Consolidated net income for The National Security Group was $3.776 million in 2000 compared to $3.756 million in 1999. On a per share basis earnings were $1.53 in 2000 compared to $1.52 in 1999. Operating results in The Company's property/casualty subsidiaries were much improved due to the elimination of several general agent auto programs, but a non-recurring charge incurred in the life insurance subsidiary due to a management decision to strengthen reserves in certain blocks of industrial life policies decreased earnings by approximately $.29 per share. Realized capital gains in 2000 were $1.72 million compared to $1.95 million in 1999. Consolidated revenues were $29.7 million in 2000 compared to $32.6 million in 1999.
Net income before income tax was $5,440,000 in 2001 compared to $3,917,000 in 2000. Improved underwriting results continued to be the primary factor contributing to the improvement in income before taxes.
Net income before income tax was $3,917,000 in 2000 compared to $2,365,000 in 1999. Improved underwriting results were the primary factor contributing to the improvement in income before tax. The elimination of several unprofitable private passenger and commercial auto insurance programs run by managing general agents was the primary factor leading to the improvement in underwriting results.
In an effort to increase premium production in internally managed auto programs, as opposed the managing general agent form of distribution, Omega acquired 100% of the outstanding stock of Liberty Southern Insurance Company for a total cash purchase price of approximately $700,000. The purchase was consummated in the second quarter of 2000. With the purchase of Liberty Southern, Omega gained entry into the monthly bill private passenger auto market. The program is expected to produce $1,500,000 in direct written premium in 2001.
A measure used to analyze a property/casualty insurer's underwriting performance is the statutory combined ratio. It is the sum of two ratios:
2001 2000 1999 ---- ---- ---- Loss and LAE Ratio ....... 54.3% 61.6% 70.9% Underwriting Expense Ratio 36.1% 34.8% 35.8% ---- ---- ----- Combined Ratio ........... 90.4% 96.4% 106.7%
The combined ratio for 2001 compared to 2000 decreased six percentage points. This improvement was attributable to a lack of storm activity in the dwelling property lines of business and the elimination of unprofitable general agent auto programs from prior years.
Asset Portfolio Review: The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 2001, the company's holdings in debt securities amounted to 68% of total investments and 58% of total assets. The following is a breakdown of the bond portfolio quality according to National Association of Insurance Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the nationally recognized rating organization equivalents of Moody's and Standard and Poor's:
The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $9.2 million and $11.4 million at December 31, 2001 and 2000 respectively. The mortgage-backed bonds are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments cause those securities to have different actual maturities than that expected at the time of purchase. Securities that are purchased at a premium to par value and prepay faster than expected will incur a reduction in yield or loss. Securities that are purchased at a discount to par value and prepay faster than expected will generate an increase in yield or gain. The degree to which a security is susceptible to either gains or losses is influenced by the difference between amortized cost and par value, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure.
The Company limits the extent of its market risk by purchasing securities that are backed by stable collateral, the majority of the assets are issued by U.S. government sponsored entities. Also, the majority of all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higher-risk mortgage backed bonds. To reduce the risk of loss of principal should prepayments exceed expectations, the Company does not purchase mortgage backed securities at significant premiums over par value.
The Company's investment approach in the equity markets is based primarily on a fundamental analysis of value. This approach requires the investment committee to invest in well managed, primarily dividend paying companies, which have a low debt to capital ratio, above average return on net worth for a sustained period of time, and low price to book value or low volatility rating (beta) relative to the market. The dividends provide a steady cash flow to help pay current claim liabilities, and it has been the Company's experience that by following this investment strategy, long term investment results have been superior to those offered by bonds, while keeping the risk of loss of capital to a minimum.
As disclosed in note K to the consolidated financial statements, in 2002, 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 $2.7 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 $23.6 million and $24.1 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 7.0 and 9.7 at December 31, 2001 and 2000 respectively. Accordingly, National Security Fire & Casualty Company meets the minimum RBC requirements.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $5.0 million and $4.1 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 8.4 and 8.4 at December 31, 2001 and 2000 respectively. Accordingly, Omega One Insurance Company meets the minimum RBC requirements.
