•The Property and Casualty (P&C) segment is the most significant segment, accounting for 91.5% of gross earned premium in 2020. The P&C segment operates in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.
The P&C segment operations are 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 NSFC organized in 1992. Omega produces no direct written premium and is authorized to underwrite lines of business similar to NSFC; therefore, all references to NSFC or P&C segment in the remainder of this discussion will include the insurance operations of both NSFC and Omega.
All of our insurance companies have been assigned ratings by A.M. Best Co (Best). On April 21, 2020, A.M. Best affirmed the Financial Strength Rating (FSR) of B++ (Good) and the Long-Term Issuer Credit Rating (Long-Term ICR) of "bbb" of NSFC. In addition, A.M. Best affirmed the FSR of B+ (Good) and Long-Term ICR of "bbb-" of Omega. The A.M. Best outlook for the ratings is "stable" for NSFC and Omega. A.M. Best upgraded the FSR to B++ (Good) and the Long-Term ICR to "bbb" for NSIC. The outlook for the ratings of NSIC is "stable". A.M. Best also affirmed the Long-Term ICR of "bb" of the parent holding company, NSEC, with a "stable" outlook.
A primary process utilized by management to review financial performance is evaluating the operating performance of each segment before intercompany eliminations. By performing the evaluation in this manner, management can better assess the profitability of each segment on a standalone basis. To provide information similar to that utilized by management, industry segment information presented in this discussion is presented on a pretax basis by segment before eliminations. Note 15 to the Consolidated Financial Statements in this Form 10-K contains a reconciliation of the net income by segment to consolidated net income.
For the twelve months ended December 31, 2020, the Company had insured claims (net of reinsurance recoveries) totaling $53,930,000 compared to $38,598,000 for the same period last year. The P&C segment was the primary source of this increase with claims up $15,446,000 in 2020, compared to 2019. The primary component of this increase was claims reported from catastrophe events which increased $17,573,000, in 2020, compared to the same period in 2019.
We provide a reconciliation of net income to the non-GAAP measurement "pretax income (loss) from operations". The purpose of this reconciliation is to provide investors with information routinely utilized by management in analyzing and comparing the performance of our insurance operations between periods. This information reflects the financial performance of our insurance operations without the impact of investment gains/losses. We typically invest in equity securities with a long-term view. Short-term volatility due to changes in market value of equity securities held for sale, along with realized investment gains/losses on both fixed maturity and equity investments, can mask both the positive or negative performance of our insurance operations from period to period.
For the year ended December 31, 2020, net premiums earned were up $927,000 at $60,810,000 compared to $59,883,000 during the same period last year. The increase in premium revenue was primarily driven by an increase in net earned premium in the P&C segment of $1,082,000 or 2.0%. The increase in P&C segment net earned premium was primarily attributable to a 4.2% increase in gross earned premium in our dwelling fire program due to rate increases in the program over the past twelve months. As mentioned previously, the increased frequency of weather related losses over the past five years has driven the need to increase rates in states and programs that have been most impacted by this persistent pattern of severe weather.
Investment gains, for the year ended December 31, 2020, were $1,623,000 compared to investment gains of $3,055,000 for the same period last year. The primary reason for the investment gain, in 2020, was a gain on available-for-sale fixed maturities of $1,361,000 compared to a gain on available-for-sale fixed maturities of $18,000
For the year ended December 31, 2020, the Company had a net loss of $8,619,000, $3.41 loss per share, compared to net income of $4,067,000, $1.61 income per share, for the same period last year. As mentioned previously, the primary reason for the 2020 net loss, compared to the 2019 net income, was a significant increase in property and casualty insured losses. The increase in P&C subsidiary losses was primarily driven by an increase in catastrophe losses from severe weather events in April of 2020 coupled with losses from Hurricanes Laura and Sally in the third quarter of 2020 as well as losses from Hurricanes Delta and Zeta in the fourth quarter of 2020.
For the year ended December 31, 2020, our pretax loss from operations was $12,641,000 compared to a pretax income from operations of $1,525,000 for the year ended December 31, 2019; a decrease of $14,166,000. As discussed above, an increase in claim activity in our P&C segment was the primary reason for the loss from operations, in 2020, compared to the same period last year.
Overview - Balance Sheet highlights at December 31, 2020 compared to December 31, 2019
Invested assets as of December 31, 2020 were $99,150,000 compared to $118,969,000 as of December 31, 2019; a decrease of 16.7%. The decrease in invested assets was primarily due to the sale of available-for-sale fixed maturity securities and equity securities to meet the liquidity requirements of increased claim activity in the P&C segment during 2020 compared to 2019.
payment of weather related insurance claims and recoveries from reinsurers under our catastrophe reinsurance agreement.
