The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSG) and its subsidiaries. We are a “smaller reporting company” under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the two year period ended December 31, 2010.
The Company ended 2010 with net income totaling $3,265,000 compared to $4,224,000 in 2009. The Company ended 2010 with net income per share of $1.32 compared to $1.71 in 2009. An 8.9% increase in policyholder benefits was the primary factor contributing to the decrease in net income. For the year 2010, policyholder benefits were 63.7% of earned premium compared to 60.1% in 2009, an increase of 3.6 percentage points. Increased accident and health claims in the Life Segment contributed approximately one percentage point to the increase while increased homeowners and auto claims in the P&C segment account for most of the remaining increase.
The Company ended 2010 with premiums earned totaling $61,263,000 compared to $59,594,000 for the same period last year. Premium revenue is generated from our two operating segments: P&C segment and Life segment. The P&C segment accounts for approximately 89% of total premium revenue while our Life segment contributes the remaining 11%. The P&C segment operates in personal lines insurance products primarily generating premium revenue from dwelling fire, allied lines and homeowners policies. Our Life segment produces premium revenue primarily from whole life, accident and critical illness insurance policies.
Net realized investment gains totaled $1,879,000 in 2010 compared to $357,000 in 2009. The primary reason for the increase was favorable market conditions coupled with an increase in sales of securities in the P&C portfolio. The most significant contributions were from the sale of four bonds and three common stocks totaling $395,000 and $759,000, respectively. The realized gains from these seven securities accounted for approximately 76% of the increase in 2010 compared to 2009.
Other income was $1,161,000 as of December 31, 2010 compared to $764,000 for the same period last year; a $397,000 increase. Other income consists primarily of billing, payment and policy fees related to the issuance of our property and automobile insurance policies in the P&C segment as well as miscellaneous income. The primary reason for the $397,000 increase was an increase in fee income related to a rise in policy issuance in the automobile program in the P&C segment during 2010.
The previously mentioned increases in policyholder benefit expense were partially offset by a decline in wind losses related to storm activity in the P&C segment. Although both 2010 and 2009 were impacted by ten non-hurricane catastrophic weather related events, losses from these storms totaled $1,704,000 in 2010 compared to $2,328,000 in 2009; a decrease of $624,000.
The Company incurred income tax expense totaling $1,372,000 compared to $1,252,000 in 2009. Income tax expense as a percent of income before taxes was 29.59% in 2010 compared to 22.86% in 2009. The most significant factor contributing to the increase in the effective tax rate was a decline in income from company owned life insurance.
Our life segment is the smaller of our insurance segments contributing 11.5% of total insurance premium revenue in 2010 and 12.1% in 2009. Premium revenues and operating income for the life segment for the years ended December 31, 2010 and 2009 are summarized below (amounts in thousands):
NSIC premium accounted for 11.5% of total consolidated premium revenue for 2010. As mentioned above, NSIC operates using two primary methods of distribution: home service employee agents and independent agents. While the company has used the traditional home service distribution method since its founding in 1947, the independent agent distribution method has become the largest source of renewal business and new business production over the past decade. For 2010, the home service and independent agent distribution methods accounted for 32.3% and 64.9%, respectively of NSIC premium revenue.
NSIC ended 2010 with premium revenue of $7,027,000 compared to $7,199,000 for the same period last year; a decrease of 2.4%. The $172,000 decrease in premium revenue was primarily due to the decline in ordinary business related to the home service distribution method. Premium revenue declined 5.6% in 2010 compared to the same period last year. Partially offsetting this decline was an 8.7% increase in A&H premium revenue produced by the independent agent distribution method.
Net investment income totaled $2,116,000 as of December 31, 2010 compared to $2,114,000 for the same period last year. Investment income in NSIC is generated from securities held in our investment portfolio as well as mortgage and policy loan interest. Investment income remained virtually unchanged increasing $2,000 in 2010 compared to 2009.
NSIC ended 2010 with net realized investment gains totaling $420,000 compared to $234,000 in 2009. The primary reason for the improved results in the current year was the lack of other-than-temporary impairment losses compared to the $293,000 in other-than-temporary impairment losses recognized during 2009.
Policyholder benefit expenses increased $355,000 ending 2010 at $5,286,000 compared to $4,931,000 for the same period last year. The primary reason for the increase was an increase in claims incurred related to supplemental accident and health claim benefits in 2010 compared to 2009.
