The National Security Group, Inc. is made up of two segments: the Life segment and the P&C segment. 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. The Company's property and casualty insurance business
The National Security Group operates in the property and casualty and life, accident and supplemental health insurance businesses and markets products primarily through independent agents. The Company operates in ten states with 49.0% of total premium revenue generated in the states of Alabama and Mississippi. Property and casualty insurance is the most significant segment, accounting for 90.3% of gross earned premium revenue in 2015. Revenue generated from the life segment accounted for 9.7% of gross insurance premium revenue in 2015.
For the year ended December 31, 2015, net income for the Company totaled $4,697,000 or $1.87 per share, compared to net income of $7,616,000, $3.04 per share, for the year ended December 31, 2014, a year over year decrease of $2,919,000. Results for 2014 were positively impacted by a gain on company owned life insurance (COLI) of $3,256,000. No COLI gain was realized in 2015. However, when comparing pretax income from operations, which excludes realized capital gains and gain on COLI (both of which can fluctuate significantly from period to period) along with income taxes, our 2015 results were comparable to our results from 2014. Pretax income from operations in 2015 totaled $5,844,000 compared to $6,019,000 in 2014. Pretax income from operations declined only $175,000 in 2015 despite a $2,724,000 year over year increase in catastrophe losses. Offsetting the increase in catastrophe claims was a 5% increase in net premium earned, driven by our P&C subsidiary, coupled with an 8.5% reduction in general and administrative expenses driven by cost reduction efforts in our life subsidiary.
For the year ended December 31, 2015, the Company had net income of $4,697,000, $1.87 per share, compared to net income of $7,616,000, $3.04 per share, for the same period in 2014, a decrease of $2,919,000. The primary reason for the decline in 2015 year to date earnings compared to 2014 was a $3,256,000 gain on company owned life insurance realized during 2014.
For the year ended December 31, 2015, pretax income from operations was $5,844,000 compared to $6,019,000 for the year ended December 31, 2014, a decrease of $175,000. The primary reason for the slight decline in pretax income from operations in 2015 compared to 2014 was an increase in catastrophe related claims in the P&C segment. The P&C segment was impacted by numerous non-hurricane catastrophe events in 2015, the most significant of which was an early October event in South Carolina which generated $1,575,000 in incurred catastrophe losses. In total, catastrophe losses increased policyholder benefits and settlements expenses by $5,373,000 in 2015. The P&C segment ended 2015 with a combined ratio of 91% with catastrophe losses contributing 10.1 percentage points to the combined ratio. In comparison, 2014 cat events added $2,629,000 to prior year policyholder benefits and settlement expenses. The P&C segment ended 2014 with a combined ratio of 87.4% with catastrophe losses contributing 5.2 percentage points to the combined ratio. Offsetting the negative impact of the cat events was an $865,000 decrease in catastrophe reinsurance cost coupled with a 3.6% increase in P&C segment gross earned premiums. Also, due to continued focus on cost reduction measures, we decreased general and administrative expenses by $800,000, primarily in the life insurance subsidiary.
Overview - Balance Sheet highlights at December 31, 2015 compared to December 31, 2014
Invested assets as of December 31, 2015 were $112,557,000 up $3,008,000, or 2.7%, compared to December 31, 2014. The increase in invested assets was primarily due to $6,880,000 in cash flow from operating activities enabling additional investment in the fixed income investment portfolio.
The Company, primarily through its insurance subsidiaries, had $6,763,000 in cash and cash equivalents at December 31, 2015, compared to $6,426,000 at December 31, 2014. Positive cash flow from insurance operations was the primary contributor to the increase in cash for the year ended December 31, 2015.
Total assets as of December 31, 2015 were $148,099,000 compared to $144,865,000 at December 31, 2014. Positive cash flow from operations of $6,880,000, primarily generated by the P&C subsidiaries, was the primary contributor to the increase in invested assets and total assets at December 31, 2015.