Policy related liabilities were $82,869,000 at December 31, 2020, compared to $78,472,000 at December 31, 2019; an increase of $4,397,000 or 5.6%. The primary reason for the increase in policy liabilities was a $2,978,000 increase in P&C segment loss reserves, in 2020, compared to 2019, due to an increase in weather related claim activity.
Total debt at December 31, 2020 was $13,677,000 compared to $14,164,000 at December 31, 2019. Debt was reduced $487,000 during 2020 primarily from the reduction in long-term debt in our holding company.
Net premiums earned for our two operating segments are summarized as follows:
The property and casualty segment composed 90.6% of consolidated net premiums earned in 2020 compared to 90.2% in 2019. Through the P&C segment, we offer primarily dwelling fire and homeowners insurance coverage to our customers. The life segment composed 9.4% of net premiums earned in 2020 compared to 9.8% in 2019 with revenue produced from life, accident and supplemental health insurance products. While reading this discussion regarding segment information, reference is made to Note 15 to the Consolidated Financial Statements which provides additional segment related information.
The following discussion outlines more specific information with regard to the individual operating segments of the Company along with non-insurance related information (primarily administration expenses and interest expense on debt) associated with the insurance holding company.
Net premiums earned in the life segment was $5,709,000 at December 31, 2020 compared to $5,864,000 at December 31, 2019; a decrease of 2.6%. The $155,000 decrease in net earned premium revenue was primarily due to a decline in new business production in both the traditional life and supplemental accident and health insurance products offered in NSIC.
While NSIC composes only 9.4% of premium revenue, the subsidiary holds 39.5% of consolidated assets. The majority of these assets consist of fixed maturity investments. Net investment income had a 3.5% decrease, at $2,583,000 for the year ended December 31, 2020 compared to $2,677,000 for the same period last year. Lower reinvestment yields on fixed maturity investments due to the declining interest rate environment experienced in 2020 was the primary factor contributing to the moderate decline in interest income.
Deferred policy acquisition cost amortization and commission expenses increased $138,000 for the year ended December 31, 2020 at $1,155,000 compared to $1,017,000 for the same period last year; an increase of 13.6%. As a percent of net premiums earned, policy acquisition cost amortization and commission expense was 20.2% in 2020 compared to 17.3% in 2019.
For the year ended December 31, 2020 and 2019, insurance taxes, licenses and fees were $216,000 and $285,000, respectively. As a percent of earned premium, insurance taxes, licenses and fees were 3.8% in 2020 and 4.9% in 2019. The primary reason for the decrease in, 2020 compared to 2019, was the payment of expenses associated with our Alabama Department of Insurance examination, in 2019, which were not incurred in 2020.
For the year ended December 31, 2020, the life segment had pretax income of $1,551,000 compared to a pretax income of $1,935,000 for the same period last year. The $155,000 decrease in life segment revenues, coupled with the $188,000 increase in policyholder claims were the primary factors contributing to the $384,000 decrease in pretax income.
Property and casualty segment net premiums earned for 2020 were $55,101,000 compared to $54,019,000 for the same period last year. The primary reason for the increase, in 2020 compared to 2019, was a 4.2% increase in gross earned premium revenue in our dwelling fire program primarily driven by rate increases in the program over the last twelve months.
Additional details regarding the structure of our 2020 catastrophe reinsurance program can be found in Note 10 to the Consolidated Financial Statements.
The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. With our 2020 catastrophe contract placement, our single event catastrophe retention remained unchanged from the prior year at $4 million. In our 2020 contract, we maintained our underlying catastrophe aggregate coverage of $2 million in excess of $2 million, subject to a $2 million aggregate annual deductible. This additional coverage effectively lowers our second event retention to $2 million. Also unchanged from last year, we maintain catastrophe reinsurance covering incurred claims of a single catastrophe event up to $72.5 million. Our catastrophe reinsurance has a reinstatement provision for one event and covers the cost of a second event up to the same $72.5 million upper limit. In our reinsurance structure, management attempts to limit the impact on pretax earnings of a single modeled 100 year cat event to no more than $4 million (net of reinsurance). It is noted, however, that hurricane models are subject to significant risk and are only a tool to estimate the impact of catastrophe events. The Company also has risk associated with multiple catastrophe events that individually may not exceed our $4 million retention and would not be covered under our catastrophe reinsurance contract.
In our reinsurance structure, management attempts to limit the impact on pretax earnings of a single modeled 100 year cat event to no more than $4 million and the primary models utilized indicate that the Company's upper limit of reinsurance is adequate to cover up to approximately a 250 year event (a single event with an estimated probability of exceedance of 0.4% in a given year). It is noted, however, that hurricane models are subject to significant risks and uncertainties and are continuously evolving. Catastrophe models are only a tool to estimate the impact of catastrophe events and actual results can differ materially from model estimates.
