market. Business is now produced by both company and independent agents. Primary products include ordinary life, accident and health, supplemental hospital, and cancer insurance products.
The Company's property and casualty subsidiaries, composing 89% of gross consolidated premium revenue, produced business during 2013 in ten states. However, 62% of property and casualty segment revenue is generated in the states of Alabama, Mississippi and Louisiana, subjecting the Company to significant geographic concentration. Consequently, adverse weather conditions or changes in the legal, regulatory or economic environment could adversely impact the Company.
The Company's life, accident and health insurance subsidiary, composing approximately 11% of gross consolidated revenues, is licensed in seven states. However, over 79% of life segment revenue 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, 2013, one agency individually produced greater than 5% of the Company's direct written premium.
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 statement of operations, and the amount related to all other factors, which is recognized in other comprehensive income.
When an equity security has a decline in value, where fair value is below cost, that is deemed to be other-than-temporary, the Company reduces the book value of the security to its current fair value, recognizing the decline as a realized loss in the statement of income. Any future increases in the market value of investments written down are reflected as changes in unrealized gains as part of accumulated other comprehensive income within shareholders' equity.
Cash and short-term investments are carried at cost, which approximates market value.
The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts. Through December 31, 2012, these balances were insured by the FDIC with no balance limits. On January 1, 2013, $250,000 per entity account balance limits were reinstated. At December 31, 2013, the net amount exceeding FDIC insured limits was $2,778,000 at one financial institution. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of the financial institution on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.
In January 2014, the FASB issued guidance which permits qualified reporting entities to use a new accounting method, the proportional amortization method, for investments in qualified affordable housing projects. Under the new method the initial cost of an investment is amortized in proportion to the tax benefits received, and investment performance is recognized as a component of income tax expense (benefit) rather than as a component of investment income. This guidance is effective for fiscal years beginning after December 15, 2014. The Company anticipates that adoption of the standard will not have a material impact on its Consolidated Financial Statements. The Company plans to adopt the guidance beginning January 1, 2015.
In July 2012, the FASB issued guidance related to impairment of indefinite-lived intangible assets other than goodwill. The new guidance allows an entity to first make a qualitative assessment of whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount before applying the quantitative impairment test. An entity is required to perform the quantitative test only if it determines that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. The Company adopted this guidance January 1, 2013. This guidance did not have a material effect on results of operations or financial position.
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) which vary in certain respects from reporting practices prescribed or permitted by insurance regulatory authorities. The significant differences for statutory reporting include: (a) acquisition costs of acquiring new business are charged to operations as incurred, (b) life policy liabilities are established utilizing interest and mortality factors specified by regulatory authorities, (c) the Asset Valuation Reserve (AVR) and the Interest Maintenance Reserve (IMR) are recorded as liabilities in the life subsidiary, and (d) non-admitted assets (primarily furniture and equipment, agents' debit balances and prepaid expenses) are charged directly to surplus.
The amortized cost and aggregate fair value of debt securities at December 31, 2013, by contractual maturity, are presented in the following table. 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.
A summary of securities available-for-sale with unrealized losses as of December 31, 2013, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as
There were no securities held-to-maturity with unrealized losses as of December 31, 2013 and December 31, 2012.
The Company conducts periodic reviews to identify and evaluate securities in an unrealized loss position in order to identify other-than-temporary impairments. For securities in an unrealized loss position, the Company assesses whether the Company has the intent to sell the security or more-likely-than-not will be required to sell the security before the anticipated recovery. If either of these conditions is met, the Company is required to recognize an other-than-temporary impairment with the entire unrealized loss reported in earnings. For securities in an unrealized loss position that do not meet these conditions, the Company assesses whether the impairment of a security is other-than-temporary. If the impairment is determined to be other-than-temporary, the Company is required to separate the other-than-temporary impairments into two components: the amount representing the credit loss and the amount related to all other factors. The credit loss is the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. The credit loss component of other-than-temporary impairments is reported in earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes.
Management has evaluated each security in a significant unrealized loss position. The Company has no material exposure to sub-prime mortgage loans and less than 3.07% of the fixed income investment portfolio is rated 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 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 securities in an accumulated loss position in the portfolio were temporary impairments.
For the year ended December 31, 2013, the Company realized no additional other-than-temporary impairments. The single largest accumulated loss not realized as an impairment was in the equity portfolio and totaled $411,000. The second largest loss position was in the bond portfolio and totaled $137,000. The third largest loss position was in the bond portfolio and totaled $108,000.
For the year ended December 31, 2012, the Company realized $87,000 in other-than-temporary impairments. The single largest accumulated loss not realized as an impairment was in the equity portfolio and totaled $457,000. The
second largest loss position was in the bond portfolio and totaled $39,000. The third largest loss position was in the bond portfolio and totaled $27,000.
An analysis of the net change in unrealized appreciation on available-for-sale securities follows (dollars in thousands):
Accounting standards define fair value as the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework to make the measurement of fair value more consistent and comparable. In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets.
