PROPERTIES. - ------- ----------- The Company does not own any real property; however, one of the property and casualty insurance subsidiaries, Dakota Fire, leases from EMC National Life Company (an affiliate of Employers Mutual) approximately 18,000 square feet of office space in which the Bismarck, North Dakota branch office is located. The Company's home office, which also serves as the home office of Employers Mutual, is located in three office buildings containing approximately 437,000 square feet of space in Des Moines, Iowa, all of which are owned by Employers Mutual. Employers Mutual also owns office buildings in which the Minneapolis, Milwaukee and Lansing branch offices operate. Employers Mutual leases approximately 208,000 square feet of office space in 16 other locations where other branch offices and service centers are located. Hamilton Mutual Insurance Company leases a property in Cincinnati, Ohio that serves as a branch office.
EMC Insurance Group Inc., a 53.7 percent owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance and reinsurance. Property and casualty insurance is the most significant segment, representing 72.4 percent of consolidated premiums earned in 2004. For purposes of this discussion, the term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries (including the Company) and an affiliate are referred to as the "EMC Insurance Companies."
Direct Premiums Written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten and issued by the Company's property and casualty insurance subsidiaries. These direct premiums written are transferred to Employers Mutual under the terms of the pooling agreement and are reflected in the Company's consolidated financial statements as premiums written ceded to affiliates. See note 3 of Notes to Consolidated Financial Statements.
Open claims, 12/31/02 ... 306 6 1,080 Reported in 2002 ........ 123 - 781 Disposed of in 2002 ..... 83 3 260
Combined ratio ........................... 104.9% 100.2% 101.9% ======== ======== ======== Losses and settlement expenses: Insured events of current year ....... $229,668 $219,029 $200,060 Increase in provision for insured events of prior years .............. 20,138 7,476 6,998 -------- -------- -------- Total losses and settlement expenses ....................... $249,806 $226,505 $207,058 ======== ======== ======== Catastrophe and storm losses ............. $ 18,492 $ 20,942 $ 8,304 ======== ======== ========
The loss and settlement expense ratio for the reinsurance segment decreased to 55.9 percent in 2004 from 65.2 percent in 2003, despite an increase in catastrophe and storm losses. The decline in the 2004 ratio reflects a decrease in the ratio of reported losses to premiums earned for 2004 policy year business, an increase in favorable development on prior years' reserves and continued improvement in overall premium rate adequacy. The favorable development experienced in 2004 is attributed to reported policy year 2003 losses for property, casualty and multi-line classes that are below 2003 implicit projections. Catastrophe and storm losses for 2004 include $4,830,000 associated with the four hurricanes that hit the Southern United States in August and September. The reinsurance segment had exposure to all four hurricanes and reached its $1,500,000 cap on losses assumed per occurrence on three of them. During 2003, two events (Midwest storms in the month of May and Hurricane Isabel) reached the $1,500,000 cap.
For the property and casualty insurance segment, the acquisition expense ratio increased to 34.3 percent in 2004 from 33.4 percent in 2003. The rise in this ratio is primarily attributed to an increase in contingent commission expense from the Company's agent profit share program and an increase in policyholder dividend expense. The Company will be implementing a new agent profit share program, which is designed to better equate agent compensation with the quality and quantity of the insurance business produced, effective January 1, 2005. Under the new program, the Company's best performing agents will be rewarded with increased compensation while agents with marginal business will experience a decline in compensation. Total profit share expense under the new program is expected to decline slightly. The increase in contingent commission expense was partially offset by $387,000 of ceded contingent commission income recognized in the fourth quarter of 2004 related to a no-claims bonus on the terrorism reinsurance contract for years 2003 and 2004.
Employers Mutual receives all premiums and pays all losses and expenses associated with the assumed reinsurance business ceded to the reinsurance subsidiary and the insurance business produced by the pool participants, and then settles the inter-company balances generated by these transactions with the participating companies on a quarterly basis. When settling the inter- company balances, Employers Mutual provides the reinsurance subsidiary and the pool participants with full credit for the premiums written during the quarter and retains all receivable amounts. Any receivable amounts that are ultimately deemed to be uncollectible are charged-off by Employers Mutual and the expense is charged to the reinsurance subsidiary or allocated to the pool members on the basis of pool participation. As a result, the Company has an off-balance sheet arrangement with an unconsolidated entity that results in a credit-risk exposure that is not reflected in the Company's financial statements. Based on historical data, this credit-risk exposure is not considered to be material to the Company's results of operations or financial position.