Life segment incurred income tax expenses totaled $648,000 compared to $497,000 in 2009. Income tax expense increased due to the impact of the small life deduction on capital gains.
NSIC ended 2010 with a year to date net loss of $128,000 compared to net income of $464,000 for the same period last year. The decrease in premium revenue coupled with the increase in policyholder benefit expense, deferred policy acquisition costs and tax expense were the primary reasons for the net loss in 2010 compared to the net income in 2009.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009:
Property and casualty segment premium revenue for 2010 was $54,236,000 compared to $52,395,000 for the same period last year; an increase of 3.5%. The primary reasons for the increase in premium revenue in 2010 compared to 2009 were the growth of the automobile line of business in addition to moderate rate increases related to our property programs in our largest states.
In our fire/allied lines and homeowners lines of business, we have slowed our rate of growth through a combination of rate increases, stricter underwriting standards and fewer appointments of new agents. These efforts have been undertaken in an effort to improve underwriting profitability, particularly in our homeowners line of business. The full effect of these efforts was not realized in 2010 as only our dwelling fire/allied lines program produced an underwriting profit. However, we expect the changes implemented, while continuing to slow top line revenue growth should lead to improved underwriting results in future periods.
Also, during 2010, we experienced rapid growth in our personal lines auto program. This program is composed primarily of non-standard auto policies with the largest concentration of business in the state of Louisiana. Due to early unfavorable underwriting results, we implemented significant rate increases in Louisiana in the second half of 2010. The rate adjustments will slow the production of new business in Louisiana going forward but is expected to help reduce underwriting losses.
The P&C segment ended 2010 with realized capital gains totaling $1,352,000 compared to $120,000 for the same period last year. The most significant contributions were from the sale of four bonds and three common stocks totaling $395,000 and $759,000, respectively. The realized gains from these seven securities accounted for approximately 94% of the increase in 2010 compared to 2009. The P&C segment was not impacted by the write-down of other-than-temporary impairments in 2010; however, other-than-temporary impairment losses totaled $151,000 in 2009. For information regarding management’s method of determining investment impairment, please see Note 4.
Partially offsetting the previously mentioned increases in policyholder benefit expense was a decline in wind losses related to storm activity in the P&C segment. Although both 2010 and 2009 were impacted by ten non-hurricane catastrophic weather related events, losses from these storms totaled $1,704,000 in 2010 compared to $2,328,000 in 2009; a decrease of $624,000.
Commission expense for 2010 totaled 13.49% of premium revenue compared to 13.97% of premium revenue in 2009. Commission expenses totaled $7,319,000 in 2010 compared to $7,317,000 in 2009; a .03% increase. During 2009, a new profit sharing bonus calculation was implemented which reduced commission expense and led to the comparable and virtually unchanged results between 2010 and the prior year.
General and administrative expenses totaled $6,203,000, or 11.4% of premium revenue in 2010 compared to $6,775,000, or 12.9% of premium revenue, in 2009. The primary reason for the decline in general and administrative expenses was the absence of a bonus accrual in 2010 compared to $364,000 accrued in 2009.
Insurance taxes, licenses and fees were $1,694,000 in 2010 compared to $1,387,000 for the same period last year. Insurance taxes, licenses and fees were 3.1% of premium revenue in 2010 compared to 2.6% in 2009. An increase in the mix of business in states with higher premium taxes was the primary factor leading to the increase in taxes, licenses and fees.
The non-insurance operations of the Company consist of our parent company, The National Security Group, Inc. The National Security Group has no material sources of revenue and relies almost entirely on dividends from subsidiaries to pay expenses. Dividends from subsidiaries are subject to insurance department approval and are subject to statutory restrictions. Dividends are eliminated upon consolidation of the subsidiaries in the audited financials included herein. The expenses of the group consist of expenses associated with the public listing of our stock, taxes and fees, and directors’ fees. The single most significant recurring expense of the group is interest expense associated with $12,372,000 in debt. This debt is composed of two trust preferred securities offerings, the first being $9,279,000 issued in the December 2005 and the second being $3,093,000 issued in June 2007. The primary use for these proceeds was to add capital to the property and casualty subsidiaries following the hurricanes of 2004 and 2005. Total interest expense for the Group associated with these borrowings in 2010 was $1,091,000 compared to $1,077,000 in 2009. Defense cost related to matters disclosed in note 16 of the consolidated financial statements, was the most significant factor impacting the increase in general expenses.
