10-Q 1 a201933110q.htm 10-Q Document

emcgrouplogoa05.jpg

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________to __________________ 
Commission File Number: 0-10956
EMC INSURANCE GROUP INC.
(Exact name of registrant as specified in its charter)
Iowa
 
42-6234555
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. employer identification no.)
717 Mulberry Street, Des Moines, Iowa
 
50309
(Address of principal executive offices)
 
(Zip code)
(515) 345-2902
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý  Yes    o  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý  Yes    o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
o
Large accelerated filer
ý
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
Emerging growth company
 
(Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o  Yes    ý  No



Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
Common Stock, Par Value $1.00
EMCI
The Nasdaq Global Select Market
(Title of class)
(Trading symbol)
(Name of each exchange on which registered)
As of April 30, 2019, there were 21,668,287 shares of common stock, $1.00 par value, issued and outstanding.



TABLE OF CONTENTS




PART I.
FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
March 31, 
 2019
 
December 31, 
 2018
($ in thousands, except share and per share amounts)
 
(Unaudited)
 

ASSETS
 
 
 
 
Investments:
 
 
 
 
Fixed maturity securities available-for-sale, at fair value (amortized cost $1,255,775 and $1,273,132)
 
$
1,291,860

 
$
1,282,909

Equity investments, at fair value (cost $167,632 and $160,371)
 
242,583

 
215,363

Equity investments, at alternative measurement of cost less impairments
 
1,200

 
1,200

Other long-term investments
 
18,099

 
19,316

Short-term investments
 
48,265

 
28,204

Total investments
 
1,602,007

 
1,546,992

 
 
 
 
 
Cash
 
232

 
337

Reinsurance receivables due from affiliate
 
35,767

 
37,361

Prepaid reinsurance premiums due from affiliate
 
7,530

 
8,789

Deferred policy acquisition costs (affiliated $47,422 and $44,440)
 
47,422

 
44,760

Amounts due from affiliate to settle inter-company transaction balances
 
11,905

 
5,154

Prepaid pension and postretirement benefits due from affiliate
 
17,355

 
17,691

Accrued investment income
 
11,713

 
10,468

Accounts receivable
 
1,038

 
1,658

Income taxes recoverable
 
2,465

 
6,697

Goodwill
 
942

 
942

Other assets (affiliated $3,678 and $4,510)
 
3,851

 
4,629

Total assets
 
$
1,742,227

 
$
1,685,478

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.

3


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
 
March 31, 
 2019
 
December 31, 
 2018
($ in thousands, except share and per share amounts)
 
(Unaudited)
 

LIABILITIES
 
 
 
 
Losses and settlement expenses (affiliated $774,644 and $771,872)
 
$
780,393

 
$
777,190

Unearned premiums (affiliated $271,127 and $267,064)
 
271,127

 
268,511

Other policyholders' funds (all affiliated)
 
8,326

 
8,807

Surplus notes payable to affiliate
 
25,000

 
25,000

Pension benefits payable to affiliate
 
3,738

 
4,070

Deferred income taxes
 
14,844

 
4,908

Other liabilities (affiliated $20,328 and $31,121)
 
22,465

 
31,210

Total liabilities
 
1,125,893

 
1,119,696

 
 
 
 
 
STOCKHOLDERS' EQUITY
 
 
 
 
Common stock, $1 par value, authorized 30,000,000 shares; issued and outstanding, 21,668,287 shares in 2019 and 21,615,105 shares in 2018
 
21,668

 
21,615

Additional paid-in capital
 
129,928

 
128,451

Accumulated other comprehensive income
 
22,090

 
1,620

Retained earnings
 
442,648

 
414,096

Total stockholders' equity
 
616,334

 
565,782

Total liabilities and stockholders' equity
 
$
1,742,227

 
$
1,685,478

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.


4


 
 
 
 
 
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

 
 
Three months ended March 31,
($ in thousands, except share and per share amounts)
 
2019
 
2018
REVENUES
 
 
 
 
Premiums earned (affiliated $166,747 and $154,246)
 
$
167,302

 
$
155,786

Net investment income
 
12,763

 
11,371

Net realized investment gains/losses and change in unrealized gains on equity investments
 
22,643

 
(5,393
)
Other income (affiliated $1,456 and $1,581)
 
1,535

 
1,615

Total revenues
 
204,243

 
163,379

 
 
 
 
 
LOSSES AND EXPENSES
 
 
 
 
Losses and settlement expenses (affiliated $102,691 and $110,570)
 
104,969

 
110,628

Dividends to policyholders (all affiliated)
 
2,771

 
2,120

Amortization of deferred policy acquisition costs (affiliated $29,892 and $26,917)
 
29,970

 
27,292

Other underwriting expenses (affiliated $22,715 and $22,920)
 
22,592

 
22,855

Interest expense (all affiliated)
 
171

 
142

Other expenses (affiliated $645 and $498)
 
1,485

 
870

Total losses and expenses
 
161,958

 
163,907

Income (loss) before income tax expense (benefit)
 
42,285

 
(528
)
 
 
 
 
 
INCOME TAX EXPENSE (BENEFIT)
 
 
 
 
Current
 
4,259

 
1,206

Deferred
 
4,495

 
(1,658
)
Total income tax expense (benefit)
 
8,754

 
(452
)
Net income (loss)
 
$
33,531

 
$
(76
)
 
 
 
 
 
Net income (loss) per common share - basic and diluted
 
$
1.55

 
$

 
 
 
 
 
Dividend per common share
 
$
0.23

 
$
0.22

 
 
 
 
 
Average number of common shares outstanding - basic and diluted
 
21,638,588

 
21,501,897

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.



5


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
 
 
 
 
 
Three months ended 
 March 31,
($ in thousands)
 
2019
 
2018
Net income (loss)
 
$
33,531

 
$
(76
)
 
 
 
 
 
OTHER COMPREHENSIVE INCOME (LOSS)
 
 
 
 
Unrealized holding gains (losses) on investment securities not reflected in net income, net of deferred income tax expense (benefit) of $5,468 and $(5,042)
 
20,568

 
(18,969
)
Reclassification adjustment for net realized investment losses included in net income, net of income tax benefit of $57 and $51
 
215

 
193

Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income, net of deferred income tax expense of $(84) and $(144):
 
 
 
 
Net actuarial loss
 
197

 
81

Prior service credit
 
(510
)
 
(622
)
Total reclassification adjustment associated with affiliate's pension and postretirement benefit plans
 
(313
)
 
(541
)
 
 
 
 
 
Other comprehensive income (loss)
 
20,470

 
(19,317
)
 
 
 
 
 
Total comprehensive income (loss)
 
$
54,001

 
$
(19,393
)
All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.


6


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)

($ in thousands, except per share amounts)
 
Common
stock
 
Additional
paid-in capital
 
Accumulated
other
comprehensive
income (loss)
 
Retained
earnings
 
Total
stockholders'
equity
Balance at December 31, 2018
 
$
21,615

 
$
128,451

 
$
1,620

 
$
414,096

 
$
565,782

Issuance of common stock through stock plans
 
73

 
2,078

 
 

 
 

 
2,151

Repurchase of common stock
 
(20
)
 
(623
)
 
 

 
 

 
(643
)
Increase resulting from stock-based compensation expense
 
 

 
22

 
 

 
 

 
22

Other comprehensive income (loss)
 
 

 
 

 
20,470

 
 

 
20,470

Net income (loss)
 
 

 
 

 
 

 
33,531

 
33,531

Dividends paid to public stockholders ($0.23 per share)
 
 

 
 

 
 

 
(2,271
)
 
(2,271
)
Dividends paid to affiliate ($0.23 per share)
 
 

 
 

 
 

 
(2,708
)
 
(2,708
)
Balance at March 31, 2019
 
$
21,668

 
$
129,928

 
$
22,090

 
$
442,648

 
$
616,334


($ in thousands, except per share amounts)
 
Common
stock
 
Additional
paid-in capital
 
Accumulated
other
comprehensive
income (loss)
 
Retained
earnings
 
Total
stockholders'
equity
Balance at December 31, 2017
 
$
21,455

 
$
124,556

 
$
83,384

 
$
374,451

 
$
603,846

Cumulative adjustment for adoption of financial instruments recognition and measurement changes
 
 
 
 
 
(66,234
)
 
66,234

 

Issuance of common stock through stock plans
 
94

 
2,304

 
 

 
 

 
2,398

Repurchase of common stock
 
(30
)
 
(772
)
 
 

 
 

 
(802
)
Increase resulting from stock-based compensation expense
 
 

 
18

 
 

 
 

 
18

Other comprehensive income (loss)
 
 

 
 

 
(19,317
)
 
 

 
(19,317
)
Net income (loss)
 
 

 
 

 
 

 
(76
)
 
(76
)
Dividends paid to public stockholders ($0.22 per share)
 
 

 
 

 
 

 
(2,128
)
 
(2,128
)
Dividends paid to affiliate ($0.22 per share)
 
 

 
 

 
 

 
(2,590
)
 
(2,590
)
Balance at March 31, 2018
 
$
21,519

 
$
126,106

 
$
(2,167
)
 
$
435,891

 
$
581,349

All affiliated balances presented above are the result of related party transactions with Employers Mutual.

See accompanying Notes to Consolidated Financial Statements.



7


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Three months ended 
 March 31,
($ in thousands)
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net income (loss)
 
$
33,531

 
$
(76
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
Losses and settlement expenses (affiliated $2,772 and $6,427)
 
3,203

 
4,443

Unearned premiums (affiliated $4,063 and $1,558)
 
2,616

 
1,274

Other policyholders' funds due to affiliate
 
(481
)
 
(427
)
Amounts due to/from affiliate to settle inter-company transaction balances
 
(6,751
)
 
(153
)
Net pension and postretirement benefits due from affiliate
 
(392
)
 
(827
)
Reinsurance receivables due from affiliate
 
1,594

 
374

Prepaid reinsurance premiums due from affiliate
 
1,259

 
1,188

Commissions payable (affiliated $(9,154) and $(7,893))
 
(9,153
)
 
(7,817
)
Deferred policy acquisition costs (affiliated $(2,982) and $(1,819))
 
(2,662
)
 
(1,778
)
Accrued investment income
 
(1,245
)
 
(330
)
Current income tax
 
4,232

 
1,207

Deferred income tax
 
4,495

 
(1,658
)
Net realized investment gains/losses and change in unrealized gains on equity investments
 
(22,643
)
 
5,393

Other, net (affiliated $(785) and $(727))
 
3,267

 
2,644

Total adjustments to reconcile net income (loss) to net cash provided by operating activities
 
(22,661
)
 
3,533

Net cash provided by operating activities
 
10,870

 
3,457

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
Purchases of fixed maturity securities available-for-sale
 
(10,311
)
 
(53,019
)
Disposals of fixed maturity securities available-for-sale
 
25,955

 
51,447

Purchases of equity investments
 
(18,333
)
 
(20,143
)
Disposals of equity investments
 
15,169

 
19,168

Purchases of other long-term investments
 

 
(4,507
)
Disposals of other long-term investments
 
77

 
2,305

Net (purchases) disposals of short-term investments
 
(20,061
)
 
1,949

Net receipts under reverse repurchase agreements
 

 
2,500

Net cash used in investing activities
 
(7,504
)
 
(300
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Issuance of common stock through affiliate’s stock plans
 
2,151

 
2,398

Repurchase of common stock
 
(643
)
 
(802
)
Dividends paid to stockholders (affiliated $(2,708) and $(2,590))
 
(4,979
)
 
(4,718
)
Net cash used in financing activities
 
(3,471
)
 
(3,122
)
NET INCREASE (DECREASE) IN CASH
 
(105
)
 
35

Cash at the beginning of the year
 
337

 
347

Cash at the end of the quarter
 
$
232

 
$
382

All affiliated balances presented above are the result of related party transactions with Employers Mutual.
See accompanying Notes to Consolidated Financial Statements.

8


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.
BASIS OF PRESENTATION
EMC Insurance Group Inc., a majority owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance and reinsurance.  The term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group inc. and its subsidiaries. The Company writes property and casualty insurance in both commercial and personal lines of insurance, with a focus on medium-sized commercial accounts; however, on October 29, 2018, the Company, Employers Mutual and their subsidiary insurance companies (collectively the "EMC Insurance Companies") announced that they had made a strategic decision to exit personal lines business so that more time and resources can be dedicated to the commercial and reinsurance business. As a result, personal lines premiums written declined significantly during the first quarter of 2019. Personal lines premiums earned also declined, though the decline was much smaller since the premiums are earned over the policies' annual terms. The Company's reinsurance business is primarily written through a quota share reinsurance agreement with Employers Mutual. A small portion of the assumed reinsurance business was previously written on a direct basis, outside the quota share reinsurance agreement.
The accompanying unaudited consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  The Company has evaluated all subsequent events through the date the financial statements were issued.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the interim financial statements have been included.  The results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year.  The consolidated balance sheet at December 31, 2018 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements.
In reading these financial statements, reference should be made to the Company’s 2018 Form 10-K and 10-K/A for more detailed footnote information.