Shareholders' equity as of December 31, 2015 was $44,883,000 up $2,126,000 compared to December 31, 2014 Shareholders' equity of $42,757,000. Book value per share was $17.87 at December 31, 2015, compared to $17.05 per share at December 31, 2014, an increase of $0.82. The primary factor contributing to the increase in Shareholders' equity was net income of $4,697,000. In addition, shares issued to directors during 2015 totaled $78,000. Offsetting the increase in Shareholders' equity was a decrease in accumulated other comprehensive income of $2,247,000 and dividends paid of $402,000. The decline in accumulated other comprehensive income was primarily driven by interest rate related decreases in market values of available for sale investment securities primarily in our fixed income portfolio.
NSIC ended 2015 with net realized investment gains of $313,000 compared to $455,000 for the same period in 2014. Realized investment gains are highly dependent on several factors including market conditions, tax position and liquidity needs of the Company and can vary significantly from period to period. The primary source of realized investment gains in both 2015 and 2014, were gains from the sale of fixed income and equity investments.
General and administrative expenses were $1,525,000 in 2015 compared to $1,893,000 in 2014. Reduction of general and administrative expenses in NSIC has been a primary focus of management. Historically, general and administrative expenses in our life segment have run higher than industry averages due to the small size of the subsidiary. This disadvantage coupled with the persistent low interest rate environment has eroded earnings in the life segment. In the second half of 2014, management began the process of implementing significant operational changes that included the consolidation of P&C and life segment operations. This consolidation process is virtually complete and was the
For the year ended December 31, 2015, the life segment had pretax income of $887,000 compared to a pretax loss of $290,000 for the same period in 2014. The decrease in claims related expenses coupled with the reduction in general and administrative expenses were the primary contributors to the increase in pretax income.
Property and casualty operations constitute our largest segment composing 89.4% and 88.7% of our total consolidated premium revenue in 2015 and 2014, respectively. Premium revenues and operating income for the P&C segment for the year ended December 31, 2015 and 2014 are summarized below:
A reduction in catastrophe reinsurance cost (ceded premium) of 11.4% also contributed significantly to our 5.7% increase in net premium earned.
Net investment income totaled $1,473,000 in 2015 compared to $1,737,000 in 2014; a decrease of $264,000. The primary reason for the decrease in net investment income in 2015 compared to 2014 was the change in value of our company owned life insurance (COLI). The change in value of the COLI decreased investment income $219,000 in 2015 compared to an increase to investment income of $68,000 for the same period last year. Persistent low investment yields also continue to hamper growth in investment income.
The P&C segment ended 2015 with realized capital gains of $190,000 compared to a realized capital loss totaling$356,000 for the same period in 2014. The realized capital gains were primarily from sales of fixed income investments. The primary reason for the realized capital loss in 2014 was a $552,000 write-down associated with a real estate investment. The realization of capital gains in the investment portfolio is influenced by both market conditions and liquidity requirements and therefore can vary significantly from year to year. Other activities, such as tax planning strategies, may also lead to significant variation in realized capital gains from year to year. The P&C segment was not impacted by the write-down of other-than-temporary impairments of fixed income or equity investments in 2015 or 2014.
Gain on company owned life insurance consists of proceeds in excess of cash surrender value on life insurance contracts. The Company owns life insurance (COLI) contracts on certain management and supervisory employees each having a face amount of approximately $2,000,000 (including accumulated cash surrender value). The Company's original investment in company owned life insurance was $5,000,000 made in 2006 and 2007. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies with cash values ultimately returned tax free in the form of death benefits. The Company pays all premium and is the owner
and principal beneficiary of these policies. The life insurance contracts are carried on the Consolidated Balance Sheet at their cash surrender value on the balance sheet date. Cash surrender value at December 31, 2015 and December 31, 2014 was $4,898,000 and $5,513,000, 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, 2015 and 2014 were a decline of $219,000 and an increase of $68,000, respectively. Death proceeds from the contracts are recorded when the proceeds become payable under the terms of the policy and proceeds in excess of cash surrender value are recognized as a gain on company owned life insurance. There were no gains on COLI recognized in income in 2015. Gains on COLI in excess of cash surrender value of $3,256,000 were recognized in income in 2014.