The life insurance and property/casualty subsidiaries primarily invest in highly liquid investment grade debt and equity securities. At December 31, 2010, the company’s holdings in debt securities amounted to 76.1% of total investments and 60.9% of total assets. The following is a breakdown of the bond portfolio quality according to the nationally recognized rating organization equivalents of Standard and Poor’s:
A summary of debt and equity securities available-for-sale with unrealized losses as of December 31, 2010 along with related fair value, aggregated by length of time that the investments have been in a continuous unrealized loss position follows:
The amortized cost and aggregate fair value of debt securities at December 31, 2010, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The total return on investments consists of return of current interest and dividend payments (current yield components) plus realized and unrealized appreciation or depreciation in asset market values. Due to a second consecutive year of improving market values on fixed income investments coupled with a capital gain return of 12.6% on the equity portfolio, we had a 7.8% total return on investments. The total return consisted of a 4.8% return from current interest and dividend payments and a 3.0% total return from increases in market values of securities. The total return in 2010 was down compared to the 11.5% total return experienced in 2009 primarily due to an overall more stable market in 2010. The results for 2009 were significantly impacted by improvements in the corporate and mortgage backed security market from the meltdown experienced in 2008.
Due to regulatory restrictions, the majority of the Company’s cash is required to be invested in investment-grade securities to provide ample protection for policyholders. The liabilities of the property and casualty insurance subsidiaries are of various terms and, therefore, those subsidiaries invest in securities with various effective maturities spread over periods usually not exceeding 10 years. The liabilities of the life insurance subsidiary are typically of a longer duration, and therefore, a higher percentage of securities in the life insurance subsidiary are invested for periods exceeding 10 years.
The National Security Group’s consolidated statement of cash flows indicates that cash flow provided from operating activities was $2,793,000 in 2010 compared to $8,723,000 in 2009. Cash flows from operating activities were negatively impacted by declines in underwriting performance for both the P&C and Life subsidiaries. Specifically, losses from the homeowners and auto lines of business were the most significant factors contributing to the decline in underwriting performance. During 2009, net cash provided by operating activities was positively impacted by recoveries of reinsurance receivables arising from losses stemming from Hurricanes Gustav and Ike which occurred during 2008. An improvement in underwriting results in our property and casualty insurance operations in 2009, largely related to no hurricane activity, was the primary source of operating cash flow in 2009. In a typical year, cash flow from operating activities and cash flow from investing activities tend to have an inverse relationship. In 2010, a decline in underwriting profits decreased cash from operations resulting in a reduction in the cash available to invest, $4,931,000 in 2010 compared to $5,587,000 in 2009. In 2009, improved underwriting results in the property and casualty subsidiaries increased cash from operations. This increased cash from operations was then used to increase investments leading to a net increase in cash used in investing activities.
The following table reflects the anticipated cash flows associated with our short- and long-term contractual obligations as of December 31, 2010:
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 consists of readily marketable securities, which can be sold for cash.
Except as discussed above and in Note 16 to the consolidated financial statements, the Company is aware of no known trends, events, or uncertainties reasonably likely to have a material effect on its liquidity, capital resources, or operations. Additionally, the Company has not been made aware of any recommendations of regulatory authorities, which if implemented, would have such an effect.
The ratios of Total Adjusted Capital to Authorized Control Level RBC for The National Security Group’s life/health and property/casualty insurance subsidiaries are all in excess of 4.0 to 1 at December 31, 2010.
National Security Insurance Company (life insurer) has regulatory adjusted capital of $11.0 million and $9.6 million at December 31, 2010 and 2009, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 12.4 and 12.2 at December 31, 2010 and 2009, respectively. Accordingly, National Security Insurance Company exceeds the minimum RBC requirements.
National Security Fire & Casualty Company (property/casualty insurer) has regulatory adjusted capital of $30.5 million and $28.7 million at December 31, 2010 and 2009, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 5.1 and 4.6 at December 31, 2010 and 2009, respectively. Accordingly, National Security Fire & Casualty Company exceeds the minimum RBC requirements.