Accounting Pronouncements Adopted
In March 2017, the Financial Accounting Standards Board (FASB) updated guidance related to Receivables-Nonrefundable Fees and Other Costs Subtopic 310-20 of the Accounting Standards CodificationTM (Codification or ASC). The objective of this update is to shorten the amortization period of premiums on certain callable fixed maturity securities to the earliest call date. The Company adopted this guidance on January 1, 2019, and it did not have a material impact on the consolidated financial statements.
In February 2016, the FASB issued updated guidance in Leases Topic 842 of the ASC, which supersedes the guidance in Leases Topic 840 of the ASC. The objective of this update is to increase transparency and comparability among organizations by requiring recognition of lease assets and lease liabilities on the balance sheet, and disclosure of key information about leasing arrangements. The Company adopted this guidance during the first quarter of 2019, though management concluded that lease costs allocated to the Company through the pooling and quota share agreements cannot be attributed to a specified asset, and therefore do not meet the definition of a leased asset contained in the guidance. As a result, adoption of this guidance had no impact on the consolidated financial statements.


9


2.
TRANSACTIONS WITH AFFILIATES
An inter-company reinsurance program is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. This reinsurance program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. The reinsurance program consists of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty is effective each year from January 1 through June 30, and has a retention of $22.0 million and a limit of $24.0 million. The total cost of this treaty is approximately $6.0 million. The second treaty is effective each year from July 1 through December 31, and has a retention of $15.0 million and a limit of $12.0 million. The total cost of this treaty is approximately $1.4 million. The terms of these treaties were the same in 2018. Losses and settlement expenses ceded to Employers Mutual under the inter-company reinsurance program totaled $527,000 for the three months ended March 31, 2019 compared to $467,000 for the same period in 2018. All catastrophe and storm losses assumed by the property and casualty insurance subsidiaries (net of applicable reinsurance recoveries from external reinsurance protections purchased by the pool participants) are subject to the terms of these treaties, and there is no co-participation provision.
An inter-company reinsurance program is also in place between the Company's reinsurance subsidiary and Employers Mutual. The reinsurance program consists of two treaties. The first is a per occurrence catastrophe excess of loss treaty with a retention of $10.0 million, a limit of $10.0 million, 20 percent co-participation, and no reinstatement. The total cost of this treaty is approximately $1.6 million. The second is an annual aggregate catastrophe excess of loss treaty with a retention of $20.0 million, a limit of $100.0 million, and 20 percent co-participation. The total cost of this treaty is approximately $3.6 million. Any losses recovered under the per occurrence treaty inure to the benefit of the aggregate treaty, and only catastrophic events with total losses greater than $500,000 are subject to the terms of the aggregate treaty. The terms of the program were the same in 2018. Losses and settlement expenses ceded to Employers Mutual under the inter-company reinsurance program totaled $1.7 million for the three months ended March 31, 2019, compared to $(753,000) for the three months ended March 31, 2018. For both periods, these amounts represent development on prior accident years' losses, net of any applicable outside reinsurance recoveries.
On November 20, 2018, the Company announced receipt of a non-binding indicative proposal dated November 15, 2018 from Employers Mutual to purchase all the outstanding common stock of the Company not already owned by Employers Mutual, and the formation of a special committee of the Company's board of directors to consider the proposal. The proposal, which is subject to certain conditions, provides that the shares will be purchased at a price of $30 per share in cash. The special committee, which consists of the Company's four independent directors, has retained its own independent financial and legal advisors to assist it in considering the proposal. Discussions between the special committee and Employers Mutual continued through the first quarter of 2019.

3.
REINSURANCE
The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, for the three months ended March 31, 2019 and 2018 is presented below.  The classification of the assumed and ceded reinsurance amounts between affiliates and nonaffiliates is based on the participants in the underlying reinsurance agreements, and is intended to provide an understanding of the actual source of the reinsurance activities.  This presentation differs from the classifications used in the consolidated financial statements, where all amounts flowing through the pooling and quota share agreements and inter-company reinsurance programs with Employers Mutual are reported as “affiliated” balances.
 
 
 
 
 
 
 
 
 
 
 
 
 
 

10


 
 
Three months ended March 31, 2019
($ in thousands)
 
Property and
casualty
insurance
 
Reinsurance
 
Total
Premiums written
 
 
 
 
 
 
Direct
 
$
105,233

 
$

 
$
105,233

Assumed from nonaffiliates
 
965

 
48,735

 
49,700

Assumed from affiliates
 
134,343

 

 
134,343

Ceded to nonaffiliates
 
(6,812
)
 
(1,973
)
 
(8,785
)
Ceded to affiliates
 
(108,213
)
 
(1,313
)
 
(109,526
)
Net premiums written
 
$
125,516

 
$
45,449

 
$
170,965

 
 
 
 
 
 
 
Premiums earned
 
 
 
 
 
 
Direct
 
$
101,267

 
$

 
$
101,267

Assumed from nonaffiliates
 
1,038

 
46,248

 
47,286

Assumed from affiliates
 
134,354

 

 
134,354

Ceded to nonaffiliates
 
(7,640
)
 
(2,405
)
 
(10,045
)
Ceded to affiliates
 
(104,247
)
 
(1,313
)
 
(105,560
)
Net premiums earned
 
$
124,772

 
$
42,530

 
$
167,302

 
 
 
 
 
 
 
Losses and settlement expenses incurred
 
 
 
 
 
 
Direct
 
$
60,935

 
$

 
$
60,935

Assumed from nonaffiliates
 
987

 
31,049

 
32,036

Assumed from affiliates
 
77,778

 
255

 
78,033

Ceded to nonaffiliates
 
(1,258
)
 
(1,582
)
 
(2,840
)
Ceded to affiliates
 
(61,462
)
 
(1,733
)
 
(63,195
)
Net losses and settlement expenses incurred
 
$
76,980

 
$
27,989

 
$
104,969


11


 
 
Three months ended March 31, 2018
($ in thousands)
 
Property and
casualty
insurance
 
Reinsurance
 
Total
Premiums written
 
 
 
 
 
 
Direct
 
$
100,044

 
$

 
$
100,044

Assumed from nonaffiliates
 
1,018

 
41,121

 
42,139

Assumed from affiliates
 
130,201

 

 
130,201

Ceded to nonaffiliates
 
(7,970
)
 
(2,005
)
 
(9,975
)
Ceded to affiliates
 
(103,024
)
 
(1,313
)
 
(104,337
)
Net premiums written
 
$
120,269

 
$
37,803

 
$
158,072

 
 
 
 
 
 
 
Premiums earned
 
 
 
 
 
 
Direct
 
$
95,745

 
$

 
$
95,745

Assumed from nonaffiliates
 
1,002

 
41,092

 
42,094

Assumed from affiliates
 
129,148

 

 
129,148

Ceded to nonaffiliates
 
(8,538
)
 
(2,625
)
 
(11,163
)
Ceded to affiliates
 
(98,725
)
 
(1,313
)
 
(100,038
)
Net premiums earned
 
$
118,632

 
$
37,154

 
$
155,786

 
 
 
 
 
 
 
Losses and settlement expenses incurred
 
 
 
 
 
 
Direct
 
$
52,287

 
$

 
$
52,287

Assumed from nonaffiliates
 
992

 
26,415

 
27,407

Assumed from affiliates
 
85,967

 
358

 
86,325

Ceded to nonaffiliates
 
(2,991
)
 
(399
)
 
(3,390
)
Ceded to affiliates
 
(52,754
)
 
753

 
(52,001
)
Net losses and settlement expenses incurred
 
$
83,501

 
$
27,127

 
$
110,628


Individual lines in the above tables are defined as follows:
“Direct” represents business produced by the property and casualty insurance subsidiaries.
“Assumed from nonaffiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of involuntary business assumed by the pool participants pursuant to state law. For the reinsurance subsidiary, this line represents the reinsurance business assumed through the quota share agreement (including “fronting” activities initiated by Employers Mutual) and the business assumed outside the quota share agreement.
“Assumed from affiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of all the pool members’ direct business.  The amounts reported under the caption “Losses and settlement expenses incurred” also include claim-related services provided by Employers Mutual that are allocated to the property and casualty insurance subsidiaries and the reinsurance subsidiary.
“Ceded to nonaffiliates” for the property and casualty insurance subsidiaries represents their aggregate 30 percent pool participation percentage of 1) the amounts ceded to nonaffiliated reinsurance companies in accordance with the terms of the reinsurance agreements providing protection to the pool and each of its participants, and 2) the amounts ceded on a mandatory basis to state organizations in connection with various programs.  For the reinsurance subsidiary, this line includes 1) reinsurance business that is ceded to other insurance companies in connection with “fronting” activities initiated by Employers Mutual, and 2) amounts ceded in connection with the purchase of additional reinsurance protection in peak exposure territories from external parties.
“Ceded to affiliates” for the property and casualty insurance subsidiaries represents the cession of their direct business to Employers Mutual under the terms of the pooling agreement and amounts ceded to Employers Mutual under the terms of the inter-company reinsurance program.  For the reinsurance subsidiary this line represents amounts ceded to Employers Mutual under the terms of the inter-company reinsurance program.

12


4.
LIABILITY FOR LOSSES AND SETTLEMENT EXPENSES
The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the Company.  Amounts presented are on a net basis, with a reconciliation of beginning and ending reserves to the gross amounts presented in the consolidated financial statements.
 
 
Three months ended March 31,
($ in thousands)
 
2019
 
2018
Gross reserves at beginning of year
 
$
777,190

 
$
732,612

Re-valuation due to foreign currency exchange rates
 
(593
)
 
525

Less ceded reserves at beginning of year
 
36,595

 
30,923

Net reserves at beginning of year
 
741,188

 
701,164

 
 
 
 
 
Incurred losses and settlement expenses related to:
 
 

 
 

Current year
 
118,259

 
116,204

Prior years
 
(13,290
)
 
(5,576
)
Total incurred losses and settlement expenses
 
104,969

 
110,628

 
 
 
 
 
Paid losses and settlement expenses related to:
 
 

 
 

Current year
 
23,608

 
24,262

Prior years
 
76,412

 
81,877

Total paid losses and settlement expenses
 
100,020

 
106,139

 
 
 
 
 
Net reserves at end of period
 
746,137

 
705,653

Plus ceded reserves at end of period
 
34,927

 
30,549

Re-valuation due to foreign currency exchange rates
 
(671
)
 
853

Gross reserves at end of period
 
$
780,393

 
$
737,055


There is an inherent amount of uncertainty involved in the establishment of insurance liabilities.  This uncertainty is greatest in the current and more recent accident years because a smaller percentage of the expected ultimate claims have been reported, adjusted and settled compared to more mature accident years.  As the carried reserves for these accident years run off, the overall expectation is that, more often than not, favorable development will occur.  However, there is also the possibility that the ultimate settlement of liabilities associated with these accident years will show adverse development, and such adverse development could be substantial.
Changes in reserve estimates are reflected in net income in the year such changes are recorded.  Following is an analysis of the reserve development the Company experienced during the three months ended March 31, 2019 and 2018.  Care should be exercised when attempting to analyze the financial impact of the reported development amounts because, as noted above, the overall expectation is that, more often than not, favorable development will occur as the prior accident years’ reserves run off.


13


2019 Development
For the property and casualty insurance segment, the March 31, 2019 estimate of loss and settlement expense reserves for accident years 2018 and prior decreased $9.6 million from the estimate at December 31, 2018.  This decrease represents 1.8 percent of the December 31, 2018 gross carried reserves and is primarily attributed to reductions in prior year ultimate loss ratios for most lines of business except personal auto liability and homeowners. The commercial auto liability and workers' compensation lines of business were the largest contributors to favorable development. Favorable development in the commercial auto liability line of business was a result of decreases in ultimate severity estimates for accident years 2014, 2016, 2017 and 2018. Favorable development in the workers compensation line of business is the result of a decrease in estimated ultimate frequency and severity for accident year 2018, and decreases in estimated ultimate severity for several prior accident years except 2015 and 2016, which experienced adverse development. Personal auto liability and homeowners experienced adverse development as estimated ultimate severity increased for accident year 2018.
For the reinsurance segment, the March 31, 2019 estimate of loss and settlement expense reserves for accident years 2018 and prior decreased $3.6 million from the estimate at December 31, 2018.  This decrease represents 1.5 percent of the December 31, 2018 gross carried reserves and is primarily attributed to lower ultimate losses impacting accident years 2003-2015 and 2018 for casualty excess contracts and accident years 2016-2018 for property-casualty global excess contracts.

2018 Development
For the property and casualty insurance segment, the March 31, 2018 estimate of loss and settlement expense reserves for accident years 2017 and prior decreased $2.1 million from the estimate at December 31, 2017.  This decrease represented 0.4 percent of the December 31, 2017 gross carried reserves and was primarily attributed to decreases in the ultimate loss ratios for several accident years, including 2017, due to reductions in expected ultimate frequency and/or severity in the workers' compensation line of business. The commercial auto liability line of business experienced adverse development due to higher than expected severity in the 2017 accident year.
For the reinsurance segment, the March 31, 2018 estimate of loss and settlement expense reserves for accident years 2017 and prior increased $3.4 million from the estimate at December 31, 2017.  This increase represented 1.5 percent of the December 31, 2017 gross carried reserves and was primarily attributed to lower ultimate loss estimates impacting accident years 2014-2017 for the property pro rata, catastrophe and per risk excess, and property-casualty global excess lines of business. The favorable development was partially offset by adverse development on casualty excess contracts for years 2007, 2012, 2014, and 2017, whose ultimates were increased in response to higher than expected reported losses.