Reports of Independent Certified Public Accountants on Financial Statement Schedules 47
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The National Security Group, Inc. and subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
In our opinion, the consolidated statements of income and cash flows referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of The National Security Group, Inc. and subsidiaries for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America.
o Securities Available-for-Sale. Bonds, notes, common stock and non-redeemable preferred stock not classified as either held-to-maturity, or trading are reported at fair value, adjusted for other-than-temporary declines in fair value.
The fair values of debt and equity securities have been determined using values supplied by independent pricing services and are disclosed together with carrying amounts in Note D.
On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133, as amended by SFAS Nos. 137 and 138, requires the Company to record all derivative financial instruments at fair value on the balance sheet. Changes in fair value of a derivative instrument are reported in net income or other comprehensive income, depending on the designated use of the derivative instrument. The adoption of SFAS No. 133 did not have a material effect on the Companys financial position or results of operations. Prospectively, the adoption of No. 133 may introduce volatility into the Companys
In June 2001, the FASB issued SFAS Nos. 141, Business Combinations, and 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that business combinations initiated after June 30, 2001, be accounted for using the purchase method. SFAS No. 142 revises the standards for accounting for acquired goodwill and other intangible assets. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and effective for any goodwill or intangible asset acquired after June 30, 2001. The Company does not expect the adoption of SFAS No. 142 to have a material effect on the Companys financial position or results of operations.
The purchase of LSIC was accounted for by the purchase method, whereby the underlying assets acquired and liabilities assumed from the purchased corporation are recorded by Omega at their fair value. The excess of the amount paid over the fair value of LSICs identifiable net assets was approximately $200,000, which has been recorded as a charge to earnings in year 2000. The operating results of LSIC have been included in the Companys consolidated financial statements since the date of acquisition. The purchase agreement provides for additional consideration to be paid the former stockholders contingent upon specified premium growth of the LSIC block of business.
The amortized cost and aggregate fair value of debt securities at December 31, 2001, 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.
(Dollars in thousands) Year ended December 31, ------------------------------ ------------------------------ 2001 2000 1999
Fixed maturities .............................. $ 3,819 $ 3,629 $ 3,567 Equity securities ............................. 544 642 630 Mortgage loans on real estate ................. 16 7 9 Investment real estate ........................ 138 142 18 Policy loans .................................. 35 43 33 Other, principally short-term investments ..... 88 121 129 ------ ------ ------ 4,640 4,584 4,386
An analysis of investment gains follows: Year ended December 31, 2001 2000 1999 Net realized investment gains (losses): Fixed maturities ........................... $ 149 $ (419) $ (16) Other, principally equity securities ....... 1,491 2,142 1,967 ------ ------ ------ $ 1,640 $ 1,723 $ 1,951 ====== ====== ======
(Dollars in Thousands) --------------------------- --------------------------- Year ended December 31, 2001 2000 ---------------------------
Deferred policy acquisition costs $ (1,569) $ (1,519) Policy liabilities 349 419 Unearned premiums 464 383 Claim liabilities 310 432 General insurance expenses 757 694 Alternative minimum tax credit carryforward 0 67 Unrealized gains on securities available-for-sale (3,394) (3,895) -------- -------- Net deferred tax liabilities $ (3,083) $ (3,419) ======== ========
The appropriate income tax effects of changes in temporary differences are as follows: Year ended December 31, ---------------------- ---------------------- 2001 2000 1999
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, 2001, 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, 2001.
(Dollars in thousands) ---------------------- 2001 2000 Note payable to bank with a 7% interest rate dated October 9, 1998; matures May 28, 2004 Payments of $63,575 due quarterly. Unsecured ...... $2,108 $2,208
Note payable to bank with a 7.44% interest rate dated February 25, 1998; matures February 26, 2003 Payments of $45,374 due quarterly. Unsecured ...... 0 193 ------ ------ 2,108 $2,401
Aggregate maturities of long-term debt for each of the three years subsequent to December 31, 2001 are as follows (dollars in thousands): 2002-$110; 2003-$118; 2004-$1,880.
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 2001, 2000 and 1999 because of lower-than-anticipated losses in commercial and private passenger automobile lines of business.
