The Company owns no property. The Life insurance subsidiary owns its principal executive offices located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 and consists of approximately 26,000 square feet. The Company believes this space to be adequate for its foreseeable future needs. The Company’s subsidiaries own certain real estate properties, including approximately 2,700 acres of timberland in Alabama.
Premium revenue reached a record high of $47.5 million in 2003, an increase of 45.3% over 2002 premium revenue of $32.6 million, a previous Company record. Continued strong growth in the property and casualty insurance segment was the primary catalyst contributing to the increase in premium revenue. Property and casualty premium revenue totaled $41.7 million in 2003 compared to $27.2 million in 2002. Strong growth in dwelling property lines of business, particularly homeowners type products, were the major contributor to the increase in property and casualty premium revenue. The life, accident and health segment continued to increase premium revenue at a healthy pace with a 7.5% increase over 2002.
Certain financial information for The National Security Group’s three segments (life and accident and health insurance, property and casualty insurance, and other) is summarized as follows (amounts in thousands):
Income before income taxes in 2003 was $563,000 compared to $1,118,000 in 2002. Litigation related expenses decreased pretax earnings by nearly $300,000 and was the primary factor contributing to the 50% decline in pre-tax earnings. Pending litigation against NSIC is discussed further in Note O to the consolidated financial statements.
Income before income taxes in 2002 was $1,118,000 compared to $586,000 in 2001. A decrease in litigation related expenses boosted income before income tax by over $200,000 during 2002. A decline in general expenses is the other significant item contributing to the increase in income before income taxes in 2002 compared to 2001.
NSIC increased premium income 4.6% to $ 5,396,000 in 2002 compared to $5,161,000 in 2001. Life insurance premium income increased 10.5% in 2002, and accident and health insurance also had an increase of 20.5% in 2002. The life insurance sales through independent agents were the source of premium growth in NSIC in 2002.
Property and casualty premium revenues increased $14.5 million for the year ended December 31, 2003 compared to the same period in 2002, an increase of over 53%. The acquisition of a book of business contributed nearly $3.0 million to the total increase in premium revenue. Increased production in the homeowners line of business added nearly $5.0 million in increased premium revenue. NSFC’s traditional dwelling fire line of business grew over 32% during the year and added nearly $5.0 million in premium revenue.
Net income before income tax was $518,000 in 2002 compared to $5,440,000 in 2001. Adverse claims experience from hurricane losses in the fourth quarter of 2002 and an increased severity of losses on new business issued were the primary reasons for the significant decrease in income. In October of 2002 Hurricane Lili swept across Louisiana causing over $1,300,000 in insured losses in NSFC and Omega. However, the most significant impact on property/casualty net income for the year was poor underwriting results on new business issued. Historically, new property insurance business issued has carried a higher loss ratio than renewal business. In 2002 the property/casualty subsidiaries issued more new business than has been issued in recent history with an increase in premium revenue of over 35%. NSFC incurred numerous total losses on business in force less than one year during 2002, mostly fire losses. 33% of all dwelling property losses incurred in 2002 were attributable to fire losses of over $25,000 per occurrence. Historically, fire losses are more numerous in the winter months of December and January, but a higher frequency of fire losses was experienced throughout the year. It is difficult to prove that these higher frequency losses were connected to any single cause, such as a colder than normal winter or lightning strikes. However, with the overall economy in a downturn and personal bankruptcy at record highs in some of the states in which NSFC and Omega writes business, management believes that at least some of the losses could be attributable to arson, which in most cases is virtually impossible to prove. In an effort to stem the frequency of total fire losses, we have instituted additional underwriting standards in some states, such as providing proof of prior insurance coverage and closer evaluation of prior claims history.
The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 2003, the company’s holdings in debt securities amounted to 73.7% of total investments and 64.1% 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 $7.8 million and $5.4 million at December 31, 2003 and 2002 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 has standby letters of credit of less than $25,000. These letters are used to guarantee obligations of the property/casualty subsidiary under assumed reinsurance contracts. Certain invested assets of the Company secure the letters of credit. The Company also routinely incurs liability for declared but unpaid dividends. Long-term liquidity needs of the Company constitute only those items, which are directly related to the principal business operations of the Company.
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 four to one at December 31, 2003.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $11.37 million and $11.47 million at December 31, 2003 and 2002, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 16.0 and 17.1 at December 31, 2003 and 2002 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $23.1 million and $20.2 million at December 31, 2003 and 2002, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 4.0 and 5.3 at December 31, 2003 and 2002 respectively. Accordingly, National Security Fire & Casualty Company meets the minimum RBC requirements.
Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not limited to changes in market conditions, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, technological changes, political and legal contingencies and general economic conditions, as well as other risks and uncertainties more completely described in the Company’s filings with the Securities and Exchange Commission. If any of these assumptions or opinions proves incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects and may cause future results to differ materially from those contemplated, projected, estimated or budgeted in such forward-looking statements.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Class A common stock, $1 par value, 2,500,000 shares authorized, none issued or outstanding
Purchase of property and equipment (852 ) (1,039 ) (335 )
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). Omega included a wholly-owned subsidiary - Liberty Southern Insurance Company (LSIC) through September 30, 2001. LSIC was liquidated on September 30, 2001. All significant intercompany transactions and accounts have been eliminated.
