-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WOZt9YOiStJywtxn5kdaXb0kwRw2F3TaV3QGf0mikJNEq/NoxIWlXRBsmfo6VMf1 6JMDpUd/UPQQ58wVQoe5CQ== 0000356130-00-000002.txt : 20000329 0000356130-00-000002.hdr.sgml : 20000329 ACCESSION NUMBER: 0000356130-00-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMC INSURANCE GROUP INC CENTRAL INDEX KEY: 0000356130 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 426234555 STATE OF INCORPORATION: IA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10956 FILM NUMBER: 581403 BUSINESS ADDRESS: STREET 1: 717 MULBERRY ST CITY: DES MOINES STATE: IA ZIP: 50309 BUSINESS PHONE: 5152802902 10-K 1 1999 EMC INSURANCE GROUP INC 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the Fiscal Year Ended December 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] 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 (I.R.S. Employer incorporation or organization) Identification No.) 717 Mulberry Street, Des Moines, Iowa 50309 - -------------------------------------- ---------- (Address of Principal Executive Office) (Zip Code) Registrant's telephone number, including area code: (515) 280-2902 --------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $1.00 ----------------------------- (Title of Class) 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. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 1, 2000 was $29,207,981. The number of shares outstanding of the registrant's common stock, $1.00 par value, on March 1, 2000, were 11,266,950. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the registrant's annual report to stockholders for the year ended December 31, 1999 are incorporated by reference under Parts II and IV. 2. Portions of the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission on or before April 29, 2000, are incorporated by reference under Part III. TABLE OF CONTENTS Part I Item 1. Business ........................................................ 2 Item 2. Properties ...................................................... 22 Item 3. Legal Proceedings ............................................... 22 Item 4. Submission of Matters to a Vote of Security Holders ............. 22 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................................. 23 Item 6. Selected Financial Data ......................................... 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .......................... 23 Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...... 23 Item 8. Financial Statements and Supplementary Data ..................... 23 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .......................... 23 Part III Item 10. Directors and Executive Officers of the Registrant .............. 24 Item 11. Executive Compensation .......................................... 24 Item 12. Security Ownership of Certain Beneficial Owners and Management ............................................... 25 Item 13. Certain Relationships and Related Transactions .................. 25 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .................................................. 26 Index to Financial Statement Schedules ................................... 26 Signatures ............................................................... 29 Index to Exhibits ........................................................ 39 PART I ------ ITEM 1. BUSINESS. - ------- --------- GENERAL - ------- EMC Insurance Group Inc. is an insurance holding company incorporated in Iowa in 1974. EMC Insurance Group Inc. is approximately 72 percent owned by Employers Mutual Casualty Company (Employers Mutual), a multiple-line property and casualty insurance company organized as an Iowa mutual insurance company in 1911 that is licensed in all 50 states and the District of Columbia. The term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries and an affiliate (including the Company), are referred to as the "EMC Insurance Companies." The Company conducts its insurance business through two business segments as follows: ............................... : : : EMC INSURANCE GROUP INC. : :.............................: : Property and : Casualty Insurance : Reinsurance ......................:................................ : : : : Illinois EMCASCO Insurance Company (Illinois EMCASCO) EMC Dakota Fire Insurance Company (Dakota Fire) Reinsurance Farm and City Insurance Company (Farm and City) Company EMCASCO Insurance Company (EMCASCO) : : EMC Underwriters, LLC. Illinois EMCASCO was formed in Illinois in 1976, Dakota Fire was formed in North Dakota in 1957 and EMCASCO was formed in Iowa in 1958 for the purpose of writing property and casualty insurance. Farm and City was formed in Iowa in 1962 to write nonstandard risk automobile insurance and was purchased by the Company in 1984. These companies are licensed to write insurance in a total of 35 states and are participants in a pooling agreement with Employers Mutual (see "Property and Casualty Insurance - Pooling Agreement"). The reinsurance subsidiary was formed in 1981 to assume reinsurance business from Employers Mutual. The company assumes a portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts, and is licensed to do business in nine states. The Company's excess and surplus lines insurance agency, EMC Underwriters, LLC., was acquired in 1985. The company was formed in Iowa in 1975 as a broker for excess and surplus lines insurance. Effective December 31, 1998, the excess and surplus lines insurance agency was converted to a limited liability company and the ownership was contributed to EMCASCO. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS - --------------------------------------------- For information concerning the Company's revenues, operating income and identifiable assets attributable to each of its industry segments over the past three years, see note 8 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. PROPERTY AND CASUALTY INSURANCE - ------------------------------- POOLING AGREEMENT The four property and casualty insurance subsidiaries of the Company and two subsidiaries and an affiliate of Employers Mutual (Union Insurance Company of Providence, EMC Property & Casualty Company and Hamilton Mutual Insurance Company) are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all the companies. The pooling agreement produces a more uniform and stable underwriting result from year to year for all companies in the pool than might be experienced individually. In addition, each company benefits from the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own assets, and from the wide range of policy forms, lines of insurance written, rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all companies in the pool. Effective January 1, 1998, Farm and City, a subsidiary of the Company that writes nonstandard risk automobile insurance business, became a participant in the pooling agreement. Farm and City assumes a 1.5 percent participation in the pool, which increased the Company's aggregate participation in the pool from 22 percent in 1997 to 23.5 percent in 1998 and 1999. In connection with this change in the pooling agreement, the Company's liabilities increased $6,224,586 and invested assets increased $5,569,567. The Company reimbursed Employers Mutual $726,509 for expenses that were incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $71,490 in interest income as the actual cash transfer did not occur until March 25, 1998. Effective January 1, 1997, Hamilton Mutual Insurance Company (Hamilton Mutual) became a participant in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,063 and invested assets increased $5,674,458. The Company reimbursed Employers Mutual $794,074 for expenses incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $75,469 in interest income as the actual cash transfer did not occur until March 24, 1997. PRINCIPAL PRODUCTS The Company's property and casualty insurance subsidiaries and the other parties to the pooling agreement underwrite both commercial and personal lines of insurance. The following table sets forth the aggregate direct written premiums of all parties to the pooling agreement for the three years ended December 31, 1999. The pooling agreement is continuous, but may be amended or terminated at the end of any calendar year as to any one or more parties. Percent Percent Percent of of of Line of Business 1999 total 1998 total 1997 total - ---------------- ---- ----- ---- ----- ---- ----- (Dollars in thousands) Commercial Lines: Automobile ............ $157,095 20.8% $131,317 18.9% $118,624 18.2% Property .............. 118,939 15.8 115,815 16.6 110,637 17.0 Workers' compensation 126,285 16.7 117,120 16.8 115,117 17.6 Liability ............. 122,528 16.2 115,377 16.6 110,647 16.9 Other ................. 16,615 2.2 15,418 2.2 15,139 2.3 -------- ----- -------- ----- -------- ----- Total commercial lines 541,462 71.7 495,047 71.1 470,164 72.0 -------- ----- -------- ----- -------- ----- Personal Lines: Automobile ............ 138,168 18.3 130,693 18.8 119,580 18.3 Property .............. 73,380 9.7 68,365 9.8 61,569 9.4 Liability ............. 2,280 0.3 2,134 0.3 2,026 0.3 Other ................. 51 - 52 - 51 - -------- ----- -------- ----- -------- ----- Total personal lines 213,879 28.3 201,244 28.9 183,226 28.0 -------- ----- -------- ----- -------- ----- Total ............ $755,341 100.0% $696,291 100.0% $653,390 100.0% ======== ===== ======== ===== ======== ===== MARKETING Marketing of insurance by the parties to the pooling agreement, excluding the nonstandard risk automobile insurance sold by Farm and City, is conducted through 18 offices located throughout the United States and approximately 3,200 independent agencies. These offices allow the Company to respond quickly to changes in local market conditions. Each office employs underwriting, claims, marketing and risk improvement representatives, as well as field auditors and branch administrative technicians. The offices are supported by Employers Mutual technicians and specialists. Systems are in place to monitor the underwriting results of each office and to maintain guidelines and policies consistent with the underwriting and marketing environment in each region. Farm and City specializes in insuring private passenger automobile risks that are found to be unacceptable in the standard automobile insurance market. Farm and City is licensed in a six state area that includes Iowa, Kansas, Missouri, Nebraska, North Dakota and South Dakota. Private passenger automobile policies are solicited through the American Agency System using approximately 1,100 independent agencies. The following table sets forth the geographic distribution of the aggregate direct written premiums of all parties to the pooling agreement for the three years ended December 31, 1999. 1999 1998 1997 ------ ------ ------ Alabama ............................ 3.7% 3.7% 3.6% Arizona ............................ 3.7 3.7 3.7 Illinois ........................... 4.8 5.2 5.3 Iowa ............................... 18.1 19.3 19.0 Kansas ............................. 7.8 7.8 8.3 Michigan ........................... 3.7 3.6 4.1 Minnesota .......................... 3.6 3.8 3.8 Nebraska ........................... 6.9 7.1 7.2 North Carolina ..................... 2.9 3.2 3.3 North Dakota ....................... 3.2 3.1 2.4 Ohio ............................... 2.3 2.3 3.2 Texas .............................. 4.9 4.4 4.4 Wisconsin .......................... 4.3 4.4 4.4 Other * ............................ 30.1 28.4 27.3 ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== ===== * Includes all other jurisdictions, none of which accounted for more than 3%. COMPETITION The property and casualty insurance business is highly competitive. The Company's property and casualty insurance subsidiaries and the other pool members compete in the United States insurance market with numerous insurers, many of which have greater financial resources. Competition in the types of insurance in which the property and casualty insurance subsidiaries are engaged is based on many factors, including the perceived overall financial strength of the insurer, premiums charged, contract terms and conditions, services offered, speed of claim payments, reputation and experience. In this competitive environment, insureds have tended to favor large, financially strong insurers and the Company faces the risk that insureds may become more selective and may seek larger and/or more highly rated insurers. BEST'S RATING A.M. Best rates insurance companies based on their relative financial strength and ability to meet their contractual obligations. The "A" (Excellent) rating assigned to the Company's property and casualty insurance subsidiaries and the other pool members is based on the pool members' 1998 operating results and financial condition as of December 31, 1998. A.M. Best reevaluates its ratings from time to time (normally on an annual basis) and there can be no assurance that the Company's property and casualty insurance subsidiaries and the other pool members will maintain their current rating in the future. Management believes that a Best's rating of "A" (Excellent) or better is important to the Company's business since many insureds require that companies with which they insure be so rated. Best's publications indicate that these ratings are assigned to companies which A.M. Best believes have achieved excellent overall performance and have a strong ability to meet their obligations over a long period of time. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. REINSURANCE CEDED The parties to the pooling agreement cede insurance in the ordinary course of business for the purpose of limiting their maximum loss exposure through diversification of their risks. The pool participants also purchase catastrophe reinsurance to cover multiple losses arising from a single event. During 1999 and 1998, the pool participants purchased aggregate property catastrophe excess of loss reinsurance to cover losses arising from multiple catastrophes. Due to substantial changes in both the terms and the cost of the coverage, this reinsurance protection has not been renewed for year 2000. If this reinsurance protection had not been in place in 1999 the Company would have reported $3,524,000 of additional operating losses, net of the premium cost savings. All major reinsurance treaties, with the exception of the pooling agreement and a boiler treaty, are on an "excess of loss" basis whereby the reinsurer agrees to reimburse the primary insurer for covered losses in excess of a predetermined amount, up to a stated limit. The boiler treaty provides for 100 percent reinsurance of the pool's direct boiler coverage written. Facultative reinsurance from approved domestic markets, which provides reinsurance on an individual risk basis and requires specific agreement of the reinsurer as to the limits of coverage provided, is purchased when coverage by an insured is required in excess of treaty capacity or where a high-risk type policy could expose the treaty reinsurance programs. Each type of reinsurance coverage is purchased in layers, and each layer may have a separate retention level. Retention levels are adjusted according to reinsurance market conditions and the surplus position of EMC Insurance Companies. The intercompany pooling arrangement aids efficient buying of reinsurance since it allows for higher retention levels and correspondingly decreased dependence on the reinsurance marketplace. A summary of the reinsurance treaties benefiting the parties to the pooling agreement as of December 31, 1999 is presented below. Retention amounts reflect the accumulated retentions of all layers within a treaty. Type of Reinsurance Treaty Retention Limits -------------------------- ----------- -------------------------- Property per risk ........... $ 2,000,000 100 percent of $18,000,000 Property catastrophe ........ $11,550,000 95 percent of $51,000,000 Aggregate property catastrophe excess ........ $21,225,000 100 percent of $37,500,000 Casualty .................... $ 2,000,000 100 percent of $38,000,000 Workers' Compensation excess $ - $20,000,000 excess of $40,000,000 Umbrella .................... $ 1,400,000* 100 percent of $ 8,600,000 Fidelity and Surety ......... $ 750,000 100 percent of $ 4,250,000 Surety excess .............. $ 1,450,000 100 percent of $10,550,000 Boiler ...................... $ 0 100 percent of $50,000,000 * An annual aggregate deductible of $3,600,000 must be reached before the reinsurers may be petitioned. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer since the primary insurer would only reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreements. The ability to collect reinsurance is subject to the solvency of the reinsurers. The major participants in the pool members' reinsurance programs as of December 31, 1999 are presented below. The percentages represent the reinsurers' share of the total reinsurance protection under all coverages. Each type of coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within these coverages. The property per risk, property catastrophe and casualty reinsurance programs are handled by a reinsurance intermediary (broker). The reinsurance of those programs is syndicated to approximately 50 domestic and foreign reinsurers. In formulating reinsurance programs, Employers Mutual is selective in its choice of reinsurers. Employers Mutual selects reinsurers on the basis of financial stability and long-term relationships, as well as price of the coverage. Reinsurers are generally required to have a Best's rating of "A-" or higher and policyholders' surplus of $50,000,000 ($100,000,000 for casualty reinsurance). Percent of total 1999 Property per risk, property catastrophe reinsurance Best's and casualty coverages: protection rating - --------------------------------------- ----------- ------ Underwriters at Lloyd's of London .................... 20.6% A Transatlantic Reinsurance Company .................... 8.9 A++ Zurich Reinsurance (North America), Inc .............. 6.5 A+ NAC Reinsurance Corporation .......................... 6.2 A+ X.L. Mid Ocean Reinsurance Company, Ltd .............. 5.6 (1) AXA Reassurance ...................................... 5.1 A+ Continental Casualty Company ......................... 3.9 A Aggregate property catastrophe excess coverage: - ----------------------------------------------- Munich Reinsurance Company (UK) ...................... 49.5 (1) Underwriters at Lloyd's of London .................... 33.4 A Workers' compensation excess coverage: - -------------------------------------- First Allmerica Financial Life Insurance Company ..... 50.0 A Trenwick America Reinsurance Corporation ............. 50.0 A+ Umbrella coverage: - ------------------ General Reinsurance Corporation ...................... 100.0 A++ Fidelity and surety coverages: - ------------------------------ SCOR Reinsurance Company ............................. 42.0 A+ GE Reinsurance Corporation ........................... 20.0 A Signet Star Reinsurance Company ...................... 20.0 A Partner Reinsurance Company of the U.S. .............. 18.0 A Boiler coverage: - ---------------- Hartford Steam Boiler Inspection and Insurance Company 100.0 A+ (1) Not rated. Premiums ceded under the pool members' reinsurance programs by all pool members and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1999 are presented below. Each type of reinsurance coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within the coverages. Since each layer of each coverage is priced separately, with the lower layers being more expensive than the upper layers, a reinsurer's overall participation in a reinsurance program does not necessarily correspond to the amount of premiums it receives. Premiums ceded by ------------------------ Property and casualty All pool insurance Reinsurer members subsidiaries - --------- ----------- ------------ General Reinsurance Corporation..................... $ 4,338,094 $ 1,019,452 Hartford Steam Boiler Inspection & Insurance Company 2,267,667 532,902 NAC Reinsurance Corporation ........................ 1,322,065 310,685 SCOR Reinsurance Company ........................... 902,154 212,006 Transatlantic Reinsurance Company .................. 874,276 205,455 Munchener Ruckversicherungs ........................ 758,796 178,317 Continental Casualty Company........................ 724,654 170,294 Signet Star Reinsurance Company .................... 720,956 169,425 Renaissance Reinsurance Company .................... 680,400 159,894 AXA Reassurance .................................... 649,503 152,633 Other Reinsurers ................................... 8,179,443 1,922,169 ----------- ------------ Total ............................................ $21,418,008 $ 5,033,232 =========== ============ The parties to the pooling agreement also cede reinsurance on both a voluntary and a mandatory basis to state and national organizations in connection with various workers' compensation and assigned risk programs and to private organizations established to handle large risks. Premiums ceded by all pool members and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1999 are presented below. Premiums ceded by ------------------------ Property and casualty All pool insurance Reinsurer members subsidiaries - --------- ----------- ------------ Wisconsin Compensation Rating Bureau ............... $ 3,737,058 $ 878,209 National Workers' Compensation Reinsurance Pool .... 3,015,899 708,736 North Carolina Reinsurance Facility ................ 1,153,243 271,012 North Carolina Insurance Underwriting Association .. 754,400 177,284 Mutual Reinsurance Bureau .......................... 495,270 116,388 Other Reinsurers ................................... 365,255 85,835 ----------- ------------ $ 9,521,125 $ 2,237,464 =========== ============ For information concerning amounts due the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums and the effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, see "Property and Casualty Insurance Subsidiaries and Reinsurance Subsidiary - Reinsurance Ceded." REINSURANCE ASSUMED The parties to the pooling agreement also assume insurance from involuntary pools and associations in conjunction with direct business written in various states. Through its participation in the pooling agreement, the Company assumes insurance business from the North Carolina Reinsurance Facility (NCRF), which is a state run assigned risk program. Prior to 1998 the Company had not recognized its share of certain surcharges reported by the NCRF. During the fourth quarter of 1998, the Company received clarification regarding such amounts and recorded its share of these cumulative surcharges. As a result, the consolidated financial statements for the year ended December 31, 1998 reflect assumed premium income of $542,656 and assumed loss recoveries of $661,818 related to prior years. Beginning in 1999, these surcharges are being recorded on a quarterly basis. RELATIONSHIP BETWEEN NET PREMIUMS WRITTEN AND SURPLUS The amount of insurance a property and casualty insurance company writes under industry standards is a multiple of its surplus calculated in accordance with statutory accounting practices. Generally, a ratio of 3 to 1 or less is considered satisfactory by regulatory authorities. The ratios of the pool members for the past three years are as follows: Year ended December 31, ------------------------------ 1999 1998 1997 ---- ---- ---- Employers Mutual .................... .86 .82 .80 EMCASCO ............................. 2.03 1.66 1.62 Illinois EMCASCO .................... 2.18 1.87 1.68 Dakota Fire ......................... 2.17 1.79 1.59 Farm and City ....................... 2.04 2.15 1.60 EMC Property & Casualty Company ..... .80 .65 1.08 Union Insurance Company of Providence .79 .75 .72 Hamilton Mutual ..................... 1.69 1.41 1.17 OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The property and casualty insurance subsidiaries' reserve information is included in the property and casualty loss reserve development for 1999. See "Property and Casualty Insurance Subsidiaries and Reinsurance Subsidiary - Outstanding Losses and Settlement Expenses." REINSURANCE - ----------- The reinsurance subsidiary is a property and casualty treaty reinsurer with a concentration in property lines. The reinsurance subsidiary assumes a quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its quota share portion of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, or any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Operations of the quota share agreement give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss per event assumed by the reinsurance subsidiary was increased from $1,000,000 to $1,500,000. In connection with the change in the quota share percentage, the Company's liabilities increased $3,173,647 and invested assets increased $3,066,705. The Company reimbursed Employers Mutual $106,942 for expenses that were incurred to generate the additional business assumed by the Company. PRINCIPAL PRODUCTS The reinsurance subsidiary assumes both pro rata and excess of loss reinsurance from Employers Mutual. The following table sets forth the assumed written premiums of the reinsurance subsidiary for the three years ended December 31, 1999. The amounts reported in the Company's financial statements for the year 1997 reflect an adjustment of $354,735 related to the change in the quota share percentage. This adjustment was made to offset the income statement effect that resulted from the increase in the reinsurance subsidiary's reserve for unearned premiums on January 1, 1997 in connection with this transaction. Percent Percent Percent of of of Line of Business 1999 total 1998 total 1997 total - ---------------- ------- ----- ------- ----- ------- ----- (Dollars in thousands) Pro rata reinsurance: Property and Casualty .. $12,642 29.0% $15,105 38.7% $ 8,985 26.2% Property ............... 7,461 17.1 2,601 6.7 6,546 19.0 Crop ................... 