5.
SEGMENT INFORMATION
The Company’s operations consist of a property and casualty insurance segment and a reinsurance segment.  The property and casualty insurance segment writes both commercial and personal lines of insurance, with a focus on medium-sized commercial accounts.  The reinsurance segment provides reinsurance for other insurers and reinsurers.  The segments are managed separately due to differences in the insurance products sold and the business environments in which they operate. Management evaluates the performance of its insurance segments using financial measurements based on Statutory Accounting Principles (SAP) instead of GAAP. Such measures include premiums written, premiums earned, statutory underwriting profit (loss), and investment results, as well as loss and loss adjustment expense ratios, trade underwriting expense ratios, and combined ratios.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

14


Summarized financial information for the Company’s segments is as follows:
Three months ended March 31, 2019
 
Property and
casualty
insurance
 
Reinsurance
 
Parent
company
 
Consolidated
($ in thousands)
 
 
 
 
Premiums earned
 
$
124,772

 
$
42,530

 
$

 
$
167,302

 
 
 
 
 
 
 
 
 
Underwriting profit (loss):
 
 
 
 
 
 
 
 
SAP underwriting profit (loss)
 
1,407

 
3,563

 

 
4,970

GAAP adjustments
 
1,210

 
820

 

 
2,030

GAAP underwriting profit (loss)
 
2,617

 
4,383

 

 
7,000

 
 
 
 
 
 
 
 
 
Net investment income
 
9,138

 
3,608

 
17

 
12,763

Net realized investment gains/losses and change in unrealized gains on equity investments
 
14,168

 
8,542

 
(67
)
 
22,643

Other income (loss)
 
1,533

 
2

 

 
1,535

Interest expense
 
171

 

 

 
171

Other expenses
 
311

 

 
1,174

 
1,485

Income (loss) before income tax expense (benefit)
 
$
26,974

 
$
16,535

 
$
(1,224
)
 
$
42,285

 
 
 
 
 
 
 
 
 
Assets
 
$
1,220,775

 
$
512,430

 
$
617,254

 
$
2,350,459

Eliminations
 

 

 
(606,809
)
 
(606,809
)
Reclassifications
 
(934
)
 

 
(489
)
 
(1,423
)
Total assets
 
$
1,219,841

 
$
512,430

 
$
9,956

 
$
1,742,227


15


Three months ended March 31, 2018
 
Property and
casualty
insurance
 
Reinsurance
 
Parent
company
 
Consolidated
($ in thousands)
 
 
 
 
Premiums earned
 
$
118,632

 
$
37,154

 
$

 
$
155,786

 
 
 
 
 
 
 
 
 
Underwriting profit (loss):
 
 
 
 
 
 
 
 
SAP underwriting profit (loss)
 
(9,036
)
 
1,563

 

 
(7,473
)
GAAP adjustments
 
262

 
102

 

 
364

GAAP underwriting profit (loss)
 
(8,774
)
 
1,665

 

 
(7,109
)
 
 
 
 
 
 
 
 
 
Net investment income
 
8,148

 
3,218

 
5

 
11,371

Net realized investment gains/losses and change in unrealized gains on equity investments
 
(3,293
)
 
(2,100
)
 

 
(5,393
)
Other income (loss)
 
2,051

 
(436
)
 

 
1,615

Interest expense
 
142

 

 

 
142

Other expenses
 
233

 

 
637

 
870

Income (loss) before income tax expense (benefit)
 
$
(2,243
)
 
$
2,347

 
$
(632
)
 
$
(528
)
 
 
 
 
 
 
 
 
 
Year ended December 31, 2018
 
 
 
 
 
 
 
 
Assets
 
$
1,191,286

 
$
485,270

 
$
565,905

 
$
2,242,461

Eliminations
 

 

 
(556,977
)
 
(556,977
)
Reclassifications
 

 

 
(6
)
 
(6
)
Total assets
 
$
1,191,286

 
$
485,270

 
$
8,922

 
$
1,685,478


16


The following table displays the premiums earned for the property and casualty insurance segment and the reinsurance segment for the three months ended March 31, 2019 and 2018, by line of insurance.
 
 
Three months ended March 31,
($ in thousands)
 
2019
 
2018
Property and casualty insurance
 
 
 
 
Commercial lines:
 
 
 
 
Automobile
 
$
32,907

 
$
30,644

Property
 
27,671

 
26,429

Workers' compensation
 
23,543

 
24,902

Other liability
 
28,905

 
24,962

Other
 
2,506

 
2,186

Total commercial lines
 
115,532

 
109,123

 
 
 
 
 
Personal lines
 
9,240

 
9,509

Total property and casualty insurance
 
$
124,772

 
$
118,632

 
 
 
 
 
Reinsurance
 
 
 
 
Pro rata reinsurance
 
$
13,006

 
$
13,073

Excess of loss reinsurance
 
29,524

 
24,081

Total reinsurance
 
$
42,530

 
$
37,154

 
 
 
 
 
Consolidated
 
$
167,302

 
$
155,786


6.
INCOME TAXES
The actual income tax expense (benefit) for the three months ended March 31, 2019 and 2018 differed from the “expected” income tax expense (benefit) for those periods (computed by applying the United States federal corporate tax rate of 21 percent to income (loss) before income tax) as follows:
 
 
Three months ended 
 March 31,
($ in thousands)
 
2019
 
2018
Computed "expected" income tax expense (benefit)
 
$
8,880

 
$
(111
)
Increases (decreases) in tax resulting from:
 
 
 
 
Tax-exempt interest income
 
(283
)
 
(310
)
Dividends received deduction
 
(132
)
 
(123
)
Proration of tax-exempt interest and dividends received deduction
 
104

 
108

Internal Revenue Code 50(d)(5) income from investment tax credits
 
221

 
36

Other, net
 
(36
)
 
(52
)
Total income tax expense (benefit)
 
$
8,754

 
$
(452
)

Pursuant to Staff Accounting Bulletin No. 118 issued by the Securities and Exchange Commission, the Company made reasonable estimates of the effects the Tax Cuts and Jobs Act (TCJA) had on deferred income tax assets and liabilities at December 31, 2017 and the interim periods in 2018. For items where the Company could not make a reasonable estimate, primarily loss reserve discounting, the Company used existing accounting guidance and the provisions of the tax laws that were in place prior to the enactment. Subsequently, the Company made its final determination of the effects of the TCJA when the Internal Revenue Service (IRS) issued Revenue Procedure 2019-06, which provided applicable discount factors for both the transition obligation (reserves at January 1, 2018), and reserves at December 31, 2018.

17


The Company had no provision for uncertain income tax positions at March 31, 2019 or December 31, 2018.  The Company recognized no interest expense or other penalties related to U.S. federal or state income taxes during the three months ended March 31, 2019 or 2018.  It is the Company’s accounting policy to reflect income tax penalties as other expense, and interest as interest expense.
The Company files a U.S. federal income tax return, along with various state income tax returns.  The Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2015.  

7.
EMPLOYEE RETIREMENT PLANS
The components of net periodic benefit cost (income) for Employers Mutual’s pension and postretirement benefit plans is as follows:
 
 
Three months ended 
 March 31,
($ in thousands)
 
2019
 
2018
Pension plans:
 
 
 
 
Service cost
 
$
4,071

 
$
4,126

Interest cost
 
2,949

 
2,665

Expected return on plan assets
 
(5,440
)
 
(5,978
)
Amortization of net actuarial loss
 
598

 
125

Net periodic pension benefit cost
 
$
2,178

 
$
938

 
 
 
 
 
Postretirement benefit plans:
 
 
 
 
Service cost
 
$
353

 
$
368

Interest cost
 
546

 
521

Expected return on plan assets
 
(1,095
)
 
(1,204
)
Amortization of net actuarial loss
 
245

 
234

Amortization of prior service credit
 
(2,285
)
 
(2,782
)
Net periodic postretirement benefit income
 
$
(2,236
)
 
$
(2,863
)

Net periodic pension benefit cost allocated to the Company amounted to $653,000 and $282,000 for the three months ended March 31, 2019 and 2018, respectively.  Net periodic postretirement benefit income allocated to the Company amounted to $636,000 and $806,000 for the three months ended March 31, 2019 and 2018, respectively. The service cost component of net periodic pension and postretirement benefit cost/(income) allocated to the Company is included in the income statement line titled "other underwriting expenses". The other components of net periodic pension and postretirement benefit cost/(income) are included in the income statement line titled "other income".
Employers Mutual plans to contribute approximately $7.0 million to the pension plan in 2019. No contributions are expected to be made to the Voluntary Employee Beneficiary Association (VEBA) trust in 2019.

8.
STOCK-BASED COMPENSATION
The Company has a stock-based compensation plan for non-employee directors. Employers Mutual also has several stock plans which utilize the common stock of the Company.  Employers Mutual can provide the common stock required under its plans by: 1) using shares of common stock that it currently owns; 2) purchasing common stock in the open market; or 3) directly purchasing common stock from the Company at the current fair value. Employers Mutual's current practice is to purchase common stock from the Company for use in all of its stock plans (including its non-employee director stock purchase plan and its employee stock purchase plan). A portion of the compensation expense recognized by Employers Mutual (as the requisite service period for restricted stock awards/units is rendered) is allocated to the Company’s property and casualty insurance subsidiaries though their participation in the pooling agreement.

18


An account Employers Mutual established to hold previously granted restricted stock awards until they vest will periodically contain excess shares of the Company's stock stemming from forfeitures and surrenders. During the first three months of 2019, the Company repurchased 20,221 shares of stock from this unvested restricted stock account at an average cost of $31.83. These repurchased shares are not deemed to be shares repurchased under the Company's stock repurchase program.
During the first three months of 2019, 122,073 restricted stock units were granted to eligible employees of Employers Mutual. Under the stock plans, 96,374 shares of restricted stock vested, and 32,262 options were exercised at a weighted average exercise price of $12.58. The Company recognized compensation expense from these plans of $283,000 ($223,000 net of tax) and $413,000 ($326,000 net of tax) for the three months ended March 31, 2019 and 2018, respectively.  

9.
DISCLOSURES ABOUT THE FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of the Company’s financial instruments as of March 31, 2019 and December 31, 2018 are summarized in the tables below.
March 31, 2019
 
Carrying
amounts
 
Estimated
fair values
($ in thousands)
 
 
Assets:
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
U.S. treasury
 
$
8,113

 
$
8,113

U.S. government-sponsored agencies
 
309,120

 
309,120

Obligations of states and political subdivisions
 
276,857

 
276,857

Commercial mortgage-backed
 
86,664

 
86,664

Residential mortgage-backed
 
168,765

 
168,765

Other asset-backed
 
17,719

 
17,719

Corporate
 
424,622

 
424,622

Total fixed maturity securities available-for-sale
 
1,291,860

 
1,291,860

 
 
 
 
 
Equity investments, at fair value
 
 
 
 
Common stocks:
 
 
 
 
Financial services
 
47,345

 
47,345

Information technology
 
39,346

 
39,346

Healthcare
 
34,006

 
34,006

Consumer staples
 
14,694

 
14,694

Consumer discretionary
 
28,764

 
28,764

Energy
 
15,853

 
15,853

Industrials
 
19,435

 
19,435

Other
 
15,471

 
15,471

Non-redeemable preferred stocks
 
18,180

 
18,180

Investment funds
 
9,489

 
9,489

Total equity investments
 
242,583

 
242,583

 
 
 
 
 
Short-term investments
 
48,265

 
48,265

 
 
 
 
 
Liabilities:
 
 
 
 
Surplus notes
 
25,000

 
16,056


19


December 31, 2018
 
Carrying
amounts
 
Estimated
fair values
($ in thousands)
 
 
Assets:
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
U.S. treasury
 
$
8,021

 
$
8,021

U.S. government-sponsored agencies
 
304,479

 
304,479

Obligations of states and political subdivisions
 
283,651

 
283,651

Commercial mortgage-backed
 
84,379

 
84,379

Residential mortgage-backed
 
162,137

 
162,137

Other asset-backed
 
20,834

 
20,834

Corporate
 
419,408

 
419,408

Total fixed maturity securities available-for-sale
 
1,282,909

 
1,282,909

 
 
 
 
 
Equity investments, at fair value
 
 
 
 
Common stocks:
 
 
 
 
Financial services
 
41,839

 
41,839

Information technology
 
31,581

 
31,581

Healthcare
 
34,571

 
34,571

Consumer staples
 
13,180

 
13,180

Consumer discretionary
 
22,765

 
22,765

Energy
 
13,372

 
13,372

Industrials
 
19,389

 
19,389

Other
 
14,371

 
14,371

Non-redeemable preferred stocks
 
16,654

 
16,654

Investment funds
 
7,641

 
7,641

Total equity investments
 
215,363

 
215,363

 
 
 
 
 
Short-term investments
 
28,204

 
28,204

 
 
 
 
 
Liabilities:
 
 
 
 
Surplus notes
 
25,000

 
15,259


The estimated fair values of fixed maturity and equity securities is based on quoted market prices, where available.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security.
Short-term investments generally include money market funds, U.S. Treasury bills and commercial paper.  Short-term investments are carried at fair value, which approximates cost, due to the highly liquid nature of the securities.   Short-term securities are classified as Level 1 fair value measurements when the fair values can be validated by recent trades.  When recent trades are not available, fair value is deemed to be the cost basis and the securities are classified as Level 2 fair value measurements.
The estimated fair value of the surplus notes is derived by discounting future expected cash flows at a rate deemed appropriate over a 25-year term (the surplus notes have no stated maturity date, and the interest to be paid is assumed to continue at the current interest rate in place of 2.73 percent).

