The Company owns no property. The Life insurance subsidiary owns its principal executive offices located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 and is approximately 26,000 square feet. The Company believes this space to be adequate for its immediate needs but is currently exploring the feasibility of adding an additional 3,500 square feet to the current office facility projected to be occupied in 2008.
Financial results for 2006 marked a significant turnaround compared to the years 2005 and 2004. Results for 2005 were marred by losses incurred from Hurricanes Dennis, Katrina and Rita. This marked the first time in the history of the Company that we incurred losses from three hurricanes in the same year. Results for 2004 were also adversely impacted by Hurricane Ivan. We did not incur any losses from hurricanes in 2006, however the property and casualty subsidiaries still incurred catastrophe related losses from tornadoes and hail storms totaling $2.0 million pre-tax in the first six months of the year. In addition to the storm related losses, the life subsidiary incurred additional charges related to the final settlement of a long-standing class action lawsuit totaling over $1.1 million pre-tax. While the storm related losses were within the range of losses to be expected in an average year, the litigation related expenses reduced net income by $726,000 or $0.29 per share. Despite the adverse impact of the litigation, we were able to post earnings of $4,250,000, our third best year in Company history and an increase of 173% over 2005 earnings of $1,558,000.
Consolidated income before income taxes increased 134% from $2,400,000 in 2005 to $5,619,000 in 2006. A significant improvement in our property-casualty segment operations due to the lack of hurricane activity was the primary factor contributing to the improved consolidated results. Life segment operations incurred a net loss before taxes in 2006 of ($1,741,000), comparable to the loss incurred in 2005 of ($271,000). Upward revisions in a litigation settlement adversely impacted life operations for both years. However, the longstanding litigation was settled in 2006 and no further material impact is expected going forward. Non-insurance operations consists of the operations of The National Security Group and a 50% owned subsidiary, The Mobile Attic, consolidated under the provisions of FIN 46R.
Consolidated income before income taxes declined 37.7% in 2005 to $2,400,000 compared to $3,853,000 in 2004. Third quarter hurricanes Dennis, Katrina and Rita were the primary factors contributing to the decline in income before taxes in 2005 compared to the same period last year. Gross incurred losses in 2005, before reinsurance recoveries, from the third quarter hurricanes totaled $38,949,000.
The Company’s life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. Our life segment is the smaller of our insurance segments contributing 11% and 12% of total insurance premium revenue for 2006 and 2005 respectively.
Premium revenue increased 5% to $6,550,000 in 2006 compared to $6,234,000 in 2005. Insurance products sold through independent agents now account for 50% of total premium revenue, while the home service method of distribution accounts for 41% of total premium revenue. Premium revenue through the independent agent distribution method continues to grow at a healthy pace, with revenue increasing 15% in 2006 compared to 2005. Home service premium revenue has continued its consistent rate of decline, dropping 5.3% in 2006 compared to 2005.
While the rate of overall premium revenue in the life segment has moderated, the quality of business has continued to improve. The lapse rate is a measure of the percentage of business in force that is cancelled during the year due to non-payment of premium or surrender for cash value by the policyholder. In our traditional home service market, the lapse rate has often approached 50%; however, with the shift to the independent agent method of distribution we have experienced significant improvement in our lapse rate. The lapse rate for 2006 was 19.6% a marginal improvement over our lapse rate in 2005 of 20.4%. Our lapse rates will generally be higher than the insurance market as a whole because our products are primarily intended for low to middle income consumers that may face other economic pressures from time to time. With decreases in disposable income during economic downturns, often life and supplemental health insurance products are among the first items to be trimmed from household budgets. Also, lapse rates are significantly higher in the first year after an insurance policy is sold to a consumer. As was discussed last year, during 2005 we became more selective in the appointment of new agents and terminated agreements with agents that produced little new business or had very high lapse rates. We believe these efforts are beginning to show results as our lapse rate continues to improve.
Commission expense, including field servicing cost from the home service method of distribution, as a percent of premium revenue had a moderate decrease of 0.6% in 2006 compared to 2005. Independent agent commission expense and other costs of distribution declined 4.9 percentage points in 2006 compared to 2005. Life insurance commission rates for independent agents are typically front loaded meaning that higher commissions are paid in the early years of a policy and commission rates decline as the policy ages. Because the independent agent method of distribution is a relatively new method of distribution, overall commission rates are skewed higher because the majority of in force policies are still paying the higher commission rates of the early years. Management is continuing to focus on reducing commissions through improving the rate of retention of new and existing business.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004:
Premium revenue increased to $6,234,000 in 2005 compared to $6,173,000 in 2004, a marginal increase of 1%. As we have discussed over the last few years, we have began a shift to the independent agent method of distribution of NSIC’s products. In 2005, for the first time in Company history, we had more business in-force that was produced by independent agents than was in-force and produced by our traditional home service method of distribution. Independent agent premium revenue grew by 11.5% year over year in 2005 while home service premium revenue declined by 5.5%.