The table below provides a recap of P&C segment gross reported losses and LAE by catastrophe event and non-catastrophe wind and hail losses and LAE for the year ended December 31, 2015 and 2014 (dollars in thousands):
During 2015, the P&C segment was impacted by 22 catastrophe events totaling $5,373,000 from 1,789 claims compared to reported losses and LAE from seven cat events totaling $2,628,000 from 842 claims in 2014. Claims reported from year to date 2015 cat events contributed 10.1 percentage points to the 2015 P&C segment loss ratio. In comparison, claims reported during 2014 from prior year cat events also contributed 5.2 percentage points to the year to date 2014 P&C segment loss ratio. The frequency of cat events was significantly higher in the current year leading to a 104.4% increase in total reported losses and LAE from cat events in 2015 compared to 2014. Claim counts from cat events were 1,789 in 2015 compared to 842 in 2014, an increase of 947 reported claims. Also, since each catastrophe event was less than our $4 million retention under our catastrophe reinsurance agreement, no catastrophe losses were covered by reinsurance in either 2015 or 2014.
Non-catastrophe wind and hail claims reported in 2015 totaled $5,615,000 compared to non-catastrophe wind and hail claims reported in 2014 totaling $5,902,000; a decline of $287,000 or 4.9%. During 2015, the P&C segment had 1,923 non-cat wind and hail claims reported (an average of $2,900 per claim) compared to 2,062 claims reported during 2014 (an average of $2,900 per claim). Non-catastrophe wind and hail claims reported during 2015 accounted for 19.1% of total P&C segment incurred losses and LAE in the current year. Non-catastrophe wind and hail claims reported during 2014 accounted for 23.2% of total P&C segment incurred losses and LAE in 2014.
Deferred policy acquisition costs totaled $2,701,000 in 2015 compared to $2,565,000 in 2014. Deferred policy acquisition costs were comparable at 5.1% of earned premium revenue for 2015 and 2014. Deferred policy acquisition costs consist of amortization of previously capitalized distribution costs, primarily commissions.
The P&C segment ended 2015 with pretax income of $7,070,000 compared to pretax income of $11,527,000 for the same period in 2014. The $4,457,000 decrease in pretax income was primarily due to the company owned life insurance benefit received in 2014 that was not received in 2015. In addition, the significant increase in claims from cat events in 2015 compared to 2014 also contributed to the reduction in pretax income between years.
The results of these ratios for the past two years were as follows:
The non-insurance operations of the Company consist of our parent company, The National Security Group, Inc. (NSG). The National Security Group has no material sources of revenue and relies on dividends and management service fees from our insurance subsidiaries to pay expenses. Dividends from subsidiaries are subject to insurance department approval and are subject to statutory restrictions. Subsidiary dividends are eliminated upon consolidation of the subsidiaries in the audited financial statements included herein. Revenues and expense for non-insurance operations for the year ended December 31, 2015 and 2014 are summarized below (amounts in thousands):
At December 31, 2015, the Company's holdings in debt securities amounted to 83.7% of total investments and 63.6% of total assets. The Company utilizes the ratings of various Nationally Recognized Statistical Rating Organizations when classifying fixed maturity investments by quality rating.
At December 31, 2015, 3.32% of total investments in the fixed income portfolio were classified as below investment grade. In evaluating whether or not the equity loss positions were other-than-temporary impairments, management evaluated financial information on each company and, where available, reviewed analyst reports from at least two independent sources. Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments. Management has evaluated each security in a significant unrealized loss position. For the year ended December 31, 2015, the Company realized no other-than-temporary impairments related to fixed maturities or equity securities.
The total return on investments in 2015 decreased significantly compared to 2014. As discussed in the preceding paragraphs of this section on investments, most of this decrease in total return was driven by a combination of interest rate driven declines in fixed income investments and declines in market value of our energy sector bond holdings. Approximately 6% of our fixed income investments consist of bonds in the energy sector. We have evaluated each of these securities for potential impairment and, based on currently available information, believe that none of these securities are other than temporarily impaired. Our energy sector portfolio is diversified with our single largest bond holding in the sector having a par value of $1,000,000, composing less than 1% of our total investments. We currently have no fixed income investments in default.