20


Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The following fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value.
 
Level 1 -
Unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.
 
 
 
 
Level 2 -
Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
 
 
 
 
Level 3 -
Prices or valuation techniques that require significant unobservable inputs because observable inputs are not available.  The unobservable inputs may reflect the Company’s own judgments about the assumptions that market participants would use.
 
 
 
 
NAV -
The fair values of investment company limited partnership investments and similar vehicles (referred to as investment funds) are based on the capital account balances reported by the investment funds subject to their management review and adjustment. These capital account balances reflect the fair value of the investment funds.
The Company uses an independent pricing source to obtain the estimated fair values of a majority of its securities, subject to an internal validation.  The fair values are based on quoted market prices, where available.  This is typically the case for equity securities and money market funds, which are accordingly classified as Level 1 fair value measurements.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security.  Fixed maturity securities, non-redeemable preferred stocks and various short-term investments in the Company’s portfolio may not trade on a daily basis; however, observable inputs are utilized in their valuations, and these securities are therefore classified as Level 2 fair value measurements.  Following is a brief description of the various pricing techniques used by the independent pricing source for different asset classes.
U.S. Treasury securities (including bonds, notes, and bills) are priced according to a number of live data sources, including active market makers and inter-dealer brokers.  Prices from these sources are reviewed based on the sources’ historical accuracy for individual issues and maturity ranges.
U.S. government-sponsored agencies and corporate securities (including fixed-rate corporate bonds and medium-term notes) are priced by determining a bullet (non-call) spread scale for each issuer for maturities going out to forty years.  These spreads represent credit risk and are obtained from the new issue market, secondary trading, and dealer quotes.  An option adjusted spread model is incorporated to adjust spreads of issues that have early redemption features.  The final spread is then added to the U.S. Treasury curve.
Obligations of states and political subdivisions are priced by tracking and analyzing actively quoted issues and reported trades, material event notices and benchmark yields.  Municipal bonds with similar characteristics are grouped together into market sectors, and internal yield curves are constructed daily for these sectors.  Individual bond evaluations are extrapolated from these sectors, with the ability to make individual spread adjustments for attributes such as discounts, premiums, alternative minimum tax, and/or whether or not the bond is callable.
Mortgage-backed and asset-backed securities are first reviewed for the appropriate pricing speed (if prepayable), spread, yield and volatility.  The securities are priced with models using spreads and other information solicited from market buy- and sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts.  To determine a tranche’s price, first the benchmark yield is determined and adjusted for collateral performance, tranche level attributes and market conditions.  Then the cash flow for each tranche is generated (using consensus prepayment speed assumptions including, as appropriate, a prepayment projection based on historical statistics of the underlying collateral).  The tranche-level yield is used to discount the cash flows and generate the price.  Depending on the characteristics of the tranche, a volatility-driven, multi-dimensional single cash flow stream model or an option-adjusted spread model may be used.  When cash flows or other security structure or market information is not available, broker quotes may be used.
On a quarterly basis, the Company receives from its independent pricing service a list of fixed maturity securities, if any, that were priced solely from broker quotes.  For these securities, fair value may be determined using the broker quotes, or by the Company using similar pricing techniques as the Company’s independent pricing service.  Depending on the level of observable inputs, these securities would be classified as Level 2 or Level 3 fair value measurements.   At March 31, 2019 and December 31, 2018, the Company had no securities priced solely from broker quotes.

21


A small number of the Company’s securities are not priced by the independent pricing service.  One of these was an equity security that was reported as a Level 3 fair value measurement since no observable inputs were used in its valuation. This security was sold in the fourth quarter of 2018 and in prior periods was reported at the fair value obtained from the Securities Valuation Office (SVO) of the National Association of Insurance Commissioners (NAIC).  The SVO established a per share price for this security based on an annual review of that company’s financial statements, typically performed during second quarter.  The other securities not priced by the Company’s independent pricing service consist of six fixed maturity securities. One of these fixed maturity securities (two at December 31, 2018), classified as Level 3 fair value measurements, are corporate securities that convey premium tax benefits and are not publicly traded. The fair values for these securities are based on discounted cash flow analyses. The other fixed maturity securities are classified as Level 2 fair value measurements.  The fair values for these fixed maturity securities were obtained from either the SVO, the Company's investment custodian, or the Company's investment department using similar pricing techniques as the Company’s independent pricing service.

22


Presented in the tables below are the estimated fair values of the Company’s financial instruments as of March 31, 2019 and December 31, 2018.
March 31, 2019
 
 
 
 
 
Fair value measurements using
($ in thousands)
 
Total
 
Investments measured at net asset value (NAV)
 
Quoted
prices in
active markets
for identical
assets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Financial instruments reported at fair value on recurring basis:
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. treasury
 
$
8,113

 
$

 
$

 
$
8,113

 
$

U.S. government-sponsored agencies
 
309,120

 

 

 
309,120

 

Obligations of states and political subdivisions
 
276,857

 

 

 
276,857

 

Commercial mortgage-backed
 
86,664

 

 

 
86,664

 

Residential mortgage-backed
 
168,765

 

 

 
168,765

 

Other asset-backed
 
17,719

 

 

 
17,719

 

Corporate
 
424,622

 

 

 
424,421

 
201

Total fixed maturity securities available-for-sale
 
1,291,860

 

 

 
1,291,659

 
201

 
 
 
 
 
 
 
 
 
 
 
Equity investments, at fair value:
 
 
 
 
 
 
 
 
 
 
Common stocks:
 
 
 
 
 
 
 
 
 
 
Financial services
 
47,345

 

 
47,345

 

 

Information technology
 
39,346

 

 
39,346

 

 

Healthcare
 
34,006

 

 
34,006

 

 

Consumer staples
 
14,694

 

 
14,694

 

 

Consumer discretionary
 
28,764

 

 
28,764

 

 

Energy
 
15,853

 

 
15,853

 

 

Industrials
 
19,435

 

 
19,435

 

 

Other
 
15,471

 

 
15,471

 

 

Non-redeemable preferred stocks
 
18,180

 

 
8,578

 
9,602

 

Investment funds
 
9,489

 
9,489

 

 

 

Total equity investments
 
242,583

 
9,489

 
223,492

 
9,602

 

 
 
 
 
 
 
 
 
 
 
 
Short-term investments
 
48,265

 

 
48,265

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial instruments not reported at fair value:
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Surplus notes
 
16,056

 

 

 

 
16,056


23


December 31, 2018
 
 
 
 
 
Fair value measurements using
($ in thousands)
 
Total
 
Investments measured at net asset value (NAV)
 
Quoted
prices in
active markets
for identical
assets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Financial instruments reported at fair value on recurring basis:
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. treasury
 
$
8,021

 
$

 
$

 
$
8,021

 
$

U.S. government-sponsored agencies
 
304,479

 

 

 
304,479

 

Obligations of states and political subdivisions
 
283,651

 

 

 
283,651

 

Commercial mortgage-backed
 
84,379

 

 

 
84,379

 

Residential mortgage-backed
 
162,137

 

 

 
162,137

 

Other asset-backed
 
20,834

 

 

 
20,834

 

Corporate
 
419,408

 

 

 
419,149

 
259

Total fixed maturity securities available-for-sale
 
1,282,909

 

 

 
1,282,650

 
259

 
 
 
 
 
 
 
 
 
 
 
Equity investments, at fair value:
 
 
 
 
 
 
 
 
 
 
Common stocks:
 
 
 
 
 
 
 
 
 
 
Financial services
 
41,839

 

 
41,839

 

 

Information technology
 
31,581

 

 
31,581

 

 

Healthcare
 
34,571

 

 
34,571

 

 

Consumer staples
 
13,180

 

 
13,180

 

 

Consumer discretionary
 
22,765

 

 
22,765

 

 

Energy
 
13,372

 

 
13,372

 

 

Industrials
 
19,389

 

 
19,389

 

 

Other
 
14,371

 

 
14,371

 

 

Non-redeemable preferred stocks
 
16,654

 

 
10,325

 
6,329

 

Investment funds
 
7,641

 
7,641

 

 

 

Total equity investments
 
215,363

 
7,641

 
201,393

 
6,329

 

 
 
 
 
 
 
 
 
 
 
 
Short-term investments
 
28,204

 

 
28,204

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial instruments not reported at fair value:
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Surplus notes
 
15,259

 

 

 

 
15,259


24


Presented in the table below is a reconciliation of the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2019 and 2018.  Any unrealized gains or losses on fixed maturity securities are recognized in other comprehensive income (loss).  Any gains or losses from settlements, disposals, impairments and unrealized gains or losses on equity securities are reported as realized investment gains or losses in net income.
($ in thousands)
 
Fair value measurements using significant unobservable (Level 3) inputs
 
 
Fixed maturity securities available-for-sale, corporate
 
Total
Three months ended March 31, 2019
 
 
 
 
Beginning balance
 
$
259

 
$
259

Settlements
 
(57
)
 
(57
)
Unrealized losses included in other comprehensive income (loss) on securities still held at reporting date
 
(1
)
 
(1
)
Balance at March 31, 2019
 
$
201

 
$
201


($ in thousands)
 
Fair value measurements using significant
unobservable (Level 3) inputs
 
 
Fixed maturity securities available-for-sale, corporate
 
Equity securities,
financial services
 
Total
Three months ended March 31, 2018
 
 
 
 
 
 
Beginning balance
 
$
620

 
$
3

 
$
623

Settlements
 
(56
)
 

 
(56
)
Unrealized losses included in other comprehensive income (loss) on securities still held at reporting date
 
(2
)
 

 
(2
)
Balance at March 31, 2018
 
$
562

 
$
3

 
$
565


10.
INVESTMENTS
Investments of the Company’s insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments that may be made by insurance companies.  In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages.  The Company believes that it is in compliance with these laws.

25


The amortized cost and estimated fair value of securities available-for-sale as of March 31, 2019 and December 31, 2018 are as follows.  All fixed maturity securities are classified as available-for-sale and are carried at fair value.
March 31, 2019
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Estimated
fair values
($ in thousands)
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
U.S. treasury
 
$
8,146

 
$

 
$
33

 
$
8,113

U.S. government-sponsored agencies
 
302,811

 
6,489

 
180

 
309,120

Obligations of states and political subdivisions
 
263,064

 
13,852

 
59

 
276,857

Commercial mortgage-backed
 
83,882

 
2,869

 
87

 
86,664

Residential mortgage-backed
 
163,955

 
6,233

 
1,423

 
168,765

Other asset-backed
 
17,892

 
301

 
474

 
17,719

Corporate
 
416,025

 
9,342

 
745

 
424,622

Total fixed maturity securities
 
$
1,255,775

 
$
39,086

 
$
3,001

 
$
1,291,860

December 31, 2018
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Estimated
fair values
($ in thousands)
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
U.S. treasury
 
$
8,139

 
$

 
$
118

 
$
8,021

U.S. government-sponsored agencies
 
303,198

 
2,799

 
1,518

 
304,479

Obligations of states and political subdivisions
 
273,727

 
10,375

 
451

 
283,651

Commercial mortgage-backed
 
83,854

 
1,287

 
762

 
84,379

Residential mortgage-backed
 
161,055

 
3,374

 
2,292

 
162,137

Other asset-backed
 
21,596

 
273

 
1,035

 
20,834

Corporate
 
421,563

 
2,605

 
4,760

 
419,408

Total fixed maturity securities
 
$
1,273,132

 
$
20,713

 
$
10,936

 
$
1,282,909


26


The following tables set forth the estimated fair values and gross unrealized losses associated with investment securities that were in an unrealized loss position recognized in accumulated other comprehensive income as of March 31, 2019 and December 31, 2018, listed by length of time the securities were consistently in an unrealized loss position.
March 31, 2019
 
Less than twelve months
 
Twelve months or longer
 
Total
($ in thousands)
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury
 
$

 
$

 
$
8,113

 
$
33

 
$
8,113

 
$
33

U.S. government-sponsored agencies
 

 

 
47,961

 
180

 
47,961

 
180

Obligations of states and political subdivisions
 

 

 
12,372

 
59

 
12,372

 
59

Commercial mortgage-backed
 

 

 
11,140

 
87

 
11,140

 
87

Residential mortgage-backed
 
4,466

 
94

 
40,869

 
1,329

 
45,335

 
1,423

Other asset-backed
 

 

 
11,167

 
474

 
11,167

 
474

Corporate
 
7,901

 
349

 
36,514

 
396

 
44,415

 
745

Total fixed maturity securities
 
$
12,367

 
$
443

 
$
168,136

 
$
2,558

 
$
180,503

 
$
3,001


December 31, 2018
 
Less than twelve months
 
Twelve months or longer
 
Total
($ in thousands)
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury
 
$

 
$

 
$
8,021

 
$
118

 
$
8,021

 
$
118

U.S. government-sponsored agencies
 
14,620

 
20

 
92,603

 
1,498

 
107,223

 
1,518

Obligations of states and political subdivisions
 

 

 
14,498

 
451

 
14,498

 
451

Commercial mortgage-backed
 
2,021

 
21

 
24,222

 
741

 
26,243

 
762

Residential mortgage-backed
 
16,852

 
145

 
45,597

 
2,147

 
62,449

 
2,292

Other asset-backed
 
4,810

 
147

 
11,691

 
888

 
16,501

 
1,035

Corporate
 
198,030

 
2,996

 
45,734

 
1,764

 
243,764

 
4,760

Total fixed maturity securities
 
$
236,333

 
$
3,329

 
$
242,366

 
$
7,607

 
$
478,699

 
$
10,936


Nearly all of the fixed maturity securities that are in an unrealized loss position are considered investment grade by credit rating agencies. Because management does not intend to sell these securities, does not believe it will be required to sell these securities before recovery, and believes it will collect the amounts due on these securities, it was determined that these securities were not “other-than-temporarily” impaired at March 31, 2019.