The company’s investment in affiliate consists of a 50% interest in Mobile Attic, Inc., a portable storage leasing company. The company accounts for this investment using the equity method (see Notes B, O and Q).
Certain financial instruments, particularly insurance liabilities other than financial guarantees and investment contracts, leases and affiliate investments, are excluded from the disclosures. In evaluating the Company’s management of interest rate and liquidity risk, the fair values of all assets and liabilities should be taken into consideration.
Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding were 2,466,600 (2,466,600 in 2002 and 2001).
In November 2002, the FASB issued FASB Interpretation (“FIN”) 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 expands the disclosures required by guarantors for obligations under certain types of guarantees. It also requires initial recognition at fair value of a liability for such guarantees. The Company adopted the disclosure requirements of FIN 45 for the quarter ended December 31, 2002 and the liability recognition requirements to all guarantees issued or modified after December 31, 2002. The adoption of these requirements did not have a material impact on the Company’s results of operations or financial position.
In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities-an Interpretation of Accounting Research Bulletin No. 51. FIN No. 46 addresses consolidation by business enterprises where equity investors do not bear the residual economic risks and rewards. The underlying principle behind FIN 46 is that if a business enterprise has the majority financial interest in an entity, which is defined in FIN 46 as a variable interest entity, the assets, liabilities and results of the activities of the variable interest entity should be included in the consolidated financial statements with those of the business enterprise. In December 2003, the FASB issued Revised FIN 46 (FIN 46R) to clarify certain aspects of FIN 46 including the determination of who is the primary beneficiary of a variable interest entity. FIN 46R postponed the effective date as to when companies are required to apply the provisions prospectively for all variable interest entities in existence prior to January 31, 2003 until the first financial reporting period that ends after March 15, 2004. However, for entities that are considered to be special purpose entities, the effective date of FIN 46R is financial reporting periods after December 15, 2003. The Company does not have an interest in any special purpose entities. The Company expects to consolidate its affiliate, Mobile Attic, Inc., upon adoption of FIN 46R in the first quarter 2004. The consolidation of Mobile Attic is expected to increase total assets by approximately $15 million, total liabilities by approximately $13 million and total shareholders’ equity by approximately $1 million. The consolidation of Mobile Attic is not expected to have a material impact on the results of operations as the Company is currently accounting for the investment under the equity method. See Notes B, O and Q for additional information related to the VIE.
Depreciation expense for the year ended December 31, 2003 was $419,000 ($206,000 for the year ended December 31, 2002 and $197,000 for the year ended December 31, 2001).
Dividends received deduction and tax-exempt interest (176 ) (184 ) (182 )
Small life insurance company deduction (18 ) (230 ) (122 )
(3.87% at December 31, 2003 and 4.18% at December 31, 2002)
$112,953 due quarterly with balloon payment at maturity. Unsecured $ 3,059
Aggregate maturities of long-term debt for each of the four years subsequent to December 31, 2003 are as follows (dollars in thousands): 2004-$339; 2005-$351; 2006-$365; 2007-$2,004.
expenses for claims arising in prior years (1,928 ) (1,547 ) (3,089 )
As a result of changes in estimates of insured events in prior years, the provision for claims and claim adjustment expenses (net of reinsurance recoveries) decreased in 2003, 2002 and 2001 because of lower-than-anticipated losses in commercial and private passenger automobile lines of business.
The Company has a geographic exposure to catastrophe losses in certain areas of the country. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophe losses are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
In 1989, the Company and its subsidiaries established a retirement savings plan and transferred the assets from the defined contribution profit sharing plan into the new plan. All full-time employees who have completed one year of service at January 1 or July 1 are eligible to participate and all employee contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Contributions for 2003, 2002, and 2001 amounted to $228,000, $177,000, and $130,000, respectively. Contributions are at the Board of Directors’ discretion subject to governmental limitations.
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 2003, 2002, and 2001 amounted to approximately $421,000, $19,000, and $35,000, 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. As a result, dividends from NSFC to the Company are limited to $2,526,000 in 2004.
The Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference.
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 Company’s consolidated financial position, it remains management’s opinion, based on information presently available, that the ultimate resolution of these matters will not have a material impact on the Company’s 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.
At December 31, notes receivable from affiliate consisted of the following:
During 2003, the company advance a total of $3,074,000 to its affiliate, Mobile Attic, Inc., under various short-term notes payable. All advances were fully repaid in 2003. The company received $25,000 in interest on the advances.
During 2002, the balance on the convertible line of credit was increased to $1 million and, under the terms of the line of credit, $725,000 of the balance was converted to common equity of the affiliate. The remaining $275,000 was converted to the long-term note described above.
In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Cash and due from banks at end of year $ 185