4,727 10.8 3,967 10.2 3,101 9.0 Casualty ............... 4,771 11.0 3,919 10.0 2,879 8.4 Marine/aviation ........ 2,289 5.3 1,424 3.6 1,866 5.4 Other .................. 261 0.6 1,661 4.2 2,116 6.2 ------- ----- ------- ----- ------- ----- Total pro rata reinsurance 32,151 73.8 28,677 73.4 25,493 74.2 ------- ----- ------- ----- ------- ----- Excess per risk reinsurance: Property ............... 2,298 5.3 2,099 5.4 2,110 6.2 Casualty ............... 1,979 4.6 2,104 5.4 1,595 4.6 Other .................. 754 1.7 868 2.2 647 1.9 ------- ----- ------- ----- ------- ----- Total excess per risk reinsurance ...... 5,031 11.6 5,071 13.0 4,352 12.7 ------- ----- ------- ----- ------- ----- Excess catastrophe/ aggregate reinsurance: Property ............... 5,674 13.0 4,744 12.1 4,293 12.5 Crop ................... 330 0.8 284 0.7 252 0.8 Marine/aviation ........ 20 - 38 0.1 8 - Other .................. 341 0.8 260 0.7 (62) (0.2) ------- ----- ------- ----- ------- ----- Total excess catastrophe/ aggregate reinsurance 6,365 14.6 5,326 13.6 4,491 13.1 ------- ----- ------- ----- ------- ----- Total excess reinsurance 11,396 26.2 10,397 26.6 8,843 25.8 ------- ----- ------- ----- ------- ----- $43,547 100.0% $39,074 100.0% $34,336 100.0% ======= ===== ======= ===== ======= ===== MARKETING Over the last several years Employers Mutual has emphasized writing excess of loss reinsurance business and has worked to increase its participation on existing contracts that had favorable terms. Employers Mutual strives to be flexible in the types of reinsurance products it offers, but generally limits its writings to direct reinsurance business rather than providing retrocessional covers. During the last three years there has been a trend in the reinsurance marketplace for "across the board" participation on excess of loss reinsurance contracts. As a result, reinsurance companies must be willing to participate in all coverages and on all layers offered under a specific contract in order to be considered a viable reinsurer. COMPETITION The reinsurance marketplace is very competitive; however, recent worldwide catastrophe losses may help ease rate adequacy concerns. Employers Mutual competes in the global reinsurance market with numerous reinsurers, many of which have greater financial resources. In this competitive environment, reinsurance brokers have tended to favor large, financially strong reinsurers who are able to provide "mega" line capacity for all lines of business. Employers Mutual is addressing this issue by accepting a larger share of coverage on desirable programs and strengthening its relationships with reinsurance intermediaries. REINSURANCE CEDED For information concerning amounts due the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums and the effect of reinsurance on premiums written and earned and losses and settlement expenses incurred, see "Property and Casualty Insurance Subsidiaries and Reinsurance Subsidiary - Reinsurance Ceded." BEST'S RATING The most recent Best's Property Casualty Key Rating Guide gives the reinsurance subsidiary a "B++" (Very Good) policyholders' rating. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The reinsurance subsidiary's reserve information is included in the property and casualty loss reserve development for 1999. See "Property and Casualty Insurance Subsidiaries and Reinsurance Subsidiary - Outstanding Losses and Settlement Expenses." PROPERTY AND CASUALTY INSURANCE SUBSIDIARIES AND REINSURANCE SUBSIDIARY - ----------------------------------------------------------------------- Employers Mutual provides various services to all of its subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are allocated to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not allocated to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. STATUTORY COMBINED RATIOS The following table sets forth the Company's insurance subsidiaries' statutory combined ratios and the property and casualty insurance industry averages for the five years ended December 31, 1999. The combined ratios below are the sum of the following: the loss ratio, calculated by dividing losses and settlement expenses incurred by net premiums earned, and the expense ratio, calculated by dividing underwriting expenses incurred by net premiums written and policyholder dividends by net premiums earned. Generally, if the combined ratio is below 100 percent, a company has an underwriting profit; if it is above 100 percent, a company has an underwriting loss. Year ended December 31, -------------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------ ------ ------ Property and casualty insurance Loss ratio ................... 83.6% 83.5% 74.3% 70.5% 67.3% Expense ratio ................ 32.0 33.3 32.8 34.3 32.6 ------ ------ ------ ------ ------ Combined ratio ............. 115.6% 116.8% 107.1% 104.8% 99.9% ====== ====== ====== ====== ====== Reinsurance Loss ratio ................... 83.1% 75.4% 68.4% 68.7% 66.3% Expense ratio ................ 30.6 31.1 34.1 31.5 32.3 ------ ------ ------ ------ ------ Combined ratio ............. 113.7% 106.5% 102.5% 100.2% 98.6% ====== ====== ====== ====== ====== Total insurance operations Loss ratio ................... 83.5% 81.9% 73.1% 70.0% 67.1% Expense ratio ................ 31.7 32.9 33.1 33.6 32.5 ------ ------ ------ ------ ------ Combined ratio ............. 115.2% 114.8% 106.2% 103.6% 99.6% ====== ====== ====== ====== ====== Property and casualty insurance industry averages (1) Loss ratio ................... 78.3% 76.3% 72.8% 78.3% 78.9% Expense ratio ................ 29.2 29.4 28.8 27.5 26.1 ------ ------ ------ ------ ------ Combined ratio ............. 107.5% 105.7% 101.6% 105.8% 105.0% ====== ====== ====== ====== ====== (1) As reported by A.M. Best Company. The ratio for 1999 is an estimate; the actual combined ratio is not currently available. REINSURANCE CEDED The following table presents amounts due to the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums as of December 31, 1999: 1999 Amount Percent Best's recoverable of total rating ----------- -------- ------ Wisconsin Compensation Rating Bureau .. $ 3,470,126 28.0% (1) National Workers' Compensation Reinsurance Pool .................... 1,813,296 14.6 (1) General Reinsurance Corporation ....... 796,609 6.4 A++ Hartford Fire Insurance Company ....... 636,935 5.1 A+ Minnesota Workers'Comp Reins Assoc .... 574,790 4.6 (2) PMA Reinsurance Corporation ........... 502,545 4.1 A+ American Re-Insurance Company ......... 472,057 3.8 A++ Mutual Reinsurance Bureau (MRB)........ 449,830 3.6 (3) GE Reinsurance Corporation ............ 345,542 2.8 A AXA Reinsurance Corporation ........... 290,479 2.3 A+ Other Reinsurers ...................... 3,057,720 24.7 ----------- -------- Total ........................... $12,409,929(4) 100.0% =========== ======== (1) Amounts recoverable reflect the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to these organizations by Employers Mutual in connection with its role as "service carrier." Under these arrangements, Employers Mutual writes business for these organizations on a direct basis and then cedes 100 percent of the business to these organizations. Credit risk associated with these amounts is minimal as all companies participating in these organizations are responsible for the liabilities of such organizations on a pro rata basis. (2) Not rated. (3) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this underwriting organization by Employers Mutual. MRB is composed of Employers Mutual and five other nonaffiliated mutual insurance companies. Each of the six members cede primarily property insurance to MRB and assume equal proportionate shares of this business. Each member benefits from the increased capacity provided by MRB. MRB is backed by the financial strength of the six member companies. All of the members of MRB were assigned an "A-" (Excellent) or better rating by A.M. Best. (4) The total amount recoverable at December 31, 1999 represented $868,550 in paid losses and settlement expenses, $10,260,815 in unpaid losses and settlement expenses and $1,280,564 in unearned premiums. The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred for the three years ended December 31, 1999 is presented below. Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Premiums written: Direct ........................ $228,588,440 $213,134,588 $175,350,677 Assumed from nonaffiliates .... 781,225 1,888,951 1,219,564 Assumed from affiliates ....... 221,051,986 204,964,038 178,624,357 Ceded to nonaffiliates ........ (7,270,696) (5,808,352) (5,615,772) Ceded to affiliates ........... (228,588,440) (213,249,508) (164,978,055) ------------ ------------ ------------ Net premiums written ........ $214,562,515 $200,929,717 $184,600,771 ============ ============ ============ Premiums earned: Direct ........................ $223,593,165 $202,514,027 $169,304,584 Assumed from nonaffiliates .... 873,710 1,969,067 1,403,778 Assumed from affiliates ....... 217,416,300 197,166,272 171,514,339 Ceded to nonaffiliates ........ (7,191,869) (5,801,680) (5,937,679) Ceded to affiliates ........... (223,593,165) (201,603,281) (159,066,776) ------------ ------------ ------------ Net premiums earned ......... $211,098,141 $194,244,405 $177,218,246 ============ ============ ============ Losses and settlement expenses incurred: Direct ........................ $183,031,797 $171,209,604 $126,922,536 Assumed from nonaffiliates .... 429,244 1,298,167 926,403 Assumed from affiliates ....... 182,375,574 171,681,607 122,827,934 Ceded to nonaffiliates ........ (5,928,570) (7,395,934) (3,364,737) Ceded to affiliates ........... (183,031,797) (178,917,350) (117,458,832) ------------ ------------ ------------ Net losses and settlement expenses incurred ......... $176,876,248 $157,876,094 $129,853,304 ============ ============ ============ OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The Company maintains reserves for losses and settlement expenses with respect to both reported and unreported claims. The amount of reserves for reported claims is primarily based upon a case-by-case evaluation of the specific type of claim, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of loss. Reserves on assumed business are the amounts reported by the ceding company. The amount of reserves for unreported claims is determined on the basis of statistical information for each line of insurance with respect to the probable number and nature of claims arising from occurrences which have not yet been reported. Established reserves are closely monitored and are frequently recomputed using a variety of formulas and statistical techniques for analyzing actual claim costs, frequency data and other economic and social factors. The Company does not discount reserves. Inflation is implicitly provided for in the reserving function through analysis of cost trends, reviews of historical reserving results and projections of future economic conditions. Large ($100,000 and over) incurred and reported gross reserves are reviewed regularly for adequacy. In addition, long-term and lifetime medical claims are periodically reviewed for cost trends and the applicable reserves are appropriately revised. Loss reserves are estimates at a given time of what the insurer expects to pay on incurred losses, based on facts and circumstances then known. During the loss settlement period, which may be many years, additional facts regarding individual claims become known, and accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim. Settlement expense reserves are intended to cover the ultimate cost of investigating claims and defending lawsuits arising from claims. These reserves are established each year based on previous years experience to project the ultimate cost of settlement expenses. To the extent that adjustments are required to be made in the amount of loss reserves each year, settlement expense reserves are correspondingly revised. Changes in reserves for losses and settlement expenses are reflected in the operating results of the year such changes are recorded. Despite the inherent uncertainties of estimating insurance company loss and settlement expense reserves, management believes that the Company's reserves are being calculated in accordance with sound actuarial practices and, based upon current information, that the Company's reserves for losses and settlement expenses at December 31, 1999 are adequate. The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the property and casualty insurance subsidiaries and the reinsurance subsidiary. 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. Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Gross reserves at beginning of year $245,610,323 $217,777,942 $202,502,986 Ceded reserves at beginning of year (15,563,600) (13,030,150) (13,796,769) ------------ ------------ ------------ Net reserves at beginning of year, before adjustments ............... 230,046,723 204,747,792 188,706,217 Adjustment to beginning reserves due to change in pooling agreement ........................ - 3,600,220 3,795,453 Adjustment to beginning reserves due to change in quota share percentage ....................... - - 2,726,913 ------------ ------------ ------------ Net reserves at beginning of year, after adjustments ................ 230,046,723 208,348,012 195,228,583 ------------ ------------ ------------ Incurred losses and settlement expenses: - ---------------------- Provision for insured events of the current year ............ 182,609,687 168,953,309 137,300,762 Decrease in provision for insured events of prior years .. (5,733,439) (11,077,215) (7,447,458) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 176,876,248 157,876,094 129,853,304 ------------ ------------ ------------ Payments: - --------- Losses and settlement expenses attributable to insured events of the current year ............ 72,970,531 73,228,354 57,649,830 Losses and settlement expenses attributable to insured events of prior years ................. 77,699,231 62,949,029 62,684,265 ------------ ------------ ------------ Total payments ............. 150,669,762 136,177,383 120,334,095 ------------ ------------ ------------ Net reserves at end of year ........ 256,253,209 230,046,723 204,747,792 Ceded reserves at end of year ...... 10,260,815 15,563,600 13,030,150 ------------ ------------ ------------ Gross reserves at end of year ...... $266,514,024 $245,610,323 $217,777,942 ============ ============ ============ The following table shows the calendar year development of loss and settlement expense reserves of the property and casualty insurance subsidiaries and the reinsurance subsidiary. Amounts presented are on a net basis with, beginning in 1992, (i) a reconciliation of the net loss and settlement expense reserves, to the gross amounts presented in the consolidated financial statements and (ii) disclosure of the gross re-estimated loss and settlement expense reserves and the related re-estimated reinsurance receivables. Reflected in this table is (1) the increase in the property and casualty insurance subsidiaries' collective participation in the pool from 17 percent to 22 percent in 1992, (2) the change in the pooling agreement whereby effective January 1, 1993 the voluntary reinsurance business written by Employers Mutual is no longer subject to cession to the pool members, (3) the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement in 1993, (4) the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool at December 31, 1993, (5) the reinsurance subsidiary's commutation of all outstanding reinsurance balances ceded to Employers Mutual under catastrophe and aggregate excess of loss reinsurance treaties related to accident years 1991 through 1993 in 1994, and (6) the increase in the reinsurance subsidiary's quota share assumption of Employers Mutual's assumed reinsurance business from 95 percent to 100 percent in 1997. The table has been restated to reflect the addition of Hamilton Mutual to the pooling agreement effective January 1, 1997 and the addition of Farm and City to the pooling agreement effective January 1, 1998. In evaluating the table, it should be noted that each cumulative redundancy (deficiency) amount includes the effects of all changes in reserves for prior periods. Conditions and trends that have affected development of the liability in the past, such as a time lag in the reporting of assumed reinsurance business, the high rate of inflation associated with medical services and supplies and the reform measures implemented by several states to control administrative costs for workers' compensation insurance, may not necessarily occur in the future. Accordingly, it may not be appropriate to project future development of reserves based on this table. During the last three years the Company has experienced favorable development in the provision for insured events of prior years. The majority of the favorable development has come from the property and casualty insurance subsidiaries. Favorable development has also been experienced in the reinsurance subsidiary, but to a lesser degree. The Company has historically experienced favorable development in its reserves and current reserving practices have not been relaxed; however, the amount of favorable development experienced is expected to fluctuate from year to year.
Year ended December 31, (Dollars in thousands) 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Statutory reserves for losses and settlement expenses ...... $127,870 131,623 139,317 180,797 182,072 191,514 196,293 191,892 205,606 230,937 257,201 Reclassification of reserve amounts associated with the National Workers' Compensation Reinsurance Pool ............. 3,855 4,338 6,830 11,364 - - - - - - - Retroactive restatement of reserves in conjunction with admittance of new participants into the pooling agreement ... 2,182 3,334 4,364 5,314 5,248 6,603 6,809 7,018 3,600 - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Statutory reserves after reclassification ............. 133,907 139,295 150,511 197,475 187,320 198,117 203,102 198,910 209,206 230,937 257,201 GAAP adjustments: Salvage and subrogation ...... (930) (1,203) (1,284) (2,026) (1,804) (1,799) (2,369) (2,400) - - - Reclass of statutory settlement expense portion of retirement benefit liability - - - - (601) (680) (729) (786) (858) (890) (948) -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Reserves for losses and settlement expenses .......... 132,977 138,092 149,227 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 Paid (cumulative) as of: One year later ............... 42,480 42,990 31,577 78,000 60,162 57,247 62,012 59,856 62,949 77,699 - Two years later .............. 66,185 59,579 79,619 109,985 89,153 88,831 92,626 92,191 99,870 - - Three years later ............ 77,009 96,796 97,152 127,885 107,372 106,691 112,985 113,343 - - - Four years later ............. 107,215 106,391 107,114 137,783 116,856 118,705 124,450 - - - - Five years later ............. 113,112 112,200 112,598 143,876 123,843 126,384 - - - - - Six years later .............. 116,338 115,858 116,670 148,518 128,931 - - - - - - Seven years later ............ 119,039 118,725 119,699 151,895 - - - - - - - Eight years later ............ 120,879 120,122 121,817 - - - - - - - - Nine years later ............. 121,758 121,763 - - - - - - - - - Ten years later .............. 122,893 - - - - - - - - - - Reserves reestimated as of: End of year .................. 132,977 138,092 149,227 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 One year later ............... 137,442 143,884 155,537 197,008 179,527 179,818 183,760 188,579 197,271 224,313 - Two years later .............. 140,272 145,101 152,771 192,318 170,653 173,162 182,285 185,465 194,287 - - Three years later ............ 139,949 143,413 148,867 186,730 166,778 172,118 179,797 181,392 - - - Four years later ............. 140,315 142,496 148,017 186,133 166,133 170,570 176,176 - - - - Five years later ............. 139,380 143,063 148,098 186,319 165,548 167,763 - - - - - Six years later .............. 141,133 143,638 148,686 186,095 163,406 - - - - - - Seven years later ............ 142,650 144,318 148,991 184,174 - - - - - - - Eight years later ............ 143,763 144,679 147,579 - - - - - - - - Nine years later ............. 143,051 143,472 - - - - - - - - - Ten years later .............. 141,920 - - - - - - - - - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Cumulative redundancy (Deficiency) ................. $ (8,943) (5,380) 1,648 11,275 21,509 27,875 23,828 14,332 14,061 5,734 - ======== ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Gross loss and settlement expense reserves - end of year (A) .............................. $220,703 202,370 209,785 212,231 209,521 221,378 245,610 266,514 Reinsurance receivables ................................... 25,254 17,455 14,147 12,227 13,797 13,030 15,563 10,261 -------- ------- ------- ------- ------- ------- ------- ------- Net loss and settlement expense reserves - end of year .................................. $195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 ======== ======= ======= ======= ======= ======= ======= ======= Gross re-estimated reserves - latest (B) .................. $206,278 178,876 181,805 190,981 198,572 209,794 240,911 266,514 Re-estimated reinsurance receivables - latest ............. 22,104 15,470 14,042 14,805 17,180 15,507 16,598 10,261 -------- ------- ------- ------- ------- ------- ------- ------- Net re-estimated reserves - latest ........................ $184,174 163,406 167,763 176,176 181,392 194,287 224,313 256,253 ======== ======= ======= ======= ======= ======= ======= ======= Gross cumulative redundancy (deficiency) (A-B) ............ $ 14,425 23,494 27,980 21,250 10,949 11,584 4,699 - ======== ======= ======= ======= ======= ======= ======= =======
Asbestos and Environmental Claims The Company has exposure to asbestos and environmental related claims associated with the insurance business written by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary. Estimating loss and settlement expense reserves for asbestos and environmental claims are very difficult due to the many uncertainties surrounding these types of claims. These uncertainties exist because the assignment of responsibility varies widely by state and claims often emerge long after the policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult. In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, the social and political conditions and the claim history and trends within the Company and the industry. Based upon current facts, management believes the reserves established for asbestos and environmental related claims at December 31, 1999 are adequate. Although future changes in the legal and political environment may result in adjustments to these reserves, management believes any adjustments will not have a material impact on the financial condition or results of operations of the Company. The following table presents asbestos and environmental related losses and settlement expenses incurred and reserves outstanding for the Company: Year ended December 31, -------------------------------- 1999 1998 1997 ---------- ---------- ---------- Losses and settlement expenses incurred: Asbestos: Property and casualty insurance ......... $ 125,687 $ 34,287 $ 25,246 Reinsurance ............................. (25,971) - 394,524 ---------- ---------- ---------- 99,716 34,287 419,770 ---------- ---------- ---------- Environmental: Property and casualty insurance ......... 11,227 18,288 25,615 Reinsurance ............................. 223,996 - 374,822 ---------- ---------- ---------- 235,223 18,288 400,437 Total loss and settlement expenses ---------- ---------- ---------- incurred .......................... $ 334,939 $ 52,575 $ 820,207 ========== ========== ========== Loss and settlement expense reserves: Asbestos: Property and Casualty insurance ......... $ 259,148 $ 186,840 $ 170,302 Reinsurance ............................. 753,481 793,624 805,429 ---------- ---------- ---------- 1,012,629 980,464 975,731 ---------- ---------- ---------- Environmental: Property and casualty insurance ......... 724,662 885,578 864,043 Reinsurance ............................. 710,520 506,056 572,961 ---------- ---------- ---------- 1,435,182 1,391,634 1,437,004 Total loss and settlement expense ---------- ---------- ---------- reserves .......................... $2,447,811 $2,372,098 $2,412,735 ========== ========== ========== INVESTMENTS - ----------- Securities classified as held-to-maturity are purchased with the intent and ability to be held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. All other securities have been classified as securities available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as accumulated other comprehensive income in stockholders' equity, net of deferred income taxes. At December 31, 1999, approximately 71 percent of the Company's bonds were invested in government or government agency issued securities. A variety of maturities are maintained in the Company's portfolio to assure adequate liquidity. The maturity structure of bond investments is also established by the relative attractiveness of yields on short, intermediate and long-term bonds. The Company does not invest in any high-yield debt investments (commonly referred to as junk bonds). During the second and third quarters of 1999, the Company sold approximately $55,000,000 of investments in tax-exempt fixed maturity securities and reinvested the proceeds into taxable fixed maturity securities that pay a higher interest rate. This change in asset allocation was implemented to increase the Company's after-tax rate of return on its investment portfolio in response to the recent deterioration in the Company's underwriting results and the expectation that underwriting results will not improve significantly in the near future. The Company's equity investment holdings include common stock and preferred stock. During 1998 the Company liquidated its common stock mutual fund portfolio and reinvested the proceeds in individual stock issues that are being managed on a tax-aware basis. 