Consolidated net income for The National Security Group (The Company) was $3.756 million in 1999 compared to $930,000 in 1998. On a per share basis earnings were $1.83 in 1999 compared to $0.42 in 1998. The increase in net income was due to improved operating results in The Company's property/casualty subsidiaries operations. Realized capital gains in 1999 were $1.95 million compared to $4.1 million in 1998. Consolidated revenues were $32.6 million in 1999 compared to $37.3 million in 1998.
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):
The Company's life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947.
As experienced in 1999, life insurance commission expense increased again in 2000. Life insurance issued by NSIC pays a higher commission in early years of the policy and the commission rate decreases in succeeding years. Since NSIC has experienced a large increase in new business volume, commission expense has increased.
Net income before income tax was $3,917,000 in 2000 compared to $2,365,000 in 1999. Improved underwriting results for the second straight year was 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.
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 will expire by mid 2001. With the elimination of this program and other similar programs over the last two years management has significantly improved underwriting results.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998:
NSFC had much improved underwriting results in the dwelling property lines of insurance compared to 1998. In 1998 NSFC incurred over $1,000,000 in tornado losses, while in 1999 tornado losses were minimal. NSFC also did not incur any significant hurricane losses in 1999. In 1998 NSFC incurred over $1,100,000 in hurricane losses. The decrease in hurricane and tornado losses of over $2 million led to much improved underwriting results in 1999 compared to 1998.
a. The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premiums earned.
2000 1999 1998 ----- ----- ---- Loss and LAE Ratio 61.6% 70.9% 87.0% Underwriting Expense Ratio 34.8% 35.8% 40.3% ------ ------- ----- Combined Ratio 96.4% 106.7% 127.3%
The combined ratio for 1999 improved substantially compared to 2000. Catastrophe losses and very unfavorable underwriting results in private passenger and commercial automobile lines of business contributed to the higher combined ratio in 1998.
The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $11.4 million and $12.8 million at December 31, 2000 and 1999 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 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, 2000, the Company had no known impairments of assets or changes in operation which would have a material adverse effect upon liquidity. Approximately 88% 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.
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, 2000.
Schedule I. Summary of Investments - December 31, 2000 and 1999.......... 41
Schedule III. Condensed Financial Information of Registrant - December 31, 2000 and 1999 ............................................. 42
Schedule V. Supplementary Insurance Information - December 31, 2000, 1999, and 1998 ...................................... 46
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 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 audit provides a reasonable basis for our opinion.
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, 2000, and the results of their operations and their cash flows for the year ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
Barfield, Murphy, Shank & Smith, P.C. Birmingham, Alabama February 16, 2001
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 as of December 31, 1999, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.
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.
Unrealized holding gains and losses, net of tax, on securities available-for-sale are reported as a net amount in a separate component of shareholders equity until realized.
Mortgage loans and policy loans are stated at the unpaid principal balance of such loans. Investment real estate is reported at cost, less allowances for depreciation computed on the straight-line basis. Short-term investments are carried at cost, which approximates market value. Investments with other than temporary impairment in value are written down to estimated realizable values.
As of December 31, 2000 and 1999, the fair value of policy loans approximated their carrying amount of $692,000 and $669,000, respectively.
The fair value of other policyholder funds on deposit is estimated to approximate their carrying amount of $1,488,000 on December 31, 2000 and $1,526,000 on December 31, 1999.
Years of Issue Interest Rate 1947 - 1968 4% 1969 - 1978 6% graded to 5% 1979 - 2000 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 was 2,055,811 in 2000 and 1999 and 2,228,940 in 1998.
Certain reclassifications have been made in the previously reported financial statements to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on the previously reported net income or shareholder equity.
In June 1999, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133, which deferred, for one year, the effective date for the implementation of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires that an entity recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair values. The Company will be required to adopt this standard for financial statements issued beginning the first quarter of fiscal year 2001. The Company is currently evaluating the effect the standard will have on its financial statements.
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 Company 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.
Pro forma results of consolidated operations for 2000 and 1999, assuming the LSIC acquisition was made at the beginning of each year, is as follows:
The above amounts exclude allocation of overhead from the Company. NSIC, NSFC, Omega and LSIC are in compliance with statutory restrictions with regard to minimum amounts of surplus and capital.