Risk management involves ceding risks to reinsurers for policies underwritten based on contractual agreements. The reinsurance purchased helps provide protection by individual loss or catastrophic event when claims exceed specified amounts. Although the reinsurance protects our company in the event a loss penetrates into a particular reinsurance agreement; ultimate responsibility for claim settlement rests with our company if any reinsurer defaults on payments due. We record an asset for reinsurance recoverable on the financials for amounts due from reinsurers and monitor the balances due by reinsurer to ensure the asset is ultimately going to be collectible. If we discover an amount due may not be received, we remove the balance and charge it to an allowance for doubtful accounts or charge it off to expense based on the information available at the time.
NSFC and Omega generally reinsure with third parties any liability in excess of $225,000 on any single policy. In addition, the property and casualty segment holds a catastrophe contract which covers losses related to a catastrophic event with multiple policyholders affected. In the event a catastrophe exceeds the $3.5 million retention stated in the contract, reinsurers will reimburse the company 95% (5% co-pay) of gross losses and loss adjustment expenses paid up to $ 17.5 million (layer one and layer two of the contract). If losses exceed $ 17.5 million, the contract allows for 100% reimbursement of losses and loss adjustment expenses up to $72.5 million. Any losses above the $72.5 million upper limit are the responsibility of our company. The contract in place during 2010 also allowed one reinstatement for coverage under the contract for a second catastrophic event if needed. The contract provided 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.
At December 31, 2010, the estimated reinsurance recoverable recorded was $1,699,000 compared to $784,000 for the same period last year. The Company does not anticipate any issues with collection of the recorded amount. In 2010, catastrophe reinsurance premiums totaled $5,876,000 ceded compared to $6,193,000 in 2009. Catastrophe reinsurance premiums are based on a premium calculation applying the agreed upon rate to the earned premium of the covered lines of business. The reduction in ceded premium in 2010 is attributable to a 3.2% decline in the premium base and a 1.9% decline in the rate applied.
At December 31, 2010 and 2009, the Company recorded $10,189,000 and $10,210,000, respectively, as an asset for DAC in the 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.
The Company uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Company’s assets and liabilities and operating loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or are settled. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period the new rate is enacted.
The Company evaluates all tax positions taken on its U.S. federal income tax return. No material uncertainties exist for any tax positions taken by the Company
At December 31, 2010 and 2009, the recorded liability for loss and loss and adjustment expense was $13,184,000 and $12,646,000, respectively, a $538,000 increase. Claim activity from fire related losses in the dwelling fire and homeowners lines of business during 2010 combined with increased automobile claims were the primary factors contributing to the increase. 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 10 to our financial statements.
Liabilities for loss contingencies arising from, but not limited to, litigation, claims, assessments, fines and penalties are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Additional details with respect to contingencies are disclosed in Note 16 to the accompanying Consolidated Financial Statements.
Effective for 2010, the FASB revised GAAP guidance related to fair value measurement to require additional disclosures and to clarify certain existing disclosure requirements. The guidance is intended to improve the disclosures and increase transparency in financial reporting. We adopted the revised guidance on January 1, 2010 except for disclosures related to purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for 2011; adoption of this accounting standard had no effect on our results of operations or financial position.
In February 2010 the FASB issued amended guidance on disclosure of subsequent events that was effective immediately. The guidance eliminates the requirement for an SEC filer to disclose the date through which it has evaluated subsequent events. Adoption of this accounting standard had no effect on our results of operations or financial position.
Effective for 2010, the FASB revised guidance which changes how a reporting entity determines whether or not to consolidate its interest in an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights. The determination of whether a reporting entity is required to consolidate another entity will now be based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. The revised guidance also requires the reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. Adoption of this accounting standard had no effect on our results of operations or financial position.
Effective for fiscal years beginning after December 15, 2011, the FASB revised guidance regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The guidance permits deferral of qualifying costs associated only with successful contract acquisitions. The portion of internal selling agent and underwriter salary and benefit costs allocated to unsuccessful contracts, as well as advertising costs, are excluded. The guidance should be applied prospectively, but may be applied retrospectively for all prior periods. We do not expect the adoption of this guidance to have a material effect on our results of operations or financial position.
We have audited the accompanying consolidated balance sheets of The National Security Group, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement and financial statement schedules presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The National Security Group, Inc. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedules listed in the accompanying index appearing under Item 8, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
it is more likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis
When an equity security has a decline in value, where fair value is below cost, that is deemed to be other than temporary, the Company reduces the book value of the security to its current fair value, recognizing the decline as a realized loss in the statement of operations. Any future increases in the market value of investments written down are reflected as changes in unrealized gains as part of accumulated other comprehensive income within shareholders’ equity.
