Consolidated net income for The National Security Group (The Company) was $4.130 million in 2001 compared to $3.776 million in 2000. On a per share basis earnings were 1.67 in 2001 compared to 1.53 in 2000. A second consecutive year of underwriting profits in the property/casualty insurance subsidiaries boosted earnings to the highest levels in more than a decade. Realized capital gains in 2001 were 1.64 million and 1.72 million in 2000. Consolidated revenues were $32.8 million in 2001 compared to $29.7 million in 2000. The operating results of the subsidiaries are discussed in further detail in the sections that follow.
Income before income taxes in 2001 was $586,000 compared to $1,667,000 in 2000. Increased field cost and general expenses and a decrease in realized capital gains were the primary factors contributing to the decrease in income in the life insurance subsidiary.
Income before income taxes in 2000 was $1,667,000 compared to $2,556,000 in 1999. A one time charge for reserve increases on certain blocks of old industrial life insurance which NSIC no longer sells was the primary factor contributing to the decrease in income before income taxes.
NSIC increased premium income 8% to $4,594,000 in 2000 compared to $4,251,000 in 1999. Life insurance premium income increased 10.3% in 2000, and accident and health insurance decreased slightly compared to 1999. Life insurance sales through independent agents were the source of premium growth in NSIC in 2000.
Earned premium for 2001 was $20,196,000 compared to $18,326,000 in 2000. The property/casualty subsidiaries experienced premium growth in dwelling fire, homeowners, and private passenger auto lines of business.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999:
Management terminated the contract of the last remaining auto general agent program in 2000. The program, which produced private passenger auto premium in Florida, was terminated due to continued poor underwriting results. The final policies in force on this program expired in mid 2001. With the elimination of this program and other similar programs over the last two years management has significantly improved underwriting results.
SVO Equivalents % of Total SVO Class Moody's Standard and Poor's Bond Portfolio - --------- ------- ---------------- -------------- 1 Aaa to A3 AAA to A- 82.2 2 Baa to Baa3 BBB+ to BBB- 15.4 3 Ba1 to Ba3 BB+ to BB- 2.4 4 B1 to B3 B+ to B- 0.0 5 Caa to Ca CCC+ to C 0.0 6 C CI to D 0.0
As of January 1, 1994, the Company adopted Financial Accounting Standards Board Statement 115 and reclassified a portion of its fixed maturity securities portfolio as "available-for-sale," with the remainder being classified as "held-to-maturity." With that reclassification, the fixed maturity securities classified as "available-for-sale" are carried at fair value and changes in fair values, net of related income taxes, are charged or credited to shareholders' equity (see Note D to the consolidated financial statements).
The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $23 million. If the market value of the S & P 500 Index decreased 10% from its December 31, 2001 value, the fair value of the Company's common stock would decrease by approximately $2.3 million.
The Company has notes payable of $2.1 million at December 31, 2001. The notes payable are to be repaid in quarterly installments over five years.
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. On December 31, 2001, the Company had no known impairments of assets or changes in operation, which would have a material adverse effect upon liquidity. Approximately 83% of the Company's assets are invested in cash, investment grade fixed income securities, short-term investments and broadly traded equity securities which are highly liquid. The values of these investments are subject to the conditions of the markets in which they are traded. Past fluctuations in these markets have had little effect on the liquidity of the Company. 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.
Statutory Risk-Based Capital of Insurance Subsidiaries: The NAIC has adopted Risk-Based Capital (RBC) requirements for life/health and property/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching, benefit and loss reserve adequacy, and other business factors. State insurance regulators will use the RBC formula as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within levels, each of which requires corrective action. The levels and ratios are as follows:
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 eight to one at December 31, 2001.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $13 million and $14.3 million at December 31, 2001 and 2000, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 15.7 and 12.9 at December 31, 2001 and 2000 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements.