27


The amortized cost and estimated fair values of fixed maturity securities at March 31, 2019, by contractual maturity, are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
($ in thousands)
 
Amortized
cost
 
Estimated
fair values
Securities available-for-sale:
 
 
 
 
Due in one year or less
 
$
23,719

 
$
23,824

Due after one year through five years
 
265,818

 
270,454

Due after five years through ten years
 
314,904

 
325,430

Due after ten years
 
402,224

 
415,475

Securities not due at a single maturity date
 
249,110

 
256,677

Totals
 
$
1,255,775

 
$
1,291,860


A summary of realized investment gains and (losses) and the change in unrealized gains on equity investments is as follows:
 
 
Three months ended March 31,
($ in thousands)
 
2019
 
2018
Fixed maturity securities available-for-sale:
 
 
 
 
Gross realized investment gains
 
$

 
$
234

Gross realized investment losses
 
(272
)
 
(478
)
 
 
 
 
 
Equity securities:
 
 
 
 
Net realized investment gains
 
4,097

 
2,716

Change in unrealized investment gains
 
19,829

 
(9,854
)
 
 
 
 
 
Other long-term investments, net
 
(1,011
)
 
1,989

Totals
 
$
22,643

 
$
(5,393
)

Gains and losses realized on the disposition of investments are included in net income.  The cost of investments sold is determined on the specific identification method using the highest cost basis first.  The Company did not have any outstanding cumulative credit losses on fixed maturity securities that have been recognized in earnings from “other-than-temporary” impairments during any of the reported periods. The net realized investment gains (losses) recognized on other long-term investments primarily represent changes in the carrying value of a limited partnership that is used solely to support an equity tail-risk hedging strategy.

11.
CONTINGENT LIABILITIES
The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business.  The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations.  The companies involved have established reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings.
On March 22, 2019, a lawsuit was filed in state court in Iowa relating to the November 15, 2018 proposal by Employers Mutual to acquire all outstanding shares of stock in the Company not already owned by Employers Mutual.  The lawsuit was filed as a purported class action, and names as defendants Employers Mutual and the five individual directors of the Company.  The lawsuit alleges that the proposal is unfair to the Company’s minority shareholders, and seeks an unspecified amount of damages.  Employers Mutual and the Company and its directors deny all allegations of wrongdoing set forth in the lawsuit. The Company believes that Directors, Officers and Organization Liability Coverage is in place that should be sufficient to cover any finding of liability.

28


The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions.  The Company’s share of case loss reserves eliminated by the purchase of those annuities was $110,000 at December 31, 2018.  The Company had a contingent liability for the aggregate guaranteed amount of the annuities of $183,000 at December 31, 2018 should the issuers of those annuities fail to perform.  Although management is not able to verify the amount, the Company would likely have a similar contingent liability at March 31, 2019.  The probability of a material loss due to failure of performance by the issuers of these annuities is considered remote.

12.
STOCK REPURCHASE PROGRAM
On November 3, 2011, the Company’s Board of Directors authorized a $15.0 million stock repurchase program.  This program does not have an expiration date.  The timing and terms of the purchases are determined by management based on board approved parameters and market conditions, and are conducted in accordance with the applicable rules of the Securities and Exchange Commission.  Common stock repurchased under this program will be retired by the Company.  The Company did not repurchase any shares during the first three months of either 2019 or 2018.

13.
ACCUMULATED OTHER COMPREHENSIVE INCOME
The Company has available-for-sale securities and receives an allocation of the actuarial losses and net prior service credits associated with Employers Mutual’s pension and postretirement benefit plans, both of which generate accumulated other comprehensive income (loss) amounts.  The following table reconciles, by component, the beginning and ending balances of accumulated other comprehensive income (loss), net of tax.
 
 
Accumulated other comprehensive income (loss) by component
 
 
Unrealized
gains (losses) on
available-for-
sale securities
 
Unrecognized pension and postretirement benefit obligations
 
 
($ in thousands)
 
 
Net actuarial loss
 
Prior service credit
 
Total
 
Total
Balance at December 31, 2018
 
$
7,724

 
$
(17,626
)
 
$
11,522

 
$
(6,104
)
 
$
1,620

Other comprehensive income (loss) before reclassifications
 
20,568

 

 

 

 
20,568

Amounts reclassified from accumulated other comprehensive income (loss)
 
215

 
197

 
(510
)
 
(313
)
 
(98
)
Other comprehensive income (loss)
 
20,783

 
197

 
(510
)
 
(313
)
 
20,470

Balance at March 31, 2019
 
$
28,507

 
$
(17,429
)
 
$
11,012

 
$
(6,417
)
 
$
22,090


 
 
Accumulated other comprehensive income (loss) by component
 
 
Unrealized
gains (losses) on
available-for-
sale securities
 
Unrecognized pension and postretirement benefit obligations
 
 
($ in thousands)
 
 
Net actuarial loss
 
Prior service credit
 
Total
 
Total
Balance at December 31, 2017
 
$
83,497

 
$
(13,074
)
 
$
12,961

 
$
(113
)
 
$
83,384

Cumulative adjustment for adoption of financial instruments recognition and measurement changes
 
(66,234
)
 

 

 

 
(66,234
)
Other comprehensive income (loss) before reclassifications
 
(18,969
)
 

 

 

 
(18,969
)
Amounts reclassified from accumulated other comprehensive income (loss)
 
193

 
81

 
(622
)
 
(541
)
 
(348
)
Other comprehensive income (loss)
 
(18,776
)
 
81

 
(622
)
 
(541
)
 
(19,317
)
Balance at March 31, 2018
 
$
(1,513
)
 
$
(12,993
)
 
$
12,339

 
$
(654
)
 
$
(2,167
)

29



The following tables display amounts reclassified out of accumulated other comprehensive income (loss) and into net income (loss) during the three months ended March 31, 2019 and 2018, respectively.
($ in thousands)
 
Amounts reclassified from accumulated other comprehensive income (loss)
 
 
Accumulated other comprehensive
income (loss) components
 
Three months ended 
 March 31, 2019
 
Affected line item in the consolidated statements of income
Unrealized gains (losses) on investments:
 
 
 
 
Reclassification adjustment for net realized investment losses included in net income
 
$
(272
)
 
Net realized investment gains/losses and change in unrealized gains on equity investments
Deferred income tax (expense) benefit
 
57

 
Total income tax expense (benefit)
Net reclassification adjustment
 
(215
)
 
Net income (loss)
 
 
 
 
 
Unrecognized pension and postretirement benefit obligations:
 
 
 
 
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income:
 
 
 
 
Net actuarial loss
 
(249
)
 
(1)
Prior service credit
 
646

 
(1)
Total before tax
 
397

 
 
Deferred income tax (expense) benefit
 
(84
)
 
 
Net reclassification adjustment
 
313

 
 
 
 
 
 
 
Total reclassification adjustment
 
$
98

 
 
(1)
These reclassified components of accumulated other comprehensive income are included in the computation of net periodic pension and postretirement benefit cost (income) (see note 7, Employee Retirement Plans, for additional details).

30


($ in thousands)
 
Amounts reclassified from accumulated other comprehensive income (loss)
 
 
Accumulated other comprehensive
income (loss) components
 
Three months ended March 31, 2018
 
Affected line item in the consolidated statements of income
Unrealized gains (losses) on investments:
 
 
 
 
Reclassification adjustment for net realized investment losses included in net income
 
$
(244
)
 
Net realized investment gains/losses and change in unrealized gains on equity investments
Deferred income tax (expense) benefit
 
51

 
Total income tax expense (benefit)
Net reclassification adjustment
 
(193
)
 
Net income (loss)
 
 
 
 
 
Unrecognized pension and postretirement benefit obligations:
 
 
 
 
Reclassification adjustment for amounts amortized into net periodic pension and postretirement benefit income:
 
 
 
 
Net actuarial loss
 
(103
)
 
(1)
Prior service credit
 
788

 
(1)
Total before tax
 
685

 
 
Deferred income tax (expense) benefit
 
(144
)
 
 
Net reclassification adjustment
 
541

 
 
 
 
 
 
 
Total reclassification adjustment
 
$
348

 
 
(1)
These reclassified components of accumulated other comprehensive income are included in the computation of net periodic pension and postretirement benefit cost (income) (see note 7, Employee Retirement Plans, for additional details).

14.
NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 2016, the FASB issued updated guidance in Financial Instruments-Credit Losses Topic 326 of the ASC. The objective of this update is to provide information about expected credit losses on financial instruments and other commitments to extend credit. Specifically, this updated guidance replaces the current incurred loss impairment methodology, which delays recognition of a loss until it is probable a loss has been incurred, with a methodology that reflects expected credit losses considering a broader range of reasonable and supportable information. This guidance covers financial assets that are not accounted for at fair value through net income, thus is not applicable to the Company's equity investments. This guidance is effective for interim and annual periods beginning after December 15, 2019, and is to be applied with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (modified-retrospective approach). Early adoption is permitted, but only to fiscal years beginning after December 15, 2018. The Company will adopt this guidance during the first quarter of 2020. The Company is currently evaluating the impact this guidance will have on the Company's consolidated financial condition and net income.

15.
SUBSEQUENT EVENTS
On May 9, 2019, it was announced that the Company and Employers Mutual had entered into a definitive merger agreement pursuant to which Employers Mutual will acquire all of the remaining shares of the Company for $36 per share in cash. The transaction is expected to close in the second half of 2019.



31


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Unaudited)

The term “Company” is used below interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.  The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included under Item 1 of this Form 10-Q, and the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2018 Form 10-K.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the opportunity to make cautionary statements regarding forward-looking statements.  Accordingly, any forward-looking statement contained in this report is based on management’s current beliefs, assumptions and expectations of the Company’s future performance, taking all information currently available into account.  These beliefs, assumptions and expectations can change as the result of many possible events or factors, not all of which are known to management.  If a change occurs, the Company’s business, financial condition, liquidity, results of operations, plans and objectives may vary materially from those expressed in the forward-looking statements.  The risks and uncertainties that may affect the actual results of the Company include, but are not limited to, the following:
catastrophic events and the occurrence of significant severe weather conditions;
the adequacy of loss and settlement expense reserves;
state and federal legislation and regulations;
changes in the U.S. federal corporate tax law;
changes in the property and casualty insurance industry, interest rates or the performance of financial markets and the general economy;
rating agency actions;
“other-than-temporary” investment impairment losses; and
other risks and uncertainties inherent to the Company’s business, including those discussed under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K.
Management intends to identify forward-looking statements when using the words “believe”, “expect”, “anticipate”, “estimate”, “project”, “may”, “intend”, “likely” or similar expressions.  Undue reliance should not be placed on these forward-looking statements. The Company disclaims any obligation to update such statements or to announce publicly the results of any revisions that it may make to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

UPDATE ON 2018 CORPORATE EVENTS
Proposal to purchase all of the Company's outstanding common stock
On November 20, 2018, the Company announced receipt of a non-binding indicative proposal dated November 15, 2018 from Employers Mutual Casualty Company (Employers Mutual) to purchase all the outstanding common stock of the Company not already owned by Employers Mutual, and the formation of a special committee of the Company's board of directors to consider the proposal. The proposal, which is subject to certain conditions, provides that the shares will be purchased at a price of $30 per share in cash. The special committee, which consists of the Company's four independent directors, has retained its own independent financial and legal advisors to assist it in considering the proposal. Discussions between the special committee and Employers Mutual continued through the first quarter of 2019.

32


Exit from personal lines of business
As announced on October 29, 2018, the Company and Employers Mutual made a strategic decision to exit personal lines business so that more time and resources could be dedicated to the commercial and reinsurance business. The companies stopped writing personal lines policies in most states (regulatory restrictions apply in some states) during the first quarter of 2019 and non-renewal notices are being sent to policyholders in accordance with state regulations as existing policies expire. Personal lines premiums earned declined less than three percent in the first quarter, but personal lines premiums written declined 36.2 percent. During the remainder of 2019, the loss and settlement expense ratio for personal lines business will deteriorate as the companies will continue to process claims and incur expenses to support this business, while premiums earned will decline significantly. All personal lines business is expected to roll off the companies' books by the end of the first quarter of 2020.