Direct ........... $4,456 $ 4,645 $ 18,951 $ 20,628 Assumed .......... -- -- -- -- Ceded ............ (51) (51) (1,460) (2,302) ------ ------- -------- -------- Net .............. $4,405 $ 4,594 $ 17,491 $ 18,326 ====== ======= ======== ========
In 1987, the Company established a deferred compensation plan for its Board of Directors. The Board members have an option of deferring their fees to a cash account or to a stock account and all share deferrals are recorded at the fair market value on the date of the award. Costs of the deferred compensation plan for 2001, 2000, and 1999 amounted to approximately $35,065, $54,755, and $48,490, respectively.
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, 2001, NSICs retained earnings unrestricted for the payment of dividends in 2002 amounted to $1,141,562.
At December 31, 2001, securities with market values of $3,458,441 ($3,745,717 at December 31, 2000) were deposited with various states pursuant to statutory requirements.
(Dollars in thousands) Year ended December 31, 2001 2000 1999 ---- ----- ------ Premium Revenues: Individual life and accident and health insurance $ 5,161 $ 4,595 $ 4,251 Property and casualty insurance 20,196 18,326 21,685 ------ ------ ------ $25,357 $22,921 $25,936 ====== ====== ======
Amortization of deferred policy acquisition costs and depreciation expense: Individual life and accident and health insurance $ 609 $ ( 61) $(252) Property and casualty Insurance 1,279 1,406 1,615 ------ ------ ------ $ 1,888 $1,345 $1,363 ====== ====== ======
The Company is obligated under a commitment to extend credit to Mobile Attic, Inc., in the form of a $1,000,000 credit line. The credit line is secured by inventory and matures on September 18, 2002. Interest is due on the unpaid principal at the rate of 8% per annum. The Company may, at its option anytime on or before the payment by Mobile Attic, Inc. of all outstanding principal and interest, elect to convert the outstanding principal and accrued interest to a proportionate share of common stock in Mobile Attic, Inc.
NSFC, a subsidiary of the Company, was named as a defendant in a purported class action filed in Lee County, Alabama. On January 4, 2000, the Circuit Court of Lee County preliminarily approved a consent settlement to this action and the settlement was finalized in the second quarter of 2000. A provision for this settlement was reflected in the 1999 results of operations of the Company.
In two separate recently filed actions, NSIC is named as a defendant in purported class actions relating to the past sale of industrial burial insurance. The actions address whether the premiums charged were excessive relative to the benefit provided and whether the premiums charged were in any manner discriminatory relative to the race of the person insured. In addition, several individual actions on behalf of specifically named persons have been filed with similar allegations. These actions are in the initial phases and little discovery has been undertaken and no class has been certified. While the cases entail separate and distinguishable facts, the legal issues are similar to the issues pending in numerous other actions currently pending nationwide against numerous insurers. While NSIC did at one time sell industrial burial insurance, no such plans have been sold for several decades.
The company establishes and maintains reserves on contingent liabilities. In many instances, however, it is not feasible to predict the ultimate outcome with any degree of accuracy. While a resolution of these matters may significantly impact consolidated earnings and the Companys consolidated financial position, it remains managements opinion, based on information presently available, that the ultimate resolution of these matters will not have a material impact on the Companys consolidated financial position. However, it should be noted that instances of class action lawsuits against insurance companies appear to be increasing in several states in which insurance subsidiaries of the company operate.
Under date of February 22, 2002, we reported on the balance sheets of The National Security Group, Inc. as of December 31, 2001 and 2000, and the related statements of income, shareholders equity and cash flows for the years then ended, 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 Companys management. Our responsibility is to express an opinion on these financial statement schedules based on our audit.
THE NATIONAL SECURITY GROUP, INC. SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED) (AMOUNTS IN THOUSANDS)
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS (AMOUNTS IN THOUSANDS)
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
Policy Claims Deferred Future and Other Acquisition Policy Unearned Benefits Costs Benefits Premiums Payable ------- ------- ------- ------ At December 31, 2001: Life and accident and health insurance $3,306 $22,734 $0 $401 Property and casualty insurance 1,309 0 7,115 11,489 ----- ------- ----- ------- Total $4,615 $22,734 $7,115 $11,890 ===== ======= ===== =======
At December 31, 1999: Life and accident and health insurance $2,881 $18,987 $0 $394 Property and casualty insurance 1,392 0 7,088 18,471 ------ ------ ----- ------ Total $4,273 $18,987 $7,088 $18,865 ====== ====== ===== ======