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 it is in compliance with these laws. The investments of EMC Insurance Group Inc. and its subsidiaries are supervised by investment committees of each entity's respective board of directors. The investment portfolios are managed by an internal staff that is composed of employees of Employers Mutual. Investment expenses are based on actual expenses incurred plus an allocation of other investment expenses incurred by Employers Mutual, which is based on a weighted average of total invested assets and number of investment transactions. The following table shows the composition of the Company's investment portfolio (at amortized cost), by type of security, as of December 31, 1999 and 1998. In the Company's consolidated financial statements, securities held-to-maturity are carried at amortized cost; securities available-for-sale are carried at fair value. Year ended December 31, -------------------------------------------- 1999 1998 --------------------- --------------------- Amortized Amortized cost Percent cost Percent ------------ ------- ------------ ------- Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $109,055,239 24.8% $140,041,154 33.0% Mortgage-backed securities 18,148,921 4.1 24,885,036 5.8 ------------ ------- ------------ ------- Total securities held- to-maturity ............ 127,204,160 28.9 164,926,190 38.8 ------------ ------- ------------ ------- Securities available-for-sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. 4,419,411 1.0 3,491,259 0.8 Obligations of states and political subdivisions ... 96,077,294 21.9 155,138,275 36.5 Mortgage-backed securities ............... 49,440,943 11.2 - - Debt securities issued by foreign governments ...... 6,479,135 1.5 - - Public utilities ........... 8,890,108 2.0 7,304,015 1.7 Corporate securities ....... 98,413,442 22.4 42,181,578 9.9 ------------ ------- ------------ ------- Total fixed maturity securities ............. 263,720,333 60.0 208,115,127 48.9 ------------ ------- ------------ ------- Equity securities: Common stock ............... 25,853,745 5.9 26,782,547 6.3 Non-redeemable preferred stocks ................... 2,640,886 0.6 3,145,886 0.7 ------------ ------- ------------ ------- Total equity securities .. 28,494,631 6.5 29,928,433 7.0 ------------ ------- ------------ ------- Total securities available-for-sale ..... 292,214,964 66.5 238,043,560 55.9 ------------ ------- ------------ ------- Short-term investments ......... 20,164,210 4.6 22,660,011 5.3 ------------ ------- ------------ ------- Total investments ........ $439,583,334 100.0% $425,629,761 100.0% ============ ======= ============ ======= Fixed maturity securities held by the Company generally have an investment quality rating of "A" or better by independent rating agencies. The following table shows the composition of the Company's fixed maturity securities, by rating, as of December 31, 1999. Securities Securities held-to-maturity available-for-sale (at amortized cost) (at fair value) --------------------- --------------------- Amount Percent Amount Percent ------------ ------- ------------ ------- Rating(1) AAA ..................... $127,204,160 100.0% $108,712,161 42.5% AA ...................... - - 56,705,280 22.1 A ....................... - - 86,180,793 33.6 BAA ..................... - - 4,583,195 1.8 ------------ ------- ------------ ------- Total fixed maturities $127,204,160 100.0% $256,181,429 100.0% ============ ======= ============ ======= (1) Ratings for preferred stocks and fixed maturity securities with initial maturities greater than one year are assigned by Moody's Investor's Services, Inc. Moody's rating process seeks to evaluate the quality of a security by examining the factors that affect returns to investors. Moody's ratings are based on quantitative and qualitative factors, as well as the economic, social and political environment in which the issuing entity exists. The quantitative factors include debt coverage, sales and income growth, cash flows and liquidity ratios. Qualitative factors include management quality, access to capital markets and the quality of earnings and balance sheet items. Ratings for securities with initial maturities less than one year are based on an evaluation of the underlying assets or the credit rating of the issuer's parent company. The amortized cost and estimated fair value of fixed maturity securities at December 31, 1999, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized fair cost value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 4,498,477 $ 4,562,505 Due after one year through five years ..... 32,067,841 33,088,104 Due after five years through ten years .... 63,257,577 62,077,061 Due after ten years ....................... 9,231,344 8,592,680 Mortgage-backed securities ................ 18,148,921 18,358,715 ------------ ------------ Totals .................................. $127,204,160 $126,679,065 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 1,753,344 $ 1,756,937 Due after one year through five years ..... 25,307,861 25,259,693 Due after five years through ten years .... 54,694,520 53,277,920 Due after ten years ....................... 132,523,665 126,452,673 Mortgage-backed securities ................ 49,440,943 49,434,206 ------------ ------------ Totals .................................. $263,720,333 $256,181,429 ============ ============ The mortgage-backed securities shown in the above table include $52,661,313 of securities issued by government corporations and agencies and $14,928,551 of collateralized mortgage obligations (CMOs). CMOs are securities backed by mortgages on real estate, which come due at various times. The Company has attempted to minimize the prepayment risks associated with mortgage-backed securities by not investing in "principal only" and "interest only" CMOs. The CMOs that the Company has invested in are designed to reduce the risk of prepayment by providing predictable principal payment schedules within a designated range of prepayments. Investment yields may vary from those anticipated due to changes in prepayment patterns of the underlying collateral. Investment results of the Company for the periods indicated are shown in the following table: Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Average invested assets (1) ........ $432,606,548 $412,682,091 $386,852,093 Investment income (2) .............. $ 25,760,561 $ 24,859,063 $ 23,780,303 Average yield ...................... 5.96% 6.02% 6.15% Realized investment gains (3) ...... $ 276,673 $ 5,901,049 $ 4,100,006 (1) Average of the aggregate invested amounts (amortized cost) at the beginning and end of the year. (2) Investment income is net of investment expenses and does not include realized gains or income tax provisions. (3) The amount for 1999 reflects realized gains of $1,589,953 resulting from the disposal of tax-exempt fixed maturity securities. The proceeds from the disposal of these tax-exempt fixed maturity securities were reinvested in taxable fixed maturity securities that pay a higher interest rate. This change in asset allocation was implemented to increase the Company's after- tax rate of return on its investment portfolio. The amount for 1998 reflects realized gains of $7,585,293 resulting from the liquidation of the Company's common stock mutual fund portfolio. The proceeds from the disposal of the common stock mutual fund portfolio were reinvested in individual stock issues that are being managed on a tax-aware basis. The amount for 1997 reflects a capital gains distribution of $4,010,683 related to the Company's common stock mutual fund portfolio. EMPLOYEES - --------- EMC Insurance Group Inc. has no employees of its own, although approximately 15 employees of Employers Mutual perform administrative duties on a part-time basis. Otherwise, the Company's business activities are conducted by employees of Employers Mutual and one of the property and casualty insurance subsidiaries, which have 1,980 and 68 employees, respectively. The property and casualty insurance subsidiaries share the costs charged to the pooling agreement in accordance with their pool participation percentages. See "Property and Casualty Insurance - Pooling Agreement." REGULATION - ---------- The Company's insurance subsidiaries are subject to extensive regulation and supervision by their home states, as well as those in which they do business. The purpose of such regulation and supervision is primarily to provide safeguards for policyholders rather than to protect the interests of stockholders. The insurance laws of the various states establish regulatory agencies with broad administrative powers, including the power to grant or revoke operating licenses and to regulate trade practices, investments, premium rates, deposits of securities, the form and content of financial statements and insurance policies, accounting practices and the maintenance of specified reserves and capital for the protection of policyholders. Premium rate regulation varies greatly among jurisdictions and lines of insurance. In most states in which the Company's subsidiaries write insurance, premium rates for their lines of insurance are subject to either prior approval or limited review upon implementation. States require rates for property and casualty insurance that are adequate, not excessive, and not unfairly discriminatory. The Company's insurance subsidiaries are required to file detailed annual reports with the appropriate regulatory agency in each state where they do business based on applicable statutory regulations, which differ from generally accepted accounting principles. Their businesses and accounts are subject to examination by such agencies at any time. Since EMC Insurance Group Inc. and Employers Mutual are domiciled in Iowa, the State of Iowa exercises principal regulatory supervision, and Iowa law requires periodic examination. The Company's insurance subsidiaries are subject to examination by state insurance departments on a periodic basis, as applicable law requires. State laws governing insurance holding companies also impose standards on certain transactions with related companies, which include, among other requirements, that all transactions be fair and reasonable and that an insurer's surplus as regards policyholders be reasonable and adequate in relation to its liabilities. Under Iowa law, dividends or distributions made by registered insurers are restricted in amount and may be subject to approval from the Iowa Commissioner of Insurance. "Extraordinary" dividends or distributions are subject to prior approval and are defined as dividends or distributions made within a 12 month period which exceed the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis. Both Illinois and North Dakota impose restrictions, which are similar to those of Iowa, on the payment of dividends and distributions. At December 31, 1999, $11,505,996 was available for distribution in 2000 to the Company without prior approval. See note 6 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. The National Association of Insurance Commissioners (NAIC) utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify property/casualty insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based on the risks applicable to the operations of the individual insurer. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk: asset risk, credit risk and underwriting risk. Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy. At December 31, 1999, each of the Company's insurance subsidiaries ratio of total adjusted capital to risk-based capital is well in excess of the minimum level required. ITEM 2. PROPERTIES. - ------- ----------- The Company does not own any real property. Lease costs of the Company's office facilities in Oak Brook, Illinois, and Bismarck, North Dakota, which total approximately $293,000 and $300,000 annually, are included as expenses under the pooling agreement. Expenses of office facilities owned and leased by Employers Mutual are borne by the parties to the pooling agreement, less the rent received from the space used and paid for by non-insurance subsidiaries and outside tenants. See "Property and Casualty Insurance - Pooling Agreement" under Item 1 of this Form 10-K. ITEM 3. LEGAL PROCEEDINGS. - ------- ------------------ 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 reserves that are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------- ---------------------------------------------------- None. PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED - ------- ------------------------------------------------- STOCKHOLDER MATTERS. -------------------- The "Stockholder Information" section from the Company's Annual Report to Stockholders for the year ended December 31, 1999, which is included as Exhibit 13(d) to this Form 10-K, is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. - ------- ------------------------ The "Selected Consolidated Financial Data" section from the Company's Annual Report to Stockholders for the year ended December 31, 1999, which is included as Exhibit 13(a) to this Form 10-K, is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS. ---------------------- The "Management's Discussion and Analysis of Financial Condition and Results of Operations" section from the Company's Annual Report to Stockholders for the year ended December 31, 1999, which is included as Exhibit 13(b) to this Form 10-K, is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. - -------- ----------------------------------------------------------- The information under the caption "Market Risk" in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section from the Company's Annual Report to Stockholders for the year ended December 31, 1999, which is included as Exhibit 13(b) to this Form 10-K, is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------- -------------------------------------------- The consolidated financial statements from the Company's Annual Report to Stockholders for the year ended December 31, 1999, which is included as Exhibit 13(c) to this Form 10-K, are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON - ------- ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURE. ------------------------------------ None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- --------------------------------------------------- See the information under the caption "Election of Directors" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 2000, which information is incorporated herein by reference. The following sets forth information regarding all executive officers of the Company. NAME AGE POSITION Bruce G. Kelley 46 President and Chief Executive Officer of the Company and of Employers Mutual since 1992 and Treasurer of both organizations since 1996. He was elected President of the Company and Employers Mutual in 1991. Mr. Kelley was Executive Vice President of the Company and Employers Mutual from 1989 to 1991. He has been employed by Employers Mutual since 1985. Fred A. Schiek 65 Executive Vice President and Chief Operating Officer of the Company and of Employers Mutual since 1992. He was Vice President of Employers Mutual from 1983 until 1992. He has been employed by Employers Mutual since 1959. John D. Isenhart 62 Senior Vice President of the Company since 1997 and of Employers Mutual since 1992. He has been employed by Employers Mutual since 1963. Margaret A. Ball 61 Senior Vice President of the Company since 1998 and of Employers Mutual since 1997. She was Vice President of the Company from 1995 until 1998. She has been employed by Employers Mutual since 1971. Ronald W. Jean 51 Senior Vice President of the Company and Employers Mutual since 1997. He was Vice President of the Company from 1985 until 1997. He has been employed by Employers Mutual since 1979. Raymond W. Davis 54 Senior Vice President of the Company and Employers Mutual since 1998. He was Vice President of the Company from 1985 until 1998. He has been employed by Employers Mutual since 1979. Donald D. Klemme 54 Senior Vice President and Secretary of the Company since 1998. Senior Vice President of Employers Mutual since 1998. He was Vice President and Secretary of the Company from 1996 until 1998. He has been employed by Employers Mutual since 1972. David O. Narigon 47 Senior Vice President of the Company and of Employers Mutual since 1998. He was Vice President of the Company from 1989 until 1998. He has been employed by Employers Mutual since 1983. Mark E. Reese 42 Vice President of the Company and Employers Mutual since 1996 and Chief Financial Officer of the Company and Employers Mutual since 1997. He has been employed by Employers Mutual since 1984. ITEM 11. EXECUTIVE COMPENSATION. - -------- ----------------------- See the information under the caption "Compensation of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 2000, which information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - -------- --------------------------------------------------------------- See the information under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 2000, which information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------- ----------------------------------------------- See the information under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 2000, which information is incorporated herein by reference. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. - -------- ----------------------------------------------------------------- (a) List of Financial Statements and Schedules. Page ---- 1. Financial Statements Independent Auditors' Report ................................ 15* Consolidated Balance Sheets, December 31, 1999 and 1998 ..... 16* Consolidated Statements of Income for the Years ended December 31, 1999, 1998 and 1997 ......................... 17* Consolidated Statements of Comprehensive Income for the Years ended December 31, 1999, 1998 and 1997 ............. 17* Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1999, 1998 and 1997 ............. 18* Consolidated Statements of Cash Flows for the Years ended December 31, 1999, 1998 and 1997 ......................... 19* Notes to Consolidated Financial Statements .................. 21-40* Form 10-K 2. Schedules Page ---- Independent Auditors' Report on Schedules ................... 30 Schedule I - Summary of Investments ....................... 31 Schedule II - Condensed Financial Information of Registrant 32 Schedule III - Supplementary Insurance Information .......... 35 Schedule IV - Reinsurance .................................. 36 Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations ..... 37 All other schedules have been omitted for the reason that the items required by such schedules are not present in the consolidated financial statements, are covered in the notes to the consolidated financial statements or are not significant in amount. * Refers to the respective page of the financial information insert of EMC Insurance Group Inc.'s 1999 Annual Report to Stockholders. The Consolidated Financial Statements and Independent Auditors' Report, which are included as Exhibit 13(c), are incorporated by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and Items 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part of this Form 10-K or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934. 3. Management contracts and compensatory plan arrangements Exhibit 10(b). 1999 Senior Executive Compensation Bonus Program. Exhibit 10(d). 1982 Employers Mutual Casualty Company Incentive Stock Option Plan, as amended. Exhibit 10(e). Deferred Bonus Compensation Plans. Exhibit 10(f). EMC Reinsurance Company Executive Bonus Program. Exhibit 10(h). Employers Mutual Casualty Company Excess Retirement Benefit Agreement. Exhibit 10(i). Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. Exhibit 10(j). 1993 Employers Mutual Casualty Company Incentive Stock Option Plan, as amended. Exhibit 10(k). Employers Mutual Casualty Company Non-Employee Director Stock Option Plan. Exhibit 10(l). Employers Mutual Casualty Company Supplemental Executive Retirement Plan. (b) Reports on Form 8-K. None (c) Exhibits. 3. Articles of incorporation and bylaws: (a) Articles of Incorporation of the Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (b) Bylaws of the Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) 10. Material contracts. (a) Quota Share Reinsurance Contract between Employers Mutual Casualty Company and EMC Reinsurance Company. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1997.) (b) 1999 Senior Executive Compensation Bonus Program. (c) EMC Insurance Companies reinsurance pooling agreements between Employers Mutual Casualty Company and certain of its affiliated companies, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (d) 1982 Employers Mutual Casualty Company Incentive Stock Option Plan, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (e) Deferred Bonus Compensation Plans. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (f) EMC Reinsurance Company Executive Bonus Program. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (g) EMC Insurance Group Inc. Amended and Restated Dividend Reinvestment and Common Stock Purchase Plan. (Incorporated by reference to Registration No. 33-34499.) (h) Employers Mutual Casualty Company Excess Retirement Benefit Agreement. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1998.) (i) Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. (Incorporated by reference to Registration No. 33-49335.) (j) 1993 Employers Mutual Casualty Company Incentive Stock Option Plan. (Incorporated by reference to Registration Nos.33-49337 and 333-45279.) (k) Employers Mutual Casualty Company Non-Employee Director Stock Option Plan. (Incorporated by reference to Registration No. 33-49339.) (l) Employers Mutual Casualty Company Supplemental Executive Retirement Plan. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1995.) 13. Annual Report to Security Holders. (a) Selected Financial Data from the Company's 1999 Annual Report to Stockholders. (b) Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's 1999 Annual Report to Stockholders. (c) Consolidated Financial Statements from the Company's 1999 Annual Report to Stockholders. (d) Stockholder Information from the Company's 1999 Annual Report to Stockholders. 21. Subsidiaries of the Registrant. 23. Consent of KPMG LLP with respect to Forms S-8 (Registration Nos. 2-93738, 33-49335, 33-49337, 33-49339 and (333-45279) and Form S-3 (Registration No. 33-34499). 24. Power of Attorney. (d) Financial statements required by Regulation S-X which are excluded from the Annual Report to Stockholders by Rule 14a-3(b)(1). None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 March 28, 2000. EMC INSURANCE GROUP INC. /s/ Bruce G. Kelley ------------------------ Bruce G. Kelley President, Treasurer and Chief Executive Officer /s/ Mark E. Reese ------------------------ Mark E. Reese Vice President - Chief Financial Officer (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 28, 2000. /s/ Mark E. Reese ------------------------ George C. Carpenter III* Director /s/ Mark E. Reese ------------------------ E. H. Creese* Director /s/ Mark E. Reese ------------------------ David J. Fisher* Director /s/ Bruce G. Kelley ------------------------ Bruce G. Kelley Director /s/ Mark E. Reese ------------------------ George W. Kochheiser* Chairman of the Board /s/ Mark E. Reese ------------------------ Raymond A. Michel* Director /s/ Mark E. Reese ------------------------ Fredrick A. Schiek* Director * by power of attorney INDEPENDENT AUDITORS' REPORT ON SCHEDULES The Board of Directors and Stockholders EMC Insurance Group Inc.: Under date of February 24, 2000, we reported on the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999, as contained in Part II, Item 8 of Form 10-K for the year 1999. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules listed in Part IV, Item 14(a)2. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Des Moines, Iowa February 24, 2000 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule I - Summary of Investments - Other Than Investments in Related Parties December 31, 1999 Amount at which shown Fair in the Type of investment Cost value balance sheet ------------------ ------------ ------------ ------------- Securities held-to-maturity: Fixed maturities: United States Government and government agencies and authorities .............. $109,055,239 $108,320,350 $109,055,239 Mortgage-backed securities ..... 18,148,921 18,358,715 18,148,921 ------------ ------------ ------------ Total fixed maturity securities 127,204,160 126,679,065 127,204,160 ------------ ------------ ------------ Securities available-for-sale: Fixed maturities: United States Government and government agencies and authorities .............. 4,419,411 4,361,084 4,361,084 States, municipalities and political subdivisions ....... 96,077,294 93,213,764 93,213,764 Mortgage-backed securities ..... 49,440,943 49,434,206 49,434,206 Debt securities issued by foreign governments .......... 6,479,135 6,569,030 6,569,030 Public utilities ............... 8,890,108 8,837,456 8,837,456 Corporate securities ........... 98,413,442 93,765,889 93,765,889 ------------ ------------ ------------ Total fixed maturity securities 263,720,333 256,181,429 256,181,429 ------------ ------------ ------------ Equity securities: Common stocks .................. 25,853,745 29,803,765 29,803,765 Non-redeemable preferred stocks 2,640,886 2,604,507 2,604,507 ------------ ------------ ------------ Total equity securities ...... 28,494,631 32,408,272 32,408,272 ------------ ------------ ------------ Short-term investments ............. 20,164,210 20,164,210 20,164,210 ------------ ------------ ------------ Total investments ...... $439,583,334 $435,432,976 $435,958,071 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule II - Condensed Financial Information of Registrant Condensed Balance Sheets December 31, -------------------------- 1999 1998 ------------ ------------ ASSETS - ------ Investment in common stock of subsidiaries (equity method) .................. $138,167,388 $157,416,941 Fixed maturity investments: Securities held-to-maturity, at amortized cost 1,999,431 3,999,138 Securities available-for-sale, at market value 1,467,525 - Short-term investments .......................... 