The Company owns 21 life insurance contracts on certain management and supervisory employees each having a face amount of approximately $2,000,000. The Company’s original investment in company owned life insurance was $5,000,000. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. The Company is the owner and principal beneficiary of these policies. The life insurance contracts are carried at their current cash surrender value. Cash surrender value at December 31, 2010 and 2009 was $5,520,000 and $5,197,000, respectively. Changes in cash surrender values are included in income in the current period. The change in surrender value included in earnings for the periods ended December 31, 2010 and 2009 was $323,000 and $740,000, respectively. Death proceeds from the contracts are recorded when the proceeds become payable under the terms of the policy.There were no proceeds received from the COLI during 2010 or 2009.
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 results 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 3-8 years for electronic data processing equipment and 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 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 loss 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 loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in the period in which they are determined.
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 2,466,600 in both 2010 and 2009.
In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. In 2010, NSFC maintained a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.
All significant reinsurers under the program carry A.M. Best ratings of A- (Excellent) or higher.
The Company expenses advertising costs as incurred. Advertising costs charged to expense were $113,000 for the year ended December 31, 2010 ($109,000 for the year ended December 31, 2009). Advertising cost consists primarily of agent convention expense and print media.
Effective for 2010, the FASB revised guidance that requires additional disclosure regarding transfers of financial assets, including securitization transactions, where entities have continuing exposure to risks related to the transferred financial assets. Adoption of this accounting standard had no effect on our results of operations or financial position.
During 2010 the FASB issued new guidance, effective for 2011, that requires entities to disclose detailed information regarding the credit quality of financing receivables, including credit risk exposures and the allowance for credit losses. do not expect the adoption of this guidance to have any impact on our results of operations or financial position.
In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 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 $3,093,000 unsecured junior subordinated deferrable interest debentures. 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 $2,995,000. 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 9, are reported in the accompanying Consolidated Balance Sheets as a component of long-term debt. The Company’s equity investments in the Trust total $93,000 and are included in Other Assets in the accompanying consolidated balance sheets.
A summary of securities available-for-sale with unrealized losses as of December 31, 2010 and 2009 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:
For 2010, gross gains of $2,016,000 ($1,102,000 for 2009) and gross losses of $247,000 ($319,000 for 2009) were realized on sales of available-for-sale-securities.
A summary of securities held-to-maturity with unrealized losses as of December 31, 2010 and 2009 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:
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Marketable debt instruments in this category generally include asset-backed securities and certain of our floating-rate notes, corporate bonds, and municipal bonds.
For the year ended December 31, 2010, there were no assets or liabilities measured at fair values on a nonrecurring basis.
The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2009:
For the year ended December 31, 2009, there were no assets or liabilities measured at fair values on a nonrecurring basis.
The aggregate balance in this account, $2,520,000 at December 31, 2010, would be taxed at current rates only if distributed to shareholders or if the account exceeded a prescribed minimum. The Deficit Reduction Act of 1984 eliminated additions to policyholders' surplus for 1984 and thereafter. Deferred taxes have not been provided on amounts designated as policyholders' surplus. The deferred income tax liability not recognized is approximately $857,000 at December 31, 2010.
Notes payable -term debt consisted of the following as of December 31, 2010 and 2009:
Long-term debt consisted of the following as of December 31, 2010 and December 31, 2009:
On September 13, 2007, the Company entered into a 5 year swap effective September 17, 2007 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 on June 21, 2007. Commencing December 17, 2007, under the terms of the swap, the Company will pay interest at the three-month LIBOR rate plus 3.4% and receive interest at the fixed rate of 8.34%.
The swaps entered into in 2007, 2009 and 2010 have fair values of $200,000 (liability), $3,000 (liability) and $24,000 (liability), respectively, for a net liability of $227,000 at December 31, 2010 ($60,000 at December 21, 2009). The swap liability is reported as a component of other liabilities on the consolidated balance sheets. A net valuation loss of $90,000 is included in accumulated other comprehensive income related to the swap agreements for the current period. A net valuation gain of $256,000 was included in accumulated other comprehensive income related to the swap at December 31, 2009.
