Net premiums earned ......$26,654 $24,372 $ 26,289 $29,240 $21,069 Net investment income .... 3,935 4,311 4,001 3,894 3,738 Net realized investment gains ............... 1,839 1,650 1,720 661 855 Other income ............. 582 505 400 602 311 ------- ------ -------- ------- ------- Total revenues ................$33,010 $30,838 $ 32,410 $34,397 $25,973 ======= ======= ======== ======= =======
Income before extraordinary Items ....................$ 1,356 $ 214 $ 3,674 $ 3,438 $ 3,755 Extraordinary gain ............ 0 0 0 263 0 ------- ------- -------- ------- ------- $ 1,356 $ 214 $ 3,674 $ 3,701 $ 3,755 ======= ======= ======== ======= =======
Book value per share ..........$ 17.43 $ 17.11 $ 16.44 $ 16.73 $ 15.30
Dividends per share ...........$ 0.65 $ 0.61 $ 0.57 $ 0.52 $ 0.47
The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related notes included elsewhere herein.
Consolidated Results of Operations: Consolidated net income from The National Security Group was $1.356 million in 1996 compared to $214,000 in 1995 ($3.674 million in 1994). Consolidated revenues were $33 million in 1996 compared to $30.8 million in 1995 ($32.4 million in 1994).
Certain financial information for The National Security Group's three segments (life and accident and health insurance, property and casualty insurance, and other) is summarized as follows:
Income before taxes and cumulative effect adjustment: 1996 % 1995 % 1994 % -------- ----- -------- ----- -------- ----- Life and accident and health insurance .........$ 1,071 (64.5) $ (178) (64.5) $ 639 13.7 Property and casualty insurance ................. 1,192 235.9 651 235.9 4,560 97.6 Other ...................... (642) (71.4) (197) (71.4) (528) (11.3) -------- ----- -------- ----- -------- ----- $ 1,621 100.0 $ 276 100.0 $ 4,671 100.0 ======== ===== ======== ===== ======== =====
Property & Casualty Operations: Premium income was $22.2 million in 1996 compared to $19.5 million in 1995. The primary reason for the increase was due to the increase in premiums from new commercial and private passenger automobile programs in the states of Louisiana, and Georgia. Growth from these programs is expected to continue in 1997 though at more moderate levels than in 1996. The property -casualty subsidiaries are expected to expand automobile insurance into two additional states by mid to late 1997. These programs are still in the planning stages at this point and premium projections are not yet available. Premium income of $19.5 million in 1995, was down nearly 8% from the 1994 total of $21.1 million, a result of the decision to discontinue a commercial automobile program during 1994 and a private passenger automobile program in 1995.
Pretax earnings were $1.19 million in 1996 up 83% from $651,000 in 1995. Earnings were up primarily due to the adverse impact of Hurricane Opal on 1995 earnings. Earnings in 1996 were still below previous levels due to increased fire and windstorm losses in the low value dwelling program. Pretax earnings of $651,000 in 1995 were down 86% from the 1994 total of $4.56 million. Several factors contributed to the decrease in earnings in 1995, the most noteworthy of which was Hurricane Opal which ripped through Alabama, where more than 60% of property and casualty net written premiums are produced. Total property losses incurred by the company exceeded $3 million. However, after catastrophe reinsurance recoveries, the pretax loss was about $2 million. Also contributing to the decrease in pretax earnings was a change in Alabama's insurance premium tax law which led to an increase in premium taxes of more than $500,000. Litigation settlements and legal expenses were more than $400,000 in 1995, and the decrease in premium revenues accounted for the remainder of the decrease in pretax income.
The combined ratio for 1996, though improved over 1995 was still higher than historical averages for the property-casualty subsidiaries. The primary reason for the high combined ratio was higher than normal incurred losses in the low value dwelling program in the first quarter of 1996. These losses were attributable to the colder than normal winter which led to more fire losses and several tornado producing storms which hit the Southeastern United States. The combined ratio for 1995 increased significantly over 1994 due to losses sustained in Hurricane Opal.
Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico, strict underwriting of risks, and adequate and timely premium rates. A major hurricane, such as Opal, hitting the coast of Alabama, Mississippi, Louisiana, or Texas could cause the combined ratio to fluctuate materially from prior years. The fire & casualty subsidiary maintains catastrophe insurance to minimize the effect of a major catastrophe.
