We also own approximately 100 acres of undeveloped commercial real estate in Greenville, Alabama. We sell undeveloped lots from this development and the development has no depreciable improvements.
For the year ended December 31, 2010 total revenues were $69,392,000 compared to $66,004,000 for the same period last year; an increase of 5.1%. Earned premium increases in the P&C segment as well as the increase in net realized investment gains were the primary contributing factors to the increase in total revenue for 2010 over 2009.
Results of Operations for Years Ended December 31, 2010 and 2009
Net investment income totaled $5,089,000 in 2010 compared to $5,289,000 in 2009; a decrease of $200,000. We currently hold $5,000,000 in company owned life insurance (COLI). The change in value related to this investment led to investment income totaling $323,000 in 2010 compared to $740,000 for the same period last year. The reduction in COLI income was the primary reason for the overall decrease in investment income. Invested assets were up 7.8% at December 31, 2010 compared to December 31, 2009. The increase in invested assets, primarily in fixed income investments, led to higher interest income from the portfolio and partially offset the decrease in income from COLI.
Policyholder benefits paid or provided increased 8.9%, ending 2010 at $39,031,000 compared to $35,839,000 for the same period last year. Policyholder benefits as a percentage of net premiums earned totaled 63.71% for the year in 2010 compared to 60.14% in 2009. The primary reason for the $3,192,000 increase was higher claims activity in the P&C segment associated with an increase in fire related losses primarily homeowners lines of business coupled with increase claims in the auto line of business. Fire losses incurred in the homeowners programs totaled $9,113,000 in 2010 compared to $7,097,000 in 2009; an increase of 2,016,000 or 28.4%. The increase in fire losses incurred in 2010 compared to fire losses incurred in 2009 in the above mentioned lines of business accounted for 63.2% of the overall increase in policyholder benefits costs. In addition, the personal lines automobile program ended 2010 with incurred losses and incurred loss adjustment expenses of $4,661,000 compared to $1,596,000 for the same period last year; an increase of $3,065,000. The auto program also experienced significant revenue growth during the year, partially contributing to the increased frequency of claims. However, the loss and adjustment expense ratio increased over 30 percentage points in 2010 compared to 2009. To stem losses in the auto program, we implemented significant rate increases in late 2010 which had an immediate impact of decreasing new business production and is expected to ultimately decrease the loss ratio on the program.
General and administrative expenses increased $276,000 in 2010 compared to the same period last year. The primary factor contributing to the increase in general expenses was an increase in litigation related defense costs associated with the Company’s sale of an investment in Mobile Attic in 2007.
Taxes, licenses and fees were $2,081,000 in 2010, up 27.6% compared to $1,631,000 for the same period last year. Taxes, licenses and fees were 3.4% of premiums earned for the year 2010 compared to 2.74% in 2009. An increase in premium revenue in the auto program was a primary factor contributing to the increase in tax expense.
Interest expense increased $30,000 in 2010 compared to 2009. The increase in interest expense was primarily associated with the interest on a revolving line of credit maintained in our holding company.
Due to the increase in policyholder benefit expenses as well as an increase in taxes, licenses and fees, the Company ended 2010 with net income of $3,265,000, down 22.7% from $4,224,000 for the same period last year.
The property and casualty segment composed 88.53% of total premium revenue in 2010 compared to 87.92% in 2009. The property and casualty segment is primarily composed of dwelling fire, allied lines and homeowners lines of business. The life segment composed 11.47% of premium revenue in 2010 compared to 12.08% in 2009 with revenue produced primarily from life insurance products.
The following discussion outlines more specific information with regard to the individual operating segments of the Company along with non-insurance related information (primarily administration expenses) associated with the insurance holding company.
Net investment income totaled $2,900,000 in 2010 compared to $3,125,000 in 2009; a decrease of $225,000. The decrease in investment income in the P&C segment was primarily attributable to decline in investment income associated with the investment of the cash value of company owned life insurance (COLI). Investment income from COLI totaled $323,000 in 2010 compared to $740,000 in 2009.
Other income was $1,158,000 in 2010 compared to $761,000 for the same period last year; a $397,000 increase. Other income consists primarily of fees related to the issuance of our property and automobile insurance policies as well as miscellaneous income. The primary reason for the $397,000 increase was policy fee income related to the automobile program. The fees associated with the automobile business totaled $340,000 in 2010 compared to $145,000 in 2009; an increase of $195,000. The increase in policy fees associated with the automobile line of business accounted for 49.1% of the total increase in other income in 2010 compared to 2009.