The following table provides severe thunderstorm and hurricane single event model estimates for a range of return periods based on a blended view of the RMS and AIR long-term models utilizing our actual inforce P&C segment policy data as of December 31, 2020:
In 2020, the P&C segment had catastrophe losses from two hurricanes exceeding our $4 million catastrophe reinsurance retention. In addition, the P&C segment had catastrophe losses from two additional hurricanes and a significant spring storm event with losses attaching to our underlying catastrophe aggregate coverage. Furthermore, the P&C segment was impacted, in 2020, by 23 additional smaller catastrophe events that individually did not exceed our catastrophe reinsurance retention; but cumulatively generated incurred losses totaling $9,787,000. In 2019, the P&C segment did not have any catastrophe losses exceeding our $4 million catastrophe reinsurance retention. However, the P&C segment was impacted, in 2019, by 23 smaller catastrophe events that individually did not exceed our catastrophe reinsurance retention; but cumulatively generated incurred losses totaling $6,623,000.
For the year ended December 31, 2020, net investment income was $1,530,000 compared to $1,683,000 for the same period in 2019; a decrease of $153,000 or 9.1%. Lower yields on new investments in 2020 was the primary factor contributing to this marginal decrease in net investment income.
Net investment gains, for the year ended December 31, 2020, were $1,043,000 compared to net investment gains of $2,178,000 for the same period in 2019; a decrease of $1,135,000. The primary reason for the decrease in net investment gains, in 2020 compared to 2019, was a gain on our company owned life insurance (COLI) investment of $1,792,000, in 2019. In addition, for the year ended December 31, 2020, we had unrealized losses in our P&C segment equity investments available for sale totaling $448,000 compared to unrealized gains in equity investments of $122,000, in 2019.
increase in P&C segment catastrophe weather claims. This increase was offset by decreases in non-catastrophe weather claims and fire claims totaling $1,267,000 and $1,820,000, respectively.
Weather related losses create the most significant variability in our loss and loss adjustment expense payments from year to year in our P&C segment. The following table provides a recap of P&C segment gross reported losses and LAE by catastrophe event and non-catastrophe wind and hail losses and LAE for the year ended December 31, 2020 and 2019:
During 2020, the P&C segment was impacted by 28 catastrophe events producing 5,546 policyholder claims totaling $24,196,000 net of reinsurance recoveries. In comparison, the P&C segment was impacted by 23 catastrophe events during 2019 from 1,353 claims totaling $6,623,000. During 2020, the P&C segment had multiple severe weather events that contributed to elevated insured losses due to damage from strong winds, hail and tornadoes as well as insured losses from four hurricanes. Reported losses from the three largest non-hurricane catastrophe events (all occurring in April) coupled with reported losses from Hurricane Laura (Cat 2050), Hurricane Sally (Cat 2063), Hurricane Delta (Cat 2071) and Hurricane Zeta (Cat 2074) totaled $18,112,000, net of reinsurance recoveries. The three April 2020 cat events accounted for 31.6% of all reported catastrophe event claims through December 31, 2020 and added 13.7 percentage points to the current year P&C segment combined ratio. Net of reinsurance, Hurricane Laura, Hurricane Sally, Hurricane Delta and Hurricane Zeta accounted for 43.3% of all reported catastrophe event claims through December 31, 2020 and added 18.8 percentage points to the 2020 P&C segment combined ratio. In comparison, reported losses in the P&C segment from Hurricane Barry (Cat 1943),
Non-catastrophe wind and hail claims reported in 2020 totaled $7,866,000 compared to non-catastrophe wind and hail claims reported in 2019 totaling $9,133,000; a decrease of $1,267,000. During 2020, the P&C segment had 1,731 non-cat wind and hail claims reported (an average of $4,500 per claim) compared to 2,197 non-cat wind and hail claims reported during 2019 (an average of $4,200 per claim). Non-cat wind and hail claims reported during 2020 accounted for 15.9% of total P&C segment incurred losses in the current year and added 14.1 percentage points to the 2020 P&C segment combined ratio. Non-cat wind and hail claims reported during 2019 accounted for 26.9% of total P&C segment incurred losses in 2019 and added 16.7 percentage points to the 2019 P&C segment combined ratio.
Commission expense for 2020 was $7,212,000 (13.1% of premium revenue) compared to $7,148,000 (13.2% of premium revenue) for the same period in 2019. The primary reason for the $64,000 increase in commission expense was the 2.2% increase in gross written premium, in 2020, compared to 2019.
General and administrative expenses in the property and casualty segment totaled $8,589,000 in 2020 compared to $8,616,000 in 2019; a 0.3% decrease. The primary factors contributing to the $27,000 decrease in general expenses, in 2020, compared to the same period last year, was a $114,000 decline in actuarial fees.