NSIC has had a primary focus on the production of new business in the independent agent method of distribution over the last five years. During the process of establishing this position, NSIC has had very low thresholds for business production and persistency. NSIC has appointments with approximately 300 independent agents that actively produced new business in 2005. During 2005 we did begin the process of implementing new performance standards that will require minimum amounts of premium production and persistency in order to retain a contract with our Company. As a result of these standards, we have become more selective in the appointment of new agents and will discontinue appointments with many current agents. In undertaking this exercise, we will be able to offer more exceptional service to fewer agents and produce higher quality business in the process. This process will take a couple of years to implement but will help improve profitability of NSIC in the future.
Commission expense, including field servicing costs from the home service method of distribution, as a percent of premium revenue increased 2 percentage points in 2005 compared to 2004. This increase was primarily due to increased separation cost associated in reducing home service management personnel. Independent agent commission expense and other costs of distribution declined 3.7 percentage points in 2005 compared to 2004. These costs are expected to continue to decline 3 to 5 percentage points per year for the next couple of years until the renewal book of business reaches a point of maturity that will support short term profitability. Unfortunately, the shift to the independent agent method of distribution is expensive as life insurance commission rates for independent agents are typically front loaded meaning that higher commissions are paid in the early years of a policy and commission rates decline as the policy ages. Because the independent agent method of distribution is a relatively new method of distribution, overall commission rates are skewed higher because the majority of in force policies are still paying the higher commission rates of the early years. Management is continuing to focus on reducing commissions through improving the rate of retention of new and existing business.
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 1992. Property and casualty operations constitute our largest segment composing 89% and 88% of our total premium revenue in 2006 and 2005, respectively.
While the lack of hurricane activity in the Gulf of Mexico and Atlantic Coast were the primary drivers of our improved operating performance, we still incurred significant losses in our two primary lines of business. Our dwelling and homeowners lines of business incurred $2.0 million in tornado and hail storm related losses in the first half of 2006. These events increased our combined ratio for the year by four percentage points.
Claims frequency decreased significantly in 2006 compared to 2005. In 2006, we incurred 6,500 claims compared to over 15,800 claims in 2005. Claims frequency in 2005 was higher due to 8,450, 1,600 and 500 claims from Hurricanes Katrina, Rita and Dennis. Non-hurricane related claims in 2005 totaled 5,250. The increase in claims, not counting hurricanes, from 2005 to 2006 is primarily related to early season hail storm and tornado losses experienced in the first half of 2006. Hail storms significantly increase frequency but usually carry a relatively low severity while tornado claims carry a lower frequency than hurricanes but usually carry a higher average severity than hurricanes.
While the MWUA assessment was covered by our catastrophe coverage and had no impact on 2006 earnings, it is still noteworthy because it brings to light the magnitude of risk that companies incur from coastal pools. First of all, this charge further depleted our remaining reinsurance protection available to cover claims we pay directly for Hurricane Katrina. The assessment brought us to within less than $1,000,000 of depleting our final layer of reinsurance protection. While we do not expect any additional material development associated with Katrina, should we exceed our final layer of coverage, we would incur additional charges to earnings for the losses in excess of our catastrophe reinsurance protection. Also, this assessment exposes the magnitude to which many of the coastal pools maintain inadequate catastrophe reinsurance protection. While some states in which we operate are pursuing changes in the structure of their coastal underwriting pools and seeking additional reinsurance protection, our risk in these pools remains difficult to quantify. We continue to actively pursue options to better manage this risk, however, as discussed earlier in our risk factors section of this report, organizational structure and equitability of state underwriting pools remain a primary concern and focus for us going forward.
Property and casualty income before income taxes was $9,282,000 for 2006 compared to $2,698,000 in 2005. Our combined ratio for 2006 was 95.7% compared to 106.6% in 2005. The combined ratio for 2006 of 95.7% included catastrophe related tornado and hail storm losses totaling over $2,100,000 and adding 4.0% to our combined ratio. Without the impact of hurricanes in 2005, our combined ratio was 89.9%. As discussed previously and as indicated by evaluation of our combined ratio, the significant decline in catastrophe losses was the primary driver of the improved results.