Policyholder benefit expenses were $33,745,000 in 2010, up $2,837,000 from $30,908,000 for the same period last year. The primary reasons for the increase were fire losses in the homeowners lines of business as well as the surge in claims frequency related to the growth of the automobile program. Fire losses incurred in 2010 in the homeowners line of business totaled $9,113,000, a 28.4% increase from fire losses incurred during 2009 which totaled $7,097,000.
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 2010, tornado and storm related frequency was below levels we experienced throughout 2009. Although the P&C segment experienced losses from ten weather related events classified as catastrophes during 2010 and 2009, incurred losses from the current year storms totaled $1,704,000 compared to $2,328,000 in the prior year; a 26.8% decrease. The average severity per claim related to the ten non-hurricane catastrophes affecting the P&C companies during 2010 and 2009 totaled approximately $,3500 and $2,500, respectively per claim.
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 cumulative claims associated with Hurricane Katrina breached the $37,500,000 million upper limit of the reinsurance agreement in effect during 2005. As of December 31, 2010, cumulative claims incurred related to Hurricane Katrina exceeded the reinsurance upper limit by $1,467,000. Although the reinsurance for this catastrophe has been exhausted and the ultimate outcome of the remaining open claims is unknown, the company believes it maintains adequate reserves for the 53 open claims based on information available at the present time.
During 2010, the P&C segment experienced adverse development related to claims from Hurricane Ike which impacted our coverage areas in September 2008. Cumulative incurred losses related to Hurricane Ike totaled $5,866,000 as of December 31, 2010 compared to $4,843,000 for the same period last year; an increase of $1,023,000. The company has met its catastrophe reinsurance deductible with regard to Ike and is still well within the upper limits of reinsurance coverage for this hurricane covering 95% of the amounts incurred and therefore expects a minimal additional net development with regard to this hurricane.
There was no significant change in deferred policy acquisition costs which totaled $3,354,000 in 2010 (6.18% of premium revenue) compared to $3,397,000 in 2009 (6.48% of premium revenue). Deferred policy acquisition cost consists of amortization of previously capitalized distribution costs; primarily commissions.
The P&C segment ended 2010 with income tax expense of $1,823,000 compared to $1,466,000 in 2009. The effective tax rate for 2010 was 25% compared to 22% in 2009 primarily due to less income from tax free bonds and tax free income from COLI in 2010 compared to 2009.
The combined ratio was 96% in 2010 compared to 95% in 2009. The increase in fire losses in the dwelling fire and homeowners lines of business combined with the increase in incurred losses in the automobile program adversely impacted the combined ratio in 2010.
A measure used to analyze a property/casualty insurer’s underwriting performance is the combined ratio. It is the sum of two ratios:
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, Louisiana, or Texas 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 2010, the P&C segment experienced an increase of one percentage point in the combined ratio. The primary reasons for the increase were a $2,384,000 increase in fire related losses primarily in the homeowners line of business as well as the $3,065,000 increase in losses incurred related to the automobile program. However, the negative impact of these claim expenses was partially offset by the $624,000 decrease in tornado and storm related losses incurred in the dwelling fire program in 2010 compared to 2009.
At December 31, 2010, 3.98% of total investments in the fixed income portfolio were classified as below investment grade. Management has evaluated each security in a significant unrealized loss position. No OTTI were recorded for the year ended December 31, 2010. For the year ended December 31, 2009, $443,000 in OTTI was recorded by the Company. Of the 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. 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.
As for the composition of the RMBS portfolio, agency mortgage backed securities compose 42% and 52% of the RMBS portfolio at December 31, 2010 and 2009, 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 are rated below investment grade and compose less than 2% of total invested assets.
Investment returns with respect to the investment portfolio for the years ended December 31, 2010 and 2009 follows:
The decrease in current yield on investments is primarily due to a decrease in average yields on new investments in corporate bonds in 2010 compared to 2009 coupled with a higher allocation of tax free investments. Tax free investments typically yield less than comparable taxable securities but result in lowering the overall effective tax rate of the company.
As of December 31, 2010, the maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows:
It should be noted that the above table represents maturities based on stated maturity. Due to call and prepayment features inherent in some debt securities, actual repayment, or effective maturities, will differ from stated maturities. The Company routinely evaluates the impact of changing interest rates on the projected maturities of bonds in the portfolio and actively manages the portfolio in order to minimize the impact of interest rate risk.
The consolidated statement of cash flows also reflects a decrease in cash used in financing activities of $(976,000) and $(1,477,000), respectively. Cash flows from financing activities in 2010 reflect cash provided of $500,000 from a short-term line of credit and shareholder dividends paid of $1,480,000.