Interest rate swaps - Interest rate swaps are recorded at fair value either as assets, within other assets or as liabilities, within other liabilities. The fair values of our interest rate swaps are provided by a third-party brokers and are classified within Level 3.
As of December 31, 2013, Level 3 fair value measurements of assets include $875,000 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.
As of December 31, 2013, Level 3 fair value measurements of liabilities include $897,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party broker who utilizes financial
modeling tools and assumptions on interest and other factors. The Company does not develop the unobservable inputs used in measuring fair value. Additional information regarding the interest rate swap agreements is provided in Note 8.
The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2013 (in thousands):
Debt - the carrying amount is a reasonable estimate of fair value.
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 2009. Tax returns have been filed through the year 2012.
At December 31, 2013, the Company has approximately $2,499,000 of net operating loss carryforwards available ($849,000 tax benefit) to be applied to future periods. These carryforwards expire in 2031 and 2032.
Short-term debt and current portion of long-term debt consisted of the following as of December 31, 2013 and December 31, 2012 (dollars in thousands):
In September 2012, the Company obtained a secured line of credit in the amount of $4,000,000 with an interest rate equal to the WSJ prime but subject to a floor of 4.5% (4.5% at December 31, 2012). In August of 2013, the Company sold substantially all timber property securing the credit line and paid the $4,000,000 principal balance outstanding. The line remains available but, due to the sale of substantially all collateral securing the line of credit, as of December 31, 2013, the line was reduced to $1,000,000 and there was $350,000 drawn on this line ($3,634,000 at December 31, 2012).
The 2013 decrease in property and casualty benefit loss reserves was primarily due to a reduced frequency of weather related losses in the property and casualty subsidiaries in the second half of 2013 compared to prior year.
The Company's insurance operations utilize reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term coverage. Property and casualty reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of re-insurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurance companies and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the companies to minimize their exposure to significant losses from reinsurance insolvencies.
areas of exposure with reinsurance companies. NSFC maintains a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.
Under the catastrophe reinsurance program, the Company retains the first $4,000,000 in losses from each catastrophe event. Catastrophe reinsurance coverage is maintained in four layers as follows:
The effect of reinsurance on premiums written and earned in the life segment is as follows (dollars in thousands):
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 years ended December 31, 2013 and 2012 amounted to $198,000 and $202,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.
The supplemental executive retirement plan (SERP) became effective March 1, 2008 and covers named executive officers with the Company contributing 15% of executive compensation to the plan. Contributions to the plan are fully vested upon the earlier of death, disability, change in control, or ten years of participation in the plan. Costs for amounts credited of the non-qualified deferred compensation plans for the period ended December 31, 2013 and 2012 amounted to approximately $259,000 and $158,000, respectively.
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, 2013, NSFC's retained earnings unrestricted for the payment of dividends in the next twelve months amounted to $2,632,000.
At December 31, 2013, securities with market values of $3,503,000 ($3,785,000 at December 31, 2012) were deposited with various states pursuant to statutory requirements.
The table below provides information regarding the Company's preferred and common stock as of December 31, 2013 and December 31, 2012:
The Company has a share based compensation plan in place for directors by which shares are issued for board service. The share based compensation plan is in accordance with the 2009 Equity Incentive Plan (the Plan) previously approved by shareholders. Under the Plan, 200,000 shares are authorized for issuance. On June 28, 2013, 27,880 shares of common stock were issued to directors as compensation under the Plan. Compensation costs for shares issued under the Plan are calculated at market value on the date of award. Compensation costs for shares issued on June 28, 2013, totaled $224,000 .
The following table presents the amounts reclassified out of AOCI for the period ended December 31, 2013 (dollars in thousands):
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 has ceased writing ocean marine, private passenger auto liability, commercial auto liability and auto physical damage coverages over the past two years with no policies remaining in-force at December 31, 2013 in the lines of business.
Management organizes the business utilizing a niche strategy focusing on lower valued dwellings. Our chief decision makers (Chief Executive Officer, Chief Financial Officer and President) review results and operating plans making decisions on resource allocations on a company-wide basis. The Company’s products are primarily produced through agents within the states in which we operate.
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 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 years ended December 31, 2013 and 2012, respectively:
The various suits seek a variety of remedies, including actual and/or punitive damages in unspecified amounts and/or declaratory relief. The Company has reserves set up on litigated claims and the reserves are included in benefit and loss reserves.
In June 2012, the Company reached a settlement agreement related to its disposition of Mobile Attic, Inc. The settlement is reflected in expenses presented in the 2012 statement of income. Also see Note 8.
Cash paid for interest during 2013 was $1,742,000 ($1,163,000 in 2012 ). Cash paid for income taxes during 2013 was $395,000. Cash received from income tax refunds during 2012 was $1,437,000.
During the twelve months ended December 31, 2013, non-cash changes in equity included $28,000 in common stock issued to Directors in lieu of cash compensation along with a corresponding $196,000 increase in additional paid in capital.