337,525 2,552,944 Cash ............................................ 5,008 62,448 Accrued investment income ....................... 78,409 50,417 Income taxes recoverable ........................ 12,000 - Accounts receivable ............................. 2,568 216 Deferred tax asset .............................. 6,252 3,850 ------------ ------------ Total assets ............................... $142,076,106 $164,085,954 ============ ============ LIABILITIES - ----------- Accounts payable ................................ $ 127,548 $ 128,245 Income taxes payable ............................ - 18,000 Indebtedness to related party ................... 32,281 1,869 ------------ ------------ Total liabilities .......................... 159,829 148,114 ------------ ------------ STOCKHOLDERS' EQUITY - -------------------- Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,265,232 shares in 1999 and 11,496,389 shares in 1998 ......... 11,265,232 11,496,389 Additional paid-in capital ...................... 65,333,686 67,822,412 Accumulated other comprehensive (loss) income ... (3,625,263) 8,079,371 Retained earnings ............................... 68,942,622 76,539,668 ------------ ------------ Total stockholders' equity ................. 141,916,277 163,937,840 ------------ ------------ Total liabilities and stockholders' equity $142,076,106 $164,085,954 ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Income Years ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Equity in undistributed (loss) earnings of subsidiaries ..................... $(7,577,404) $ 1,685,244 $ 9,377,037 Dividends received from subsidiaries .. 6,800,055 4,275,035 3,750,032 Investment income ..................... 364,042 463,889 445,816 Other income .......................... 52 - - ----------- ----------- ----------- (413,255) 6,424,168 13,572,885 Operating expenses .................... 390,894 387,056 313,762 ----------- ----------- ----------- (Loss) income from operations before income tax (benefit) expense ..... (804,149) 6,037,112 13,259,123 Income tax (benefit) expense .......... (164) 24,247 42,556 ----------- ----------- ----------- Net (loss) income ....... $ (803,985) $ 6,012,865 $13,216,567 =========== =========== =========== Condensed Statements of Comprehensive Income Years ended December 31, ------------------------------------- 1999 1998 1997 ------------ ----------- ----------- Net (loss) income ..................... $ (803,985) $ 6,012,865 $13,216,567 ------------ ----------- ----------- Other Comprehensive Income: Unrealized holding (losses) gains arising during the period, net of deferred income tax (benefit) expense ........................... (11,527,264) 4,264,242 6,399,757 Reclassification adjustment for gains included in net (loss) income, net of income tax expense ............. (177,370) (3,871,963) (2,704,732) ------------ ----------- ----------- Other comprehensive (loss) income (11,704,634) 392,279 3,695,025 ------------ ----------- ----------- Total comprehensive (loss) income $(12,508,619) $ 6,405,144 $16,911,592 ============ =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Cash Flows Years ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Net cash provided by operating activities ................ $ 6,740,085 $ 4,015,569 $ 3,702,567 ----------- ----------- ----------- Cash flows from investing activities: Purchases of fixed maturity securities held-to-maturity ....... - - (3,999,340) Disposals of fixed maturity securities held-to-maturity ....... 2,000,000 2,500,000 2,000,000 Purchases of fixed maturity securities available-for-sale ..... (1,500,000) - - Net sales (purchases) of short-term investments ...................... 2,215,419 (1,643,245) 1,413,904 ----------- ----------- ----------- Net cash provided by (used in) investing activities ........... 2,715,419 856,755 (585,436) ----------- ----------- ----------- Cash flows from financing activities: Issuance of common stock ........... 278,794 823,927 1,019,919 Dividends paid to stockholders ..... (6,793,061) (5,637,687) (4,314,083) Repurchase of common stock ......... (2,998,677) - - ----------- ----------- ----------- Net cash used in financing activities ..................... (9,512,944) (4,813,760) (3,294,164) ----------- ----------- ----------- Net (decrease) increase in cash ....... (57,440) 58,564 (177,033) Cash at beginning of year ............. 62,448 3,884 180,917 ----------- ----------- ----------- Cash at end of year ................... $ 5,008 $ 62,448 $ 3,884 =========== =========== =========== Income taxes paid ..................... $ 31,952 $ 50,229 $ 40,000 Interest paid ......................... $ 285 $ - $ - EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule III - Supplementary Insurance Information For Years Ended December 31, 1999, 1998 and 1997 Deferred Losses and policy settlement acquisition expense Unearned Segment costs reserves premiums ------- ----------- ------------ ----------- Year ended December 31, 1999: Property and casualty insurance $11,992,874 $194,872,984 $57,598,773 Reinsurance ................... 1,626,318 71,641,040 7,392,356 Parent company ................ - - - ----------- ------------ ----------- Consolidated ............. $13,619,192 $266,514,024 $64,991,129 =========== ============ =========== Year ended December 31, 1998: Property and casualty insurance $10,666,188 $182,529,015 $53,785,443 Reinsurance ................... 1,689,294 63,081,308 7,678,608 Parent company ................ - - - ----------- ------------ ----------- Consolidated ............. $12,355,482 $245,610,323 $61,464,051 =========== ============ =========== Year ended December 31, 1997: Property and casualty insurance $ 8,949,126 $159,403,277 $47,532,320 Reinsurance ................... 1,611,531 58,374,665 7,325,143 Parent company ................ - - - ----------- ------------ ----------- Consolidated ............. $10,560,657 $217,777,942 $54,857,463 =========== ============ =========== Losses and Net settlement Premium investment expenses Segment revenue income incurred ------------ ----------- ------------ Year ended December 31, 1999: Property and casualty insurance $167,265,093 $18,282,642 $140,481,323 Reinsurance ................... 43,833,048 7,113,877 36,394,925 Parent company ................ - 364,042 - ------------ ----------- ------------ Consolidated ............. $211,098,141 $25,760,561 $176,876,248 ============ =========== ============ Year ended December 31, 1998: Property and casualty insurance $155,523,486 $17,635,076 $128,666,666 Reinsurance ................... 38,720,919 6,760,098 29,209,428 Parent company ................ - 463,889 - ------------ ----------- ------------ Consolidated ............. $194,244,405 $24,859,063 $157,876,094 ============ =========== ============ Year ended December 31, 1997: Property and casualty insurance $143,112,560 $16,719,458 $106,547,480 Reinsurance ................... 34,105,686 6,615,029 23,305,824 Parent company ................ - 445,816 - ------------ ----------- ------------ Consolidated ............. $177,218,246 $23,780,303 $129,853,304 ============ =========== ============ Amortization of deferred policy Other acquisition underwriting Premiums Segment costs expenses written ------- ----------- ----------- ------------ Year ended December 31, 1999: Property and casualty insurance $38,374,266 $13,698,660 $171,015,719 Reinsurance ................... 9,682,652 3,767,162 43,546,796 Parent company ................ - - - ----------- ----------- ------------ Consolidated ............. $48,056,918 $17,465,822 $214,562,515 =========== =========== ============ Year ended December 31, 1998: Property and casualty insurance $35,754,919 $13,829,886 $161,855,333 Reinsurance ................... 8,907,722 3,186,535 39,074,384 Parent company ................ - - - ----------- ----------- ------------ Consolidated ............. $44,662,641 $17,016,421 $200,929,717 =========== =========== ============ Year ended December 31, 1997: Property and casualty insurance $27,688,763 $16,557,572 $149,909,925 Reinsurance ................... 8,253,329 3,498,497 34,690,846 Parent company ................ - - - ----------- ----------- ------------ Consolidated ............. $35,942,092 $20,056,069 $184,600,771 =========== =========== ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule IV - Reinsurance For years ended December 31, 1999, 1998 and 1997 Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------------ ------------ ------------ ------------ ---------- Year ended December 31, 1999: Earned premiums: Consolidated property and casualty insurance .......................... $223,593,165 $230,785,034 $218,290,010 $211,098,141 103.4% ============ ============ ============ ============ ========== Year ended December 31, 1998: Earned premiums: Consolidated property and casualty insurance .......................... $202,514,027 $207,404,961 $199,135,339 $194,244,405 102.5% ============ ============ ============ ============ ========== Year ended December 31, 1997: Earned premiums: Consolidated property and casualty insurance .......................... $169,304,584 $165,004,455 $172,918,117 $177,218,246 97.6% ============ ============ ============ ============ ==========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule VI - Supplemental Insurance Information Concerning Property-Casualty Insurance Operations For Years Ended December 31, 1999, 1998 and 1997 Discount, Deferred Reserves for if any, policy losses and deducted Net Consolidated property- acquisition settlement from Unearned Earned investment casualty entities costs expenses reserves premiums premiums income - ---------------------- ----------- ------------ -------- ----------- ------------ ----------- Year ended December 31, 1999: $13,619,192 $266,514,024 $ -0- $64,991,129 $211,098,141 $25,760,561 =========== ============ ======== =========== ============ =========== Year ended December 31, 1998: $12,355,482 $245,610,323 $ -0- $61,464,051 $194,244,405 $24,395,174 =========== ============ ======== =========== ============ =========== Year ended December 31, 1997: $10,560,657 $217,777,942 $ -0- $54,857,463 $177,218,246 $23,334,487 =========== ============ ======== =========== ============ ===========
Losses and Amortization settlement expenses of deferred Paid incurred related to policy losses and Consolidated property- Current Prior acquisition settlement Premiums casualty entities Year Years costs expenses (1) Written - ---------------------- ------------ ----------- ------------ ------------ ------------ Year ended December 31, 1999: $182,609,687 ($ 5,733,439) $ 48,056,918 $150,669,762 $214,562,515 ============ =========== ============ ============ ============ Year ended December 31, 1998: $168,953,309 ($11,077,215) $ 44,662,641 $132,577,163 $200,929,717 ============ =========== ============ ============ ============ Year ended December 31, 1997: $137,300,762 ($ 7,447,458) $ 35,942,092 $113,811,729 $184,600,771 ============ =========== ============ ============ ============
(1) The amount for 1998 reflects an adjustment of ($3,600,220) related to the 1998 change in the property and casualty insurance subsidiaries' pooling agreement. This adjustment was made to offset the income statement effect that resulted from the $3,600,220 increase in reserves for losses and settlement expenses on January 1, 1998 related to this transaction. The 1997 amount reflects an adjustment of ($3,795,453) related to the 1997 change in the property and casualty insurance subsidiaries' pooling agreement and ($2,726,913) related to the change in the reinsurance subsidiary's quota share percentage. These adjustments were made to offset the income statement effect that resulted from the $6,522,366 increase in reserves for losses and settlement expenses on January 1, 1997 related to these transactions. The index to exhibits in the electronic format indicates the exhibits are included in the direct transmission. The circulated document contains the page numbers of the exhibits. EMC Insurance Group Inc. and Subsidiaries Index to Exhibits Exhibit number Item ------ ---- 10(b) 1999 Senior Executive Compensation Included in Bonus Program. direct transmission 13(a) Selected Financial Data. Included in direct transmission 13(b) Management's Discussion and Analysis of Financial Condition and Results Included in of Operations. direct transmission 13(c) Consolidated Financial Statements. Included in direct transmission 13(d) Stockholder Information. Included in direct transmission 21 Subsidiaries of the Registrant. Included in direct transmission 23 Consent of KPMG LLP with respect to Included in Forms S-8 and Form S-3. direct transmission 24 Power of Attorney. Included in direct transmission EX-10.B 2 Exhibit 10(b) ------------- 1999 SENIOR EXECUTIVE COMPENSATION BONUS PROGRAM The Senior Executive Bonus Program is a measure of the three areas often looked at when comparing results of different companies or in comparing current company results from one year to the next. PURPOSE 1. To provide a motivational tool in the form of compensation to help executives focus on specific organizational goals to improve profits, surplus and service in all areas of the corporation. 2. To maintain competitive advantage in terms of recruitment and retention of senior executives. 3. To provide a plan based on EMC results and industry results, to provide a better measure of performance. 4. Reward superior results more appropriately. 5. Provide a maximum bonus difficult to attain so there is incentive to strive for better results. 6. To provide a measure of safety to the company so that senior officers' total compensation is reduced if company performance declines. GENERAL BONUS CALCULATION The bonus plan uses production, surplus growth and the combined ratio, all valid measures of performance, as follows: 1. EMC WRITTEN PREMIUM - Compares consolidated written premium to a goal that is established each year. 2. CHANGE IN SURPLUS 3. COMBINED RATIO - Compares EMC combined ratio to a target ratio established by the Committee each year. Also compares EMC's combined ratio to that of the industry. - ---------------------------------------------------------------------------- The initial Industry estimate published in December or January by A.M. Best will be the number used in the calculation regardless of any adjustments A.M. Best may make to the Industry number later in the year. - ---------------------------------------------------------------------------- ALL CALCULATIONS ARE ROUNDED TO THE NEAREST ONE TENTH OF ONE PERCENT. The factors in each of the formulas are subject to change each year with final approval by the Senior Executive Compensation and Incentive Stock Option Committee. WRITTEN PREMIUM This component is based on actual net written premium growth compared to a consolidated written premium goal established each year and approved by the Committee. Achieving goal results in a bonus contribution of plus 7.5 percent of salary. This changes by 1.5 percent for each 1.0 percent variation from goal, subject to a maximum contribution of plus 15.0 percent and a minimum contribution of minus 15.0 percent. - ---------------------------------------------------------------------------- The written premium component is determined as follows: Percent of actual change, minus goal, plus 5.0, times 1.50. - ---------------------------------------------------------------------------- Example 1: The goal equals 8.5 percent premium growth. - --------- The actual change equals 7.5 percent premium growth. 7.5 percent minus 8.5 percent equals minus 1 plus 5.0, equals 4.0 times 1.50 equals 6.0. The contribution in this example of written premium towards the total bonus is equal to 6.0 percent. ------------ Example 2: The goal equals 5.7 percent premium growth. The actual change - --------- equals minus 1.3 percent premium growth. Minus 1.3 percent minus 5.7 percent equals minus 7.0 plus 5.0 equals minus 2.0 times 1.50 equals minus 3.0. ---------- Example 3: The goal equals 4.7 percent premium growth. - --------- The actual change equals 9.8 percent premium growth. 9.8 percent minus 4.7 percent equals 5.1 percent plus 5.0 equals 10.1 times 1.50 equals 15.2 percent. The contribution in this example of written premium towards the total bonus equals plus 15.0 percent. ------------- (This component not to exceed plus or minus 15.0 percent of total bonus.) SURPLUS The component of surplus is based on the actual change in surplus. Each one percent change in surplus represents a change in bonus equal to .75 percent of salary subject to a maximum of 20.0 percent and a minimum of 0.0 percent. - ---------------------------------------------------------------------------- Note: No bonus is payable if there is a decrease is surplus. - ---------------------------------------------------------------------------- Example 1: Change in surplus equals plus 4.6 percent. - --------- Contribution towards total bonus from surplus component equals 4.6 percent times .75 equals 3.5 percent. ------------ Example 2: Change in surplus equals a minus 2.4 percent. There would be - --------- no bonus because of the decrease in surplus. Example 3: Change in surplus equals a plus 10.7 percent. Contribution - --------- towards total bonus from surplus component equals 10.7 percent times .75 equals 8.0 percent. ------------ COMBINED RATIO The component for combined ratio is based on EMC's consolidated combined ratio relative to a target combined ratio on a trade basis, adjusted by a comparison of the EMC combined ratio to that of the industry. The target combined ratio for 1999 is 104.0 percent. Current actuarial calculations estimate that a combined ratio of 104.0 percent produces a return on statutory surplus of 12.5 percent after taxes. This considers income from all sources including investment return on surplus and assumes a premium to surplus ratio of two to one. The formula uses a target ratio of 104.0 percent which is subject to Committee approval each year. For each 1.0 percent change in the combined ratio, the bonus contribution changes 2.9 percent subject to a maximum contribution of plus 60.0 percent and a minimum contribution of minus 35.0 percent. - ---------------------------------------------------------------------------- First determine EMC's relationship to the industry by subtracting EMC's combined ratio from that of the industry. - ---------------------------------------------------------------------------- The initial Industry estimate published in December or January by A.M. Best will be the number used in the calculation regardless of any adjustments A.M. Best may make to the Industry number later in the year. If the result is a positive number, subtract result (not to exceed 3.0 percent) from EMC's combined ratio to obtain adjusted combined ratio. Subtract adjusted combined ratio from target combined ratio, add 6.0, multiply by 2.90 to equal the bonus produced by the combined ratio component. If the result is a negative number or 0.0, no adjustment is necessary and the EMC combined ratio is the adjusted combined ratio. Subtract the adjusted combined ratio from the target combined ratio, add 6.0, multiply by 2.90 to equal the bonus produced by the combined ratio component. - ---------------------------------------------------------------------------- The combined ratio formula is determined as follows: 104.0 minus the adjusted combined ratio plus 6.0 times 2.90. - ---------------------------------------------------------------------------- Example 1: Industry ratio equals 101.6 percent. - --------- EMC ratio equals 97.1 percent. Adjustment * 101.6 minus 97.1 equals 3.0 (maximum adjustment allowed). Adjusted ratio * 97.1 minus 3.0 equals 94.1 percent. Target ratio equals 104.0 percent. 104.0 percent minus 94.1 percent equals 9.9 plus 6 equals 15.9 times 2.90 equals 46.1 percent. ------------- The contribution towards total bonus from the combined ratio component equals 46.1 percent. ------------- Example 2: Industry ratio equals 101.6 percent. - --------- EMC ratio equals 100.1 percent. Adjustment * 101.6 minus 100.1 equals 1.5 percent. Adjusted ratio * 100.1 minus 1.5 equals 98.6 percent. Target ratio equals 104.0 percent. 104.0 percent minus 98.6 percent equals 5.4 percent plus 6.0 equals 11.4 percent times 2.90 equals 33.1 percent. ------------- The contribution towards the total bonus from the combined ratio component equals 33.1 percent. ------------- Example 3: Industry ratio equals 101.6 percent. - --------- EMC ratio equals 110.1 percent. Adjustment - None (If EMC performance is worse than the industry average, use the EMC ratio in the formula). Adjusted ratio * 110.1. Target ratio equals 104.0 percent. 104.0 percent minus 110.1 percent equals minus 6.1 plus 6.0 equals minus 0.1 times 2.90 equals minus 0.3. ---------- The contribution towards the total bonus from the combined ratio component equals minus 0.3 percent. ------------------ Assuming each example represents one year, the bonus for the three years would be as follows: Component Example 1 Example 2 Example 3 - --------- --------- --------- --------- Written Premium 6.0% -3.0% 15.0% Surplus 3.5% *0.0% 8.0% Combined Ratio 46.1% 33.1% -0.3% ----- ----- ----- Total Bonus 55.6% 0% 22.7% * Actual change in surplus was minus 2.4%. No bonus is payable since surplus decreased. This represents the bonus for Vice Presidents. Factors would be applied as follows to arrive at the bonus calculations for Senior Vice Presidents, Executive Vice President, and President. Position Example 1 Example 2 Example 3 - -------- --------- --------- --------- Vice President 55.6% 0% 22.7% Senior VP Multiply by 1.10 61.2% 0% 25.0% Executive VP Multiply by 1.20 66.7% 0% 27.2% President Multiply by 1.30 72.3% 0% 29.5% MAXIMUM BONUS For Vice Presidents, the total bonus is the sum of the three components subject to a maximum of 75 percent of salary. Maximum Bonus ------------- For Vice Presidents, the percent of salary is 75.0 % For Senior Vice Presidents, multiply the bonus percentage by 1.10. 82.5 % For Executive Vice President, multiply the bonus percentage by 1.20. 90.0 % For President, multiply the bonus percentage by 1.30. 97.5 % EXECUTIVES ELIGIBLE FOR BONUS Vice Presidents Senior VP Executive VP President - --------------- --------- ------------ --------- Mark E. Reese Margaret A. Ball Fred A. Schiek Bruce G. Kelley Richard W. Hoffmann John D. Isenhart Douglas J. Zmolek Ronald W. Jean David O. Narigon Raymond W. Davis Donald D. Klemme PLAN ADMINISTRATION 1. An executive must be on the payroll a minimum of six months before he/she is eligible for a bonus payment. 2. An executive terminating employment with the companies before the established date for the payment of bonuses will not be paid a bonus. 3. Executives retiring or becoming deceased or disabled before the established date for the payment of bonuses will receive a bonus on the basis of the portion of the year he/she was on the payroll. 4. If an executive becomes a member of the Policy Committee at some time during the year, they will receive a prorata bonus for that portion of the year they are a member. 5. If an executive is promoted during the year and/or given a salary increase, the bonus will be prorated on the basis of the position and/or the salaries paid for the specific position. 6. Deductions for federal and state income taxes, and FICA, if applicable, will be made from each bonus on the basis of IRS regulations. 7. Before any bonuses are paid, a member of KPMG Peat Marwick Auditing Firm will determine that the calculations are correct according to the bonus plan document. 8. The Executive Compensation Committee may, at its discretion adjust the bonus calculation for unusual or extenuating circumstances that unfairly impact the results. Such circumstances may include but are not limited to the following: 1. Surplus declines due to an acquisition but other factors would have produced a bonus. 2. Surplus decline is minimal and other factors produce a bonus. 3. Required change in accounting methodology has a material affect on any of the factors. 9. If there is a disagreement or misunderstanding of the basis for the bonus or in the calculation in the amounts, the decision of the Senior Executive Compensation and Incentive Stock Option Committee will be final. EX-13.A 3 SELECTED FINANCIAL DATA. EXHIBIT 13(a) - ------------------------ ------------- Year ended December 31, ----------------------------------- 1999 1998 1997 1996 -------- -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $211,098 $194,244 $177,218 $165,191 Investment income, net ........... 25,761 24,859 23,780 24,007 Realized investment gains ........ 277 5,901 4,100 1,891 Other income ..................... 2,194 1,701 1,023 904 -------- -------- -------- ------- Total revenues .............. 239,330 226,705 206,121 191,993 Losses and expenses .............. 245,321 223,031 189,318 171,324 -------- -------- -------- -------- (Loss) income before income tax (benefit) expense .......... (5,991) 3,674 16,803 20,669 Income tax (benefit) expense ..... (5,187) (2,339) 3,586 5,635 -------- -------- -------- ------- (Loss) income from: Continuing operations ......... (804) 6,013 13,217 15,034 Discontinued operations ....... - - - - Accounting changes ............ - - - - -------- -------- -------- -------- Net (loss) income .......... $ (804)$ 6,013 $ 13,217 $ 15,034 ======== ======== ======== ======== Net (loss) income per common share - basic and diluted: Continuing operations ....... $ (.07)$ .53 $ 1.18 $ 1.37 Discontinued operations ..... - - - - Accounting changes .......... - - - - -------- -------- -------- -------- Total ...................... $ (.07)$ .53 $ 1.18 $ 1.37 ======== ======== ======== ======== Premiums earned by segment: Property and casualty insurance $167,265 $155,523 $143,113 $128,516 Reinsurance .................... 