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.
The increase in premium revenues also produced an increase in commission expense. First year commissions are paid at a higher rate than commissions paid in succeeding years. The increase in premium revenues was produced entirely by sales of new insurance policies, and consequently increased commission expense. As these policies renew in succeeding years, commissions on these policies will decrease.
Net income before income tax was $2.4 million in 1999 compared to a pretax loss of $1.0 million in 1998. An improvement in underwriting results and reduced litigation expenses were the major factors contributing to the improvement in pretax income.
The automobile insurance programs had underwriting losses of over $1.5 million in 1999. Several of these programs which were managed by independent managing general agents have been discontinued over the last year and management believes that future losses from the discontinued programs will be greatly reduced compared to losses incurred in 1998 and 1999. One program managed by a managing general agent is still in operation in Florida, but management has taken steps to minimize additional losses from this program. Company management expects to maintain a presence in the automobile insurance market, but future growth and expansion will be through the traditional independent agents with claims and underwriting functions managed and closely monitored by in-house personnel.
One of the property and casualty subsidiaries, NSFC, was hit by natural disaster losses in the first and last half of the year. During the first six months of 1998, NSFC incurred over $1.0 million in tornado losses. The most severe tornado loss was in Jefferson County, Alabama in the Spring of 1998. This single tornado, which was reported to be a category tornado with winds of over 200 miles per hour, caused over $550,000 in damage to NSFC policyholders. In the last half of 1998 NSFC was hit by Hurricane Georges which hit the Gulf Coast of Alabama and Mississippi and caused over $1.1 million in incurred losses. In total, hurricane losses accounted for 10% of all property and casualty losses. However, even though catastrophe losses were substantial in 1998, NSFC's low value dwelling line of business, which was hit with a majority of these catastrophe losses, ended the year with a combined ratio of less than 100%. NSFC had no significant catastrophic losses in 1997.
The most significant operating result in the property and casualty subsidiaries was the continued poor performance of the subsidiaries private passenger and commercial automobile programs. The combined ratio of these programs, which produced over $7.7 million in earned premium, was over 150%. Pretax losses from these automobile programs totaled over $4.1 million. Two of the programs, both in Louisiana, have been discontinued. The remaining in-force policies from a private passenger auto program expired in late 1998, and in early 1999, a commercial taxi program in Louisiana was discontinued. The remaining in-force policies from this program expired in mid-1999. Based on previous loss experience, the taxi program is expected to incur losses in excess of earned premium until the remaining policies expire. These two programs accounted for 1998 pretax losses of $2.7 million.
Asset Portfolio Review: The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 1999, the company's holdings in debt securities amounted to 62% of total investments and 54% of total assets. The following is a breakdown of the bond portfolio quality according to
The insurance subsidiaries' fixed maturity securities include mortgage-backed bonds, primarily collateralized mortgage obligations (CMO's), of $12.8 million and $15.5 million at December 31, 1999 and 1998 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 is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $27.6 million. If the market value of the S & P 500 Index decreased 10% from its December 31, 1999 value, the fair value of the Company's common stock would decrease by approximately $2.7 million.
Certain fixed interest rate market risk sensitive instruments may not give rise to incremental income or loss during the period illustrated but may be subject to changes in fair values. Note 1 presents additional disclosures concerning fair values of Financial Assets and Financial Liabilities, and is incorporated by reference herein.
The National Security Group's consolidated statement of cash flows indicate that operating activities provided (used) cash of $868,000, $(1.90 million), $7.48 million in 1999, 1998, and 1997 respectively. Those statements also classify the other sources and uses of cash by investing activities, and financing activities and disclose the amount of cash available at the end of the year to meet the Company's obligations. An increase in net income and a decrease in reinsurance balances recoverable were the primary sources of the increase in cash flow for 1999. An increase in claim payments was a primary use of cash in operating activities for 1998. A large decrease in reinsurance recoveries of $4 million are the major causes of a $6 million increase in cash provided from operations in 1997.
As disclosed in note 8 to the consolidated financial statements, in 2000, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company is limited to $1.5 million in the life insurance subsidiary and $2.3 million in the property/casualty insurance subsidiary. However, that condition poses no short-term or long-term liquidity concerns for the parent company.
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) Company action level 2 Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7
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, 1999.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $15.2 million and $14.4 million at December 31, 1999 and 1998, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 10.9 and 9.5 at December 31, 1999 and 1998 respectively. Accordingly, National Security Insurance Company meets the minimum RBC requirements.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $3.2 million and $3.2 million at December 31, 1999 and 1998, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 4.6 and 4.0 at December 31, 1999 and 1998 respectively. Accordingly, Omega One Insurance Company meets the minimum RBC requirements.
The Company completed all year 2000 date conversations prior to December 31, 1999, and has experienced no major problems or disruptions of business due to the year 2000 issue.
Schedule III. Condensed Financial Information of Registrant - December 31, 1999 and 1998................................. 39
Schedule V. Supplementary Insurance Information - December 31, 1999, 1998, and 1997........................... 43
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period 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 audits.
