Operating results 1998 1997 1996 1995 1994 - ----------------- ----- ----- ---- ---- -----
Total shareholders' equity .... $ 41,968 $ 46,352 $ 40,519 $ 39,774 $38,482
Book value per share .......... $ 20.46 $ 20.04 $ 17.43 $ 17.11 $ 16.44
Consolidated net income for The National Security Group was $3.0 million for 1997 compared to $1.4 million in 1996. On a per share basis earnings were $1.28 in 1997 compared to $0.58 in 1996. The increase in net income is primarily due to a reduction in litigation expenses and an increase in realized capital gains from the sale of common stock investments. Consolidated revenues grew 17% to $38.8 million in 1997 compared to $33.0 million in 1996. Revenue increases were primarily due to growth in the property/casualty subsidiaries private passenger automobile programs in Louisiana and Georgia.
The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1993.
Pretax earnings were $1.572 million in 1997, a 32% increase over 1996 pretax earnings of $1.191 million. The low valued dwelling fire and extended coverage program (LVD) was much improved in 1997. The LVD program incurred a greater than normal amount of fire and windstorm losses in 1996. Unfortunately the improved results in the LVD program were offset by adverse loss development in the automobile programs in Georgia and Louisiana. Omega attempted to obtain rate increases for a private passenger auto program in Louisiana due to the adverse loss development, but the rate filings were denied by the State Insurance Rating Bureau. Due to the failed attempts to adjust rates, the Louisiana automobile program was discontinued in 1998. NSFC was granted a rate increase for a private passenger auto program in the State of Georgia, and more stringent underwriting guidelines were implemented, so this program has continued, but at a greatly reduced premium volume. The primary reason for the improvement in earnings in 1997 compared to 1996 was an increase in capital gains realized from the sale of common stock investments.
The Company is exposed to equity price risk on its equity securities. The Company holds common stock with a fair value of $30.9 million. If the market value of the S & P 500 Index decreased 10% from its December 31, 1998 value, the fair value of the Company's common stock would decrease by $3.9 million.
The Company limits the extent of its market risk by purchasing securities that are backed by stable collateral, the majority of the assets are guaranteed by U.S. government sponsored entities. Also, the majority of all of the subsidiaries' CMO's are Planned Amortization Class (PAC) bonds. PAC bonds are typically the lowest risk CMO's, and provide greater cash flow predictability. Such securities with reduced risk typically have a lower yield, but higher liquidity, than higher-risk mortgage backed bonds. To reduce the risk of loss of principal should prepayments exceed expectations, the Company does not purchase mortgage backed securities at significant premiums over par value.
The Company's investment approach in the equity markets is based primarily on a fundamental analysis of value. This approach requires the investment committee to invest in well managed, primarily dividend paying companies, which have a low debt to capital ratio, above average return on net worth for a sustained period of time, and low price to book value or low volatility rating (beta) relative to the market. The dividends provide a steady cash flow to help pay current claim liabilities, and it has been the Company's experience that by following this investment strategy, investment results have been superior to those offered by bonds, while keeping the risk of loss of capital to a minimum.
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, 1998, the Company had no known impairments of assets or changes in operation which would have a material adverse effect upon liquidity. Approximately 84% 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.
As disclosed in note 8 to the consolidated financial statements, in 1999, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company is limited to $1.7 million in the life insurance subsidiary and $2.5 million in the property/casualty insurance subsidiary. However, that condition poses no short-term or long-term liquidity concerns for the parent company.
Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1998, 1997, and 1996......................... 22
Report of Independent Certified Public Accountants on Financial Statement Schedules...................................... 35
Schedule V. Supplementary Insurance Information - December 31, 1998, 1997, and 1996..................................... 41
(Dollars in thousands except per share amounts) Years Ended December 31,
REVENUES Net premiums earned ........................ $ 28,451 $ 31,156 $ 26,654 Net investment income ...................... 4,351 4,204 3,935 Net realized investment gains .............. 4,117 2,720 1,839 Other income ............................... 385 695 582 -------- -------- -------- 37,304 38,775 33,010 ======== ======== ========
Income Before Income Taxes .......... 1,106 3,360 1,621 -------- -------- -------- INCOME TAX EXPENSE Current ..................................... 93 848 421 Deferred .................................... 83 (486) (156) -------- -------- -------- 176 362 265 -------- -------- -------- Net Income ........ $ 930 $ 2,998 $ 1,356 ======== ======== ======== EARNINGS PER COMMON SHARE
Net Income ........ $ .42 $ 1.28 $ .58 ======== ======== ========
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: Principles of Consolidation 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.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - CONTINUED Disclosures About Fair Value of Financial Instruments SFAS No. 107 defines fair value as the quoted market prices for those instruments that are actively traded in financial markets. In cases where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. The fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument.
The fair value of the mortgage loan portfolio was approximately equal to the carrying amount of $135,000 on December 31, 1998 and $320,000 on December 31, 1997.
The fair value of other policyholder funds on deposit is estimated to approximate carrying amount of $1,635,000 on December 31, 1998 and $1,729,000 on December 31, 1997.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - CONTINUED Policy Liabilities 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 - 1998 7% graded to 6%
Recently Issued Accounting Standards 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.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: - CONTINUED Recently Issued Accounting Standards - Continued
The adoption of SFAS No. 130 did not have a material impact on the financial statements of the Company
Available-for-sale securities: Due in one year or less .............. $ 1,000 $ 1,030 Due after one year through five years 5,240 5,339 Due after five years through ten years 7,325 7,480 Due after ten years .................. 6,750 6,488 ------- ------- Total ......... $20,315 $20,337 ======= ======= Held-to-maturity securities: Due in one year or less .............. $ 2,312 $ 2,326 Due after one year through five years 10,266 10,781 Due after five years through ten years 7,900 8,311 Due after ten years .................. 10,329 10,417 ------- ------- Total ......... $30,807 $31,835 ======= =======
(Dollars in thousands) Year ended December 31, ------------------------------ 1998 1997 1996 ---- ---- ----
An analysis of investment gains follows: Year ended December 31, -------------------------- 1998 1997 1996 ---- ---- ---- Net realized investment gains: Fixed maturities ................... $ 53 $ 66 $ 12 Other, principally equity securities 4,064 2,654 1,827 ------ ------ ------ $4,117 $2,720 $1,839 ====== ====== ======
Federal income tax rate applied to pre-tax income .......................... $ 376 $ 1,142 $ 551 Dividends received deduction and tax-exempt interest ..................... (174) (239) (256) Other, net ................................. (54) (134) (30) Small life insurance company deduction ..... (440) (407) 0 Alternative minimum tax effect ............. 468 0 0 ------- ------- ------- Federal income tax expense ................. $ 176 $ 362 $ 265 ======= ======= =======
(Dollars in Thousands) December 31, December 31 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, 1998, 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 tax liability not recognized is approximately $1,270,000 at December 31, 1998.
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 condition 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, 1998, reinsurance receivables with a carrying value of $906,000 and prepaid reinsurance premiums of $266,000 were associated with a single reinsurer.
(Dollars in Thousands) ---------------------------------- NSIC NSFC ---------------- ---------------- Written Earned Written Earned ------- ------ ------- -------- Direct ......... $ 4,118 $ 4,039 $ 29,271 $ 30,815 Assumed ........ -- -- -- -- Ceded .......... (48) (48) (2,086) (3,650) -------- -------- -------- -------- Net ............ $ 4,070 $ 3,991 $ 27,185 $ 27,165 -------- -------- -------- --------
NOTE 6 - REINSURANCE: - CONTINUED NSFC also reinsures certain portions of insurance risk which exceed various retention limits. Claim liabilities for NSFC are stated after a deduction for reinsurance ceded to other companies totaling $5,889,000 at December 31, 1998. Reinsurance recoveries for claims and claim settlement expense were $844,000 during 1998.