43,833 38,721 34,105 36,675 -------- -------- -------- -------- Total ...................... $211,098 $194,244 $177,218 $165,191 ======== ======== ======== ======== Balance Sheet Data Total assets ..................... $496,576 $496,046 $459,110 $430,328 ======== ======== ======== ======== Stockholders' equity ............. $141,916 $163,938 $162,346 $148,729 ======== ======== ======== ======== SELECTED FINANCIAL DATA.(continued) - ----------------------------------- Year ended December 31, ---------------------------------- 1999 1998 1997 1996 -------- -------- -------- ------- ($ in thousands, except per share amounts) Other Data Average return on equity ......... (.5)% 3.7% 8.5% 10.5% ======== ======== ======== ======== Book value per share ............. $ 12.60 $ 14.26 $ 14.30 $ 13.42 ======== ======== ======== ======== Dividends paid per share ......... $ .60 $ .60 $ .60 $ .57 ======== ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 23.5% 23.5% 22% 22% ======== ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 100% 100% 100% 95% ======== ======== ======== ======== Closing stock price ............. $ 9 1/8 $ 12 3/4 $ 13 1/4 $ 12 ======== ======== ======== ======== Net investment yield (pretax) .... 5.96% 6.02% 6.15% 6.54% ======== ======== ======== ======== Cash dividends to closing stock price ............ 6.6% 4.7% 4.5% 4.8% ======== ======== ======== ======== Common shares outstanding ........ 11,265 11,496 11,351 11,084 ======== ======== ======== ======== Statutory combined ratio ......... 115.2% 114.8% 106.2% 103.6% ======== ======== ======== ======== SELECTED FINANCIAL DATA.(continued) - ----------------------------------- Year ended December 31, ----------------------------------- 1995 1994 1993 1992 -------- -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $162,266 $164,829 $156,438 $147,410 Investment income, net ........... 23,204 21,042 20,936 21,586 Realized investment gains ........ 1,043 520 684 384 Other income ..................... 1,005 1,128 668 701 -------- -------- -------- -------- Total revenues .............. 187,518 187,519 178,726 170,081 Losses and expenses .............. 163,202 168,842 169,707 169,106 -------- -------- -------- -------- (Loss) income before income tax (benefit) expense .......... 24,316 18,677 9,019 975 Income tax (benefit) expense ..... 6,967 5,171 1,885 759 -------- -------- -------- -------- (Loss) income from: Continuing operations ......... 17,349 13,506 7,134 216 Discontinued operations ....... - - - - Accounting changes ............ - - 2,621 - -------- -------- -------- -------- Net (loss) income .......... $ 17,349 $ 13,506 $ 9,755 $ 216 ======== ======== ======== ======== Net (loss) income per common share - basic and diluted: Continuing operations ....... $ 1.62 $ 1.29 $ .70 $ .02 Discontinued operations ..... - - - - Accounting changes .......... - - .26 - -------- -------- -------- -------- Total ...................... $ 1.62 $ 1.29 $ .96 $ .02 ======== ======== ======== ======== Premiums earned by segment: Property and casualty insurance $126,440 $127,573 $123,114 $120,795 Reinsurance .................... 35,826 37,256 33,324 26,615 -------- -------- -------- -------- Total .......................$162,266 $164,829 $156,438 $147,410 ======== ======== ======== ======== Balance Sheet Data Total assets ..................... $412,881 $387,370 $368,936 $372,807 ======== ======== ======== ======== Stockholders' equity ............. $136,889 $116,727 $109,634 $100,911 ======== ======== ======== ======== SELECTED FINANCIAL DATA.(continued) - ----------------------------------- Year ended December 31, ----------------------------------- 1995 1994 1993 1992 -------- -------- -------- -------- ($ in thousands, except per share amounts) Other Data Average return on equity ......... 13.7% 11.9% 9.3% .2% ======== ======== ======== ======== Book value per share ............. $ 12.66 $ 11.03 $ 10.63 $ 9.98 ======== ======== ======== ======== Dividends paid per share ......... $ .53 $ .52 $ .52 $ .52 ======== ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 22% 22% 22% 22% ======== ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 95% 95% 95% 95% ======== ======== ======== ======== Closing stock price ............. $ 13 3/4 $ 9 1/2 $ 9 1/2 $ 8 1/2 ======== ======== ======== ======== Net investment yield (pretax) .... 6.65% 6.59% 6.83% 7.50% ======== ======== ======== ======== Cash dividends to closing stock price ............ 3.9% 5.5% 5.5% 6.1% ======== ======== ======== ======== Common shares outstanding ........ 10,814 10,577 10,317 10,112 ======== ======== ======== ======== Statutory combined ratio ......... 99.6% 101.3% 106.3% 113.9% ======== ======== ======== ======== SELECTED FINANCIAL DATA.(continued) - ----------------------------------- Year ended December 31, -------------------------- 1991 1990 1989 -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $113,419 $101,323 $ 91,728 Investment income, net ........... 20,223 20,038 19,345 Realized investment gains ........ 65 48 257 Other income ..................... 860 888 543 -------- -------- ------- Total revenues .............. 134,567 122,297 111,873 Losses and expenses .............. 124,135 111,457 103,096 -------- -------- ------- (Loss) income before income tax (benefit) expense .......... 10,432 10,840 8,777 Income tax (benefit) expense ..... 3,124 2,894 2,055 -------- -------- ------- (Loss) income from: Continuing operations ......... 7,308 7,946 6,722 Discontinued operations ....... 1,853 319 274 Accounting changes ............ - - - -------- -------- ------- Net (loss) income .......... $ 9,161 $ 8,265 $ 6,996 ======== ======== ======= Net (loss) income per common share - basic and diluted: Continuing operations ....... $ .73 $ .80 $ .71 Discontinued operations ..... .18 .03 .03 Accounting changes .......... - - - -------- -------- -------- Total ...................... $ .91 $ .83 $ .74 ======== ======== ======== Premiums earned by segment: Property and casualty insurance $ 88,410 $ 80,627 $ 73,107 Reinsurance .................... 25,009 20,696 18,621 -------- -------- -------- Total ...................... 113,419 $101,323 $ 91,728 ======== ======== ======== Balance Sheet Data Total assets ..................... $311,001 $296,126 $284,396 ======== ======== ======== Stockholders' equity ............. $105,144 $100,615 $ 95,911 ======== ======== ======== SELECTED FINANCIAL DATA.(continued) - ----------------------------------- Year ended December 31, -------------------------- 1991 1990 1989 -------- -------- -------- ($ in thousands, except per share amounts) Other Data Average return on equity ......... 8.9% 8.4% 7.5% ======== ======== ======== Book value per share ............. $ 10.47 $ 10.04 $ 9.82 ======== ======== ======== Dividends paid per share ......... $ .52 $ .52 $ .52 ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 17% 17% 17% ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 95% 95% 95% ======== ======== ======== Closing stock price ............. $ 9 1/2 $ 6 7/8 $ 8 ======== ======== ======== Net investment yield (pretax) .... 8.02% 8.53% 8.74% ======== ======== ======== Cash dividends to closing stock price ............ 5.5% 7.6% 6.5% ======== ======== ======== Common shares outstanding ........ 10,046 10,015 9,762 ======== ======== ======== Statutory combined ratio ......... 109.2% 109.5% 112.7% ======== ======== ======== Amounts previously reported in prior consolidated financial statements have been reclassified to conform to current presentation. EX-13.B 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL EXHIBIT 13(b) ------------------------------------------------- ------------- CONDITION AND RESULTS OF OPERATIONS. ------------------------------------ The following discussion and analysis of EMC Insurance Group Inc. and its subsidiaries' financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere herein. OVERVIEW EMC Insurance Group Inc., an approximately 72 percent owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance and reinsurance. Property and casualty insurance is the most significant segment, representing 79.2 percent of consolidated premiums earned. For purposes of this discussion, the term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries. The Company adopted Statement of Financial Accounting Standard (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information" in the fourth quarter of 1998. Implementation of this standard caused the Company to redefine its reportable segments (see note 8 of Notes to Consolidated Financial Statements). The Company's four property and casualty insurance subsidiaries and two subsidiaries and an affiliate of Employers Mutual are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all the companies. The pooling agreement produces a more uniform and stable underwriting result from year to year for all companies in the pool than might be experienced individually. In addition, each company benefits from the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own assets, and from the wide range of policy forms, lines of insurance written, rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all companies in the pool. Effective January 1, 1998, Farm and City Insurance Company (Farm and City), a subsidiary of the Company that writes nonstandard risk automobile insurance business, became a participant in the pooling agreement. Farm and City assumes a 1.5 percent participation in the pool, which increased the Company's aggregate participation in the pool from 22 percent in 1997 to 23.5 percent in 1998 and 1999. In connection with this change in the pooling agreement, the Company's liabilities increased $6,225,000 and invested assets increased $5,570,000. The Company reimbursed Employers Mutual $727,000 for the expenses that were incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $72,000 in interest income as the actual cash transfer did not occur until March 25, 1998. As a result of this change in structure, the Company now has four subsidiaries that comprise the property and casualty insurance segment and no longer has a separate segment for the nonstandard risk automobile insurance business. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Effective January 1, 1997, Hamilton Mutual Insurance Company (Hamilton Mutual), a new affiliate of Employers Mutual, became a participant in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,000 and invested assets increased $5,674,000. The Company reimbursed Employers Mutual $794,000 for the expenses that were incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $75,000 in interest income as the actual cash transfer did not occur until March 24, 1997. The Company's reinsurance subsidiary assumes a quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its quota share portion of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss assumed per event was increased from $1,000,000 to $1,500,000. In connection with the change in the quota share percentage, the Company's liabilities increased $3,174,000 and invested assets increased $3,067,000. The Company reimbursed Employers Mutual $107,000 for the expenses that were incurred to generate the additional business assumed by the Company. CONSOLIDATED RESULTS OF OPERATIONS Operating results for the three years ended December 31, 1999 are as follows: ($ in thousands) 1999 1998 1997 -------- -------- -------- Premiums earned .......................... $211,098 $194,244 $177,218 Losses and settlement expenses ........... 176,876 157,876 129,853 Acquisition and other expenses ........... 66,760 63,554 58,529 -------- -------- -------- Underwriting loss ........................ (32,538) (27,186) (11,164) Net investment income .................... 25,760 24,859 23,780 Other income ............................. 510 100 87 -------- -------- -------- Operating (loss) income before income tax (benefit) expense ........... (6,268) (2,227) 12,703 Realized investment gains ................ 277 5,901 4,100 -------- -------- -------- (Loss) income before income tax (benefit) expense ...................... (5,991) 3,674 16,803 Income tax (benefit) expense ............. (5,187) (2,339) 3,586 -------- -------- -------- Net (loss) income ........................ $ (804) $ 6,013 $ 13,217 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $182,609 $168,953 $137,301 Decrease in provision for insured events of prior years ................ (5,733) (11,077) (7,448) -------- -------- -------- Total losses and settlement expenses $176,876 $157,876 $129,853 ======== ======== ======== Catastrophe and storm losses ............. $ 11,162 $ 13,477 $ 5,846 ======== ======== ======== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Operating results before income taxes have declined significantly over the last three years. This decline is primarily attributable to the property and casualty insurance segment, which has experienced inadequate premium rates, high levels of catastrophe and storm losses and increased loss frequency and severity. The reinsurance segment has also experienced a steady decline in operating income over the last three years, but continues to be profitable. Inadequate premium rates, which have resulted from thirteen consecutive years of intense rate competition within the insurance industry, continue to be the primary cause of the Company's substandard performance. Premium rates showed signs of stabilization during 1999 as the Company was able to implement moderate rate increases on select lines of business; however, overall premium rate adequacy continued to decline due to rate reductions that were implemented in prior years. As the impact of the 1999 rate increases become more fully reflected in earned premiums, profit margins should begin to improve. However, overall premium rate adequacy is not expected to improve significantly in the near future due to the competitive rate environment that continues to exist in the insurance industry. As a result, management is working to improve profitability through re-underwriting programs for both the existing book of business and the agency force. Operating results for 1998 reflect earnings of $1,204,000 that resulted from a one-time adjustment in certain balances reported by a state run assigned risk program in which the Company's property and casualty insurance segment participates. Premium income increased 8.7 percent in 1999, 9.6 percent in 1998 and 7.3 percent in 1997. These increases are primarily attributable to the property and casualty insurance segment, which has benefited from the regional presence provided by Employers Mutual's 18 branch offices and the addition of Hamilton Mutual to the pooling agreement in 1997. The addition of Farm and City to the pooling agreement in 1998 did not have a material impact on the revenues of the Company. The reinsurance segment experienced a significant increase in premium income in 1999 and 1998 after reporting a decline in 1997. These increases are due to the addition of several new accounts during 1998. Losses and settlement expenses increased 12.0 percent in 1999, 21.6 percent in 1998 and 12.6 percent in 1997. Catastrophe and storm losses remained at an unusually high level for the second consecutive year as both the property and casualty insurance segment and the reinsurance segment experienced significant storm activity. In addition to the high level of catastrophe and storm losses, the results for 1998 were negatively impacted by an unusually large increase in the frequency and severity of losses unrelated to catastrophe and storm activity. Development on prior years' reserves remained favorable in 1999 but declined substantially from the amount experienced in 1998. The Company has historically experienced favorable development in its reserves and current reserving practices have not been relaxed; however, the amount of development experienced will fluctuate from year to year. The catastrophe and storm loss amounts reported for 1999 and 1998 reflect ceded reinsurance recoveries of $3,825,000 and $1,762,000, respectively, related to an aggregate excess of loss catastrophe reinsurance agreement that was in effect for those years for the property and casualty insurance segment. Due to substantial changes in both the terms and the cost of the coverage, thi reinsurance protection has not been renewed for year 2000. If this reinsurance protection had not been in place in 1999 the Company would have reported additional operating losses, net of premium cost savings, of $3,524,000 or $0.21 per share after taxes. Acquisition and other expenses increased 5.0 percent in 1999, 8.6 percent in 1998 and 6.3 percent in 1997. These increases primarily relate to the property and casualty insurance segment and reflect a variety of factors including increased production levels and higher commission costs. The increases reported for 1998 and 1997 also include expenses associated with the addition of Hamilton Mutual and Farm and City to the pooling agreement and the increase in the reinsurance subsidiary's quota share percentage. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Net investment income increased 3.6 percent in 1999 and 4.5 percent in 1998 after declining 0.9 percent in 1997. These increases are primarily attributable to increases in the average invested asset balances. The Company has experienced a decline in the average rate of return earned on fixed maturity investments over the last three years due to declining interest rates. During the second and third quarters of 1999 the Company sold approximately $55,000,000 of investments in tax-exempt fixed maturity securities and reinvested the proceeds into taxable fixed maturity securities that pay a higher interest rate. This change in asset allocation was implemented to increase the Company's after-tax rate of return on its investment portfolio in response to the recent deterioration in the Company's underwriting results and the expectation that underwriting results will not improve significantly in the near future. Realized investment gains declined in 1999 after increasing in 1998 and 1997. Realized investment gains for 1999 reflect $1,590,000 of gains from the disposal of the tax-exempt fixed maturity securities noted above. These gains were mostly offset by realized losses of $1,284,000 that were recognized on the Company's equity portfolio during the fourth quarter of 1999. The realized investment gains for 1998 are primarily the result of the liquidation of the Company's common stock mutual fund portfolio. Proceeds from this liquidation were reinvested into individual stock issue ax-aware basis. Realized investment gains for 1997 reflect capital gains distributions from the common stock mutual fund portfolio. Income tax benefits increased substantially during the last two years, especially when compared to the pre-tax operating results reported for those years. These increases are primarily a result of the large amount of tax- exempt interest earned by the Company and the relative relationship this tax- exempt interest has had to the declining pre-tax operating results. Tax-exempt interest totaled $6,784,000 in 1999 and $7,250,000 in 1998, which exceeded the pre-tax loss of $5,991,000 reported for 1999 and the pre-tax income of $3,674,000 reported in 1998. Tax-exempt interest is expected to decline to approximately $5,285,000 in 2000 due to the previously noted sale of approximately $55,000,000 of tax-exempt bonds during 1999. In addition, the tax benefits for 1999 and 1998 include $800,000 and $400,000, respectively, related to a reduction in a deferred tax valuation allowance associated with future postretirement benefit deductions. The valuation allowance was eliminated in 1999 due to the establishment by Employers Mutual of Voluntary Employee Beneficiary Association (VEBA) trusts that will fund the liability for postretirement benefits. Tax benefits for 1998 also include $550,000 related to a reduction in an accrual that had been established for potential tax examination adjustments. SEGMENT RESULTS Property and Casualty Insurance Operating results for the three years ended December 31, 1999 are as follows: ($ in thousands) 1999 1998 1997 -------- -------- -------- Premiums earned .......................... $167,265 $155,523 $143,112 Losses and settlement expenses ........... 140,481 128,667 106,547 Acquisition and other expenses ........... 53,310 51,460 46,777 -------- -------- -------- Underwriting loss ........................ (26,526) (24,604) (10,212) Net investment income .................... 18,283 17,635 16,720 Other income ............................. 781 319 181 -------- -------- -------- Operating (loss) income before income taxes ........................... $ (7,462) $ (6,650) $ 6,689 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $145,806 $136,209 $112,192 Decrease in provision for insured events of prior years ................ (5,325) (7,542) (5,645) -------- -------- -------- Total losses and settlement expenses $140,481 $128,667 $106,547 ======== ======== ======== Catastrophe and storm losses ............. $ 7,389 $ 10,163 $ 4,570 ======== ======== ======== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED As previously noted, Farm and City became a 1.5 percent participant in the pooling agreement on January 1, 1998, which increased the property and casualty insurance segment's aggregate participation in the pooling agreement from 22 percent in 1997 to 23.5 percent in 1998 and 1999. The segment results reported for 1997 have been restated to include the results of Farm and City for comparative purposes. Premiums earned increased 7.6 percent in 1999, 8.7 percent in 1998 and 11.4 percent in 1997. This growth in premium income, which is significantly greater than the industry average of less than two percent annually over this time period, is primarily the result of an increase in the number of policies issued. This growth in policy count has resulted from an increase in the retention rate on renewal business as well as a steady amount of new business. The increase for 1997 also reflects the addition of Hamilton Mutual to the pooling agreement, which added $8,634,000 to premiums earned. Premium rate levels, which had declined steadily for thirteen consecutive years due to intense competition, exhibited signs of stabilization during 1999 as the property and casualty insurance subsidiaries were able to implement moderate rate increases on select lines of business. This trend of moderate rate increases is expected to continue in 2000 as large-scale rate increases are not considered likely due to the significant amount of excess capacity that continues to exist in the insurance industry. As a result, overall premium rate adequacy is not expected to improve significantly in the near future. Losses and settlement expenses increased 9.2 percent in 1999, 20.8 percent in 1998 and 18.1 percent in 1997. Catastrophe and storm losses declined in 1999 from the storm plagued amounts reported in 1998, but continued to have a significant impact on operating results. In addition to the high level of catastrophe and storm losses, the property and casualty insurance segment has been negatively impacted during the last two years by an increase in the severity and frequency of losses unrelated to catastrophe and storm activity. Development on prior years' reserves remained favorable in 1999, but declined from the amount experienced in 1998. As previously noted, the catastrophe and storm loss amounts reported for 1999 and 1998 reflect ceded reinsurance recoveries of $3,825,000 and $1,762,000, respectively, related to an aggregate excess of loss catastrophe reinsurance agreement that was in effect for those years. Due to substantial changes in both the terms and the cost of the coverage, this reinsurance protection has not been renewed for year 2000. Acquisition and other expenses increased 3.6 percent in 1999, 10.0 percent in 1998 and 7.2 percent in 1997. These increases reflect additional expenses associated with the higher production levels achieved during the last three years and an increase in commission costs related to the intense competition for insurance business and the growing book of property business. The large increase for 1998 reflects the payment of approximately $727,000 of expenses in connection with the addition of Farm and City to the pooling agreement and an increase in the estimate of deferrable acquisition expenses. The increase for 1997 reflects an increase in the size of the pool and the payment of approximately $794,000 of expenses related to the addition of Hamilton Mutual to the pooling agreement. Underwriting results for the property and casualty insurance segment have deteriorated significantly over the last three years. Inadequate premium rates, high levels of catastrophe and storm losses and increased loss severity and frequency have combined to produce substandard results. Premium rate levels exhibited signs of stabilization during 1999, but overall premium rate adequacy continued to decline due to rate decreases that were implemented in prior years. Profit margins are expected to improve in 2000 as the impact of the 1999 rate increases become more fully recognized; however, underwriting results could be negatively impacted by increased catastrophe and storm losses due to the cancellation of the aggregate excess of loss catastrophe reinsurance agreement. Management is working to improve profitability through re- underwriting programs for both the current book of business and the agency force and by controlling the usage of discretionary rate credits. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Through its participation in the pooling agreement, the property and casualty insurance subsidiaries assume insurance business from the North Carolina Reinsurance Facility (NCRF), which is a state run assigned risk program. Prior to 1998, the property and casualty insurance subsidiaries were not recognizing their share of certain surcharges reported by the NCRF. During 1998, the property and casualty insurance subsidiaries received clarification regarding such amounts and recorded their share of the cumulative surcharges. As a result, operating results for 1998 reflect assumed premium income of $543,000 and assumed loss recoveries of $662,000 related to prior years. Beginning in 1999, these surcharges are being recorded on a quarterly basis. Reinsurance Operating results for the three years ended December 31, 1999 are as follows: ($ in thousands) 1999 1998 1997 -------- -------- -------- Premiums earned ............................ $ 43,833 $ 38,721 $ 34,106 Losses and settlement expenses ............. 36,395 29,209 23,306 Acquisition and other expenses ............. 13,450 12,094 11,752 -------- -------- -------- Underwriting loss .......................... (6,012) (2,582) (952) Net investment income ...................... 7,114 6,760 6,615 Other income ............................... 119 168 219 -------- -------- -------- Operating income before income taxes ....... $ 1,221 $ 4,346 $ 5,882 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ....... $ 36,803 $ 32,744 $ 25,109 Decrease in provision for insured events of prior years .................. (408) (3,535) (1,803) -------- -------- -------- Total losses and settlement expenses $ 36,395 $ 29,209 $ 23,306 ======== ======== ======== Catastrophe losses ......................... $ 3,773 $ 3,314 $ 1,276 ======== ======== ======== Premium income increased 13.2 percent in 1999 and 13.5 percent in 1998 after declining in 1997. The increase reported for 1999 is primarily attributable to the delayed reporting of several foreign reinsurance contracts written in 1998. Production for 1999 was also impacted by the addition of new contracts and increases in premiums on existing contracts, but to a lesser degree. The increase reported for 1998 reflects the addition of several new accounts. Premium income decreased in 1997 despite an increase in the quota share percentage from 95 percent to 100 percent and the cancellation of an aggregate reinsurance treaty with Employers Mutual. This decline is attributed to a decrease in the estimate of earned but not reported premium, rate reductions and the absence of run-off premium that was recognized in 1996. Premium rates stabilized somewhat during 1999 as moderate rate increases were implemented on some foreign contracts that were exposed to losses in 1998; however, overall rate adequacy did not improve as rate decreases were experienced on domestic contracts with good loss experience. Losses and settlement expenses increased 24.6 percent in 1999 and 25.3 percent in 1998 after declining in 1997. These fluctuations are consistent with the changes experienced in premium income. Results for 1999 reflect a large decline in the amount of favorable development experienced on prior years' reserves. In addition, the results for 1999 were negatively impacted by heavy storm losses in Europe and by large losses on several property per-risk, property pro-rata and aggregate excess of loss contracts. The losses and settlement expenses reported for 1998 reflect a large increase in catastrophe losses and a deterioration in the loss experience of a reinsurance pool that Employers Mutual participates in, which was attributed to a high level of storm activity. Acquisition and other expenses increased 11.2 percent in 1999, 2.9 percent in 1998 and 2.6 percent in 1997. The large increase for 1999 is reflective of the increase in premium income. The increases for 1998 and 1997 differ from the changes experienced in premium income due to fluctuations in contingent commission expense, which is based on the profitability of the assumed book of business. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED Underwriting results of the reinsurance segment have declined steadily over the last three years. This decline can be attributed to premium rate reductions, higher levels of catastrophe and storm losses and increased loss severity. Premium rate levels continue to be negatively impacted by excess capacity in the reinsurance industry. Employers Mutual is working to address this issue by accepting a larger share of coverage on desirable programs, strengthening its relationships with reinsurance intermediaries and adopting the use of new underwriting tools and technologies, while continuing to emphasize profitability over premium growth. Parent Company The parent company reported an operating loss before income taxes of $27,000 in 1999 compared to operating income of $77,000 in 1998 and $132,000 in 1997. The decrease in 1999 operating results is attributed to a decline in investment income, which resulted from a decrease in the invested asset balance. The decline in 1998 results is primarily due to higher operating expenses while the results for 1997 reflect additional investment income that resulted from an increase in the invested asset balance. LOSS AND SETTLEMENT EXPENSE RESERVES Loss and settlement expense reserves are the Company's largest liability. Management continually reviews these reserves using a variety of statistical and actuarial techniques to analyze claim costs, frequency and severity data, and social and economic factors. Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of the loss. During the loss settlement period, additional facts regarding individual claims become known, and accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim. Such changes in estimates are reflected in operating results in the year the changes are recorded. The Company's financial results have not been materially affected by losses associated with asbestos and environmental exposures. Total reserves for asbestos and environmental related claims totaled $2,448,000 at December 31, 1999. Approximately $1,464,000 of these reserves are attributed to the reinsurance business assumed by the Company's reinsurance subsidiary with the remaining $984,000 attributed to the direct insurance business written by the parties to the pooling agreement. LIQUIDITY AND INVESTMENTS The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid investments to ensure the availability of funds to meet claims and expenses. The remainder of the investment portfolio, excluding investments in equity securities, is invested in securities with maturities that approximate the anticipated liabilities of the insurance issued. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED The Company considers itself to be a long-term investor and generally purchases fixed maturity investments with the intent to hold them to maturity. The Company has previously classified a portion of its investments in fixed maturity securities, primarily bonds issued by municipalities and corporations, as available-for-sale securities to provide flexibility in the management of the portfolio. Beginning in the third quarter of 1999, all newly acquired securities are being classified as available-for-sale to provide increased management flexibility. Unrealized holding losses on fixed maturity securities available-for-sale, net of tax, totaled $7,539,000 at December 31, 1999 compared to unrealized holding gains of $6,194,000 and $4,577,000 at December 31, 1998 and 1997, respectively. The decrease in the market value of these investments is primarily due to an increase in interest rates during 1999. Since the Company does not actively trade in the bond market, 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 investment policy as changing conditions warrant. At December 31, 1999, a valuation allowance of $1,233,000 was established for the deferred tax asset associated with net unrealized holding losses on the Company's available-for-sale fixed maturity and equity securities. This valuation allowance was established due to uncertainties concerning the future realization of these tax benefits. The majority of the Company's assets are invested in fixed maturity securities. These investments provide a substantial amount of income which supplements underwriting results and contributes to net earnings. As these investments mature, the proceeds will be reinvested at current 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 depending on the interest rate level. During the third quarter of 1999, the Company began participating in a securities lending program whereby certain fixed maturity securities from the investment portfolio are loaned to other institutions for short periods of time. The Company receives a fee for each security loaned out under this program and requires initial collateral equal to 102 percent of the market value of the loaned securities. During the second and third quarters of 1999 the Company disposed of approximately $55,000,000 of investments in tax-exempt fixed maturity securities and reinvested the proceeds in taxable fixed maturity securities. This change in asset allocation is not expected to have a material impact on the operations of the Company, as forced liquidations of investments are not anticipated. During the third quarter of 1998 the Company liquidated its common stock mutual fund portfolio and reinvested the proceeds in individual stock issues that are being managed on a tax-aware basis. This change in investment strategy allows the Company to control both the timing and the amount of sales that occur in these investments. The major ongoing sources of the Company's liquidity are insurance premium income, investment income and cash provided from maturing or liquidated investments. The principal outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends and investment purchases. The Company generated positive cash flows from operations of $22,457,000 in 1999, $25,565,000 in 1998 and $22,564,000 in 1997. Included in the amounts for 1998 and 1997 are $5,570,000 and $8,741,000, respectively, received from Employers Mutual in connection with the addition of Farm and City and Hamilton Mutual to the pooling agreement and the increase in the reinsurance subsidiary's quota share percentage. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED During the second quarter of 1999 the Company completed a $3,000,000 stock repurchase plan that was approved by its Board of Directors on November 20, 1998. A total of 254,950 shares of common stock were repurchased under this plan at an average cost of $11.76 per share. During the second quarter of 1999, Employers Mutual elected to increase its participation in the Company's dividend reinvestment plan. As a result, Employers Mutual is now reinvesting 100 percent of its dividends in additional shares of the Company's common stock. Prior to the second quarter of 1999, Employers Mutual was reinvesting 50 percent of its dividends in additional shares of the Company's common stock. MARKET RISK The main objectives in managing the investment portfolios of the Company are to maximize after-tax investment income and total investment return while minimizing credit risks, in order to provide maximum support for the underwriting operations. Investment strategies are developed based upon many factors including underwriting results and the Company's resulting tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are centrally managed by investment professionals and are supervised by the investment committees of the respective board 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. The market risks of the financial instruments of the Company relate to the investment portfolio, which exposes the Company to interest rate 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. Interest rate risk includes the price sensitivity of a fixed maturity security to changes in interest rates and the affect on future earnings from short-term investments and maturing long-term investments, given a change in interest rates. The following analysis illustrates the sensitivity of the Company's financial instruments to selected changes in market rates and prices. A hypothetical one percent increase in interest rates as of December 31, 1999 would result in a corresponding pre-tax decrease in the fair value of the fixed maturity portfolios of approximately $21,500,000 or 5.3 percent. In addition, a hypothetical one percent decrease in interest rates at December 31, 1999 would result in a corresponding decrease in pre-tax income over the next twelve months of approximately $400,000, assuming the current maturity and prepayment patterns. The Company monitors interest rate risk through the analysis of interest rate simulations, and adjusts the average duration of its fixed maturity portfolio by investing in either longer or shorter term instruments given the results of interest rate simulations and judgments of cash flow needs. The effective duration of the fixed maturity portfolio at December 31, 1999 was 5.27 years. The valuation of the Company's marketable equity portfolios is subject to equity price risk. In general, equities have more year-to-year price variability than bonds. However, returns from equity securities over longer time frames have been consistently higher. The Company invests in a diversified portfolio of readily marketable equity securities. A hypothetical 10 percent decrease in the S&P 500 as of December 31, 1999 would result in a corresponding pre-tax decrease in the fair value of the Company's equity portfolio of approximately $3,000,000. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED The Company invests in high quality fixed maturity securities, thus minimizing credit quality risk. At December 31, 1999 the portfolio of long- term fixed maturity securities consists of 15.0 percent U.S. Treasury, 13.9 percent government agency, 15.2 percent mortgage-backed, 24.6 percent municipal, and 31.3 percent corporate securities. At December 31, 1998 the portfolio of long-term fixed maturity securities consisted of 24.5 percent U.S. Treasury, 13.3 percent government agency, 6.8 percent mortgage-backed, 42.1 percent municipal, and 13.3 percent corporate securities. No securities are below investment grade. Prepayment risk refers to the changes in prepayment patterns that can either shorten or lengthen the expected timing of the principal repayments and thus the average life and the effective yield of a security. Such risk exists primarily within the portfolio of mortgage-backed securities. The prepayment risk analysis is monitored regularly through the analysis of interest rate simulations. At December 31, 1999 the effective duration of the mortgage- backed securities is 4.4 years with an average life and current yield of 7.5 years and 7.7 percent, respectively. At December 31, 1998 the effective duration of the mortgage-backed securities was 1.5 years with an average life and current yield of 2.1 years and 7.7 percent, respectively. CAPITAL RESOURCES Insurance company operations require capital to support premium writings. The Company believes that its insurance company subsidiaries have sufficient capital to support their expected near-term writings. The National Association of Insurance Commissioners (NAIC) maintains certain risk-based capital standards for property and casualty insurance companies. Risk-based capital 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, 1999, each of the Company's insurance subsidiaries has a ratio of total adjusted capital to risk-based capital well in excess of the minimum level required. A major source of cash flows for the Company is dividend payments from its subsidiaries. State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval. See note 6 of Notes to Consolidated Financial Statements for additional information regarding dividend restrictions. The Company received $6,800,000, $4,275,000 and $3,750,000 of dividends from its insurance subsidiaries and paid cash dividends to its stockholders totaling $6,793,000, $5,638,000 and $4,314,000 in 1999, 1998 and 1997, respectively. Total dividends, including amounts reinvested in shares of the Company's common stock, amounted to $6,793,000, $6,865,000 and $6,715,000 in 1999, 1998 and 1997, respectively. As of December 31, 1999, the Company had no material commitments for capital expenditures. IMPACT OF INFLATION Inflation has a widespread effect on the Company's results of operations, primarily through increased losses and settlement expenses. The Company considers inflation, including social inflation that reflects an increasingly litigious society and increasing jury awards, when setting reserve amounts. Premiums are also affected by inflation, although they are often restricted or delayed by competition and the regulatory rate-setting environment. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS The Year 2000 issue presented both operational and underwriting risks to the Company. Operational risks included the failure of computer systems and equipment owned and operated by Employers Mutual, as well as those owned and operated by vendors and other parties with which the Company conducts business. Underwriting risks included, but were not limited to, potential claims by the Company's policyholders to recover losses due to interruption of business or liability to third parties that resulted from the failure of computer systems. To date, the Company has not encountered any significant problems as the result of the Year 2000 date rollover. All of the Company's systems are functioning normally. In addition, the Company has not encountered any significant problems with any vendor-supplied hardware or software. The Company continues to monitor the situation closely for any future Year 2000 issues. The Company distributed a letter during 1999 to all of its commercial policyholders notifying them that their policies did not cover Year 2000 losses, but that coverage was available through an endorsement to the policy. A questionnaire was developed and provided to them to aid in the assessment of potential risks associated with Year 2000 noncompliance. Very few policyholders elected to purchase the additional coverage provided by this endorsement. The parties to the pooling agreement purchased reinsurance protection for potential third party liability claims against policyholders arising from Year 2000 issues. To date, no significant claims have been reported relating to Year 2000 losses. Year 2000 compliance efforts were in process for a number of years. The majority of the costs associated with these efforts represented the salaries and benefit expenses of the information systems department of Employers Mutual. These costs were charged to operations in the year incurred and were not separately tracked. In addition, most purchases of computer hardware and software applications were not made specifically for Year 2000 compliance, and were not considered costs of the Year 2000 compliance effort. The Company's share of the costs associated with the Year 2000 compliance project did not exceed estimates. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities", effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB Statement No. 133", which defers the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. Currently, the Company's investment strategy does not include investments in derivative instruments or hedging activities. Accordingly, adoption of this statement is not expected to have any effect on the operating results of the Company. Effective January 1, 1999, the Company adopted Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", issued by the American Institute of Certified Public Accountants. This statement provides accounting guidance for insurance and other types of entities that are subject to guaranty fund and other insurance-related assessments. The Company's accounting policies were previously in compliance with the provisions of this statement. Adoption of this statement did not have a material effect on the Company's operating results. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED DEVELOPMENTS IN INSURANCE REGULATION The NAIC is in the final stages of a project to codify statutory accounting principles. The goal of this project is to establish a uniform set of accounting rules and regulations that will be utilized by all insurance companies when preparing financial reports submitted to regulatory authorities. The issue papers documenting this new comprehensive basis of accounting have been finalized; however, the adoption process is not yet complete. The Company has begun a study to determine the impact of adopting the proposed accounting and reporting requirements in the codification of statutory accounting principles, but has not determined what impact, if any, this project will have on the statutory surplus of its insurance subsidiaries when enacted. 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 expectations and actual results of the Company may differ materially from such expectations. 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; state and federal legislation and regulations; changes in the demand for, pricing of, or supply of insurance or reinsurance; changes in interest rates and the performance of financial markets; the adequacy of loss and settlement expense reserves, including asbestos and environmental claims; subsequent losses associated with Year 2000 compliance issues by the Company, its vendors or third party service providers; and other risks and uncertainties inherent in the Company's business. EX-13.C 5 CONSOLIDATED FINANCIAL STATEMENTS. EXHIBIT 13(c) - --------------------------------- ------------- Management's Responsibility for Financial Reporting The management of EMC Insurance Group Inc. and Subsidiaries is responsible for the preparation, integrity and objectivity of the accompanying financial statements, as well as other financial information in this report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based on management's estimates and judgments where necessary. The Company's financial statements have been audited by KPMG LLP, independent certified public accountants. Management has made available to KPMG LLP all of the Company's financial records and related data, as well as the minutes of the stockholders' and directors' meetings. Furthermore, management believes that all representations made to KPMG LLP during its audit were valid and appropriate. Their report appears elsewhere in this annual report. Management of the Company has established and continues to maintain a system of internal controls that are designed to provide assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal controls provides for appropriate division of responsibility. Certain aspects of these systems and controls are tested periodically by the Company's internal auditors. Management considers the recommendations of its internal auditors and independent accountants concerning the Company's internal controls and takes the necessary actions that are cost-effective in the circumstances to respond appropriately to the recommendations presented. Management believes that as of December 31, 1999, the Company's system of internal controls was adequate to accomplish the above objectives. The Audit Committee of the Board of Directors, composed solely of outside directors, met during the year with management and the independent accountants to review and discuss audit findings and other financial and accounting matters. The independent accountants and the internal auditors have free access to the Audit Committee, with and without management present, to discuss the results of their audit work. /s/ Bruce G. Kelley /s/ Mark E. Reese - ------------------------------------ ------------------------------------- Bruce G. Kelley Mark E. Reese President, Treasurer and Vice President and Chief Executive Officer Chief Financial Officer Independent Auditors' Report The Board of Directors and Stockholders EMC Insurance Group Inc.: We have audited the accompanying consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ KPMG LLP Des Moines, Iowa February 24, 2000 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, -------------------------- 1999 1998 ------------ ------------ ASSETS Investments (note 9): Fixed maturities: Securities held-to-maturity, at amortized cost (fair value $126,679,065 and $174,623,439) ... $127,204,160 $164,926,190 Securities available-for-sale, at fair value (amortized cost $263,720,333 and $208,115,127) 256,181,429 217,499,600 Equity securities available-for-sale, at fair value (cost $28,494,631 and $29,928,433) ...... 32,408,272 32,785,429 Short-term investments, at cost ................. 20,164,210 22,660,011 ------------ ------------ Total investments ........................... 435,958,071 437,871,230 Cash .............................................. 1,508,678 2,133,056 Accrued investment income ......................... 6,886,939 5,865,307 Accounts receivable (net of allowance for uncollectible accounts of $633,000 and $400,000) 3,293,537 2,779,041 Income taxes recoverable .......................... 1,537,000 3,224,000 Reinsurance receivables (note 3) .................. 11,129,365 16,627,791 Deferred policy acquisition costs ................. 13,619,192 12,355,482 Deferred income taxes (note 10) ................... 18,121,317 10,371,754 Intangible assets, including goodwill, at cost less accumulated amortization of $2,347,208 and $2,212,695 .................................. 1,210,612 1,345,125 Prepaid reinsurance premiums (note 3) ............. 1,280,564 1,201,737 Other assets ...................................... 2,030,703 2,271,829 ------------ ------------ Total assets ................................ $496,575,978 $496,046,352 ============ ============ LIABILITIES Losses and settlement expenses (notes 2, 4 and 5) $266,514,024 $245,610,323 Unearned premiums (note 2) ....................... 64,991,129 61,464,051 Other policyholders' funds ....................... 1,093,254 1,951,683 Indebtedness to related party (note 2) ........... 3,886,559 5,862,685 Postretirement benefits (note 12) ................ 6,768,219 6,017,565 Deferred income .................................. 158,831 277,854 Other liabilities ................................ 11,247,685 10,924,351 ------------ ------------ Total liabilities ......................... 