During 2020, the P&C segment experienced an increase of 26.0 percentage points in the combined ratio compared to 2019. Catastrophe losses increased in 2020 compared to 2019, leading to a 31.32 percentage point increase in the P&C segment combined ratio and was the primary reason for the overall increase. Non-catastrophe losses decreased the P&C segment combined ratio 4.80 percentage points in the current year compared to the same period last year. As noted in the table above, catastrophe loss is the primary source of variability in our combined ratio and is generally the primary driver of variability in our earnings. While catastrophe events are unpredictable and often occur in cycles, management has sought to increase margins through efficiency measures and improved rate optimization. Management continues to improve rate adequacy, reduce significant exposure concentrations and implement other risk management strategies in order to further improve underwriting profitability, mitigate earnings volatility and reduce downside risk to our capital position.
The non-insurance operations of the Company consist of our ultimate holding company parent, The National Security Group, Inc. (NSEC). NSEC, as a standalone entity, has no material sources of revenue and relies on dividends and management service fees from our insurance subsidiaries to pay expenses. Dividends from subsidiaries are subject to insurance department approval and are also subject to statutory restrictions. Subsidiary dividends and service fees are eliminated upon consolidation of the subsidiaries in the audited financial statements included herein. Revenues and expense (excluding intercompany dividends from subsidiaries) for non-insurance operations for the year ended December 31, 2020 and 2019 are summarized as follows:
At December 31, 2020, the Company's holdings in fixed maturity securities amounted to 83% of total investments and 54.7% of total assets. The Company utilizes the ratings of various Nationally Recognized Statistical Rating Organizations when classifying fixed maturity investments by credit quality.
Our holdings in below investment grade securities are primarily comprised of energy sector investments and collateralized debt obligations (CDO's). We have evaluated our current below investment grade holdings for potential impairment, along with any other security with a market value substantially below our amortized cost. We currently have no investment below 80% of amortized cost and based on presently available information, we do not believe any below investment grade securities are other-than-temporarily impaired. We also currently have no fixed income investments in default.
The amortized cost and aggregate fair values of investments in investment securities at December 31, 2020 and December 31, 2019 are as follows:
A downside of investing in longer duration securities in the life segment is that the portfolio is exposed to more significant price volatility as market interest rates rise. This exposure to sudden interest rate changes can lead to
Investment returns with respect to the investment portfolio for the years ended December 31, 2020 and 2019 follows:
The Company's subsidiaries maintain repurchase agreements for cash held on deposit under which insurance regulations dictates that our policy requires 102% (100% minimum) of the fair value of the securities purchased to be maintained as collateral. The repurchase investments are overnight agreements and investments are limited to government securities that are highly liquid. Therefore, these investments are reflected on the balance sheet as cash equivalents. Due to a combination of the 102% collateral requirement and low short-term interest rates, we realize limited interest income from repurchase agreements/short-term investments. However, repurchase agreements utilizing government agency securities do provide deposit protection for short-term cash held in excess of FDIC deposit limits. The Company does not lend securities to any counterparty under repurchase agreements.
As discussed above, changing interest rates can have a significant impact on the market value of fixed maturity investments. Fixed maturity securities classified as available-for-sale increase the liquidity resources of the Company as they can be sold at any time to pay claims or meet other Company obligations. However, these securities are required to be carried at market value with net of tax change in accumulated unrealized gains and losses directly impacting shareholder's equity. While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 8% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.
The Holding Company had $3,108,000 in cash at December 31, 2020. The Holding Company primarily relies on cash from subsidiaries to meet its obligations, including payment of dividends to shareholders along with interest and principal on outstanding debt. Currently the Holding Company has adequate liquidity on hand to meet its anticipated obligations through 2021 without additional dividend payments from subsidiaries. Cash and cash equivalents held by subsidiaries at December 31, 2020 totaled $16,779,000.
The Company had a total of $13,177,000 of long-term debt outstanding as of December 31, 2020, compared to $13,664,000 at December 31, 2019, which includes $12,372,000 in trust preferred securities issued by the Company in addition to the installment note. Current year and prior year amounts were reduced by the unamortized portion of the placement fees associated with the issuance of the trust preferred securities, $195,000 and $208,000, respectively.
The Company's liquidity requirements are primarily met by funds provided from operations of the insurance subsidiaries. The Company receives funds from its subsidiaries through payment of dividends, management fees, reimbursements for federal income taxes and reimbursement of expenses incurred at the corporate level for the subsidiaries. These funds are used to pay stockholder dividends, principal and interest on debt, corporate administrative expenses, federal income taxes, and for funding investments in the subsidiaries. The Company has no separate source of revenue other than dividends and fees from the insurance subsidiaries. Also, dividends from the insurance subsidiaries are subject to regulatory restrictions and, therefore, are limited depending on capital levels and earnings of the subsidiaries.