(Dollars in thousands) Year ended December 31, ------------------------------ ------------------------------ 2000 1999 1998
Less: Investment expenses ..................... (150) (32) (43) ------ ------ ------ Net investment income ......................... $ 4,434 $ 4,354 $ 4,351 ====== ====== ======
(Dollars in Thousands) --------------------------- --------------------------- Year ended December 31, 2000 1999 ---------------------------
Deferred policy acquisition costs $ (1,519) $ (1,453) Policy liabilities 419 488 Unearned premiums 383 327 Claim liabilities 432 548 General insurance expenses 694 712 Alternative minimum tax credit carryforward 67 314 Unrealized gains on securities available-for-sale (3,895) (3,950) -------- -------- Net deferred tax liabilities $ (3,419) $ (3,014) ======== ========
Deferred policy acquisition costs .......... $ 66 $ 41 $ (22) Policy liabilities ......................... 69 (25) 56 Unearned premiums .......................... (56) 113 2 General insurance expenses ................. 18 (1) 222 Alternative minimum tax credit carryforward 247 (314) 0 Claim liabilities .......................... 116 21 ( 39) ------ -------- ------- $ 460 $ (165) $ 219 ====== ======== =======
(Dollars in thousands) 2000 1999 ---- ---- Note payable to bank with 7% interest rate dated October 9, 1998; matures May 28, 2004. Payments of $63,575 due quarterly. Unsecured. $2,208 $2,300
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. 193 372 ------ ------ $2,401 $2,672 ====== ======
Claims and claim adjustment expense reserves at beginning of year $18,471 $21,528 $21,860 Less reinsurance recoverables on unpaid losses 3,907 5,889 7,146 ------ ------ ------ Net balances at beginning of year 14,564 15,639 14,714 Provision for claims and claim adjustment expenses for claims arising in current year 14,465 15,859 22,194 Estimated claims and claims adjustment expenses for claims arising in prior years (5,411) (3,074) (3,855) ------ ------ ------ Total increases 9,054 12,785 18,339 Claims and claim adjustment expense payments for claims arising in: Current year 8,792 9,934 13,536 Prior years 2,509 3,926 3,878 ------ ------ ------ Total payments 11,301 13,860 17,414 ------ ------ ------ Net balance at end of year 12,317 14,564 15,639 Plus reinsurance recoverables on unpaid losses 3,092 3,907 5,889 ------ ------ ------ Claims and claim adjustment expense reserves at end of year $15,409 $18,471 $21,528 ====== ====== ======
Direct ........... $3,886 $ 3,892 $ 26,085 $ 26,194 Assumed .......... -- -- -- -- Ceded ............ (55) (55) (1,503) (1,580) ------ ------- -------- -------- Net .............. $3,831 $ 3,837 $ 24,582 $ 24,614 ====== ====== ======== ========
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, 2000, NSICs retained earnings unrestricted for the payment of dividends in 2001 amounted to $1,254,587. 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 $2,417,050 in 2001.
Securities with market values of $3,745,717 and $3,060,389, at December 31, 2000 and 1999, respectively, were deposited with various states pursuant to statutory requirements.
(Dollars in thousands) Year ended December 31, 2000 1999 1998 ---- ----- ------ Premium Revenues: Individual life and accident and health insurance $ 4,595 $ 4,251 $ 3,837 Property and casualty insurance 18,326 21,685 24,614 ------ ------ ------ $22,921 $25,936 $28,451 ------ ====== ======
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 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 Company 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 16, 2001, we reported on the balance sheet of The National Security Group, Inc. as of December 31, 2000, and the related statements of income, shareholder equity and cash flows for the year 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 Company management. Our responsibility is to express an opinion on these financial statement schedules based on our audit.
Under date of February 18, 2000, we reported on the balance sheet of The National Security Group, Inc. as of December 31, 1999, and the related statements of income, shareholder equity and cash flows for each of the years in the two-year period ended December 31, 1999, which are included in this Form 10-K. In connection with our audits 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 Company management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.
December 31, ------------------ 2000 1999 ----- ------ Assets Cash .............................................. $ 66 $ 68 Investment in subsidiaries (equity method) eliminated upon consolidation ................... 46,481 44,904 Other assets ...................................... 458 390 ------- -------
Liabilities and Shareholders' Equity Accrued general expenses .......................... $ 824 $ 802 Notes Payable ................................... 2,401 2,672 ------- -------
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY) SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS)
THE NATIONAL SECURITY GROUP, INC. SCHEDULE V. SUPPLEMENTARY INSURANCE INFORMATION (CONSOLIDATED) (Amounts in thousands)