Digital transformation project
During 2018, management began a digital transformation project that will guide the design, build and deployment of a new "EMC Digital Business Platform". This digital platform will consist of new core insurance systems, such as policy, rating, billing, claims, agent portal, customer portal, and an enterprise data warehouse. These new systems, together with some enhanced systems, will replace the majority of Employers Mutual's current legacy systems. Employers Mutual will also adopt cloud technology, and integrate and configure vendor purchased systems. Management, with the assistance of outside consultants, has selected a vendor product and established a five-year project time line. While the total cost of the project has not yet been finalized, management currently estimates that the Company's portion of the pre-tax expense will approximate $28.0 million over the next five years.

COMPANY OVERVIEW
The Company, a majority owned subsidiary of Employers Mutual, is an insurance holding company with operations that consist of a property and casualty insurance segment and a reinsurance segment. Management evaluates the performance of its insurance segments based upon statutory underwriting profit (loss), which is calculated as premiums earned, less loss and settlement expenses and acquisition and other expenses. Additional information is presented in note 5, "Segment Information", of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q.
Property and casualty insurance operations are conducted through three subsidiaries and represent the most significant segment of the Company’s business, totaling 75 percent of consolidated premiums earned during the first three months of 2019.  The property and casualty insurance operations are integrated with the property and casualty insurance operations of Employers Mutual through participation in a reinsurance pooling agreement.  Because the Company conducts its property and casualty insurance operations together with Employers Mutual through the reinsurance pooling agreement, the Company shares the same business philosophy, management, employees and facilities as Employers Mutual and offers the same types of insurance products.
Reinsurance operations are conducted through EMC Reinsurance Company and accounted for 25 percent of consolidated premiums earned during the first three months of 2019.  The principal business activity of EMC Reinsurance Company is to assume, through a quota share reinsurance agreement, 100 percent of Employers Mutual’s assumed reinsurance business, subject to certain exceptions.
An inter-company reinsurance program, consisting of two semi-annual aggregate catastrophe excess of loss treaties, is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. The program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. An inter-company reinsurance program is also in place between the Company's reinsurance subsidiary and Employers Mutual. This program also consists of two treaties, one being a per occurrence catastrophe excess of loss treaty and the other an annual aggregate catastrophe excess of loss treaty. The terms of all of these treaties did not change from 2018. For detailed information regarding the inter-company reinsurance programs, see note 2, "Transactions with Affiliates", of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The accounting policies and estimates considered by management to be critically important in the preparation and understanding of the Company’s financial statements and related disclosures are presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Company’s 2018 Form 10-K.

33



RESULTS OF OPERATIONS
Results of operations by segment and on a consolidated basis for the three months ended March 31, 2019 and 2018 are as follows:
 
 
Three months ended March 31,
($ in thousands)
 
2019
 
2018
Property and casualty insurance
 
 
 
 
Premiums earned
 
$
124,772

 
$
118,632

Losses and settlement expenses
 
76,980

 
83,501

Acquisition and other expenses
 
45,175

 
43,905

Underwriting profit (loss)
 
$
2,617

 
$
(8,774
)
 
 
 
 
 
GAAP ratios:
 
 
 
 
Loss and settlement expense ratio
 
61.7
 %
 
70.4
 %
Acquisition expense ratio
 
36.2
 %
 
37.0
 %
Combined ratio
 
97.9
 %
 
107.4
 %
 
 
 
 
 
Reconciliation of loss and settlement expense ratio to underlying loss and settlement expense ratio1:
 
 
 
 
Loss and settlement expense ratio
 
61.7
 %
 
70.4
 %
Catastrophe and storm losses
 
(4.7
)%
 
(3.6
)%
Favorable development on prior years' reserves
 
7.7
 %
 
1.8
 %
Underlying loss and settlement expense ratio
 
64.7
 %
 
68.6
 %
 
 
 
 
 
Favorable development on prior years' reserves
 
$
(9,643
)
 
$
(2,135
)
 
 
 
 
 
Catastrophe and storm losses
 
$
5,888

 
$
4,260

1 Underlying loss and settlement expense ratio: The loss and settlement expense ratio is the ratio (expressed as a percentage) of losses and settlement expenses incurred to premiums earned, which management uses as a measure of underwriting profitability of the Company’s property and casualty insurance business. The underlying loss and settlement expense ratio is a non-GAAP financial measure which represents the loss and settlement expense ratio, excluding the impact of catastrophe and storm losses and development on prior years’ reserves. Management uses this ratio as an indicator of the property and casualty insurance segment’s underwriting discipline and performance for the current accident year. Management believes this ratio is useful for investors to understand the property and casualty insurance segment’s periodic earnings and variability of earnings caused by the unpredictable nature (i.e., the timing and amount) of catastrophe and storm losses and development on prior years’ reserves. While this measure is consistent with measures utilized by investors and analysts to evaluate performance, it is not intended as a substitute for the GAAP financial measure of loss and settlement expense ratio.
 
 
 
 
 
 
 
 
 
 
 
 
 

34


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
 
2019
 
2018
($ in thousands)
 
Premiums earned
 
Losses and settlement expenses
 
Loss and settlement expense ratio
 
Premiums earned
 
Losses and settlement expenses
 
Loss and settlement expense ratio
Property and casualty insurance
 
 
 
 
 
 
 
 
 
 
 
 
Commercial lines:
 
 
 
 
 
 
 
 
 
 
 
 
Automobile
 
$
32,907

 
$
21,415

 
65.1
 %
 
$
30,644

 
$
26,456

 
86.3
%
Property
 
27,671

 
17,428

 
63.0
 %
 
26,429

 
18,723

 
70.8
%
Workers' compensation
 
23,543

 
13,735

 
58.3
 %
 
24,902

 
12,531

 
50.3
%
Other liability
 
28,905

 
17,341

 
60.0
 %
 
24,962

 
17,701

 
70.9
%
Other
 
2,506

 
(384
)
 
(15.3
)%
 
2,186

 
494

 
22.6
%
Total commercial lines
 
115,532

 
69,535

 
60.2
 %
 
109,123

 
75,905

 
69.6
%
Personal lines
 
9,240

 
7,445

 
80.6
 %
 
9,509

 
7,596

 
79.9
%
Total property and casualty insurance
 
$
124,772

 
$
76,980

 
61.7
 %
 
$
118,632

 
$
83,501

 
70.4
%
 
 
Three months ended March 31,
($ in thousands)
 
2019
 
2018
Reinsurance
 
 
 
 
Premiums earned
 
$
42,530

 
$
37,154

Losses and settlement expenses
 
27,989

 
27,127

Acquisition and other expenses
 
10,158

 
8,362

Underwriting profit
 
$
4,383

 
$
1,665

 
 
 
 
 
GAAP ratios:
 
 
 
 
Loss and settlement expense ratio
 
65.8
%
 
73.0
%
Acquisition expense ratio
 
23.9
%
 
22.5
%
Combined ratio
 
89.7
%
 
95.5
%
 
 
 
 
 
Favorable development on prior years' reserves
 
$
(3,648
)
 
$
(3,441
)
 
 
 
 
 
Catastrophe and storm losses
 
$
19

 
$
396

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
 
2019
 
2018
($ in thousands)
 
Premiums earned
 
Losses and settlement expenses
 
Loss and settlement expense ratio
 
Premiums earned
 
Losses and settlement expenses
 
Loss and settlement expense ratio
Reinsurance
 
 
 
 
 
 
 
 
 
 
 
 
Pro rata reinsurance
 
$
13,006

 
$
5,914

 
45.5
%
 
$
13,073

 
$
4,665

 
35.7
%
Excess of loss reinsurance
 
29,524

 
22,075

 
74.8
%
 
24,081

 
22,462

 
93.3
%
Total reinsurance
 
$
42,530

 
$
27,989

 
65.8
%
 
$
37,154

 
$
27,127

 
73.0
%

35


 
 
Three months ended March 31,
($ in thousands, except per share amounts)
 
2019
 
2018
Consolidated
 
 
 
 
REVENUES
 
 
 
 
Premiums earned
 
$
167,302

 
$
155,786

Net investment income
 
12,763

 
11,371

Net realized investment gains (losses) and change in unrealized gains on equity investments
 
22,643

 
(5,393
)
Other income
 
1,535

 
1,615

 
 
204,243

 
163,379

LOSSES AND EXPENSES
 
 
 
 
Losses and settlement expenses
 
104,969

 
110,628

Acquisition and other expenses
 
55,333

 
52,267

Interest expense
 
171

 
142

Other expense
 
1,485

 
870

 
 
161,958

 
163,907

 
 
 
 
 
Income (loss) before income tax expense (benefit)
 
42,285

 
(528
)
Income tax expense (benefit)
 
8,754

 
(452
)
Net income (loss)
 
$
33,531

 
$
(76
)
 
 
 
 
 
Net income (loss) per share
 
$
1.55

 
$

 
 
 
 
 
GAAP ratios:
 
 
 
 
Loss and settlement expense ratio
 
62.7
%
 
71.0
%
Acquisition expense ratio
 
33.1
%
 
33.6
%
Combined ratio
 
95.8
%
 
104.6
%
 
 
 
 
 
Favorable development on prior years' reserves
 
$
(13,291
)
 
$
(5,576
)
 
 
 
 
 
Catastrophe and storm losses
 
$
5,907

 
$
4,656


The Company reported net income of $33.5 million ($1.55 per share) for the three months ended March 31, 2019, compared to a net loss of $76,000 ($0.00 per share) during the same period in 2018.  Included in the net income amount reported in 2019 is a $19.8 million pre-tax increase in unrealized gains on the Company's equity investments, and $2.8 million of pre-tax realized investment gains. Included in the net loss reported in 2018 is a $9.9 million pre-tax decline in unrealized gains on the Company's equity investments, which was partially offset by $4.5 million of pre-tax realized investment gains. Both segments reported improved underwriting results in the first quarter of 2019. The property casualty insurance segment benefited from an increase in favorable development on prior years' reserves and improvement in the underlying loss and settlement expense ratio (which excludes the impact of catastrophe and storm losses and development on prior years' reserves) from the disappointing results reported in the first quarter of 2018, which was impacted by a high level of non-catastrophe losses. The improvement in the reinsurance segment is primarily attributed to an increase in premiums earned.


36


Premium income
Premiums earned increased 7.4 percent to $167.3 million for the three months ended March 31, 2019 from $155.8 million for the same period in 2018.  Rate levels for both segments continue to be constrained by a high level of competition, especially for quality accounts with good loss experience; however, the moderate rate level improvements that began last year have continued through the first quarter. Average rate level increases were slightly positive in the property and casualty insurance segment, with variances by line of business. Commercial auto continues to receive larger (mid-to-upper single digit) rate increases, while rates for the workers' compensation line of business continue to decline due to mandatory rate decreases. During the January 1, 2019 renewal season, the reinsurance industry placed greater emphasis on wildfire exposures following a second consecutive year of significant losses from this peril. As a result, programs with wildfire losses received the largest rate level increases during the January 1, 2019 reinsurance renewal season, while other programs generally renewed flat or slightly down.
Premiums earned in the property and casualty insurance segment increased 5.2 percent to $124.8 million for the three months ended March 31, 2019 from $118.6 million for the same period in 2018.  The majority of this increase is attributed to small rate level increases on renewal business and an increase in retained policies in the commercial lines of business. Personal lines premiums earned declined less than three percent during the first quarter as new business was not accepted due to management's decision in late 2018 to exit this line of business; however, this decline will increase significantly during the remainder of 2019 as existing policies are not renewed upon expiration. Commercial lines new business premium (representing 15 percent of the pool participants’ direct premiums written) was approximately 6 percent higher in the three months ended March 31, 2019 than the same period in 2018. Management continues to seek growth in most territories for its commercial lines of business, particularly outside of the core Midwest market, which will help diversify the pool participants' book of business geographically while staying consistent with the industry and the commercial lines mix of business. Renewal business premium increased approximately 4 percent during the first three months of 2019. After factoring in the continued implementation of some mandatory rate reductions on workers' compensation business, the overall rate change on renewal business was approximately 2.1 percent. Rate levels are expected to be mixed during the remainder of 2019, with the largest rate increases expected in the commercial auto line of business. Rate decreases are expected to slow or stop in the workers' compensation and general liability lines of business, and rates on most other lines of business are expected to increase slightly. The commercial lines policy retention rate remained strong during the first three months of 2019 at 86 percent, which approximates that reported at the end of 2018.
Premiums earned in the reinsurance segment increased 14.5 percent to $42.5 million for the three months ended March 31, 2019 from $37.2 million for the same period in 2018. This increase is attributed to increases in participation and higher estimated premiums achieved on existing multi-line contracts, and new business written in the property and liability excess lines, including from Mutual Re. Underwriting capacity tightened somewhat during the January 1, 2019 renewal season. As a result, reinsurance rate levels were mixed, with increases implemented on programs that sustained losses from wildfires and other catastrophic events, while rate levels remained stable on programs not affected by 2017 and 2018 catastrophic events.

Losses and settlement expenses
Losses and settlement expenses decreased 5.1 percent to $105.0 million for the three months ended March 31, 2019 from $110.6 million for the same period in 2018.  The loss and settlement expense ratio decreased to 62.7 percent for the three months ended March 31, 2019 from 71.0 percent for the same period in 2018. This decrease is primarily attributed to the property and casualty insurance segment and reflects a significant increase in the amount of favorable development experienced on prior years' reserves and improvement in the underlying loss and settlement expense ratio. The reinsurance segment also reported a decrease in its loss and settlement expense ratio, which is primarily attributed to an increase in premiums earned and improved loss experience. The actuarial analysis of the Company’s carried reserves at March 31, 2019 indicates that they are in the upper third of the range of reasonable reserves.