Dividends paid from the insurance subsidiaries are subject to regulatory restrictions and prior approval of the Alabama Department of Insurance. As disclosed in Note 12 to the audited Consolidated Financial Statements included in our 2020 Annual Report on Form 10-K, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company during 2021 is statutorily limited to $1,168,000 in the life insurance subsidiary and $3,650,000 in the property/casualty insurance subsidiary. Dividends are limited to the greater of net income (operating income for life subsidiary) or 10% of statutory capital, and regulators consider dividends paid within the preceding twelve months when calculating the available dividend capacity. Therefore, all of the above referenced dividend capacity will not be available for consideration of payment until dividends paid in the preceding twelve months have been considered on a rolling basis. The Company also has to continuously evaluate other factors such as subsidiary operating performance, subsidiary capital requirements and potential impact by rating agencies in making decisions on how much capital can be released from insurance subsidiaries for payment of dividends to NSG. These factors are considered along with the goal of growing year over year statutory surplus in the subsidiaries, and these considerations along with potential adverse impacts on regulatory surplus, will likely lead to dividend payments to NSG substantially below the above referenced regulatory maximums. The Company received $1,100,000 in dividends from its subsidiaries during the year ended December 31, 2020. Due to a decline in statutory surplus in our P&C subsidiaries during 2020, the result of increased in catastrophe losses, we do not expect to pay any dividends from these subsidiaries for at least the next twelve months as our primary focus will be on rebuilding statutory surplus.
The Company’s subsidiaries require cash in order to fund policy acquisition costs, claims, other policy benefits, interest expense, general expenses, and dividends to the Company. Premium and investment income, as well as maturities, calls, and sales of invested assets, provide the primary sources of cash for both subsidiaries. A significant portion of the Company’s investment portfolio, which is held by the insurance subsidiaries, consists of readily marketable securities, which can be sold for cash.
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 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 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.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $36,505,000 and $36,264,000 at December 31, 2020 and 2019, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 4.8 and 5.1 at December 31, 2020 and 2019, respectively. Accordingly, National Security Fire & Casualty Company exceeds the minimum RBC requirements.
At December 31, 2020, the estimated reinsurance recoverable recorded was $6,874,000 compared to $276,000 for the same period last year. The Company does not anticipate any issues with collection of the recorded amount. In 2020, catastrophe reinsurance premiums ceded totaled $6,274,000 compared to $6,008,000 ceded in 2019. Catastrophe reinsurance premiums are based on a premium calculation applying the agreed upon rate to the total insured value of the covered lines of business. In addition to catastrophe reinsurance, the Company placed reinstatement premium protection (RPP) reinsurance during 2020 and 2019 totaling $1,022,000 and $1,033,000, respectively.
At December 31, 2020 and 2019, the Company recorded $7,408,000 and $7,666,000, respectively, as an asset for DAC in the Consolidated Financial Statements. We do not foresee any issues related to recoverability of these capitalized costs. For more information regarding deferred policy acquisition costs, see Note 1 to our Consolidated Financial Statements.
At December 31, 2020 and 2019, the recorded liability for loss and loss adjustment expense was $10,177,000 and $7,199,000, respectively, a $2,978,000 increase. The increase in claim and claim adjustment expense reserves is primarily due to claims outstanding from third and fourth quarter hurricanes at December 31, 2020. We believe the estimate of unpaid losses and loss adjustment expenses to be sufficient based on currently available information and a review of our historical reserving practices. For more information regarding loss and loss adjustment expense, see Note 9 to our Consolidated Financial Statements.
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. (the Company) as of December 31, 2020 and 2019 and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2020, and the related notes and financial statement schedules I, II, III, IV and V (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
The liability for future life insurance policy benefits is computed using a net level premium method including assumptions based on the issuance policy year with a corresponding interest rate with mortality assumptions with the withdrawal assumptions based on the Company’s experience. Claim liabilities represent the estimated liability for claims reported plus claims incurred but not yet reported and the related loss adjustment expenses which are determined
using case-basis evaluations and statistical analysis. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance. Management utilizes expected losses along with historical data analysis of paid and incurred loss development patterns over the past ten years.
The principal considerations for our determination that the policy and claims reserves is a critical audit matter is due to the significant judgment used by management in determining the reserves. The significant judgment was primarily due to the sensitivity of management’s estimates to the actuarial methods selected and assumptions used in the loss development factors and ultimate claim costs
How We Addressed the Matter in Our Audit Our audit procedures related to the estimates and actuarial assumptions used by management and the Company’s external actuaries included the following procedures, among others:
•We performed walkthroughs of the processing of the information from inception to recording in the consolidated financial statements and related disclosures in the notes to the consolidated financial statements,
•We obtained the actuarial reports from management and engaged independent actuaries for review of the life policies and the property and casualty claims. The independent actuaries reviewed the methodology, consistency, validity of the assumptions used and accepted actuarial methods
•We agreed the information from the actuary reports to the Loss Triangle data for the property and casualty policies and to the in-force file for the life insurance policies,
•We performed various analytics on the data as well as the rollforward of balances from the balance sheet reporting dates,
•Finally, with the assistance of the specialist, we evaluated the incorporation of the applicable assumptions into the model and tested the model's computational accuracy.