It should be noted that the above table represents maturities based on stated/contractual maturity. Due to call and prepayment features inherent in some debt securities and principal pay-downs on mortgage backed securities, actual repayment, or effective maturities, will differ from stated maturities. The Company routinely evaluates the impact of changing interest rates on the projected maturities of bonds in the portfolio and actively manages the portfolio in order to minimize the impact of interest rate risk. However, due to other factors, both regulatory and those associated with good investment management practices associated with asset/liability matching, we do have exposure to changes in market values of securities due to changes in interest rates. Currently, a 100 basis point immediate increase in interest rates would generate approximately a $5,247,000, or 5.7%, decline in the market value of fixed income investments. Alternatively, a 100 basis point decrease in interest rates will generate approximately $4,831,000, or 5.3%, in increases in market value of fixed income investments. Management has attempted, to the extent possible, to reduce risk in a rising rate environment. However, due to asset liability matching requirements, particularly in the life subsidiary portfolio, interest rate risk can not be eliminated.
At December 31, 2015, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $44,883,000, up $2,126,000 compared to $42,757,000 at December 31, 2014. Components of the change in equity were net income of $4,697,000, decrease in accumulated unrealized gains on investments of $2,128,000, a net unrealized loss of $119,000 related to interest rate swaps and cash dividends paid totaling $402,000. Also contributing to the change in equity were 4,000 shares of common stock issued to directors as compensation under the 2009 Equity Incentive Plan previously approved by shareholders and an associated $74,000 increase in additional paid in capital.
While the increase in interest rates causes near term declines in the value of fixed income securities, we are able to reap the benefit of reinvesting at higher rates as current fixed income investments are called, amortized (mortgage backed securities) or reach contractual maturity. Over the next twelve months, based on cash flow projection modeling that considers such factors as anticipated principal payments on mortgage backed securities, likelihood of call provisions being enacted and regular contractual maturities, we expect approximately 5.5% of our current fixed income portfolio to be reinvested or otherwise available to meet Company obligations.
Net cash used in financing activities totaled $1,708,000 for the period ended December 31, 2015, compared to $3,420,000 for the same period last year. During the year ended December 31, 2015, the Company repaid a $500,000 long-term note payable and a $700,000 short-term note payable. As of December 31, 2015, a total of $5,143,000 remained outstanding on the note associated with the Mobile Attic settlement with the next installment due in November of 2016. This installment is $857,000 and is included in short-term notes payable. The Company maintains a $1,000,000 operating line of credit which matures in September 2017, as well as a $700,000 line of credit which was renewed in February of 2016, $1,000,000 of which was available at December 31, 2015.
In estimating the time interval for payment of property and casualty claim reserves, the Company utilized historical payment patterns. By the nature of the insurance contracts under which these liabilities exist, there can be no certainty that actual payments will fall in the periods indicated above. However, management believes that current liquidity and capital resources are sufficient to pay these obligations as they come due. Also, due to the relatively short-tail nature of the majority of the Company's property and casualty claim liabilities, management can conclude with a reasonable level of confidence that historical patterns indicate that approximately 75% of claim liabilities at the end of a given year are settled within the following two year period.
Our P&C segment is the primary source of dividends to the holding company. Due to a combination of growth opportunities and continued risk of capital exposure to weather related events, management is maintaining a conservative stance with regard to paying of dividends to the holding company. While we have made significant progress over the past three years, strengthening capital levels in the insurance subsidiaries and reduction of debt remains a priority.
Omega One Insurance Company (property/casualty insurer), which began writing business in late 1995, has regulatory adjusted capital of $10.7 million and $9.9 million at December 31, 2015 and 2014, respectively, and a ratio of regulatory total adjusted capital to authorized control level RBC of 37.8 and 36.1 at December 31, 2015 and 2014, respectively. Accordingly, Omega One Insurance 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 some of the more critical judgment areas in regards to the application of our accounting policies and their effect on our financial condition and results of operations.
At December 31, 2015 and 2014, the Company recorded $8,485,000 and $8,592,000, respectively, as an asset for DAC in the Consolidated Financial Statements. We do not foresee any issues related to recoverability of these capitalized costs. For more information regarding deferred policy acquisition costs, see Note 1 to our Consolidated Financial Statements.
At December 31, 2015, there is no evidence to suggest to management that any deferred tax asset is unrealizable. For more information regarding deferred income taxes, see Note 7 to our Consolidated Financial Statements.