37


The loss and settlement expense ratio for the property and casualty insurance segment decreased to 61.7 percent for the three months ended March 31, 2019 from 70.4 percent for the same period in 2018. The underlying loss and settlement expense ratio, which excludes the impact of catastrophe and storm losses and development on prior years' reserves, decreased to 64.7 percent in the first quarter of 2019 from 68.6 percent for the same period in 2018. All commercial lines of business experienced declines in their respective underlying loss and settlement expense ratios, except for workers' compensation, where mandatory rate decreases are having a negative impact. These decreases stem from declines in both loss frequency and, with the exception of the commercial auto liability line of business, loss severity. A significant increase in favorable development on prior years' reserves across all commercial lines of business also contributed to the decrease in the loss and settlement expense ratio. See note 4, "Liability for Losses and Settlement Expenses", of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q for information regarding the sources of development on prior years' reserves. Catastrophe and storm losses totaled $5.9 million in the first quarter of 2019 compared to $4.3 million for the same period in 2018, and accounted for 4.7 percentage points of the loss and settlement expense ratio in the first quarter of 2019 compared to 3.6 percentage points for the same period in 2018.
The loss and settlement expense ratio for the reinsurance segment decreased to 65.8 percent for the three months ended March 31, 2019 from 73.0 percent for the same period in 2018. This decrease is primarily attributed to the increase in premiums earned and improved loss experience. Catastrophe and storm losses declined to $19,000 in the first quarter of 2019 compared to $396,000 for the same period in 2018, and accounted for 0.0 percentage points of the loss and settlement expense ratio for the first quarter of 2019, compared to 1.1 percentage points during the same period in 2018. The reinsurance subsidiary reported favorable development on prior years' reserves totaling $3.6 million in the first quarter of 2019, compared to $3.4 million in the first quarter of 2018. See note 4, "Liability for Losses and Settlement Expenses", of Notes to Consolidated Financial Statements under Part I, Item 1 of this Form 10-Q for information regarding the sources of development on prior years' reserves.

Acquisition and other expenses
Acquisition and other expenses increased 5.9 percent to $55.3 million for the three months ended March 31, 2019 from $52.3 million for the same period in 2018.  The acquisition expense ratio decreased to 33.1 percent for the three months ended March 31, 2019 from 33.6 percent for the same period in 2018. This decrease is attributed to the property and casualty insurance segment.  
The acquisition expense ratio for the property and casualty insurance segment decreased to 36.2 percent for the three months ended March 31, 2019 from 37.0 percent for the same period in 2018. This decrease primarily reflects a decline in salary expense, partially offset by an increase in commission expense.
The acquisition expense ratio for the reinsurance segment increased to 23.9 percent for the three months ended March 31, 2019 from 22.5 percent for the same period in 2018. This increase primarily reflects an increase in contingent commission expense.

Investment results
Net investment income increased 12.2 percent to $12.8 million for the three months ended March 31, 2019 from $11.4 million for the same period in 2018. This increase is primarily the result of actions taken during 2018 to sell fixed maturity securities with lower book yields and reinvest the proceeds in fixed maturity securities with similar characteristics but higher yields. This allowed the Company to increase the portfolio's book yield without altering quality or duration, while also taking advantage of a 14 percent tax differential that could be achieved by carrying the losses from the sales back to a previous tax year subject to the prior 35 percent federal corporate tax rate. Growth in the fixed maturity portfolio also contributed to the increase in net investment income, but to a lesser extent. The pre-tax yield on the fixed maturity portfolio increased to 3.63 percent at March 31, 2019 from 3.45 percent at March 31, 2018, but declined slightly from 3.68 percent at December 31, 2018.  The effective duration of the fixed maturity portfolio, excluding interest-only securities, declined to 4.4 at March 31, 2019 from 4.9 at December 31, 2018.
Net realized investment gains/losses and the change in unrealized gains on equity investments increased to a gain of $22.6 million for the three months ended March 31, 2019 from a loss of $5.4 million for the same period in 2018. This increase is primarily due to a $19.8 million pre-tax increase in unrealized gains on the Company's equity investments compared to a $9.9 million pre-tax decline in unrealized gains in 2018. The amounts reported also include a loss of $938,000 and a gain of $1.8 million in 2019 and 2018, respectively, from changes in the carrying value of a limited partnership that the Company invests in to help protect the equity portfolio from a sudden and significant decline in value (an equity tail-risk hedging strategy).

38


Other income
Other income totaled $1.5 million during the three months ended March 31, 2019, compared to $1.6 million during the same period in 2018. The 2019 amount includes $1.3 million of net periodic pension and postretirement benefit income.  The 2018 amount includes $1.9 million of net periodic pension and postretirement benefit income and $436,000 of foreign currency exchange losses on the reinsurance segment’s foreign currency denominated reinsurance business.

Income tax
The Company reported income tax expense of $8.8 million for the three months ended March 31, 2019, compared to an income tax benefit of $452,000 for the same period in 2018. The effective tax rate for the three months ended March 31, 2019 was 20.7 percent, compared to 85.5 percent for the same period in 2018. The first quarter 2018 effective tax rate is calculated using an income tax benefit relative to pretax losses, thus the larger number is actually indicative of a low effective tax rate. The primary contributors to the differences between these effective tax rates and the United States federal corporate tax rate of 21 percent are tax-exempt interest income earned and the dividends received deduction.

SUBSEQUENT EVENT
On May 9, 2019, it was announced that the Company and Employers Mutual had entered into a definitive merger agreement pursuant to which Employers Mutual will acquire all of the remaining shares of the Company for $36.00 per share in cash. The transaction is expected to close in the second half of 2019.

LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet cash obligations.  The Company had positive cash flows from operations of $10.9 million and $3.5 million during the first three months of 2019 and 2018, respectively. The Company typically generates substantial positive cash flows from operations because cash from premium payments is generally received in advance of cash payments made to settle claims.  These positive cash flows provide the foundation of the Company’s asset/liability management program and are the primary driver of the Company’s liquidity.  The Company invests in high quality, liquid securities to match the anticipated payments of losses and settlement expenses of the underlying insurance policies.  Because the timing of the losses is uncertain, the majority of the portfolio is maintained in short to intermediate maturity securities that can be easily liquidated or that generate adequate cash flow to meet liabilities.
The Company is a holding company whose principal asset is its investment in its property and casualty insurance subsidiaries and its reinsurance subsidiary (“insurance subsidiaries”).  As a holding company, the Company is dependent upon cash dividends from its insurance subsidiaries to meet all its obligations, including cash dividends to stockholders, the funding of the Company’s stock repurchase program and, more recently, expenses associated with evaluating and responding to Employers Mutual's non-binding indicative proposal to purchase all of the common stock of the Company not already owned by Employers Mutual.  State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval.  The maximum amount of dividends that the insurance subsidiaries can pay to the Company in 2019 without prior regulatory approval is approximately $48.0 million.  The Company received $5.1 million and $3.5 million of dividends from its insurance subsidiaries and paid cash dividends to its stockholders totaling $5.0 million and $4.7 million during the first three months of 2019 and 2018, respectively.
The Company’s insurance subsidiaries must maintain adequate liquidity to ensure that their cash obligations are met; however, because of the property and casualty insurance subsidiaries’ participation in the pooling agreement and the reinsurance subsidiary’s participation in the quota share agreement, they do not have the daily liquidity concerns normally associated with an insurance company.  This is because under the terms of the pooling and quota share agreements, Employers Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the Company’s reinsurance subsidiary, and then settles inter-company balances generated by these transactions with the participating companies on a monthly (pool participants) or quarterly (reinsurance subsidiary) basis.

39


At the insurance subsidiary level, the primary sources of cash are premium income, investment income and proceeds from called or matured investments.  The principal outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends, interest and principal payments on debt, and investment purchases.  Cash outflows vary because of uncertainties regarding settlement dates for unpaid losses and the potential for large losses, either individually or in the aggregate.  Accordingly, the insurance subsidiaries maintain investment and reinsurance programs intended to provide adequate funds to pay claims without forced sales of investments.  The insurance subsidiaries also have the ability to borrow funds on a short-term basis (180 days) from Employers Mutual and/or its subsidiaries under an Inter-Company Loan Agreement. In addition, Employers Mutual maintains access to a line of credit with the Federal Home Loan Bank that could be used to provide the insurance subsidiaries additional liquidity if needed.
The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid investments to ensure the availability of funds to pay claims and expenses.  A variety of maturities are maintained in the Company’s investment portfolio to assure adequate liquidity.  The maturity structure of the fixed maturity portfolio is also established by the relative attractiveness of yields on short, intermediate and long-term securities.  The Company does not invest in non-investment grade debt securities.  Any non-investment grade securities held by the Company are the result of rating downgrades subsequent to their purchase.
The Company invests for the long term and generally purchases fixed maturity securities with the intent to hold them to maturity.  Despite this intent, the Company currently classifies fixed maturity securities as available-for-sale to provide flexibility in the management of its investment portfolio.  At March 31, 2019 and December 31, 2018, the Company had net unrealized holding gains, net of deferred taxes, on its fixed maturity securities available-for-sale of $28.5 million and $7.7 million, respectively.  The fluctuation in the fair value of these investments is primarily due to changes in the interest rate environment during this time period, but also reflects fluctuations in risk premium spreads over U.S. Treasuries.  Since the Company intends to hold fixed maturity securities to maturity, such fluctuations in the fair value of these investments are not expected to have a material impact on the operations of the Company, as forced liquidations of investments are not anticipated. The Company closely monitors the bond market and makes appropriate adjustments in its portfolio as conditions warrant.
The majority of the Company’s assets are invested in fixed maturity securities.  These investments provide a substantial amount of investment income that supplements underwriting results and contributes to net earnings.  As these investments mature, or are called, the proceeds are reinvested at current interest rates, which may be higher or lower than those now being earned; therefore, more or less investment income may be available to contribute to net earnings.  
The Company held $18.1 million and $19.3 million in other long-term investments at March 31, 2019 and December 31, 2018, respectively, which primarily consist of holdings in limited partnerships, and privately placed common and non-redeemable convertible preferred stock in start-up technology companies with ties to the insurance industry. The equity method of accounting is used for these investments, with changes in the carrying value recorded as realized investment gains (losses). During 2018, the Company invested additional funds of $7.5 million into a limited partnership that is designed to help protect the Company from a sudden and significant decline in the value of its equity portfolio (included $2.3 million of gains realized from the program that were reinvested). No additional funds were invested into this program during the first quarter of 2019. Also included in other long-term investments are holdings in limited liability companies that convey renewable energy tax credits that are carried at amortized cost. After reductions for the utilization of the tax credits and impairment losses, the carrying values of these investments totaled $2.1 million at March 31, 2019 and $2.2 million at December 31, 2018.
The Company participates in reverse repurchase arrangements, involving the purchase of investment securities from third-party sellers with the agreement that the purchased securities be sold back to the third-party sellers for agreed-upon prices at specified future dates. The third-party sellers are required to pledge collateral with a value greater than the amount of cash received in the transactions. In accordance with GAAP, the investment securities purchased under the reverse repurchase agreements are not reflected in the Company's consolidated balance sheets, but instead a receivable is recorded for the principal amount lent. The Company did not have a receivable under reverse repurchase agreements as of March 31, 2019 or December 31, 2018.
The Company’s cash balance was $232,000 and $337,000 at March 31, 2019 and December 31, 2018, respectively.
During the first three months of 2019, Employers Mutual made no contributions to its qualified pension plan or postretirement benefit plans. The Company's share of Employers Mutual's 2019 planned contribution to its pension plan, if made, will be approximately $2.1 million. No contributions will be made to the postretirement benefit plans in 2019.
During the first three months of 2018, Employers Mutual made no contributions to its qualified pension plan or postretirement benefit plans.  The Company reimbursed Employers Mutual $2.4 million for its share of the total 2018 pension contribution (no contributions were made to the postretirement benefit plans during 2018).