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). The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated in the consolidated financial statements. The financial information presented herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, which includes information and disclosures not presented herein.
The Company's property and casualty subsidiaries, composing 91.5% of consolidated direct written premium, produced business during 2020 in eight states. However, 51% of property and casualty segment direct written premium is generated in the states of Alabama, Mississippi and Louisiana, subjecting the Company to significant geographic concentration. Consequently, adverse weather conditions or changes in the legal, regulatory or economic environment could adversely impact the Company.
•Held-to-maturity investments are fixed maturity securities for which the Company has the positive intent and ability to hold to maturity. These securities 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.
•Trading securities are securities acquired with the intent to sell in the near term and are carried at fair value with changes in fair value reported in earnings.
Changes in fair value of equity securities available-for-sale are reported as investment gains/losses in the consolidated statement of operations.
Investment gains and losses on fixed maturity securities arise when the investments are sold. Investment gains and losses on the sale of fixed maturity investments available-for-sale are determined using the specific-identification method and include write downs for fixed maturity securities considered to be other-than-temporarily impaired.
Interest on fixed income securities is credited to income as it accrues on the principal amounts outstanding adjusted for amortization of premiums and accretion of discounts computed utilizing the interest method. Premiums and discounts on mortgage backed securities amortize or accrete using anticipated prepayments with changes in anticipated prepayments accounted for prospectively. The model used to determine anticipated prepayment assumptions for mortgage backed securities uses separate home sale, refinancing, curtailment and pay-off assumptions derived from a variety of industry sources. Mortgage backed security valuations are subject to prospective adjustments in yield due to changes in prepayment assumptions. The utilization of the prospective method will result in a recalculated effective yield that will equate the carrying amount of the investment to the
present value of the projected future cash flows. The recalculated yield is used to accrue income on investments for subsequent periods.
Cash and cash equivalents consist of demand deposit and money market accounts and investments with maturities of three months or less when purchased. Cash and cash equivalents are carried at cost, which approximates fair value.
Investments with other-than-temporary impairment in value are written down to estimated realizable values and losses recognized as a component of investments gains and losses in the consolidated statements of operations. The fair value of the investment becomes its new cost basis.
Property and equipment is carried at cost less accumulated depreciation and includes expenditures that substantially increase the useful lives of existing property and equipment. Significant costs incurred for internally developed software are capitalized and amortized over estimated useful lives of 3 years. Maintenance, repairs, and minor renovations are charged to expense as incurred. Upon sale or retirement of property and equipment, the costs and related accumulated depreciation are eliminated from the respective account and the resulting gain or loss is included in the consolidated statement of operations. The Company provides for depreciation of property and equipment using the straight-line method designed to amortize costs over estimated useful lives. Estimated useful lives range up to 40 years for buildings and from 3-10 years for equipment, furniture and fixtures. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
The Company leases automobiles and some office equipment. The Company accounts for leases existing prior to January 1, 2019 under their original classification and omits any new costs classified as initial direct costs. The Company classified all leases as operating leases and accounts for separate lease and nonlease components as a single lease component. Leases are not considered material and the Company recognizes a right of use (ROU) asset which is included in other assets and a corresponding lease liability in other liabilities. The ROU asset recognized by the Company at December 31, 2020 was $242,000 and the corresponding lease liability was $251,000. The ROU asset recognized by the Company at December 31, 2019 was $389,000 and the corresponding lease liability was $427,000.
The costs of acquiring new insurance business are deferred and amortized over the lives of the policies. Deferred costs include commissions, premium taxes, other agency compensation and expenses, and other underwriting expenses directly related to the level of new business produced.
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 2,530,651 at December 31, 2020 and 2,529,652 at December 31, 2019. The Company did not have any dilutive securities as of December 31, 2020 and 2019.
The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts subject to FDIC insured limits of $250,000 per entity. At December 31, 2020, the net amount exceeding FDIC insured limits was $6,491,000 at three financial institutions. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of financial institutions on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.
Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet its obligation could result in losses to the insurance subsidiaries. Allowances for losses on reinsurance recoverables are established if amounts are believed to be uncollectible. At December 31, 2020 and December 31, 2019, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At December 31, 2020, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.
Treasury shares are reported at cost and are reflected on the consolidated balance sheets as a reduction of total equity.