Property and casualty premium revenues totaled $47,329,000 in 2005 compared to $46,812,000 in 2004, an increase of just over 1%. The property and casualty subsidiaries have generated significant growth in revenue over the last four years. While growth has slowed, 2005 premium revenue was reduced 5% due to additional ceded reinsurance premium paid under the reinstatement provisions of our catastrophe reinsurance contracts triggered by Hurricane Katrina. Premium revenue for 2004 was reduced by 3% due to similar provisions triggered by Hurricane Ivan.
The 2005 hurricane season was the overriding event that led to a decline in earnings for the year and of course property and casualty operations was the operating segment that bore the full brunt of the 2005 hurricane season. Income before income tax in the segment declined to $2,698,000 in 2005 compared to $4,224,000 in 2004, a decrease of 36.1%.
therefore, severity is greater from tornado losses. Non-catastrophe related dwelling losses typically have an average per loss severity in the $3,500 to $4,000 range for the P&C subsidiaries.
To help add a little perspective to the magnitude of the 2005 hurricane season, we thought it may be useful to give a few statistics. Total insured losses from Hurricane Katrina alone totaled more than the cumulative amount of hurricane losses paid in previous Company history dating back to 1959. Hurricane Katrina was the most expensive Hurricane in Company history, exceeding the previous most costly storm, Hurricane Ivan, by over 200%. Hurricane Rita, which was a bit of an afterthought in the media, was the fourth most costly hurricane in Company history with losses of $5,093,000. Our property and casualty subsidiaries had previously never incurred two major hurricanes in a season until Hurricanes Katrina and Rita in 2005. We had also never incurred consecutive hurricane seasons with a major hurricane until 2004 and 2005 with Ivan (2004), Katrina (2005) and Rita (2005).
The combined ratio for 2006 improved significantly at 95.7% compared to 106.6% in 2005. No hurricane activity was experienced in 2006 which led to the reduction in the combined ratio.
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-to-maturity.” 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 4 to the consolidated financial statements).
As of December 31, 2006, the maturity schedule for all bonds and notes held by the Company, stated at amortized cost, was as follows:
The National Security Group’s consolidated statement of cash flows indicates that operating activities provided (used) cash of $7,802,000, $(5,449,000), and $886,000 in 2006, 2005, and 2004, respectively. The significant increase in cash flow from operating activities in 2006 was primarily due to the improvement in underwriting results in the property and casualty subsidiaries. The negative cash flow from operations in 2005 was due to the significant increase in hurricane losses. Cash flow from operations in 2004 was also adversely impacted by the significant increase in hurricane claims associated with Hurricane Ivan.
Short term debt obligations consist of $2,171,000 held directly by the Company and $9,409,000 in debt held by Mobile Attic. The Company will most likely seek to refinance the $2,171,000 in debt at maturity. We do not foresee any issues arising that would prevent us from refinancing at rates comparable to what we are now paying. Should the negotiations to sell Mobile Attic materialize, the terms of the sale would include the assumption of Mobile Attic debt by the purchaser and the release of our guarantees of the debt. Otherwise, we expect that Mobile Attic will refinance its debt and we will remain guarantor of the debt until such time that Mobile Attic can obtain more favorable financing on its own.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $32.6 million and $27.2 million at December 31, 2006 and 2005, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 6.2 and 4.4 at December 31, 2006 and 2005 respectively. Accordingly, National Security Fire & Casualty Company exceeds the minimum RBC requirements.
Our consolidated financial statements are based upon the development and application of accounting policies that require management to make significant estimates and assumptions. Accounting policies may be based on (including but not limited to) GAAP authoritative literature, statutory authoritative literature, regulations and industry standards. The Company’s financial results would be directly impacted by changes in assumptions and judgments used to select and apply our accounting policies. It is management’s opinion that the following are
As part of our risk management strategy we routinely cede risks associated with insurance policies we underwrite to reinsurers pursuant to contractual agreements. Reinsurance provides protection for individual loss occurrences, including catastrophes, to alleviate fluctuation in the results of our underwriting activities and to limit our net liability for individual risks. The estimated reinsurance recoverable on paid losses, including an estimate for losses incurred but not reported, and amounts paid to reinsurers applicable to unexpired terms of policies in force are reported as assets.
year loss, that is a loss that has a less than ½ of 1% probability of occurring in any given year, the property and casualty subsidiaries would pay (pre-tax) approximately $7.7 million in losses and reinstatement and reinsurers would pay (pre-tax) $38.4 million.