In estimating the time interval for payment of property and casualty claim reserves, the Company utilized historical payment patterns. By the nature of the insurance contracts under which these liabilities exist, there can be no certainty that actual payments will fall in the periods indicated above. However, management believes that current liquidity and capital resources are sufficient to pay these obligations as they come due. Also, due to the relatively short-tail nature of the majority of the Company’s property and casualty claim liabilities, management can conclude with a reasonable level of confidence that historical patterns indicate that approximately 70% of claim liabilities at the end of a given year are settled within the following two year period.
The ability of the Company to meet its commitments for timely payment of claims and other expenses depends, in addition to current cash flow, on the liquidity of its investments. The Company has relatively little exposure to lower grade fixed income investments which might be especially subject to liquidity problems due to thinly traded markets.
As disclosed in Note 16 to the consolidated financial statements regarding contingencies, the Company is involved in litigation related to the sale of Mobile Attic, Inc. As is customarily discussed in the Management Discussion and Analysis, the Company’s liquidity requirements are primarily met by funds provided from operations of the insurance 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. In the event of a substantial adverse judgment related to the litigation against the Company, we could face limitations in our ability to fund shareholder dividends and service interest payments on outstanding debt.
The Company filed a claim for coverage under a liability policy having aggregate limits of $5,000,000, but the insurer has denied coverage and no provision for any recovery has been made in the accompanying condensed consolidated financial statements.
The Company’s business is concentrated primarily in the Southeastern United States. Accordingly, unusually severe storms or other disasters in the Southeastern United States might have a more significant effect on the Company than on a more geographically diversified insurance company. However, the Company maintains a catastrophe reinsurance program to limit the effect of such catastrophic events on the Company’s financial condition. The Company deductible under the terms of the reinsurance contract totals $3.5 million; however, the Company maintains cash and short-term investments in sufficient amounts to cover the deductible payment in the event of a catastrophic event.
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. The outstanding balance at December 31, 2010 was $500,000.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $9.0 million and $9.6 million at December 31, 2010 and 2009, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 12.8 and 23.0 at December 31, 2010 and 2009, respectively. Accordingly, Omega One Insurance Company exceeds the minimum RBC requirements.
For more information regarding reinsurance, please see the Notes to our consolidated financial statements.
At December 31, 2010, 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.
Effective for 2010, the FASB revised guidance that requires additional disclosure regarding transfers of financial assets, including securitization transactions, where entities have continuing exposure to risks related to the transferred financial assets. We do not expect the adoption of this guidance to have any impact on our results of operations or financial position.
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses
During 2010 the FASB issued new guidance, effective for 2011, that requires entities to disclose detailed information regarding the credit quality of financing receivables, including credit risk exposures and the allowance for credit losses. We do not expect the adoption of this guidance to have any impact on our results of operations or financial position.
Effective for 2011, the FASB revised guidance related to goodwill impairment testing. The revised guidance clarifies that when evaluating goodwill associated with a reporting unit that has a zero or negative carrying value, an initial determination should be made as to whether it is more likely than not that the goodwill is impaired. When impairment is more likely than not, the goodwill is required to be tested for impairment. We do not expect the adoption of this guidance to have any impact on our results of operations or financial position.
Schedule I. Summary of Investments Other Than Investments in Related Parties -
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 is incorporated under the laws of the State of Delaware. Its Common Stock is traded on the NASDAQ Global Market under the ticker symbol NSEC. Pursuant to the regulations of the United States Securities and Exchange Commission (SEC), the Company is considered a “Smaller Reporting Company” as defined by SEC Rule 12b-2 of the Exchange Act. The Company has elected to comply with the new scaled disclosure requirements of Regulation S-K and only two years of financial statements are included herein. The Company previously used a non-accelerated filer status.
The Company’s property and casualty segment is licensed or operates on a surplus lines basis in 13 states. However, over 60% of 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 segment, composing nearly 14% 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.
For the year ended December 31, 2010, one agency individually produced greater than 5% of the Company’s direct written premium.
Unrealized gains and losses on investments, net of tax, on securities available-for-sale are reflected directly in shareholders’ equity as a component of accumulated other comprehensive income, and accordingly, have no effect on net income until realized.
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.
Accounts receivable are reported at net realizable value. Management determines the allowance for doubtful accounts based on historical losses and current economic conditions. On a continuing basis, management analyzes delinquent receivables and, once these receivables are determined to be uncollectible, they are written off through a charge against an existing allowance account or against earnings.