In December of 2010, the Company renewed an unsecured line of credit for $700,000, with an interest rate of 5%, to be made available for general corporate purposes. The Company had drawn $500,000 on this line at December 31, 2010 while no funds were drawn at December 31, 2009.
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, 2010, the Company’s estimate of unpaid losses and adjustment expenses for hurricane related claims incurred in prior years totaled $1,320,000 before reinsurance ($787,000 in 2009). Because the Company has exhausted its catastrophe coverage limits available for Hurricane Katrina any additional development will not be covered by reinsurance. The Company maintains case reserves of $254,000 for losses in excess of catastrophe reinsurance ($519,000 in 2009).
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.
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, 2010, NSIC’s retained earnings unrestricted for the payment of dividends in 2011 amounted to $1,002,000.
Under applicable Alabama insurance laws and regulations, Omega is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $500,000.
The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share. In the event of any liquidation, dissolution or distribution of the assets of the Company remaining after the payments to the holders of the Preferred Stock of the full preferential amounts to which they may be entitled as provided in the resolution or resolutions creating any series thereof, the remaining assets of the Company shall be divided and distributed among the holders of both classes of common stock, except as may otherwise be provided in any such resolution or resolutions.
The Company and its subsidiaries operate primarily in the insurance industry. Selected balance sheet information by industry segment for the years ended December 31, 2010 and 2009 is summarized below:
Premium revenues and operating income by industry segment for the years ended December 31, 2010 and 2009 are summarized below:
The Company has been sued in a putative class action in the State of Alabama. The Plaintiff alleges entitlement to, but did not receive, payment for general contractor overhead and profit (“GCOP”) in the proceeds received from the Company concerning the repair of the Plaintiff’s home. Plaintiff alleges that said failure to include GCOP is a material breach by the
Under the terms of the Stock Purchase Agreement, the Purchaser paid the Company $2,700,000 for 45% of the total outstanding stock of Mobile Attic and paid the other Sellers $960,000 for an additional 16% of the total outstanding stock in Mobile Attic, thus obtaining a controlling interest of 61% of the outstanding stock. The Stock Purchase Agreement also required the Purchaser as a condition to the transaction to cause the Company to be released from its guaranty of a bank loan to Mobile Attic having an outstanding principal balance of approximately $9,400,000. The bank loan was secured by portable storage containers of Mobile Attic. The Sellers made certain warranties to the Purchaser in the Stock Purchase Agreement regarding the financial condition of Mobile Attic and agreed to jointly and severally indemnify the Purchaser for any damages resulting from a breach of any of the warranties.
On July 9, 2009, the Company filed a complaint in intervention requesting the Court to find that the Company is not liable for indemnity under the Stock Purchase Agreement, or in the alternative, to award damages to the Company for any loss suffered as a result of the fraudulent actions of Peter Cash and as a result of the negligence of Mobile Attic and its auditors in the preparation of Mobile Attic's financial statements. [Mobile Attic, Inc., MA Manufacturing Company, Inc. and Bagley Family Revocable Trust, plaintiffs, v. Peter L. Cash, Cash Brothers Leasing, Inc., Bridgeville Trailers, Inc., and Barfield, Murphy, Shank & Smith, P.C, defendants, v. The National Security Group, Inc., intervenor plaintiff, v. Peter L. Cash, Barfield, Murphy, Shank & Smith, P.C. and Bagley Family Revocable Trust, intervenor defendants, U.S. District Court, Middle District of Alabama, Eastern Division, Civil Action No. 09-cv-00024.]
The Company has denied the allegations supporting Purchaser's claims. The financial records of Mobile Attic have been in the possession of Purchaser since Purchaser acquired the stock of Mobile Attic in early 2007 and are only available to the Company through discovery in the litigation. The Company is actively conducting discovery in defense of Purchaser's claims and has requested Purchaser to provide the financial information supporting the allegations made in its complaint. Discovery has not been completed at this time. The Company believes that the Purchaser's claim for damages is unreasonable and excessive even if the Purchaser is able to prove the alleged misrepresentations in Mobile Attic's financial statements. Given the difficulty in obtaining access to the Mobile Attic financial records and the fact that discovery is ongoing, the Company is unable to predict the amount of the ultimate liability that the Company may have if the Purchaser is successful in this litigation. Management has recorded an estimate of aggregate litigation related expenses related to these actions as of December 31, 2010 and the amounts are included in other liabilities in the accompanying consolidated financial statements.
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.