Consolidated Statements of Income - Years Ended December 31, 2001, 2000, and 1999 24
Consolidated Statements of Cash Flows - Years Ended December 31, 2001, 2000, and 1999 27
Schedule III. Supplementary Insurance Information - December 31, 2001, 2000, and 1999 53
Schedule IV. Reinsurance - Years Ended December 31, 2001, 2000, and 1999 54
To the Board of Directors and Shareholders of The National Security Group, Inc. Elba, Alabama
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, shareholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We have audited the accompanying consolidated statements of income and cash flows of The National Security Group, Inc. and subsidiaries for the year ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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 consolidated statements of income and cash flows are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated statements of income and cash flows. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated statements of income and cash flows. We believe that our audit of the statements of income and cash flows provides a reasonable basis for our opinion.
o Securities Held-to-Maturity. Bonds, notes and redeemable preferred stock for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using methods which approximate level yields over the period to maturity.
SFAS No. 107 excludes certain financial instruments, particularly insurance liabilities other than financial guarantees and investment contracts, from its disclosure requirements. In evaluating the Companys management of interest rate and liquidity risk, the fair values of all assets and liabilities should be taken into consideration.
The fair value of the mortgage loan portfolio was approximately equal to the carrying amount of $275,000 on December 31, 2001 ($116,000 on December 31, 2000).
As of December 31, 2001, the fair value of policy loans approximated their carrying amount of $726,000 ($692,000 as of December 31, 2000).
The fair value of other policyholder funds on deposit is estimated to approximate their carrying amount of $1,503,000 on December 31, 2001 ($1,488,000 on December 31, 2000).
The liability for future life insurance policy benefits is computed using a net level premium method including the following assumptions: Years of Issue Interest Rate 1947 - 1968 4% 1969 - 1978 6% graded to 5% 1979 - 2001 7% graded to 6%
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 2000 and 1999).
reported net income and other comprehensive income depending on future market conditions and the Companys hedging activities.
The adoption of this accounting standard did not have a material effect on the Companys financial position or results of operations.
In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires that companies record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. The Statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on the Companys financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 revises SFAS No. 121 by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 144 to have a material effect on the Companys financial position or results of operations.
2000 1999 Net premiums earned .......................... $23,817 $26,787 Income before taxes .......................... $ 4,653 $ 4,450 Net income ................................... $ 3,585 $ 3,690 Earnings per common share .................... $ 1.45 $ 1.50
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, and (d) non-admitted assets (furniture and equipment, agents debit balances and prepaid expenses) are charged directly to surplus.
(Dollars in Thousands) Amortized Fair Available-for-sale securities: Cost Value Due in one year or less ............................... $ 1,795 1,812 Due after one year through five years ................. 6,243 6,285 Due after five years through ten years ................ 17,734 18,142 Due after ten years ................................... 8,929 8,906 ------- ------- Total $34,701 $35,145 ======= ======= Held-to-maturity securities: Due in one year or less ............................... $ 2,384 $2,454 Due after one year through five years ................. 5,783 6,049 Due after five years through ten years ................ 6,046 6,262 Due after ten years ................................... 8,922 9,157 ------ ------ Total $23,135 $23,922 ====== ======
Less: Investment expenses ..................... (134) (150) (32) ------ ------ ------ Net investment income ......................... $ 4,506 $ 4,434 $ 4,354 ====== ====== ======
An analysis of net decrease in unrealized appreciation on available-for-sale securities follows:
Deferred policy acquisition costs .......... $ 49 $ 66 $ 41 Policy liabilities ......................... 70 69 (25) Unearned premiums .......................... (81) (56) 113 General insurance expenses ................. (62) 18 (1) Alternative minimum tax credit carryforward 243 247 (314) Claim liabilities .......................... 122 116 21 ------ -------- ------- $ 341 $ 460 $(165) ====== ======== =======
(Dollars in thousands) 2001 2000 ---- ---- Benefit and loss reserves Property and casualty ...................... $11,489 $15,409 Accident and health ........................ 318 301 Life and annuity ........................... 22,416 19,486 Unearned premiums ............................ 7,115 6,364 Policy and contract claims ................... 401 358 ------- ------- $41,739 $41,918 ======= =======
Claims and claim adjustment expense reserves at beginning of year $15,409 $18,471 $21,528 Less reinsurance recoverables on unpaid losses 3,092 3,907 5,889 ------ ------ ------ Net balances at beginning of year 12,317 14,564 15,639 Provision for claims and claim adjustment expenses for claims arising in current year 14,045 14,465 15,859 Estimated claims and claims adjustment expenses for claims arising in prior years (3,089) (5,411) (3,074) ------ ------ ------ Total increases 10,956 9,054 12,785 Claims and claim adjustment expense payments for claims arising in: Current year 9,891 8,792 9,934 Prior years 4,289 2,509 3,926 ------ ------ ------ Total payments 14,180 11,301 13,860 ------ ------ ------ Net balance at end of year 9,093 12,317 14,564 Plus reinsurance recoverables on unpaid losses 2,396 3,092 3,907 ------ ------ ------ Claims and claim adjustment expense reserves at end of year $11,489 $15,409 $18,471 ====== ====== ======
The Companys insurance operations participate in 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. 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 reinsurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurers and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize their exposure to significant losses from reinsurance insolvencies. At December 31, 2001, reinsurance receivables with a carrying value of $618,000 ($912,000 at December 31, 2000) and prepaid reinsurance premiums of $291,000 ($293,000 at December 31, 2000) were associated with a single reinsurer. The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2001, 2000 and 1999 were approximately $988,801, $605,000, and $1,819,000, respectively
Direct ........... $5,047 $ 5,206 $ 22,528 $ 21,777 Assumed .......... -- -- -- -- Ceded ............ (45) (45) (1,579) (1,581) ------ ------- -------- -------- Net .............. $5,002 $ 5,161 $ 20,949 $ 20,196 ====== ======= ======== ========
Direct ........... $4,047 $ 4,300 $ 21,421 $ 23,078 Assumed .......... -- -- -- -- Ceded ............ (49) (49) (1,385) (1,393) ------ ------- -------- -------- Net .............. $3,998 $ 4,251 $ 20,036 $ 21,685 ====== ====== ======== ========
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 2001, 2000, and 1999 amounted to $130,000, $127,000, and $161,000, respectively. Contributions are at the Board of Directors discretion subject to governmental limitations.
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 $2,719,538 in 2002.
Assets Individual life and accident and health insurance $44,513 $42,150 $41,323 Property and casualty insurance 54,962 55,256 56,714 Other 509 157 68 ------ ------ ------ $99,984 $97,563 $ 98,105 ====== ====== ======
The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations. These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Companys subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief.
The Company maintains its cash accounts primarily with banks located in Alabama. The total cash balances are insured by the FDIC up to $100,000 per bank. The Company had cash balances on deposit with Alabama banks at December 31, 2001 that exceeded the balance insured by the FDIC in the amount of $617,888.
December 31, ------------------------ 2001 2000 ------ ---- Assets Cash $101 $66 Investment in subsidiaries (equity method) eliminated upon consolidation 47,062 46,481 Other assets 722 458 ----- ------ Total Assets $47,885 $47,005 ====== ======
Liabilities and Shareholders Equity Accrued general expenses $893 $824 Notes Payable 2,108 2,401 ----- ------ Total Liabilities 3,001 3,225 ----- ------ Total Shareholders' Equity $44,884 $43,780 ------ ------ Total Liabilities and Shareholders' Equity $47,885 $47,005 ======= ======
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS)
Note 2-Cash Dividends from Subsidiaries Dividends of $2.5 million in 2001, $2.4 million in 2000 and $2.3 million in 1999 were paid to the Registrant by it subsidiaries.
At December 31, 2000: Life and accident and health insurance $3,240 $19,787 $0 $358 Property and casualty insurance 1,229 0 6,364 15,409 ------ ------- ----- ------- Total $4,469 $19,787 $6,364 $15,767 ====== ======= ====== =======
THE NATIONAL SECURITY GROUP, INC. SCHEDULE IV. REINSURANCE (CONSOLIDATED) (Amounts in thousands)