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
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, 2010 the single largest balance due from one agent totaled $479,000.
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, 2010 and 2009, 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, 2010, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.
Effective prospectively for business combinations for which the acquisition date is on or after January 1, 2011, the FASB issued guidance related to pro forma disclosure information for business combinations. The guidance clarifies that the required pro forma revenue and earnings disclosures should be prepared as if the business combination had occurred at the beginning of the prior annual reporting period. The guidance also expands supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments included in the reported pro forma revenue and earnings. We do not expect the adoption of this guidance to have any impact on our results of operations or financial position.
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 $9,279,000 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 the accompanying consolidated balance sheets.
According to the most recent accounting guidance, for securities in an unrealized loss position, the Company is required to assess 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. For the year ended December 31, 2010, the Company realized no other than temporary impairments. The single largest accumulated loss was in the equity portfolio and totaled $360,000. The second largest loss position was in the bond portfolio and totaled $185,000. The third largest loss position was in the equity portfolio and totaled $83,000. Most unrealized losses in the fixed income portfolio are interest rate driven as opposed to credit quality driven, and management believes no ultimate loss will be realized. The Company has no material exposure to sub-prime mortgage loans and less than 4% of the fixed income investment portfolio is rated below investment grade. For the year ended December 31, 2009, the Company realized $443,000 in other than temporary impairments. The single largest accumulated loss was in the equity portfolio and totaled $337,000. The second largest loss position was in the bond portfolio and totaled $332,000. The third largest loss position was in the equity portfolio and totaled $163,000. Most unrealized losses in the fixed income portfolio are interest rate driven as opposed to credit quality driven and management believes no ultimate loss will be realized. The Company has no material exposure to sub-prime mortgage loans and less than 2% 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 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 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, 2010:
The carrying amount and estimate fair value of the Company’s financial instruments as of December 31are as follows:
Depreciation expense for the year ended December 31, 2010 was $394,000 ($424,000 for the year ended December 31, 2009).
The Company recognizes tax-related interest and penalties as a component of tax expense. The Company incurred $-0- in interest and penalties as of both December 31, 2010 and December 31, 2009. 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 2006. No income tax returns are currently under examination by the Internal Revenue Service or any state or local taxing authority. Tax returns have been filed through the year 2009.
Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The Company recognized net deferred tax liabilities of $1,043,000 in 2010 and $61,000 in 2009.
The subordinated debentures (debentures) have the same maturities and other applicable terms and features as the associated trust preferred securities (TPS). Payment of interest may be deferred for up to 20 consecutive quarters; however, stockholder dividends cannot be paid during any extended interest payment period or any time the debentures are in default. All have stated maturities of thirty years. None of the securities require the Company to maintain minimum financial covenants. The Company has guaranteed that amounts paid to the Trusts (discussed in Note 2) will be remitted to the holders of the associated TPS. This guarantee, when taken together with the obligations of the Company under the debentures, the Indentures pursuant to which the debentures were issued, and the related trust agreement (including obligations to pay related trust fees, expenses, debt and other obligations with respect to the TPS), provides a full and unconditional guarantee of amounts due the Trusts. The amount guaranteed is not expected to at any time exceed the obligations of the TPS, and no additional liability has been recorded related to the guarantee.
On March 19, 2009, the Company entered into a forward swap effective September 17, 2012, which will also hedge against changes in cash flows following the termination of the 5 year swap agreement discussed previously. Commencing September 17, 2012, under the terms of the forward swap, the Company will pay interest at the three-month LIBOR rate plus 3.4% and receive interest at the fixed rate of 7.02%. This forward swap will effectively fix the interest rate on $3,000,000 in debt until September of 2019.
On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which will hedge against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company will pay interest at a fixed rate of 8.49% until March 15, 2020.
We use dollar offset at the hedge's inception and for each reporting period thereafter to assess whether the derivative used in a hedging transaction is expected to be, and has been, effective in offsetting changes in the fair value of the hedged item. Since inception no portion of the hedged item has been deemed ineffective. For all hedges, we discontinue hedge accounting if it is determined that a derivative is not expected to be, or has ceased to be, effective as a hedge.
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 securities on deposit with fair market values of $822,000 ($660,000 of which is posted as collateral) ($469,000 at December 31, 2009). Please see Note 6 for additional information about the interest rate swaps.
The 2010 increase 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 increase in claim activity from fire related losses in the dwelling fire and homeowners lines of business during 2010 as well as the increase in claims related to the automobile program. These two factors were also the source of the increase in claims and claim adjustment expense payments for claims arising in the current year compared to the previous year.