In March 2020, the Financial Accounting Standards Board (FASB) issued guidance that provides temporary optional expedients and exceptions to the current guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. The Company has exposure to LIBOR based financial instruments through its subordinated debentures. The contracts with respect to these borrowings contain alternative reference rates that would automatically take effect upon the phasing out of LIBOR and would not materially change the liability exposure. The guidance was effective upon issuance and may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2022. The Company is evaluating the optional expedients and exceptions in the guidance but does not expect the adoption of this guidance to have a material impact on its financial position or results of operations.
is currently evaluating the impact of this new guidance. The Company does not expect the adoption to have a material impact on its financial position or results of operations.
In August 2018, the FASB issued guidance that removes, modifies and adds to the disclosure requirements related to fair value measurements. The guidance removes the requirements to disclose the amount and reasons for transfers between Level 1 and Level 2 assets, the policy for timing and transfers between levels and the valuation process for Level 3 fair value measurements. The guidance modifies disclosure requirements for investments in certain entities that calculate net asset value and clarifies the purpose of the measurement uncertainty disclosure. The guidance adds requirements to disclose changes in unrealized gains or losses included in other comprehensive income for recurring Level 3 fair value measurements and to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The Company adopted this guidance on January 1, 2020. The adoption of this guidance did not have a material impact on its financial position or results of operations.
The Company holds passive interests in limited partnerships that are considered to be Variable Interest Entities (VIE) under the provisions of ASC 810 Consolidation. The Company is not the primary beneficiary of the entities and is not required to consolidate under ASC 810. The entities are private placement investment funds formed for the purpose of investing in private equity investments. The Company owns less than 1% of the limited partnerships. The carrying value of the investments totals $460,000 and is included as a component of Other Invested Assets in the accompanying consolidated balance sheets.
In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust
preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,279,000 of variable rate subordinated debentures issued by the Company. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 8, are reported in the accompanying consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $279,000 and are included in Other Assets in the accompanying consolidated balance sheets.
Our investment in available-for-sale securities, which are reported at fair value, includes fixed maturity securities and equity securities. Net unrealized gains or losses on fixed maturities are reported after-tax as a component of
other comprehensive income. Changes in fair value of equity securities are reported in investment gains/losses as a component of net income.
The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2020 are as follows:
A summary of securities available-for-sale with unrealized losses as of December 31, 2020, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows:
Management has evaluated each security in a significant unrealized loss position in the fixed maturity investment portfolio. The Company has no material exposure to sub-prime mortgage loans and approximately 7% of the fixed income investment portfolio is rated below investment grade. Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that, other than the impairment described below, the securities in an accumulated loss position in the portfolio were temporary impairments.
For the year ended December 31, 2020, the Company realized $180,000 other-than-temporary impairments. For the year ended December 31, 2019, the Company realized no other-than-temporary impairments. At December 31, 2020, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $55,000, $37,000 and $27,000. After evaluation by management, it was determined that each of these losses were driven by changes in market interest rates and, in some cases, a lack of liquidity in some sectors driven by market dislocation. However, management currently has the intent and ability to hold these investments until recovery so no other-than-temporary impairments were recognized. At December 31, 2019, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $60,000, $23,000 and $20,000.
Our available-for-sale securities consists of fixed maturity and equity securities which are recorded at fair value in the accompanying consolidated balance sheets.
Accounting standards define fair value as the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework to make the measurement of fair value more consistent and comparable. In determining fair value, we
Level 1 - Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 1 assets and liabilities consist of money market fund deposits and certain of our marketable debt and equity instruments, including equity instruments offsetting deferred compensation, that are traded in an active market with sufficient volume and frequency of transactions.
Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. Level 3 assets and liabilities include marketable debt instruments, non-marketable equity investments, derivative contracts, and company issued debt with values are determined using inputs that are both unobservable and significant to the values of the instruments being measured. Level 3 assets also include marketable debt instruments that are priced using indicator prices that we were unable to corroborate with observable market quotes. Marketable debt instruments in this category generally include asset-backed securities and certain floating-rate notes, corporate bonds, and municipal bonds.
Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2020 are summarized in the following table by the type of inputs applicable to the fair value measurements:
Fixed maturities available-for-sale - The fair values of the Company’s public fixed maturity securities are generally based on prices obtained from independent pricing services. Consistent with the fair value hierarchy described above, securities with quoted market prices in active markets for identical assets are reflected within Level 1 while securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.
As of December 31, 2020, Level 3 fair value measurements of liabilities include $619,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party that utilizes financial modeling tools and assumptions on interest and other factors. The Company does not develop the unobservable inputs used in measuring fair value. Additional information regarding the interest rate swap agreements is provided in Note 8.
The Company is exposed to certain risks in the normal course of its business operations. The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings. This risk is managed through the use of interest rate swap agreements which are designated as cash flow hedges. For cash flow hedges, the effective portion of the gain or loss on the interest rate swap is included as a component of other
comprehensive income and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings. The Company does not hold or issue derivatives that are not designated as hedging instruments. See Note 8 for additional information about the interest rate swap agreements.