For 2007, the property and casualty subsidiaries maintained catastrophe reinsurance protection in the amount of $42.5 million. However, due to continued increases in rates, we increased our deductible from $3,000,000 to $3,500,000. The increase in the catastrophe reinsurance rate for 2007 was 9%. In addition to the increase in rates, we are currently seeking to add an additional layer or reinsurance protection, increasing our total reinsurance coverage up to $47.5 million. This has become necessary to maintain protection based on changes in computer models given the increase in hurricane frequency and severity in 2004 and 2005. This will provide protection up to at least a 100 year “near term” event as depicted in catastrophe modeling results. The “near term” catastrophe modeling results reflect a predicted increase in storm activity given the current weather pattern and various factors projected to impact our weather patterns in the near term. We believe that maintaining protection to at least a 100 year near term event will be comparable with our past practice of maintaining catastrophe reinsurance protection up to a 250 year event under the previous models.
For more information regarding reinsurance please see Note 10 to our consolidated financial statements.
At December 31, 2006, we had recorded $7,922,000 as an asset for DAC in our financial statements. We do not foresee any issues related to recoverability of these capitalized costs. For more information regarding deferred policy acquisition costs, please see Note 1 to our financial statements.
Investments are recorded at fair value based upon quoted prices when available. Quoted prices are available for every investment debt and equity security included in the financial statements. Periodically, the carrying values of an individual investment may become temporarily impaired because of time value, volatility, credit quality and existing market conditions. Management evaluates investments to determine whether the impairment is other-than-temporary. Evaluation criteria include credit quality of security, severity of decrease between cost and market value, length of time of the impairment and likelihood that the impairment will reverse in the near future.
At December 31, 2006, there were no other-than-temporary impairments. For more information regarding valuation of investments, see Note 1 to our financial statements.
At December 31, 2006, the recorded liability for loss and loss and adjustment expense was $12,498,000. We believe this estimate of unpaid losses and loss adjustment expense 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 financial statements.
Equity securities available-for-sale, at estimated fair value (cost: 2006 - $7,224
Investment real estate, at book value (accumulated depreciation: 2006 - $18; 2005 - $18)
Class A common stock, $1 par value, 2,000,000 shares authorized, none issued or outstanding
Adjustments to reconcile net income to net cash provided by (used in)
NSFC is licensed in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Oklahoma, South Carolina, Tennessee and West Virginia. In addition NSFC operates on a surplus lines basis in Louisiana, Missouri, and Texas. NSFC operates in various property and casualty lines, the most significant of which are dwelling property fire and extended coverage, homeowners, mobile homeowners, ocean marine, nonstandard automobile physical damage and liability and nonstandard commercial auto liability.
Generally, realized gains and losses on sales of investments are recognized in net income using the specific identification method.
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.
Mobile Attic, Inc. recognizes leasing revenues from royalties, storage unit rentals and sales on a monthly basis. Revenues from delivery charges are recognized when these services are billed. Mobile Attic executes franchise agreements that set the terms of its arrangement with each franchisee. The franchisee agreement requires the franchisee to pay an initial, non-refundable fee ranging from $35,000 to $55,000 and continuing fees based on percentage of rents. The initial term of the franchise is 20 years and, subject to Mobile Attic’s approval and payment of a renewal fee, a franchise may generally renew its agreement upon its expiration for an additional 10 years.
represents that portion of total revenues from franchises not yet open. There were two company-owned locations in operation during the years ended December 31, 2006 and 2005.
As territory is assigned to each franchise sold, Mobile Attic may reach the point where existing markets become saturated and initial franchising revenue declines. Unless new markets are entered, franchise revenues after market saturation will come primarily from renewal fees for existing franchises.
Acquisition costs relating to life contracts are amortized over the premium paying period of the contracts, or the first renewal period of term policies, if earlier. Assumptions utilized in amortization are consistent with those utilized in computing policy liabilities.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for prospective reinsurance contracts are reported as prepaid reinsurance premiums and amortized over the remaining contract period. In the normal
course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage contracts. NSIC retains a maximum of $50,000 of coverage per individual life. The cost of reinsurance is amortized over the contract period of the reinsurance.