354,659,701 332,108,512 ------------ ------------ STOCKHOLDERS' EQUITY (notes 6, 7 and 13) Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,265,232 shares in 1999 and 11,496,389 shares in 1998 .......... 11,265,232 11,496,389 Additional paid-in capital ....................... 65,333,686 67,822,412 Accumulated other comprehensive (loss) income .... (3,625,263) 8,079,371 Retained earnings ................................ 68,942,622 76,539,668 ------------ ------------ Total stockholders' equity ................ 141,916,277 163,937,840 ------------ ------------ Contingent liabilities (notes 3 and 15) Total liabilities and stockholders' equity $496,575,978 $496,046,352 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Income Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ REVENUES: Premiums earned (notes 2 and 3) .... $211,098,141 $194,244,405 $177,218,246 Investment income, net (note 9) .... 25,760,561 24,859,063 23,780,303 Realized investment gains (note 9) 276,673 5,901,049 4,100,006 Other income ....................... 2,194,162 1,700,331 1,022,371 ------------ ------------ ------------ 239,329,537 226,704,848 206,120,926 ------------ ------------ ------------ LOSSES AND EXPENSES (note 2): Losses and settlement expenses (notes 3, 4 and 5) ...... 176,876,248 157,876,094 129,853,304 Dividends to policyholders ......... 1,237,368 1,874,900 2,530,747 Amortization of deferred policy acquisition costs ......... 48,056,918 44,662,641 35,942,092 Other underwriting expenses ........ 17,465,822 17,016,421 20,056,069 Other expenses ..................... 1,684,455 1,600,936 935,981 ------------ ------------ ------------ 245,320,811 223,030,992 189,318,193 ------------ ------------ ------------ (Loss) income before income tax (benefit) expense ...... (5,991,274) 3,673,856 16,802,733 ------------ ------------ ------------ INCOME TAX (BENEFIT) EXPENSE (note 10): Current ........................ (1,599,826) (1,516,892) 4,266,959 Deferred ....................... (3,587,463) (822,117) (680,793) ------------ ------------ ------------ (5,187,289) (2,339,009) 3,586,166 ------------ ------------ ------------ Net (loss) income ............ $ (803,985) $ 6,012,865 $ 13,216,567 ============ ============ ============ Net (loss) income per common share - basic and diluted .............. $ (0.07) $ 0.53 $ 1.18 ============ ============ ============ Average number of shares outstanding - basic and diluted .............. 11,330,705 11,440,592 11,193,243 ============ ============ ============ Consolidated Statements of Comprehensive Income Year ended December 31, ------------------------------------- 1999 1998 1997 ------------ ----------- ----------- Net (loss) income ..................... $ (803,985) $ 6,012,865 $13,216,567 ------------ ----------- ----------- OTHER COMPREHENSIVE INCOME (note 9): Unrealized holding (losses) gains arising during the period, before deferred income tax (benefit) expense ........................... (15,597,992) 6,460,974 9,696,600 Deferred income tax (benefit) expense (4,070,728) 2,196,732 3,296,843 ------------ ----------- ----------- (11,527,264) 4,264,242 6,399,757 ------------ ----------- ----------- Reclassification adjustment for gains included in net (loss) income, before income tax expense ......... (268,742) (5,866,610) (4,098,079) Income tax expense .................. 91,372 1,994,647 1,393,347 ------------ ----------- ----------- (177,370) (3,871,963) (2,704,732) ------------ ----------- ----------- Other comprehensive (loss) income (11,704,634) 392,279 3,695,025 ------------ ----------- ----------- Total comprehensive (loss) income $(12,508,619) $ 6,405,144 $16,911,592 ============ =========== =========== See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- COMMON STOCK: Beginning of year ...................$ 11,496,389 $ 11,351,119 $ 11,084,461 Issuance of common stock: Stock option plans ................ 23,793 55,102 71,073 Dividend reinvestment plan (note 13) .................. - 90,168 195,585 Repurchase of common stock (note 13) (254,950) - - ----------- ----------- ----------- End of year ......................... 11,265,232 11,496,389 11,351,119 ----------- ----------- ----------- ADDITIONAL PAID-IN CAPITAL: Beginning of year ................... 67,822,412 65,916,681 62,762,613 From issuance of common stock: Stock option plans ................ 255,001 722,511 854,641 Dividend reinvestment plan ........ - 1,183,220 2,299,427 Repurchase of common stock .......... (2,743,727) - - ----------- ----------- ----------- End of year ......................... 65,333,686 67,822,412 65,916,681 ----------- ----------- ----------- ACCUMULATED OTHER COMPREHENSIVE INCOME: Beginning of year ................... 8,079,371 7,687,092 3,992,067 Change in other comprehensive income ............................ (11,704,634) 392,279 3,695,025 ----------- ----------- ----------- End of year ......................... (3,625,263) 8,079,371 7,687,092 ----------- ----------- ----------- RETAINED EARNINGS: Beginning of year ................... 76,539,668 77,391,564 70,889,887 Net (loss) income ................... (803,985) 6,012,865 13,216,567 Dividends on common stock ($.60 per share in 1999, 1998 and 1997): Cash dividends .................. (6,793,061) (5,637,687) (4,314,083) Dividends reinvested in shares of common stock ............... - (1,227,074) (2,400,807) ----------- ----------- ----------- End of year ......................... 68,942,622 76,539,668 77,391,564 ----------- ----------- ----------- Total stockholders' equity ........$141,916,277 $163,937,840 $162,346,456 =========== =========== =========== See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income ................... $ (803,985) $ 6,012,865 $13,216,567 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Losses and settlement expenses .. 20,903,701 24,524,043 9,356,859 Unearned premiums ............... 3,527,078 4,345,359 4,125,443 Other policyholders' funds ...... (858,429) (829,861) (685,905) Deferred policy acquisition costs (1,263,710) (1,794,825) (1,538,794) Indebtedness of related party ... (1,976,126) 5,346,899 (7,707,448) Accrued investment income ....... (1,021,632) (113,012) 814,891 Accrued income taxes: Current ....................... 1,687,000 (6,772,000) 606,000 Deferred ...................... (3,587,463) (822,116) (680,794) Realized investment gains ....... (276,673) (5,901,049) (4,100,006) Postretirement benefits ......... 750,654 588,652 496,079 Reinsurance receivables ......... 5,498,426 (3,026,100) 1,134,095 Prepaid reinsurance premiums .... (78,827) (6,672) 321,907 Amortization of deferred income (119,023) (168,824) (218,872) Other, net ...................... 76,476 (1,388,392) (1,316,735) ----------- ----------- ----------- 23,261,452 13,982,102 606,720 Cash provided by the change in the property and casualty insurance subsidiaries' pooling agreement (note 2) ............ - 5,569,567 5,674,458 Cash provided by the change in the reinsurance subsidiary's quota share agreement (note 2) - - 3,066,705 ----------- ----------- ----------- Net cash provided by operating activities .... $22,457,467 $25,564,534 $22,564,450 ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturity securities held-to-maturity .... $(13,459,272) $(20,959,844) $(35,504,382) Maturities of fixed maturity securities held-to-maturity .... 51,260,724 42,025,415 38,138,196 Purchases of fixed maturity securities available-for-sale .. (135,872,298) (57,514,297) (46,586,660) Disposals of fixed maturity securities available-for-sale .. 81,893,552 22,210,930 20,769,810 Purchases of equity securities available-for-sale ............. (24,924,562) (40,789,067) (5,024,876) Disposals of equity securities available-for-sale ............. 25,037,159 42,941,862 4,010,683 Net sales (purchases) of short-term investments ......... 2,495,796 (7,733,017) 2,626,614 ------------ ------------ ----------- Net cash used in investing activities .............. (13,568,901) (19,818,018) (21,570,615) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock ......... 278,794 823,927 1,019,919 Dividends paid to stockholders (note 13) ......... (6,793,061) (5,637,687) (4,314,083) Repurchase of common stock (note 13) ................ (2,998,677) - - ------------ ------------ ------------ Net cash used in financing activities .............. (9,512,944) (4,813,760) (3,294,164) ------------ ------------ ------------ Net (decrease) increase in cash .... (624,378) 932,756 (2,300,329) Cash at beginning of year .......... 2,133,056 1,200,300 3,500,629 ------------ ------------ ------------ Cash at end of year ................ $ 1,508,678 $ 2,133,056 $ 1,200,300 ============ ============ ============ Income taxes (recovered) paid ...... $ (3,294,499) $ 5,236,047 $ 3,660,959 Interest paid ...................... $ 89,032 $ - $ 88,922 See accompanying Notes to Consolidated Financial Statements EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION EMC Insurance Group Inc., an approximately 72 percent owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance and reinsurance. Both commercial and personal lines of insurance are written, with the focus on medium-sized commercial accounts. About one-half of the premiums written are in Iowa and contiguous states. 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's subsidiaries include EMCASCO Insurance Company, Illinois EMCASCO Insurance Company, Dakota Fire Insurance Company, Farm and City Insurance Company, EMC Reinsurance Company and EMC Underwriters, LLC. The consolidated financial statements have been prepared on the basis of generally accepted accounting principles (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. PROPERTY AND CASUALTY INSURANCE AND REINSURANCE OPERATIONS Premiums are recognized as revenue ratably over the terms of the respective policies. Unearned premiums are calculated on the daily pro rata method. Amounts paid as ceded reinsurance premiums are reported as prepaid reinsurance premiums and amortized over the remaining contract period in proportion to the amount of insurance protection provided. Certain costs of acquiring new business, principally commissions, premium taxes and other underwriting expenses that vary with and are directly related to the production of business have been deferred. Such deferred costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Liabilities for losses are based upon case-basis estimates of reported losses, estimates of unreported losses based upon prior experience adjusted for current trends, and estimates of losses expected to be paid under assumed reinsurance contracts. Liabilities for settlement expenses are provided by estimating expenses expected to be incurred in settling the claims provided for in the loss reserves. Changes in estimates are reflected in current operating results (see note 4). Ceded reinsurance amounts with nonaffiliated reinsurers relating to reinsurance receivables for paid and unpaid losses and loss settlement expenses and prepaid reinsurance are reported on the balance sheet on a gross basis. Amounts ceded to Employers Mutual relating to the affiliated reinsurance pooling agreement have not been grossed up because the contracts provide that receivables and payables may be offset upon settlement. The liabilities for losses and settlement expenses are considered adequate to cover the ultimate net cost of losses and claims incurred to date. Since the provisions are necessarily based on estimates, the ultimate liability may be more or less than such provisions. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued INVESTMENTS Securities classified as held-to-maturity are purchased with the intent and ability to be held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. All other securities have been classified as securities available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as accumulated other comprehensive income in stockholders' equity, net of deferred income taxes. Short-term investments represent money market funds and are carried at cost. The Company's carrying value for investments is reduced to its estimated realizable value if a decline in the fair value is deemed other than temporary. Such reductions in carrying value are recognized as realized losses and charged to income. Premiums and discounts on debt securities are amortized over the life of the security as an adjustment to yield using the effective interest method. Realized gains and losses on 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. Included in investments at December 31, 1999 and 1998 are securities on deposit with various regulatory authorities as required by law amounting to $12,011,143 and $11,958,675, respectively. During the third quarter of 1999, the Company began participating in a securities lending program whereby certain fixed-maturity securities from the investment portfolio are loaned to other institutions for a short period of time. The Company receives a fee in exchange for the loan of securities and requires initial collateral equal to 102 percent of the market value of the loaned securities. INSURANCE-RELATED ASSESSMENTS Effective January 1, 1999, the Company adopted Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", issued by the American Institute of Certified Public Accountants. This statement provides accounting guidance for insurance and other types of entities that are subject to guaranty fund and other insurance-related assessments. The Company's accounting policies were previously in compliance with the provisions of this statement. As a result, adoption of this statement did not have a material effect on operating results. BENEFIT PLANS The Company participates in Employers Mutual's defined benefit retirement plan covering substantially all employees. The plan is funded by employer contributions and provides benefits based on the employee's years of service and compensation level. Benefits generally vest after five years of service. It is Employers Mutual's policy to fund pension costs according to regulations provided under the Internal Revenue Code. Assets held in the plan are a mix of equity, debt and guaranteed interest securities and real estate funds. The Company also participates in Employers Mutual's postretirement benefit plans, which provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for those benefits if they reach normal retirement age and have attained the required length of service while working for Employers Mutual or its subsidiaries. The health care postretirement plan requires contributions from participants and contains certain cost sharing provisions such as coinsurance and deductibles. The life insurance plan is noncontributory. The benefits provided under both plans are subject to change. During 1998, Employers Mutual established two Voluntary Employee Beneficiary Association (VEBA) trusts to accumulate funds for the payment of postretirement health care and life insurance benefits. Contributions to the VEBA trusts are used to fund the accumulated postretirement benefit obligation as well as pay current year benefits. Assets held in the VEBA trusts are primarily invested in life insurance products purchased from Employers Modern Life Company, a subsidiary of Employers Mutual. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued INCOME TAXES The Company files a consolidated Federal income tax return with its subsidiaries. Consolidated income taxes/benefits are allocated among the entities based upon separate tax liabilities. Deferred income taxes are provided for temporary differences between the tax basis of assets and liabilities and the reported amounts of those assets and liabilities for financial reporting purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted. A valuation allowance is established to reduce deferred tax assets to their net realizable value if it is "more likely than not" that a tax benefit will not be realized. NET INCOME PER SHARE - BASIC AND DILUTED The Company's basic and diluted net income per share are computed by dividing net income by the weighted average number of common shares outstanding during each year. The Company had no potential common shares outstanding during 1999, 1998 and 1997 that would have been dilutive to net income per share. INTANGIBLE ASSETS Goodwill, which represents the excess of cost over the fair value of net assets of acquired subsidiaries, is being amortized on a straight-line basis over 25 years. The Company reviews the recoverability of the unamortized balance of goodwill on a periodic basis using projected cash flows. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved. RECLASSIFICATIONS Certain amounts previously reported in prior years' consolidated financial statements have been reclassified to conform to current year presentation. 2. AFFILIATION AND TRANSACTIONS WITH AFFILIATES PROPERTY AND CASUALTY INSURANCE SUBSIDIARIES The Company's four property and casualty insurance subsidiaries and two subsidiaries and an affiliate of Employers Mutual are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment and income tax activities of the pool participants are not subject to the pooling agreement. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Effective January 1, 1998, Farm and City Insurance Company (Farm and City), a subsidiary of the Company that writes nonstandard risk automobile insurance business, became a participant in the pooling agreement. Farm and City assumes a 1.5 percent participation in the pool, which increased the Company's aggregate participation in the pool from 22 percent in 1997 to 23.5 percent in 1998 and 1999. In connection with this change in the pooling agreement, the Company's liabilities increased $6,224,586 and invested assets increased $5,569,567. The Company reimbursed Employers Mutual $726,509 for expenses that were incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $71,490 in interest income as the actual cash transfer did not occur until March 25, 1998. Effective January 1, 1997, a new affiliate of Employers Mutual became a participant in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,063 and invested assets increased $5,674,458. The Company reimbursed Employers Mutual $794,074 for expenses that were incurred to generate the additional business assumed by the Company and Employers Mutual paid the Company $75,469 in interest income as the actual cash transfer did not occur until March 24, 1997. REINSURANCE SUBSIDIARY Employers Mutual voluntarily assumes reinsurance business from nonaffiliated insurance companies and cedes a portion of this business to the Company's reinsurance subsidiary, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its share of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Operations of the quota share agreement give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss per event assumed by the reinsurance subsidiary was increased from $1,000,000 to $1,500,000. In connection with this change in the quota share percentage, the Company's liabilities increased $3,173,647 and invested assets increased $3,066,705. The Company reimbursed Employers Mutual $106,942 for expenses that were incurred to generate the additional business assumed by the Company. Premiums assumed by the reinsurance subsidiary from Employers Mutual amounted to $43,546,796, $39,074,384 and $34,690,846 in 1999, 1998 and 1997, respectively. It is customary in the reinsurance business for the assuming company to compensate the ceding company for the acquisition expenses incurred in the generation of the business. Commissions paid by the reinsurance subsidiary to Employers Mutual amounted to $10,156,159, $9,862,675 and $8,134,202 in 1999, 1998 and 1997, respectively. The reinsurance subsidiary pays an annual override commission to Employers Mutual in connection with the $1,500,000 cap on losses assumed per event, which totaled $2,286,207, $2,051,405 and $1,821,270 in 1999, 1998 and 1997, respectively. Employers Mutual retained losses and settlement expenses totaling ($6,484) in 1999, $144,329 in 1998 and ($93,621) in 1997 under this agreement. The reinsurance subsidiary also pays for 100 percent of the outside reinsurance protection Employers Mutual purchases to protect itself from catastrophic losses on the assumed reinsurance business. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary and amounted to $1,660,950, $1,648,583 and $1,841,000 in 1999, 1998 and 1997, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued SERVICES PROVIDED BY EMPLOYERS MUTUAL Employers Mutual provides various services to all of its subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are allocated to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not allocated to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. 3. REINSURANCE The parties to the pooling agreement cede insurance business to other insurers in the ordinary course of business for the purpose of limiting their maximum loss exposure through diversification of their risks. In its consolidated financial statements, the Company treats risks to the extent they are reinsured as though they were risks for which the Company is not liable. Insurance ceded by the pool participants does not relieve their primary liability as the originating insurers. Employers Mutual evaluates the financial condition of the reinsurers of the parties to the pooling agreement and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize exposure to significant losses from reinsurer insolvencies. As of December 31, 1999, reinsurance ceded to two nonaffiliated reinsurers aggregated $5,283,422, which represents a significant portion of the total prepaid reinsurance premiums and reinsurance receivables for losses and settlement expenses. These amounts reflect the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded by Employers Mutual to these organizations in connection with its role as "service carrier". Under these arrangements, Employers Mutual writes business for these organizations on a direct basis and then cedes 100 percent of this business to these organizations. Credit risk associated with these amounts is minimal, as all companies participating in these organizations are responsible for the liabilities of such organizations on a pro rata basis. The parties to the pooling agreement also assume insurance from involuntary pools and associations in conjunction with direct business written in various states. Through its participation in the pooling agreement, the Company assumes insurance business from the North Carolina Reinsurance Facility (NCRF), which is a state run assigned risk program. Prior to 1998 the Company had not recognized its share of certain surcharges reported by the NCRF. During the fourth quarter of 1998, the Company received clarification regarding such amounts and recorded its share of these cumulative surcharges. As a result, the consolidated financial statements for the year ended December 31, 1998 reflect assumed premium income of $542,656 and assumed loss recoveries of $661,818 related to prior years. Beginning in 1999, these surcharges are being recorded on a quarterly basis. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, for the three years ended December 31, 1999 is presented below. Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ PREMIUMS WRITTEN Direct ......................... $228,588,440 $213,134,588 $175,350,677 Assumed from nonaffiliates ..... 781,225 1,888,951 1,219,564 Assumed from affiliates ........ 221,051,986 204,964,038 178,624,357 Ceded to nonaffiliates ......... (7,270,696) (5,808,352) (5,615,772) Ceded to affiliates ............ (228,588,440) (213,249,508) (164,978,055) ------------ ------------ ------------ Net premiums written ......... $214,562,515 $200,929,717 $184,600,771 ============ ============ ============ PREMIUMS EARNED Direct ......................... $223,593,165 $202,514,027 $169,304,584 Assumed from nonaffiliates ..... 873,710 1,969,067 1,403,778 Assumed from affiliates ........ 217,416,300 197,166,272 171,514,339 Ceded to nonaffiliates ......... (7,191,869) (5,801,680) (5,937,679) Ceded to affiliates ............ (223,593,165) (201,603,281) (159,066,776) ------------ ------------ ------------ Net premiums earned .......... $211,098,141 $194,244,405 $177,218,246 ============ ============ ============ LOSSES AND SETTLEMENT EXPENSES INCURRED Direct ......................... $183,031,797 $171,209,604 $126,922,536 Assumed from nonaffiliates ..... 429,244 1,298,167 926,403 Assumed from affiliates ........ 182,375,574 171,681,607 122,827,934 Ceded to nonaffiliates ......... (5,928,570) (7,395,934) (3,364,737) Ceded to affiliates ............ (183,031,797) (178,917,350) (117,458,832) ------------ ----------- ------------ Net losses and settlement expenses incurred .......... $176,876,248 $157,876,094 $129,853,304 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 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. Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Gross reserves at beginning of year $245,610,323 $217,777,942 $202,502,986 Ceded reserves at beginning of year (15,563,600) (13,030,150) (13,796,769) ------------ ------------ ------------ Net reserves at beginning of year, before adjustments ............... 230,046,723 204,747,792 188,706,217 Adjustment to beginning reserves due to change in pooling agreement (note 2) ............... - 3,600,220 3,795,453 Adjustment to beginning reserves due to change in quota share percentage (note 2) .............. - - 2,726,913 ------------ ------------ ------------ Net reserves at beginning of year, after adjustments ................ 230,046,723 208,348,012 195,228,583 ------------ ------------ ------------ Incurred losses and settlement expenses: - ---------------------- Provision for insured events of the current year ............ 182,609,687 168,953,309 137,300,762 Decrease in provision for insured events of prior years .. (5,733,439) (11,077,215) (7,447,458) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 176,876,248 157,876,094 129,853,304 ------------ ------------ ------------ Payments: - --------- Losses and settlement expenses attributable to insured events of the current year ............ 