At December 31, 2004, the Company had unrealized losses on held-to- maturity and available-for-sale securities as presented in the table below. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services. None of these securities are considered to be in concentrations by either security type or industry. The Company uses several factors to determine whether the carrying value of an individual security has been other-than-temporarily impaired. Such factors include, but are not limited to, the security's value and performance in the context of the overall markets, length of time and extent the security's fair value has been below carrying value, key corporate events and collateralization of fixed maturity securities. Based on these factors, and the Company's ability and intent to hold the fixed maturity securities until maturity, it was determined that the carrying value of these securities was not other-than-temporarily impaired at December 31, 2004. Risks and uncertainties inherent in the methodology utilized in this evaluation process include interest rate risk, equity price risk and the overall performance of the economy, all of which have the potential to adversely affect the value of the Company's investments. Should a determination be made at some point in the future that these unrealized losses are other-than-temporary, the Company's earnings would be reduced by approximately $288,000, net of tax; however, the Company's financial position would not be affected due to the fact that unrealized losses on available-for-sale securities are reflected in the Company's financial statements as a component of stockholders' equity, net of deferred taxes.
Estimated guaranty fund assessments of $1,207,000 and $1,253,000, which are used by states to pay claims of insolvent insurers domiciled in that state, have been accrued as of December 31, 2004 and 2003, respectively. The guaranty fund assessments are expected to be paid over the next two years with premium tax offsets of $1,544,000 expected to be realized within ten years of the payments. Estimated second injury fund assessments of $1,390,000 and $1,109,000, which are designed to encourage employers to employ a worker with a pre-existing disability, have been accrued as of December 31, 2004 and 2003, respectively. The second injury fund assessment accruals are based on projected loss payments. The periods over which the assessments will be paid is not known.
Ratings for preferred stocks and fixed maturity securities with initial maturities greater than one year are assigned by Moody's Investor's Services, Inc. Moody's rating process seeks to evaluate the quality of a security by examining the factors that affect returns to investors. Moody's ratings are based on quantitative and qualitative factors, as well as the economic, social and political environment in which the issuing entity exists. The quantitative factors include debt coverage, sales and income growth, cash flows and liquidity ratios. Qualitative factors include management quality, access to capital markets and the quality of earnings and balance sheet items. Ratings for securities with initial maturities less than one year are based on an evaluation of the underlying assets or the credit rating of the issuer's parent company.
The Audit Committee of the Board of Directors, composed solely of outside directors, met during the year with management and the independent auditors to review and discuss audit findings and other financial and accounting matters. The independent auditors and the internal auditors have free access to the Audit Committee, with and without management present, to discuss the results of their audit work.
Bruce G. Kelley Mark E. Reese President and Senior Vice President and Chief Executive Officer Chief Financial Officer
Year ended December 31, ---------------------------------------- 2004 2003 2002 ------------ ------------ ------------ Net income ......................... $ 13,184,683 $ 20,349,123 $ 16,101,738 ------------ ------------ ------------ OTHER COMPREHENSIVE INCOME Unrealized holding gains arising during the period, before deferred income tax expense ........................ 13,051,438 13,290,568 7,454,522 Deferred income tax expense ...... 4,568,003 4,651,699 2,609,079 ------------ ------------ ------------ 8,483,435 8,638,869 4,845,443 ------------ ------------ ------------
Effective April 1, 2003, the Company was included in Employers Mutual's consolidated tax return due to the fact that Employers Mutual attained 80 percent ownership of the Company at the end of March. The Company filed a short-period tax return with its subsidiaries for the period January 1, 2003 through March 31, 2003. During October 2004, Employers Mutual's ownership of the Company fell below 80 percent upon successful completion of the follow-on stock offering. Accordingly, the Company is no longer included in Employers Mutual's consolidated tax return effective October 1, 2004, and the Company will file a short-period tax return for the period October 1, 2004 through December 31, 2004. Consolidated income taxes/benefits are allocated among the entities based upon separate tax liabilities.
The weighted average fair value of options granted amounted to $4.44, $2.93 and $3.28 for 2004, 2003 and 2002, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model with the following weighted-average assumptions used for the grants:
Year ended December 31, ---------------------------------------- 2004 2003 2002 ------------ ------------ ------------ Gross reserves at beginning of year $373,782,916 $331,226,753 $314,518,588
For the reinsurance segment, the December 31, 2003 estimate of loss and settlement expense reserves for accident years 2002 and prior decreased $1,538,670 from the estimate at December 31, 2002. This decrease represents 1.5 percent of the December 31, 2002 carried reserves. This decrease is primarily from the 2002 accident year on the Home Office Reinsurance Assumed Department (HORAD) book of business, which has experienced very low reported loss activity. The favorable development was partially offset by $326,000 of asbestos reserve strengthening.