The carrying amount and estimated fair value of the Company’s financial instruments as of December 31, 2020 and December 31, 2019 are as follows:
Depreciation expense for the year ended December 31, 2020 was $109,000 ($124,000 for the year ended December 31, 2019).
Long-term debt consisted of the following as of December 31, 2020 and December 31, 2019:
The Company has entered into various swap agreements related to the trust preferred securities. On February 26, 2020, the Company entered into a forward swap effective March 16, 2020, with a notional amount of $3,000,000 and designated the swap as a hedge against changes in cash flows attributable to changes in the benchmark interest rate (LIBOR) associated with the subordinated debentures issued June 21, 2007. Quarterly, commencing June 15, 2020, under the terms of the forward swap, the Company pays interest at a fixed rate of 4.93% until March 15, 2030. On February 26, 2020, the Company entered into a forward swap with a notional amount of $9,000,000 effective March 16, 2020, which hedges against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing June 15, 2020 under the terms of the forward swap, the Company pays interest at a fixed rate of 5.28% until March 15, 2030. On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which hedges against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company paid interest at a fixed rate of 8.49% until March 15, 2020.
The interest rate swaps have fair values of $155,000 (liability) and $464,000 (liability), respectively, for a total liability of $619,000 at December 31, 2020 ($65,000 at December 31, 2019). The swap liability is reported as a component of other liabilities on the consolidated balance sheets. A net valuation loss of $438,000 (net of tax) is included in accumulated other comprehensive income related to the swap agreements at December 31, 2020. A net valuation gain of $134,000 (net of tax) was included in accumulated other comprehensive income related to the swap at December 31, 2019. There is no portion of the existing valuation loss expected to be reclassified into earnings within the next 12 months.
fair market values of $294,000 (all of which was posted as collateral). See Note 5 for additional information about the interest rate swaps.
Management periodically estimates the liability for claims that have been reported but not paid and for claims incurred but not reported (IBNR). Management utilizes expected losses along with historical data analysis of paid and incurred loss development patterns over the past ten years to aide in establishing the claims liability. Management also separately evaluates any recent large events in establishing claim reserves. The Company also engages a consulting actuary to review managements' estimates of claim liabilities each year. There has been no material change in reserving methodology in 2020 compared to prior years.
At December 31, 2020, the largest reinsurance recoverable of a single reinsurer was $1,263,000 ($10,000 at December 31, 2019). Amounts reported as ceded incurred losses were related to development of losses from prior year catastrophes.
The Company and its subsidiaries established an Employee Stock Ownership Plan (ESOP) in January 2010, to enable eligible employees to acquire a proprietary interest in the Company's common stock and to provide retirement and other benefits to such employees. There were contributions of $100,000 during the year ended December 31, 2020 and no contributions were made during the year ended December 31, 2019. All contributions were made in cash for purchase of Company shares in the open market. The Company has not allocated newly issued shares directly to the plan and the plan has no debt.
The Company is dependent on dividends from its insurance subsidiaries to fund operations and for the payment of shareholder dividends. Dividend payments from the insurance subsidiaries are subject to regulatory review/approval and statutory limitations. The statutory limitations are outlined as follows:
At December 31, 2020, securities with market values of $3,349,000 ($3,188,000 at December 31, 2019) were pledged with various states pursuant to statutory requirements.
The table below provides information regarding the Company's preferred and common stock as of December 31, 2020 and December 31, 2019:
On May 22, 2020, 1,763 shares of common stock were issued to directors as compensation under the 2019 Equity
Treasury stock may be purchased pursuant to the share repurchase plan authorized by the Board of Directors in May 2020. Effective June 1, 2020, the Board authorized the repurchase of up to $500,000 of the Company's outstanding common stock. The plan expires May 31, 2021.
During the year ended December 31, 2020, the Company purchased 2,509 shares of common stock which were placed in treasury stock. During the year ended December 31, 2019, the Company purchased 436 shares of common stock which were placed in treasury stock.
Total assets by industry segment at December 31, 2020 and December 31, 2019 are summarized below:
Net income (loss) by business segment for the year ended December 31, 2020 and 2019 is summarized below:
The Company maintains loss and loss adjustment expense reserves on litigated claims that occur in the routine course of business in the insurance operations of the subsidiaries. These reserves are included in the liability for benefit and loss reserves on the balance sheet and include estimates for associated legal costs. There are no individual actions deemed material by management based upon evaluation of information presently available.
Management has evaluated subsequent events and their potential effects on these consolidated financial statements through the filing date of this Form 10-K.
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 47.
In 2020, cash dividends of $1,100,000 were paid to the Registrant by its subsidiaries ($2,750,000 in 2019).