At December 31, 2010, the largest reinsurance recoverable of a single reinsurer was $278,000 ($95,000 in 2009). The Company incurred no losses from covered events occurring in 2010 or 2009. Amounts reported as ceded incurred losses in 2010 and 2009 were related to development of losses from prior year catastrophes.
In 1989, the Company and its subsidiaries established a retirement savings plan (401K Plan) and transferred the assets from the defined contribution profit sharing plan into the new 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 2010 and 2009 amounted to $239,000 and $219,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.
In 1987, the Company established a non-qualified deferred compensation plan for its Board of Directors. The Board members had 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. The directors’ non-qualified deferred compensation plan was frozen on December 31, 2004, and deferrals are no longer allowed. A new non-qualified plan became effective January 1, 2006 under which directors are allowed to defer all or a portion of directors’ fees into various investment options. 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 2010 and 2009 amounted to approximately $254,000 and $388,000, 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, 2010, NSFC’s retained earnings unrestricted for the payment of dividends in 2011 amounted to $5,394,000.
At December 31, 2010, securities with market values of $3,597,000 ($3,530,000 at December 31, 2009) were deposited with various states pursuant to statutory requirements.
The Company and its subsidiaries continue to be named individually 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.
The Company has been sued in a putative class action in the State of Alabama. The Plaintiff alleges entitlement to, but did not receive, payment for general contractor overhead and profit (“GCOP”) in the proceeds received from the Company concerning the repair of the Plaintiff’s home. Plaintiff alleges that said failure to include GCOP is a material breach by the Company of the terms of its contract of insurance with Plaintiff and seeks monetary damages in the form of contractual damages. A class certification hearing was held on March 1, 2010 with the trial court taking the Plaintiff’s motion for class certification under advisement. On May 10, 2010, the trial court issued its ruling granting Plaintiff’s motion to certify the class. The Company filed its Appellant Brief on October 5, 2010. The Company denies Plaintiff’s allegations and intends to vigorously defend this lawsuit.
In April 2007, the Company sold substantially all of its 50% interest in its subsidiary, Mobile Attic, Inc. The Company, Peter L. Cash and Russell L. Cash (collectively the "Sellers") sold to Purchaser 61% of the outstanding stock of Mobile Attic under the terms of the terms of a Stock Purchase Agreement dated April 5, 2007, executed by Sellers, Mobile Attic and Purchaser's assignor, James W. Bagley (the "Stock Purchase Agreement").
On January 9, 2009, Mobile Attic, MA Manufacturing Company, Inc., and Purchaser initiated an action against Peter Cash, Cash Brothers Leasing, Inc., Bridgeville Trailers, Inc., and Barfield, Murphy, Shank & Smith, P.C. in United States District Court for the Middle District of Alabama. In the complaint, Plaintiffs asserted, among other claims, a claim for damages resulting from a breach of certain of the warranties regarding the financial statements of Mobile Attic and other financial information provided by Mobile Attic. Purchaser then notified the Company of its claim for breach of warranty under the Stock Purchase Agreement and requested indemnity from the Company.
The Purchaser has asserted that the Company is jointly and severally liable with the other Sellers (whom the Company believes have limited resources) for all losses suffered by Purchaser as a result of Sellers' misrepresentations. Purchaser claims that the misrepresentations caused Purchaser to purchase the stock of Mobile Attic, Inc. with the result that Sellers should be liable for all of Purchaser's losses resulting from the transaction, which include the value paid for the stock of Mobile Attic, Inc., the losses suffered on the assumption of the bank loan, the operating losses funded by Purchaser after the transaction, and attorneys' fees incurred by Purchaser to enforce its claim for indemnity.
On August 13, 2009, the Court granted the Company's motion to intervene. The parties have conducted initial discovery in this action, and at the request of the Court, each party filed an amended complaint on or before August 23, 2010. The Purchaser has asserted counterclaims against the Company for losses incurred as a result of failure to disclose material facts or alleged innocent, negligent or reckless false representations made to induce Purchaser to enter into the Stock Purchase Agreement, breach of the Stock Purchase Agreement and indemnification of Purchaser's losses and damages as a result of the breach of representations and warranties in the Stock Purchase Agreement. .
Cash paid for interest during 2010 was $1,156,000 ($1,077,000 in 2009). Cash paid for income taxes in 2010 was $662,000 compared to cash received for income taxes in 2009 of $796,000.
Management has evaluated subsequent events and their potential effects on these consolidated financial statements.
In 2010 and 2009, dividends of $2.8 million per year were paid to the Registrant by its subsidiaries.