Underwriting gain (loss) .............. (32,261,993) 15,227,552 - (17,034,441) Net investment income 20,236,342 9,498,925 164,936 29,900,203 Realized gains ........ 3,270,862 1,108,452 - 4,379,314 Interest expense ...... 772,500 339,900 - 1,112,400 Other income .......... 600,732 - - 600,732 Other expenses ........ 495,783 - 666,628 1,162,411 ------------ ------------ ------------ -------------- Income (loss) before income tax expense (benefit) ......... $ (9,422,340)$ 25,495,029 $ (501,692)$ 15,570,997 ============ ============ ============ ==============
Temporary differences between the consolidated financial statement carrying amount and tax basis of assets and liabilities that give rise to significant portions of the deferred income tax asset at December 31, 2004 and 2003 are as follows: Year ended December 31, ------------------------- 2004 2003 ----------- ----------- Loss reserve discounting .......................... $18,864,562 $17,036,591 Unearned premium reserve limitation ............... 9,037,165 8,592,924 Postretirement benefits ........................... 3,007,951 2,671,261 Other policyholders' funds payable ................ 989,033 486,708 Net operating loss carry forward .................. 2,427,675 - Minimum tax credits ............................... 954,953 954,954 Other-than-temporary impairment losses on investments ..................................... - 1,337,513 Other, net ........................................ 1,135,774 1,311,318 ----------- ----------- Total deferred income tax asset ............. 36,417,113 32,391,269 ----------- ----------- Deferred policy acquisition costs ................. (9,779,204) (9,358,224) Net unrealized holding gains ...................... (15,038,403) (11,999,975) Other, net ........................................ (2,095,313) (687,641) ----------- ----------- Total deferred income tax liability ......... (26,912,920) (22,045,840) ----------- ----------- Net deferred income tax asset ............. $ 9,504,193 $10,345,429 =========== ===========
Year ended December 31, -------------------------------- 2004 2003 2002 -------- -------- -------- Shares available for purchase, beginning of year .................. 271,838 416,899 501,230 Shares purchased under plan .......... (63,018) (145,061) (84,331) -------- -------- -------- Shares available for purchase, end of year ........................ 208,820 271,838 416,899 ======== ======== ======== Range of purchase prices ............. $18.75 $16.98 $15.38 to to to $24.97 $21.32 $21.99
The estimated fair value of the Company's financial instruments is summarized below. Carrying Estimated amount fair value ------------ ------------ December 31, 2004 - ----------------- Assets: Fixed maturity securities: Held-to-maturity ............................ $ 29,205,871 $ 30,593,606 Available-for-sale .......................... 619,654,403 619,654,403 Equity securities available-for-sale .......... 78,692,893 78,692,893 Short-term investments ........................ 46,238,853 46,238,853 Other long-term investments ................... 5,550,093 5,550,093 Liabilities: Surplus notes ................................. 36,000,000 36,000,000
STOCKHOLDERS' EQUITY Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 13,568,945 shares in 2004 and 11,501,065 shares in 2003 ......... 13,568,945 11,501,065 Additional paid-in capital ...................... 103,467,293 69,113,228 Accumulated other comprehensive income .......... 27,928,463 22,285,668 Retained earnings ............................... 83,508,331 77,850,590 ------------ ------------ Total stockholders' equity ................. 228,473,032 180,750,551 ------------ ------------ Total liabilities and stockholders' equity $228,686,424 $180,961,286 ============ ============
Years ended December 31, ------------------------------------- 2004 2003 2002 ----------- ----------- ----------- Net cash provided by operating activities ................ $ 6,910,340 $ 6,691,273 $ 5,988,850 ----------- ----------- ----------- Cash flows from investing activities Maturities of fixed maturity securities available-for-sale ..... - 1,665,000 1,505,313 Purchases of fixed maturity securities available-for-sale ..... (1,500,000) (500,000) (1,694,104) Net sales (purchases) of short-term investments ...................... 505,560 (2,312,603) (467,269) Capital contribution to subsidiaries (34,890,085) - - ----------- ----------- ----------- Net cash used in investing activities .................... (35,884,525) (1,147,603) (656,060) ----------- ----------- -----------