The Company expenses advertising costs as incurred except for nondirect-response advertising costs, which are expensed the first time the advertising takes place. Advertising costs charged to expense were $446,000 for the year ended December 31, 2006 ($250,000 and $142,000 for the years ended December 31, 2005 and 2004, respectively). Advertising costs capitalized at December 31, 2005 were $192,000.
During 2006, the Financial Accounting Standards Board (FASB) issued the following pronouncements:
FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties, accounting for income taxes in interim periods, financial disclosures, and transition. This interpretation is effective for fiscal
SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans will require a company to recognize on a prospective basis an asset for a plan’s overfunded status or a liability for a plan’s underfunded status in its statement of financial position, to measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and to recognize changes in the funded status of a defined postretirement plan in the year in which the changes occur as a component of other comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements of the statement are effective for fiscal years ending after December 15, 2006. The requirement to measure the plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan or other postretirement plans and as a result the adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations.
In December 2003, the FASB issued Revised FIN 46 (FIN 46R) to clarify certain aspects of FIN 46 including the determination of who is the primary beneficiary of a variable interest entity (VIE). FIN 46R postponed the effective date as to when companies are required to apply the provisions prospectively for all variable interest entities in existence prior to January 31, 2003 until the first financial reporting period that ends after March 15, 2004. However, for entities that are considered to be special purpose entities, the effective date of FIN 46R is financial reporting periods after December 15, 2003. The Company does not have an interest in any special purpose entities. The Company consolidated its affiliate, Mobile Attic, Inc., upon adoption of FIN 46R in the first quarter 2004 due to the Company’s guarantee of Mobile Attic’s line of credit. The consolidation of Mobile Attic increased total assets by approximately $15 million and total liabilities by approximately $13 million. There was no effect on total shareholders’ equity. The consolidation of Mobile Attic did not have a material impact on the results of operations as the Company previously accounted for the investment under the equity method. See Note 17 for additional information related to the VIE.
In December 2005, the Company formed National Security Capital Trust I (the Trust), a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9 million 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 $9.3 million 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 million. 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
NSFC - including realized capital gains of $1,803, $3,098, and $1,847, respectively
Omega - including realized capital gains of $180, $180, and $35, respectively
The amortized cost and aggregate fair values of investments in securities are as follows:
A summary of securities available-for-sale with unrealized losses as of December 31, 2006 and 2005 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:
A summary of securities held-to-maturity with unrealized losses as of December 31, 2006 and 2005 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:
Depreciation expense for the year ended December 31, 2006 was $743,000 ($905,000 for the year ended December 31, 2005 and $805,000 for the year ended December 31, 2004).
Note payable to bank with an interest rate based on LIBOR (8.10% at December 31, 2006 and 7.12% at December 31, 2005) dated March, 2002; maturity March, 2007. Payments of $112,953 due quarterly with balloon payment at maturity. Unsecured
Note payable to bank with an interest rate based on prime minus 25 basis points (8.00% at December 31, 2006 and 7.00% at December 31, 2005) dated June, 2004; maturity June, 2007. Interest payments due quarterly. Secured by $9,005 of leasing equipment.
Subordinated debentures issued on December 15, 2005 with fixed interest rate of 8.83% each distribution period thereafter until December 15, 2015 when the coupon rate shall equal the 3-month LIBOR plus 3.75% applied to the outstanding principal; maturity December, 2035. Interest payments due quarterly. Unsecured
The Company has a geographic exposure to catastrophe losses in certain areas of the country. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophe losses are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance. At December 31, 2006, the Company’s estimate of unpaid losses and adjustment
expenses for hurricane related claims incurred in prior years totaled $1 million. Because all remaining outstanding claims are covered by the companies reinsurance contract, net outstanding losses to the Company total less than $10,000 including an allowance for estimated incurred but not reported losses.
The Company’s insurance operations participate in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term. Property and casualty reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of reinsurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurers and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize their exposure to significant losses from reinsurance insolvencies. At December 31, 2006, reinsurance receivables with a carrying value of $175,000 ($233,000 at December 31, 2005) and prepaid reinsurance premiums of $16,000 ($196,000 at December 31, 2005) were associated with a single reinsurer. The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2006, 2005 and 2004 were approximately $7,525,000, $32,613,000, and $11,284,000, respectively. The Company did not incur any losses from an event occurring in 2006. Amounts reported as ceded incurred losses in 2006 were due to development of losses from prior year catastrophic losses primarily associated with assessments from the Mississippi Windstorm Underwriting Association stemming from losses associated from Hurricane Katrina in 2005. This assessment, while increasing gross losses, was covered by the Company’s catastrophe reinsurance contract and no net losses were incurred due to this adverse development. The significant increase in recoveries pertaining to reinsurance contracts in 2005 compared to prior years was due to reinsurance associated with losses incurred from Hurricanes Katrina and Rita.