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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.
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). All significant intercompany transactions and accounts have been eliminated.
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 shareholders' equity.
Effective January 1, 1998 the Company and its subsidiaries adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, ("SFAS No. 130"). SFAS No. 130 establishes reporting and presentation standards for comprehensive income and its components in a set of general-purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances arising from nonowner sources. SFAS No. 130 is effective for both interim and annual financial statements issued for periods beginning after December 15, 1997. Restatement of prior periods for comparative financial statements is required. The adoption of SFAS No. 130 did not have a material impact on the financial statements of the Company.
Effective January 1, 1998 the Company and its subsidiaries adopted Statement of Financial Accounting Standards No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, ("SFAS No. 132"). SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits, eliminates certain disclosures and requires additional information on changes in benefit obligations and fair values of plan assets. SFAS No. 132 is effective for annual financial statements for periods beginning after December 15, 1997. Restatement of disclosures for previous periods is also required. The adoption of SFAS No. 132 did not have a material impact on the financial statements of the Company.
The amoritzed cost and aggregate fair value of debt securities at December 31, 1999, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Gross gains of $2,041,304 and 4,009,429 and gross losses of $30,319 and $5,884 for 1999 and 1998, respectively, were realized on sales of available-for-sale securities.
Fixed maturities .............................. $ 3,567 $ 3,503 $ 3,334 Equity securities ............................. 630 682 654 Mortgage loans on real estate ................. 9 17 29 Investment real estate ........................ 18 18 18 Policy loans .................................. 33 38 37 Other, principally short-term investments ..... 129 136 222
An analysis of investment gains follows: Year ended December 31, 1999 1998 1997 Net realized investment gains (losses): Fixed maturities ........................... $ (16) $ 53 $ 66 Other, principally equity securities ....... 1,967 4,064 2,654 ------ ------ ------ $ 1,951 $ 4,117 $ 2,720 ====== ====== ======
Net deferred tax liabilties are determined based on the estimated future tax effects of differences between the financial statements and tax bases of assets and liabilities given the provisions of the enacted tax laws.
The tax effect of significant differences representing deferred tax assets and liabilities are as follows:
The approximate income tax effects of changes in temporary differences are as follows: Year ended December 31, ---------------------- ---------------------- 1999 1998 1997
Under pre-1984 life insurance company tax laws, a portion of NSIC's gain from operations was not subject to current income taxation, but was accumulated for tax purposes in a memorandum account designated "policyholders' surplus". The aggregate balance in this account, $3,720,000 at December 31, 1999, would be taxed at current rates only if distributed to shareholders or if the account exceeded a prescribed minimum. The Deficit Reduction Act of 1984 eliminated additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have not been provided on amounts designated as policyholders' surplus. The deferred income tax liability not recognized is approximately $1,270,000 at December 31, 1999.
NOTE 6 - REINSURANCE: NSFC and NSIC are involved in transactions in which another insurance company assumes some of the risk originally undertaken by NSFC and NSIC. Reinsurance contracts do not relieve NSIC and NSFC from their obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to NSIC and NSFC. NSIC and NSFC 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, 1999, reinsurance receivables with a carrying value of $435,000 and prepaid reinsurance premiums of $257,000 were associated with a single reinsurer.
(Dollars in Thousands) ---------------------------------------------------- ---------------------------------------------------- NSIC NSFC ----------------------- ---------------------------- ----------------------- ---------------------------- Written Earned Written Earned
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 1999, 1998, and 1997 amounted to $161,000, $61,000, and $170,000, respectively. Contributions are at the Board of Directors' discretion subject to governmental limitations.
The Company and its subsidiaries are 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 wrongfull 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.
On October 4, 1996, a jury in the Circuit Court of Palm Beach County, Florida returned a verdict against National Security Fire & Casualty Company, a subsidiary of the Company, in the amount of $995,252. The plaintiff, Leon B. King, had alleged that the Company's subsidiary had acted in bad faith in, among other actions, failing to timely deliver a settlement check in connection with a 1986 automobile accident. This same case was previously tried in 1993 with the jury returning a verdict in favor of the Company's subsidiary on all counts alleged. This verdict was subsequently reversed on appeal which resulted in the subject trial. Various post-trial motions including a motion for a new trial were denied and the verdict was appealed. The Florida District Court of Appeal for the Fourth District subsequently affirmed the verdict and concurrently granted the motion for attorney's fees and costs filed by the attorneys for the plaintiff, remanding the case to the trial court for a determination of the amount. The Company's subsidiary subsequently reached a settlement of the attorney's fee issue and the judgement, including all related issues, was satisfied on July 8, 1998.
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, 1999 that exceeded the balance insured by the FDIC in the amount of $817,375.
December 31, ------------------ 1999 1998 ----- ------ Assets Cash .............................................. $ 68 $ 119 Investment in subsidiaries (equity method) eliminated upon consolidation ................... 44,904 45,367 Other assets ...................................... 390 357 ------- -------
Note: Investment income and other operating expenses are reported separately by segment and not allocated.