Asset Portfolio Review: The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 1996, the company's holdings in debt securities amounted to 66% of total investments and 51% of total assets. The following is a breakdown of the bond portfolio quality according to National Association of Insurance Commissioners (NAIC) Securities Valuation Office (SVO) rating standards, and the nationally recognized rating organization equivalents of Moody's and Standard and Poor's:
SVO Equivalents % of Total SVO Class Moody's Standard and Poor's Bond Portfolio - --------- ------- ------------------- -------------- 1 Aaa to A3 AAA to A- 88.5 2 Baa to Baa3 BBB+ to BBB- 8.5 3 Ba1 to Ba3 BB+ to BB- 1.2 4 B1 to B3 B+ to B- 1.8 5 Caa to Ca CCC+ to C 0.0 6 C Ci to D 0.0
As of January 1, 1994, the Company adopted Financial Accounting Standards Board Statement 115 and reclassified a portion of its fixed maturity securities portfolio as "available-for-sale," with the remainder being classified as "held-tomaturity." With that reclassification, the fixed maturity securities classified as "available-for-sale" are carried at fair value and changes in fair values, net of related income taxes, are charged or credited to shareholders' equity (see Note 3 to the consolidated financial statements).
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, 1996, the Company had no known impairments of assets or changes in operation which would have a material adverse effect upon liquidity. Approximately 75% 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 1997, the amount that The National Security Group's insurance subsidiaries can transfer in the form of dividends to the parent company is limited to $800,000 in the life insurance subsidiary and $2.4 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 Cash Flows - Years Ended December 31, 1996, 1995, and 1994...................... 22
Schedule III. Condensed Financial Information of Registrant - December 31, 1996 and 1995.......................................... 36
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31,1996. 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.
The Company's securities are classified in two categories and accounted for as follows:
o Securities Available-for-Sale. Bonds, notes, common stock and non-redeemable preferred stock not classified as either held-tomaturity, or trading are reported at fair value, adjusted for other-than-temporary declines in fair value.
Disclosures About Fair Value of Financial Instruments In 1995, the Company adopted Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107) which requires companies to disclose fair value information about certain 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 comparision to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument.
SFAS No. 107 excludes certain financial instruments, particularly insurance liabilities other than financial guarantees and investment contracts, from its disclosure requirements. In evaluating the Company's management of interest rate and liquidity risk, the fair values of all assets and liabilities should be taken into consideration.
The fair values of cash, cash equivalents, short-term investments and balances due on account from agents, reinsurers and others approximate their carrying amounts as reflected in the consolidated balance sheets due to their short-term availabilty or maturity.
The fair value of the mortgage loan portfolio was approximately equal to the carrying amount of $405,000 on December 31, 1996 and $484,000 on December 31, 1995.
As of December 31, 1996 and 1995, the fair value of policy loans approximated their carrying amount of $622,000 and $627,000, respectively.
The fair value of other policyholder funds on deposit is estimated to approximate carrying amount of $1,842,000 on December 31, 1996 and $1,885,000 on December 31, 1995.
Statement of Cash Flows For purposes of reporting cash flows, cash includes cash-on-hand and demand deposits with banks.
Premium Revenues Life insurance premiums are recognized as revenues when due. Property and casualty insurance premiums, less amounts ceded to reinsurers, are recognized on a pro rata basis over the terms of the policies. Reinsurance premiums assumed are recognized as reported by the ceding company.
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 - 1996 7% graded to 6%
Claim Liabilities The liability for unpaid claims represents the estimated liability for claims reported to the Company and its subsidiaries plus claims incurred but not yet reported and the related adjustment expenses. The liabilities for claims and related adjustment expenses are determined using case-basis evaluations and statistical analyses and represent estimates of the ultimate net cost of all losses incurred through December 31 of each year. Although considerable variability is inherent in such estimates, management believes that the liabilities for unpaid claims and related adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The above amounts exclude allocation of overhead from the Company. NSIC, NSFC and OMEGA are in compliance with statutory restrictions with regard to minimum amounts of surplus and capital.
The amortized cost and aggregate fair value of debt securities at December 31, 1996, 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 prepayment penalties.