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 1998, 1997 and 1996 amounted to approximately $90,300, $228,525, and $61,813, respectively.
NOTE 10 - INDUSTRY SEGMENTS: The Company and its subsidiaries operate primarily in the insurance industry. Premium revenues and operating income by industry segment for the years ended December 31, 1998, 1997 and 1996 are summarized below:
(Dollars in thousands) Year ended December 31, 1998 1997 1996 Assets: Individual life and accident and health insurance ................................ $ 41,935 $ 39,569 $ 35,590 Property and casualty insurance ............ 61,842 67,286 62,538 Other ...................................... 196 103 91 ------- ------- ------- $103,973 $106,958 $ 98,219 ======= ======= =======
Amortization of deferred policy acquisition costs and depreciation expense: Individual life and accident and health insurance ................................ $ 450 $ 319 $ 232 Property and casualty insurance ............ 1,599 1,339 879 ------- ------- ------- $ 2,049 $ 1,658 $ 1,111 ======= ======= =======
NOTE 11 - CONTINGENCIES: 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 Company's subsidiaries, and miscellaneous other causes of action. Most of these lawsuits include claims for punitive damages in addition to other specified relief. It is not feasible to predict or determine the ultimate outcome of these matters. A resolution of these matters may significantly impact the Company's consolidated financial position, although it remains management's opinion, based upon information presently available, that the ultimate resolution of these matters will not have a material impact on the Company's consolidated financial position.
This judgement and the settlement of the attorney's fee award resulted in a combined charge to the Company's 1998 earnings of $2 million. The Company's subsidiary is now pursuing recovery of the amount it has expended in the resolution of this litigation from the independent adjusting firm whose actions it believes caused or contributed to the basis for the subject litigation. No provision has been established for any potential recovery.
NOTE 12 - CONCENTRATION OF CREDIT RISK: 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, 1998 that exceeded the balance insured by the F.D.I.C. in the amount of $322,000.
To the Board of Directors and Shareholders of The National Security Group, Inc.
We have audited in accordance with generally accepted auditing standards, the financial statements of The National Security Group, Inc. as of December 31, 1998 and 1997 and for the years then ended included in this Form 10-K, and have issued our report thereon dated February 19, 1999. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules as of December 31, 1998 and 1997 and for the years then ended have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Birmingham, Alabama February 19, 1999 Dudley, Hopton-Jones, Sims & Freeman PLLP
December 31, ------------------ 1998 1997 -------- ------- Assets Cash ............................................ $ 119 $ 167 Investment in subsidiaries (equity method) eliminated upon consolidation ............... 45,367 46,721 Other assets .................................... 357 380 ------- -------
The "Notes to Consolidated Financial Statements of The National Security Group, Inc." are an integral part of this condensed financial information of the registrants. See accompanying "Notes to Condensed Financial Information of Registrant"
The "Notes to Consolidated Financial Statements of The National Security Group, Inc." are an integral part of this condensed financial information of the registrants. See accompanying "Notes to Condensed Financial Information of Registrant" ]
Note 1-Basis of Presentation Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Information of the Registrant does not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles. It is, therefore, suggested that this Condensed Financial Information be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Registrant's Annual Report as referenced in Form 10-K, Part II, Item 8, page 18.
Policy Claims Deferred Future and Other Acquisition Policy Unearned Benefits Costs Benefits Premiums Payable --------- -------- -------- -------- At December 31, 1998: Life and accident and health insurance $ 2,588 $18,833 $ 0 $ 347 Property and casualty insurance ...... 1,566 0 8,745 21,528 ------- ------- ------- ------- Total ............................ $ 4,154 $18,833 $ 8,745 $21,875 ======= ======= ======= =======
At December 31, 1997: Life and accident and health insurance $ 2,659 $18,667 $ 0 $ 386 Property and casualty insurance ...... 1,557 0 8,853 21,860 ------- ------- ------- ------- Total ............................ $ 4,216 $18,667 $ 8,853 $22,246 ======= ======= ======= =======