40


Capital Resources
Capital resources consist of stockholders’ equity and debt, representing funds deployed or available to be deployed to support business operations.  For the Company’s insurance subsidiaries, capital resources are required to support premium writings.  Regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to its statutory surplus should not exceed three to one.  On an annualized basis, all of the Company’s property and casualty insurance subsidiaries were well under this guideline at March 31, 2019.
The Company’s insurance subsidiaries are required to maintain a certain minimum level of surplus on a statutory basis, and are subject to regulations under which the payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities.  The Company’s insurance subsidiaries are also subject to annual Risk Based Capital (RBC) requirements that may further impact their ability to pay dividends.  RBC requirements attempt to measure minimum statutory capital needs based upon the risks in a company’s mix of products and investment portfolio.  At December 31, 2018, the Company’s insurance subsidiaries had total adjusted statutory capital of $527.1 million, which is well in excess of the minimum risk-based capital requirement of $101.9 million.
The Company’s total cash and invested assets at March 31, 2019 and December 31, 2018 are summarized as follows:
 
 
March 31, 2019
($ in thousands)
 
Amortized
cost
 
Fair
value
 
Carrying value
 
Percent of total carrying value
Fixed maturity securities available-for-sale
 
$
1,255,775

 
$
1,291,860

 
$
1,291,860

 
80.7
%
Equity investments, at fair value
 
167,632

 
242,583

 
242,583

 
15.1
%
Cash
 
232

 
232

 
232

 
%
Short-term investments
 
48,265

 
48,265

 
48,265

 
3.0
%
Equity investments, at alternative measurement of cost less impairments
 
1,200

 
XXXX

 
1,200

 
0.1
%
Other long-term investments
 
18,099

 
XXXX

 
18,099

 
1.1
%
 
 
$
1,491,203

 
XXXX

 
$
1,602,239

 
100.0
%

 
 
December 31, 2018
($ in thousands)
 
Amortized
cost
 
Fair
value
 
Carrying value
 
Percent of total carrying value
Fixed maturity securities available-for-sale
 
$
1,273,132

 
$
1,282,909

 
$
1,282,909

 
83.0
%
Equity investments, at fair value
 
160,371

 
215,363

 
215,363

 
13.9
%
Cash
 
337

 
337

 
337

 
%
Short-term investments
 
28,204

 
28,204

 
28,204

 
1.8
%
Equity investments, at alternative measurement of cost less impairments
 
1,200

 
XXXX

 
1,200

 
0.1
%
Other long-term investments
 
19,316

 
XXXX

 
19,316

 
1.2
%
 
 
$
1,482,560

 
XXXX

 
$
1,547,329

 
100.0
%

The Company’s property and casualty insurance subsidiaries have $25.0 million of surplus notes issued to Employers Mutual.  The interest rate on the surplus notes was increased to 2.73 percent from 1.35 percent effective February 1, 2018. Reviews of the interest rate are conducted by the Inter-Company Committees of the boards of directors of the Company and Employers Mutual every five years, with the next review due in 2023.  Payments of interest and repayments of principal can only be made out of the applicable subsidiary’s earned surplus and are subject to prior approval by the insurance commissioners of the respective states of domicile.  The surplus notes are subordinate and junior in right of payment to all obligations or liabilities of the applicable insurance subsidiaries.  Total interest expense incurred on these surplus notes was $171,000 during the first three months of 2019 and $142,000 during the first three months of 2018.  
As of March 31, 2019, the Company had no material commitments for capital expenditures.

41



Off-Balance Sheet Arrangements
Employers Mutual collects from agents, policyholders and ceding companies all premiums written associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the reinsurance subsidiary. Employers Mutual also collects from its reinsurers all losses and settlement expenses recoverable under the reinsurance contracts protecting the pool participants and the reinsurance subsidiary, as well as the fronting business ceded to the reinsurance subsidiary. Employers Mutual settles with the pool participants (monthly) and the reinsurance subsidiary (quarterly) the premiums written from these insurance policies and the paid losses and settlement expenses recoverable under the external reinsurance contracts, providing full credit for the premiums written and the paid losses and settlement expenses recoverable under the external reinsurance contracts generated during the period (not just the collected portion). Due to this arrangement, and since a significant portion of the premium balances are collected over the course of the underlying coverage periods, Employers Mutual carries a substantial receivable balance for insurance and reinsurance premiums in process of collection and, to a lesser extent, paid losses and settlement expenses recoverable from the external reinsurance companies. Any of these 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 off-balance sheet arrangements with an unconsolidated entity that results in credit-risk exposures (Employers Mutual’s insurance and reinsurance premium receivable balances, and paid loss and settlement expense recoverable amounts) that are not reflected in the Company’s financial statements.  The average annual expense for such charge-offs allocated to the Company over the past ten years is $414,000. Based on this historical data, this credit-risk exposure is not considered to be material to the Company’s results of operations or financial position and, accordingly, no loss contingency liability has been recorded.

Investment Impairments and Considerations
At March 31, 2019, the Company had unrealized losses on fixed maturity securities available-for-sale as presented in the following table. The estimated fair value is based on quoted market prices, where available.  In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security. 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 the amount of collateral available. Based on these factors, the absence of management’s intent to sell these securities prior to recovery or maturity, and the fact that management does not anticipate that it will be forced to sell these securities prior to recovery or maturity, it was determined that the carrying value of these securities were not “other-than-temporarily” impaired at March 31, 2019.  Risks and uncertainties inherent in the methodology utilized in this evaluation process include interest rate 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 $2.4 million, net of tax; however, the Company’s financial position would not be affected because unrealized losses on fixed maturity securities available-for-sale are reflected in the Company’s financial statements as a component of stockholders’ equity, net of deferred taxes.

42


Following is a schedule of the length of time fixed maturity securities available-for-sale have continuously been in an unrealized loss position as of March 31, 2019.
 
 
Less than twelve months
 
Twelve months or longer
 
Total
($ in thousands)
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
 
Fair
values
 
Unrealized
losses
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury
 
$

 
$

 
$
8,113

 
$
33

 
$
8,113

 
$
33

U.S. government-sponsored agencies
 

 

 
47,961

 
180

 
47,961

 
180

Obligations of states and political subdivisions
 

 

 
12,372

 
59

 
12,372

 
59

Commercial mortgage-backed
 

 

 
11,140

 
87

 
11,140

 
87

Residential mortgage-backed
 
4,466

 
94

 
40,869

 
1,329

 
45,335

 
1,423

Other asset-backed
 

 

 
11,167

 
474

 
11,167

 
474

Corporate
 
7,901

 
349

 
36,514

 
396

 
44,415

 
745

Total fixed maturity securities
 
$
12,367

 
$
443

 
$
168,136

 
$
2,558

 
$
180,503

 
$
3,001


The Company does not purchase non-investment grade fixed maturity securities.  Any non-investment grade fixed maturity securities held are the result of rating downgrades that occurred subsequent to their purchase.  At March 31, 2019, the Company held $4.4 million of non-investment grade fixed maturity securities in a net unrealized loss position of $204,000.
Following is a schedule of gross realized losses recognized in the first three months of 2019 on fixed maturity securities available-for-sale.  The schedule is aged according to the length of time the underlying securities were in an unrealized loss position.  
 
 
Realized losses from sales
 
"Other-than-
temporary"
impairment
losses
 
Total
gross
realized
losses
($ in thousands)
 
Book
value
 
Sales
price
 
Gross
realized
losses
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
Three months or less
 
$

 
$

 
$

 
$

 
$

Over three months to six months
 

 

 

 

 

Over six months to nine months
 

 

 

 

 

Over nine months to twelve months
 

 

 

 

 

Over twelve months
 
4,841

 
4,569

 
272

 

 
272

Subtotal, fixed maturity securities
 
$
4,841

 
$
4,569

 
$
272

 
$

 
$
272


LEASES, COMMITMENTS AND CONTINGENT LIABILITIES
The Company does not have any lease agreements, but Employers Mutual has entered into leases for 16 branch and service office facilities, the costs of which are charged to the pool and allocated among the pool participants based on their respective participation interests. The Company's contractual obligations as of March 31, 2019 did not change materially from those presented in the Company's 2018 Form 10-K.

43


The participants in the pooling agreement are subject to guaranty fund assessments by states in which they write business.  Guaranty fund assessments are used by states to pay policyholder liabilities of insolvent insurers domiciled in those states.  Many states allow assessments to be recovered through premium tax offsets.  The Company has accrued estimated guaranty fund assessments of $531,000 and $615,000 as of March 31, 2019 and December 31, 2018, respectively. Premium tax offsets of $662,000 and $809,000, which are related to prior guarantee fund payments and current assessments, have been accrued as of March 31, 2019 and December 31, 2018, respectively.  The guaranty fund assessments are expected to be paid over the next two years and the premium tax offsets are expected to be realized within ten years of the payments.  The participants in the pooling agreement are also subject to second-injury fund assessments, which are designed to encourage employers to employ workers with pre-existing disabilities.  The Company had accrued estimated second-injury fund assessments of $2.3 million at March 31, 2019 and $2.4 million at December 31, 2018.  The second-injury fund assessment accruals are based on projected loss payments.  The periods over which the assessments will be paid is not known.
The participants in the pooling agreement have purchased annuities from life insurance companies, under which the claimant is payee, to fund future payments that are fixed pursuant to specific claim settlement provisions.  Based on information provided by the life insurance companies on an annual basis, the Company’s share of case loss reserves eliminated by the purchase of those annuities was $110,000 at December 31, 2018.  The Company had a contingent liability for the aggregate guaranteed amount of the annuities of $183,000 at December 31, 2018 should the issuers of those annuities fail to perform. Although management is not able to verify the amount, the Company would likely have a similar contingent liability at March 31, 2019.  The probability of a material loss due to failure of performance by the issuers of these annuities is considered remote.
On March 22, 2019, a lawsuit was filed in state court in Iowa relating to the November 15, 2018 proposal by Employers Mutual to acquire all outstanding shares of stock in the Company not already owned by Employers Mutual.  The lawsuit was filed as a purported class action, and names as defendants Employers Mutual and the five individual directors of the Company.  The lawsuit alleges that the proposal is unfair to the Company’s minority shareholders, and seeks an unspecified amount of damages.  Employers Mutual and the Company and its directors deny all allegations of wrongdoing set forth in the lawsuit. The Company believes that Directors, Officers and Organization Liability Coverage is in place that should be sufficient to cover any finding of liability.


44


ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The main objectives in managing the Company’s investment portfolios are to maximize after-tax investment return while minimizing risk, in order to provide maximum support for the underwriting operations.  Investment strategies are developed based upon many factors including the economic environment, business cycle, regulatory requirements, fluctuations in interest rates, underwriting results and consideration of other market risks.  Investment decisions are centrally managed by investment professionals and are supervised by the investment committees of the respective boards of directors for each of the Company’s subsidiaries.
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments, and is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded.  The market risks of the financial instruments owned by the Company relate to the investment portfolio, which exposes the Company to interest rate (inclusive of credit spreads) and equity price risk and, to a lesser extent, credit quality and prepayment risk. Monitoring systems and analytical tools are in place to assess each of these elements of market risk; however, there can be no assurance that future changes in interest rates, creditworthiness of issuers, prepayment activity, liquidity available in the market and other general market conditions will not have a material adverse impact on the Company’s results of operations, liquidity or financial position.
Two categories of influences on market risk exist as it relates to financial instruments.  First are systematic aspects, which relate to the investing environment and are out of the control of the investment manager.  Second are non-systematic aspects, which relate to the construction of the investment portfolio through investment policies and decisions, and are under the direct control of the investment manager.  The Company is committed to controlling non-systematic risk through sound investment policies and diversification.
Further analysis of the components of the Company’s market risk (including interest rate risk, equity price risk, credit quality risk, and prepayment risk) can be found in the Company’s 2018 Form 10-K.

ITEM 4.
CONTROLS AND PROCEDURES
The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely making known to them material information relating to the Company and the Company’s consolidated subsidiaries required to be disclosed in the Company’s reports filed or submitted under the Exchange Act.
There were no changes in the Company’s internal control over financial reporting that occurred during the first quarter ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.



45


PART II.
OTHER INFORMATION

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding purchases of equity securities by the Company and affiliated purchasers for the three months ended March 31, 2019:
Period
 
(a) Total
number of
shares
(or units)
purchased
1
 
(b) Average
price
paid
per share
(or unit)
 
(c) Total number
of shares (or
units) purchased
as part of publicly
announced plans
or programs
2
 
(d) Maximum number
(or approximate dollar
value) of shares
(or units) that may yet
be purchased under the
plans or programs
($ in thousands)
2,3
1/1/2019 - 1/31/2019
 
36

 
$
31.74

 

 
$
18,456

2/1/2019 - 2/28/2019
 
48

 
32.34

 

 
18,456

3/1/2019 - 3/31/2019
 
894

 
32.70

 

 
18,456

Total
 
978

 
$
32.64

 

 
 

1 Consists of shares purchased in the open market to fulfill the Company's obligations under its dividend reinvestment and common stock purchase plan.
2 On November 3, 2011, the Company’s Board of Directors authorized a $15.0 million stock repurchase program.  This program does not have an expiration date.  A total of $14.0 million remains available in this plan for the purchase of additional shares.
3 On May 12, 2005, the Company announced that its parent company, Employers Mutual, had initiated a $15.0 million stock purchase program under which Employers Mutual may purchase shares of the Company’s common stock in the open market. This purchase program does not have an expiration date; however, this program has been dormant while the Company’s repurchase programs have been in effect.  A total of $4.5 million remains in this program.

46


ITEM 6.
EXHIBITS
Exhibit number
 
Item
31.1*
 
 
 
 
31.2*
 
 
 
 
32.1*
 
 
 
 
32.2*
 
 
 
 
101.INS**
 
XBRL Instance Document
 
 
 
101.SCH**
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL**
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF**
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB**
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE**
 
XBRL Taxonomy Extension Presentation Linkbase Document
*
Filed herewith
**
Furnished, not filed


47


EMC INSURANCE GROUP INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 9, 2019.

EMC INSURANCE GROUP INC.
Registrant
 
/s/ Bruce G. Kelley
Bruce G. Kelley
President, Chief Executive Officer, Treasurer and Director
(Principal Executive Officer)

/s/ Mark E. Reese
Mark E. Reese
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

48