Available-for-sale securities: Due in on e year or less ................$ 500,048 $ 500,000 Due after one year through five years.... 2,755,657 2,783,000 Due after five years through ten years... 3,266,327 3,291,431 Due after ten years...................... 3,223,076 2,957,330 ------------ ------------ Total $ 9,745,108 $ 9,531,761 ============ ============ Held-to-maturity securities: Due in one year or less..................$ 4,006,349 $ 3,997,120 Due after one year through fiveyears..... 7,421,289 7,655,238 Due after five years through ten years... 12,333,430 12,398,523 Due after ten years...................... 11,651,540 11,987,549 ------------ ------------ Total $ 35,412,608 $ 36,038,430 ============ ============
Proceeds from the sale of available-for-sale securities during 1996 were $4,473,791. Gross gains of $2,006,247 and gross losses of $1,879 for 1996 were realized on those sales.
NOTE 4 - NET INVESTMENT INCOME: Major categories of investment income are summarized as follows:
Investment real estate with a carrying value of approximately $2,000,000 produced insignificant income during each of the two years in the period ended December 31, 1995. This property was sold during the year ended December 31, 1995.
Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws.
The tax effect of significant temporary differences representing deferred tax assets and liabilities are as follows:
Deferred policy acquisition costs.................. $( 1,364) $( 1,138) Policy liabilities................................. 516 499 Unearned premiums.................................. 440 353 Claim liabilities.................................. 329 291 General insurance expenses......................... 582 314 Unrealized gains on securities available-for-sale.. ( 3,355) ( 2,983) Other.............................................. - 28 ------ ----- Net deferred tax liabilities....................... $( 2,852) $( 2,636) ====== ====== The approximate income tax effects of changes in temporary differences are as follows:
NOTE 6 - REINSURANCE: NSFC is involved as a reinsurer in which it assumes some of the risk originally undertaken by another insurance company. Conversely, NSFC and NSIC also 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 insolvences. At December 31, 1996, reinsurance receivables with a carrying value of $646,000 and prepaid reinsurance premiums of $443,000 were associated with a single reinsurer.
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 $9,967,000 at December 31, 1996. Reinsurance recoveries for claims and claim settlement expense were $2,423,000 during 1996.
NOTE 7 - EMPLOYEE BENEFIT PLAN: 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 1996, 1995 and 1994 amounted to $90,708, $-0- and $103,000, respectively. Contributions are at the Board of Directors' discretion subject to governmental limitations.
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 1996, 1995 and 1994 amounted to approximately $61,813, $13,000 and $44,000, respectively.
Under applicable Alabama insurance laws and regulations, the Company is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $200,000.
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, 1996, 1995 and 1994 are summarized below:
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 this verdict is being appealed.
NOTE 12 - STOCK SPLIT On February 28, 1994, the Company issued 779,940 shares of common stock in connection with a three-for-two stock split effected in the form of a 50% stock dividend. Accordingly, $779,940, representing the par value of the additional shares issued, was transferred from retained earnings to the common stock account.
All per share figures included in the consolidated financial statements and notes are based on the increased number of shares of common stock after giving effect to the split.
NOTE 13 - 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 $100,00 per bank. A summary of the total insured and uninsured amounts held by all banks at December 31, 1995 follows:
(Dollars in thousands) Cash and cash equivalents per balance sheet $ 147 Checks outstanding in excess of bank balance per balance sheet ( 1,516) -------- Cash on hand ( 1,369)
Deposits in transit ( 414) Outstanding checks 3,302 -------- Total cash held at banks 1,519 Portion secured by FDIC ( 185) -------- Uninsured cash balances $ 1,334 ========
For the Years Ended December 31, 1996 1995 1994 ----- ----- ----- Income From subsidiaries-eliminated upon consolidation Dividends .................................. $ 1,800 $ 1,680 $ 1,450 ----- ----- ----- Expenses State taxes .................................. 25 25 25 Other expenses ............................... 575 60 163 ----- ----- ----- 600 85 188 ----- ----- ----- Income before income taxes and equity in undistributed earnings of subsidiaries....... 1,200 1,595 1,262 Income tax benefit ............................. (175) (43) (119) ----- ----- ----- Income before equity in undistributed earnings of subsidiaries ............................. 1,375 1,638 1,381 Equity in undistributed (losses) earnings of subsidiaries.............................. (19) (1,424) 2,293 ----- ----- ----- Net Income ..................................... $ 1,356 $ 214 $ 3,674 ===== ===== =====
The "Notes to Consolidated Financial Statements of The National Security Group, Inc." are an integral part of these statements.
Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Statements of the Registrant do 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 these Condensed Financial Statements 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 23.
Dividends of $1.80 million in 1996, $1.68 million in 1995 and $1.45 million in 1994 were paid to the Registrant by its subsidiaries.