The amount of dividends paid from NSIC to the Company in any year may not exceed, without prior approval of regulatory authorities, the greater of 10% of statutory surplus as of the end of the preceding year, or the statutory net gain from operations for the preceding year. At December 31, 2006, NSIC’s retained earnings unrestricted for the payment of dividends in 2007 amounted to $934,000.
At December 31, 2006, securities with market values of $3,827,000 ($3,780,000 at December 31, 2005) were deposited with various states pursuant to statutory requirements.
Under applicable Alabama insurance laws and regulations, NSFC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $100,000.
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, 2006, 2005 and 2004 are summarized below:
On December 12, 2005, the United States District court for the Middle District of Alabama (the “Court”) entered an order preliminarily approving a proposed settlement of a case pending against a subsidiary of the Company styled Mary W. Williams, et al v. National Security Insurance Company (“Williams Litigation”) and preliminarily certifying such case as a class action. The Williams Litigation related primarily to claims that a subsidiary of the Company sold industrial burial insurance policies to racial minorities on which it charged higher premiums or provided inferior benefits than premiums charged to or policy benefits provided to similarly situated non-minority policyholders. The Company’s subsidiary has not sold industrial burial insurance for more than 20 years. Following a fairness hearing held on August 22, 2006, the Court, in an order dated August 30, 2006, granted final approval to the proposed settlement. The effective date of the settlement was September 30, 2006, with an implementation date of December 29, 2006. The settlement provided for the Company’s subsidiary to, among other matters, provide additional policyholder benefits, including premium adjustments and benefit enhancements on existing policies and additional benefits on matured policies and pay attorneys fees. The Company had previously established litigation reserves with respect to this matter and had taken a policy reserve charge with respect to adjustments to the subject policies that were voluntarily made in 2000. The remaining costs associated with this settlement, including costs associated with prospective enhancements, are fully reflected in the attached financial statements for the period ending December 31, 2006. The class, as certified, did not permit any class
members to opt out of the settlement and enjoined all similar litigation against the Company’s subsidiary. In the settlement, the Company’s subsidiary denied all claims and allegations made in the lawsuit.
The company establishes and maintains reserves on contingent liabilities. In many instances, however, it is not feasible to predict the ultimate outcome with any degree of accuracy. While a resolution of these matters may
Cash paid for interest during 2006 was $1,846,000 ($1,139,000 in 2005 and, $645,000 in 2004). Cash paid for income taxes in 2006 was $300,000 ($400,000 in 2005 and $2,000,000 in 2004). Noncash investing activities in 2006 and 2005 included converting $551,000 and $276,000, respectively, of storage units from furniture and equipment into inventory. Noncash investing activities in 2006 also included converting $746,000 of storage units from inventory into furniture and equipment.
During the years ended December 31, 2006, 2005 and 2004 the Company’s affiliate Mobile Attic acquired $2,861,000; $2,632,000; and $1,389,000, respectively, of equipment from Cash Brothers Leasing, Inc. (Cash Brothers). The principal owners of Cash Brothers are also stockholders in Mobile Attic. Cash Brothers is also a distributor of the mobile storage units. During 2006, 2005 and 2004 Mobile Attic paid $36,000; $103,000; and $100,000, respectively, in commissions to Cash Brothers. At December 31, 2006 and 2005, Mobile Attic had accrued expenses due Cash Brothers of $10,000 and $16,000, respectively.
Mobile Attic also acquired $4,213,000 and $4,977,000 of equipment from Bridgeville Trailers during the years ended December 31, 2006 and 2005, respectively. Two of the majority shareholders of Bridgeville Trailers each own 25% of Mobile Attic.
The Company has entered into discussions with a party regarding the sale of its interest in Mobile Attic, Inc. The terms of the agreement have yet to be finalized but the consummation of an agreement would be contingent upon a provision to release the Company from any existing debt guarantees of Mobile Attic and consequently an elimination of the requirement to consolidate Mobile Attic under the provisions of FIN 46R.
conjunction with the Consolidated Financial Statements and Notes thereto included in the
Dividends of $1.5 million in 2006, $2.5 million in 2005, and $2.8 million in 2004 were paid to the