72,970,531 73,228,354 57,649,830 Losses and settlement expenses attributable to insured events of prior years ................. 77,699,231 62,949,029 62,684,265 ------------ ------------ ------------ Total payments ............. 150,669,762 136,177,383 120,334,095 ------------ ------------ ------------ Net reserves at end of year ........ 256,253,209 230,046,723 204,747,792 Ceded reserves at end of year ...... 10,260,815 15,563,600 13,030,150 ------------ ------------ ------------ Gross reserves at end of year ...... $266,514,024 $245,610,323 $217,777,942 ============ ============ ============ Underwriting results of the Company are significantly influenced by estimates of loss and settlement expense reserves. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. During the last three years, the Company has experienced favorable development in the provision for insured events of prior years. The majority of the favorable development has come from the property and casualty insurance subsidiaries. Favorable development has also been experienced in the reinsurance subsidiary. The Company has historically experienced favorable development in its reserves; however, the amount of favorable development experienced is expected to fluctuate from year to year. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 5. ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS The Company has exposure to asbestos and environmental related claims associated with the insurance business written by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary. Reserves for asbestos and environmental related claims totaled $2,447,811 and $2,372,098 at December 31, 1999 and 1998, respectively. Estimating loss and settlement expense reserves for asbestos and environmental claims is very difficult due to the many uncertainties surrounding these types of claims. These uncertainties exist because the assignment of responsibility varies widely by state and claims often emerge long after the policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult. In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, the social and political conditions, and the claim history and trends within the Company and the industry. 6. RETAINED EARNINGS Retained earnings of the Company's insurance subsidiaries available for distribution as dividends are limited by law to the statutory unassigned surplus of each of the subsidiaries as of the previous December 31, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the state of domicile of each subsidiary. Subject to this limitation, the maximum dividend that may be paid within a 12 month period by Iowa corporations without prior approval of the insurance regulatory authorities is restricted to the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis. Both Illinois and North Dakota impose restrictions, which are similar to those of Iowa, on the payment of dividends and distributions. At December 31, 1999, $11,505,996 was available for distribution to the Company in 2000 without prior approval. The National Association of Insurance Commissioners utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based on the risks applicable to the operations of the individual insurer. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk: asset risk, credit risk and underwriting risk. Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy. At December 31, 1999, each of the Company's insurance subsidiaries' ratio of total adjusted capital to risk-based capital is well in excess of the minimum level required. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 7. RECONCILIATION OF STATUTORY NET INCOME AND SURPLUS A reconciliation of net income and surplus from that reported on a statutory basis to that reported in the accompanying consolidated financial statements on a GAAP basis is as follows: Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Net (loss) income from insurance subsidiaries, statutory basis .... $ (5,439,665) $ 2,117,464 $ 10,389,599 Change in deferred policy acquisition costs ................ 1,263,710 1,794,825 1,538,794 Change in salvage and subrogation accrual .......................... - - (419,578) Change in other policyholders' funds 858,429 829,861 685,905 Change in pension accrual .......... (516,880) (33,749) 476,705 GAAP postretirement benefit cost in excess of statutory cost ...... (583,380) (368,061) (235,916) Deferred income tax benefit ........ 3,585,061 815,135 683,349 Prior years' income tax expense and related interest ................. (96,134) - (117,948) GAAP basis amortization of reserve discount on commutation of reinsurance contract ............. 119,023 168,824 218,872 Prior years' NCRF surcharges (note 3) ......................... - 1,204,474 - Other, net ......................... 32,487 (568,494) (92,713) ------------ ------------ ------------ Net (loss) income from insurance subsidiaries, GAAP basis ......... (777,349) 5,960,279 13,127,069 Net (loss) income from Parent Company........................... (26,636) 52,586 89,498 ------------ ------------ ------------ Net (loss) income, GAAP basis .... $ (803,985) $ 6,012,865 $ 13,216,567 ============ ============ ============ Surplus from insurance subsidiaries, statutory basis .................. $116,151,399 $127,251,446 $129,258,305 Deferred policy acquisition costs .. 13,619,192 12,355,482 10,560,657 Other policyholders' funds payable (1,093,254) (1,951,683) (2,781,544) Prepaid pension cost ............... 1,012,770 1,529,650 1,566,343 GAAP postretirement benefit liability in excess of statutory liability ........................ (3,351,848) (2,768,468) (2,400,407) Deferred income tax asset .......... 18,115,065 10,367,904 9,754,853 Goodwill ........................... 1,210,612 1,345,125 1,479,638 Excess of statutory reserves over statement reserves .......... 37,491 40,847 677,975 GAAP basis reserve discount on commutation of reinsurance contract in excess of statutory recognition ...................... (158,831) (277,854) (446,678) Unrealized holding (losses) gains on available-for-sale securities .... (7,495,349) 9,398,727 6,940,501 Other, net ......................... 120,141 125,765 229,775 ------------ ------------ ------------ Equity from insurance subsidiaries, GAAP basis ......... 138,167,388 157,416,941 154,839,418 Equity from Parent Company ......... 3,748,889 6,520,899 7,507,038 ----------- ----------- ----------- Stockholders' equity, GAAP basis .. $141,916,277 $163,937,840 $162,346,456 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 8. 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 environment in which they operate. The accounting policies of the segments are described in the summary of significant accounting policies. Summarized financial information for the Company's segments is as follows: Property Year ended and casualty Parent December 31, 1999 insurance Reinsurance company Consolidated - ----------------- ------------ ------------ ------------ ------------ Premiums earned ......... $167,265,093 $ 43,833,048 $ - $211,098,141 Underwriting loss ....... (26,526,524) (6,011,691) - (32,538,215) Net investment income ... 18,282,642 7,113,877 364,042 25,760,561 Realized (losses) gains (4,127) 280,800 - 276,673 Other income ............ 2,075,087 119,023 52 2,194,162 Other expenses .......... (1,293,561) - (390,894) (1,684,455) ------------ ------------ ------------ ------------ (Loss) income before income tax (benefit) expense ............... $ (7,466,483)$ 1,502,009 $ (26,800)$ (5,991,274) ============ ============ ============ ============ Assets .................. $372,378,937 $123,658,090 $142,076,106 $638,113,133 Eliminations ............ - - (141,537,155)(141,537,155) ------------ ------------ ------------ ------------ Net assets ......... $372,378,937 $123,658,090 $ 538,951 $496,575,978 ============ ============ ============ ============ Year ended December 31, 1998 - ----------------- Premiums earned ......... $155,523,486 $ 38,720,919 $ - $194,244,405 Underwriting loss ....... (24,602,885) (2,582,766) - (27,185,651) Net investment income ... 17,635,076 6,760,098 463,889 24,859,063 Realized gains .......... 5,870,125 30,924 - 5,901,049 Other income ............ 1,531,507 168,824 - 1,700,331 Other expenses .......... (1,213,880) - (387,056) (1,600,936) ------------ ------------ ------------ ------------ (Loss) income before income tax (benefit) expense ............... $ (780,057)$ 4,377,080 $ 76,833 $ 3,673,856 ============ ============ ============ ============ Assets .................. $372,974,038 $117,739,839 $164,085,954 $654,799,831 Eliminations ............ - - (158,753,479)(158,753,479) ------------ ------------ ------------ ------------ Net assets ......... $372,974,038 $117,739,839 $ 5,332,475 $496,046,352 ============ ============ ============ ============ Year ended December 31, 1997 - ----------------- Premiums earned ......... $143,112,560 $ 34,105,686 $ - $177,218,246 Underwriting loss ....... (10,212,002) (951,964) - (11,163,966) Net investment income ... 16,719,458 6,615,029 445,816 23,780,303 Realized gains .......... 4,077,083 22,923 - 4,100,006 Other income ............ 803,499 218,872 - 1,022,371 Other expenses .......... (622,219) - (313,762) (935,981) ------------ ------------ ------------ ------------ Income before income tax expense ........... $ 10,765,819 $ 5,904,860 $ 132,054 $16,802,733 ============ ============ ============ ============ Assets .................. $340,552,986 $111,568,145 $162,519,792 $614,640,923 Eliminations ............ - - (155,531,127)(155,531,127) ------------ ------------ ------------ ------------ Net assets ......... $340,552,986 $111,568,145 $ 6,988,665 $459,109,796 ============ ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 9. INVESTMENTS The amortized cost and estimated fair value of securities held-to- maturity and available-for-sale as of December 31, 1999 and 1998 are as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services. Gross Gross Estimated Amortized unrealized unrealized fair December 31, 1999 cost gains losses value ----------------- ------------ ---------- ------------ ------------ Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $109,055,239 $2,043,252 $ (2,778,141)$108,320,350 Mortgage-backed securities ........... 18,148,921 334,351 (124,557) 18,358,715 ------------ ---------- ------------ ------------ Total securities held-to-maturity $127,204,160 $2,377,603 $ (2,902,698)$126,679,065 ============ ========== ============ ============ Securities available-for- sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $ 4,419,411 $ - $ (58,327)$ 4,361,084 Obligations of states and political subdivisions ......... 96,077,294 1,305,302 (4,168,832) 93,213,764 Mortgage-backed securities ........... 49,440,943 175,699 (182,436) 49,434,206 Debt securities issued by foreign governments .. 6,479,135 89,895 - 6,569,030 Public utilities ....... 8,890,108 2,050 (54,702) 8,837,456 Corporate securities ... 98,413,442 143,084 (4,790,637) 93,765,889 ------------ ---------- ------------ ------------ Total fixed maturity securities ....... 263,720,333 1,716,030 (9,254,934) 256,181,429 ------------ ---------- ------------ ------------ Equity securities: Common stocks .......... 25,853,745 6,798,240 (2,848,220) 29,803,765 Non-redeemable preferred stocks ..... 2,640,886 65,497 (101,876) 2,604,507 ------------ ---------- ------------ ------------ Total equity securities ....... 28,494,631 6,863,737 (2,950,096) 32,408,272 ------------ ---------- ------------ ------------ Total securities available-for-sale $292,214,964 $8,579,767 $(12,205,030)$288,589,701 ============ ========== ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Gross Gross Estimated Amortized unrealized unrealized fair December 31, 1998 cost gains losses value ----------------- ------------ ----------- ----------- ------------ Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $140,041,154 $ 8,696,984 $ (17,335)$148,720,803 Mortgage-backed securities ........... 24,885,036 1,017,600 - 25,902,636 ------------ ----------- ----------- ------------ Total securities held-to-maturity $164,926,190 $ 9,714,584 $ (17,335)$174,623,439 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $ 3,491,259 $ - $ (4,354)$ 3,486,905 Obligations of states and political subdivisions ......... 155,138,275 8,026,883 (86,485) 163,078,673 Public utilities ....... 7,304,015 212,312 (17) 7,516,310 Corporate securities ... 42,181,578 1,243,951 (7,817) 43,417,712 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... 208,115,127 9,483,146 (98,673) 217,499,600 ------------ ----------- ----------- ------------ Equity securities: Common stocks .......... 26,782,547 4,293,187 (1,551,293) 29,524,441 Non-redeemable preferred stocks ..... 3,145,886 129,164 (14,062) 3,260,988 ------------ ----------- ----------- ------------ Total equity securities ....... 29,928,433 4,422,351 (1,565,355) 32,785,429 ------------ ----------- ----------- ------------ Total securities available-for-sale $238,043,560 $13,905,497 $(1,664,028)$250,285,029 ============ =========== =========== ============ The amortized cost and estimated fair value of fixed maturity securities at December 31, 1999, 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. Estimated Amortized fair cost value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 4,498,477 $ 4,562,505 Due after one year through five years ..... 32,067,841 33,088,104 Due after five years through ten years .... 63,257,577 62,077,061 Due after ten years ....................... 9,231,344 8,592,680 Mortgage-backed securities ................ 18,148,921 18,358,715 ------------ ------------ Totals ................................ $127,204,160 $126,679,065 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 1,753,344 $ 1,756,937 Due after one year through five years ..... 25,307,861 25,259,693 Due after five years through ten years .... 54,694,520 53,277,920 Due after ten years ....................... 132,523,665 126,452,673 Mortgage-backed securities ................ 49,440,943 49,434,206 ------------ ------------ Totals ................................ $263,720,333 $256,181,429 ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Realized investment gains and losses from calls and prepayments of fixed maturity securities held-to-maturity and available-for-sale and sales of fixed maturity securities and equity securities available-for-sale are presented below. Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Fixed maturity securities held-to-maturity: Gross realized investment gains ... $ 7,931 $ 34,439 $ 1,927 Gross realized investment losses .. - - - Fixed maturity securities available-for-sale: Gross realized investment gains ... 1,593,437 46,620 110,304 Gross realized investment losses .. (3,490) (81) (22,908) Equity securities available-for-sale: Gross realized investment gains ... 2,299,740 7,865,619 4,010,683 Gross realized investment losses .. (3,620,945) (2,045,548) - ---------- ---------- ---------- Totals .......................... $ 276,673 $5,901,049 $4,100,006 ========== ========== ========== During the second and third quarters of 1999, the Company sold approximately $55,000,000 of investments in tax-exempt fixed maturity securities available-for-sale and reinvested the proceeds into taxable fixed maturity securities available-for-sale that pay a higher interest rate. This change in asset allocation was implemented to increase the Company's after-tax rate of return on its investment portfolio. Realized investment gains for 1999 reflect $1,589,953 of gains from the disposal of these tax-exempt fixed maturity securities. During 1998, the Company liquidated its common stock mutual fund portfolio. Total proceeds amounted to $28,675,920 and included realized investment gains of $7,585,293. Realized investment gains for 1997 reflect capital gain distributions of $4,010,683 related to the Company's common stock mutual fund portfolio. A summary of net investment income is as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Interest on fixed maturities .......... $24,504,253 $23,496,941 $22,876,491 Dividends on equity securities ........ 582,496 547,238 599,043 Interest on short-term investments .... 1,387,774 1,483,167 1,250,492 Securities lending .................... 21,313 - - ----------- ----------- ----------- Total investment income ........... 26,495,836 25,527,346 24,726,026 Investment expenses ................... (735,275) (668,283) (945,723) ----------- ----------- ----------- Net investment income ............. $25,760,561 $24,859,063 $23,780,303 =========== =========== =========== A summary of net changes in unrealized holding gains (losses) on securities available-for-sale is as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ------------ ----------- ----------- Fixed maturity securities ........... $(16,923,379) $ 2,448,942 $ 3,691,046 Applicable income tax (benefit) expense ........................... (5,753,949) 832,641 1,254,955 ------------ ----------- ----------- Total fixed maturity securities (11,169,430) 1,616,301 2,436,091 ------------ ----------- ----------- Equity securities ................... 1,056,645 (1,854,578) 1,907,475 Applicable income tax expense (benefit) ......................... 359,259 (630,556) 648,541 ------------ ----------- ----------- Total equity securities ......... 697,386 (1,224,022) 1,258,934 ------------ ----------- ----------- Valuation allowance ................. 1,232,590 - - ------------ ----------- ----------- Total available-for-sale securities .................... $(11,704,634) $ 392,279 $ 3,695,025 ============ =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 10. INCOME TAXES Temporary differences between the consolidated financial statement carrying amount and tax basis of assets and liabilities that give rise to significant portions of the deferred tax asset at December 31, 1999 and 1998 relate to the following: Year ended December 31, ------------------------ 1999 1998 ----------- ----------- Loss reserve discounting ........................... $13,587,146 $12,514,967 Unearned premium reserve limitation ................ 4,295,775 4,060,198 Postretirement benefits ............................ 1,935,776 1,743,193 Other policyholders' funds payable ................. 371,706 663,572 Prepayment of tax on commutation of loss reserves .. 54,003 94,470 Minimum tax credit ................................. 2,200,598 560,719 Net unrealized holding losses ...................... 1,232,590 - Other, net ......................................... 843,766 613,221 ----------- ----------- Total gross deferred income tax asset ........ 24,521,360 20,250,340 Less valuation allowance ........................... (1,232,590) (800,000) ----------- ----------- Total deferred income tax asset .............. 23,288,770 19,450,340 ----------- ----------- Deferred policy acquisition costs .................. (4,630,525) (4,200,864) Net unrealized holding gains ....................... - (4,162,100) Other, net ......................................... (536,928) (715,622) ----------- ----------- Total gross deferred income tax liability .... (5,167,453) (9,078,586) ----------- ----------- Net deferred income tax asset .............. $18,121,317 $10,371,754 =========== =========== The valuation allowance at December 31, 1999 consists of $1,232,590 related to the tax benefits associated with unrealized holding losses on fixed maturity securities available-for-sale. The valuation allowance at December 31, 1998 relates to the tax benefits associated with postretirement benefit deductions that are scheduled to reverse more than fifteen years into the future. These valuation allowances were established due to the uncertainty concerning the future realization of the tax benefits. Based upon anticipated future taxable income and consideration of all other available evidence, management believes that it is "more likely than not" that the Company's net deferred income tax asset will be realized. The actual income tax (benefit) expense for the years ended December 31, 1999, 1998 and 1997 differed from the "expected" tax (benefit) expense for those years (computed by applying the United States federal corporate tax rate of 34 percent to (loss) income before income tax (benefit) expense) as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Computed "expected" tax (benefit) expense ............................ $(2,037,033) $ 1,249,111 $ 5,712,929 Increases (decreases) in tax resulting from: Tax-exempt interest income ....... (2,306,517) (2,464,971) (2,330,842) Change in accrual of prior year taxes .......................... - (550,000) (424,161) Change in valuation allowance .... (800,000) (400,000) - Settlement of tax examinations ... - - 29,026 Proration of tax-exempt interest and dividends received deduction 150,159 239,147 226,175 Other, net ....................... (193,898) (412,296) 373,039 ----------- ----------- ----------- Income tax (benefit) expense ... $(5,187,289) $(2,339,009) $ 3,586,166 =========== =========== =========== During 1999 and 1998, the valuation allowance was reduced as the result of the establishment of VEBA trusts that will accelerate the postretirement benefit deductions and reduce the uncertainty of future realization of the tax benefits (note 1). EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Comprehensive income tax (benefit) expense included in the consolidated financial statements for the years ended December 31, 1999, 1998 and 1997 is as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Income tax (benefit) expense on: Operations .......................... $(5,187,289) $(2,339,009) $ 3,586,166 Unrealized holding (losses) gains on revaluation of securities available-for-sale ................ (4,162,100) 202,085 1,903,496 ----------- ----------- ----------- Comprehensive income tax (benefit) expense ............. $(9,349,389) $(2,136,924) $ 5,489,662 =========== =========== =========== 11. EMPLOYEE RETIREMENT PLAN The following table sets forth the funded status of the Employers Mutual defined benefit retirement plan, based upon a measurement date of November 1, 1999 and 1998, respectively: Year ended December 31, ------------------------ 1999 1998 ----------- ----------- Change in projected benefit obligation: Projected benefit obligation at beginning of year... $82,478,544 $68,560,979 Service cost ....................................... 4,359,955 3,482,226 Interest cost ...................................... 5,426,633 4,835,259 Actuarial (gain) loss .............................. (6,565,958) 10,571,289 Benefits paid ...................................... (5,713,244) (5,005,271) Amendments ......................................... 1,552,384 34,062 ----------- ----------- Projected benefit obligation at end of year ...... 81,538,314 82,478,544 ----------- ----------- Change in plan assets: Fair value of plan assets at beginning of year...... 90,099,993 85,475,793 Actual return on plan assets ....................... 11,437,594 9,629,471 Benefits paid ...................................... (5,713,244) (5,005,271) ----------- ----------- Fair value of plan assets at end of year ......... 95,824,343 90,099,993 ----------- ----------- Funded status ...................................... 14,286,029 7,621,449 Unrecognized net actuarial gain .................... (11,562,801) (600,529) Unrecognized initial net asset ..................... (755,787) (1,805,492) Unrecognized prior service costs ................... 3,602,821 2,485,365 ----------- ----------- Prepaid pension cost ............................. $ 5,570,262 $ 7,700,793 =========== =========== The components of net periodic pension cost for the Employers Mutual defined benefit retirement plan is as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Service cost .......................... $ 4,359,955 $ 3,482,226 $ 3,174,041 Interest cost ......................... 5,426,633 4,835,259 4,673,368 Expected return on plan assets ........ (7,041,280) (6,980,310) (6,168,223) Amortization of initial net asset ..... (1,049,705) (1,075,440) (1,075,440) Amortization of prior service costs ... 434,928 437,957 437,957 ----------- ----------- ----------- Net periodic pension cost ........... $ 2,130,531 $ 699,692 $ 1,041,703 =========== =========== =========== The weighted average discount rate used to measure the projected benefit obligation was 7.75 percent for 1999, 6.75 percent for 1998 and 7.25 percent for 1997. The assumed long-term rate of return on plan assets was 8.00 percent for 1999, 1998 and 1997. The rate of increase in future compensation levels used in measuring the projected benefit obligation was 5.95 percent in 1999, 5.96 percent in 1998 and 5.26 percent in 1997. Pension expense for the Company amounted to $516,880, $172,985 and $257,812 in 1999, 1998 and 1997, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 12. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The following tables set forth the funded status of the Employers Mutual postretirement benefit plans based upon a measurement date of November 1, 1999 and 1998, respectively. Year ended December 31, ------------------------- 1999 1998 ------------ ------------ Change in postretirement benefit obligation: Benefit obligation at beginning of year ........... $ 35,326,000 $ 26,242,000 Service cost ...................................... 2,370,000 1,321,000 Interest cost ..................................... 2,350,000 1,871,000 Actuarial (gain) loss ............................. (7,565,000) 6,499,000 Benefits paid ..................................... (1,021,000) (607,000) ------------ ------------ Postretirement benefit obligation at end of year 31,460,000 35,326,000 ------------ ------------ Change in plan assets: Fair value of plan assets at beginning of year .... - - Actual return on plan assets ...................... 222,000 - Employer contribution ............................. 3,671,000 607,000 Benefits paid ..................................... (1,021,000) (607,000) ------------ ------------ Fair value of plan assets at end of year ........ 2,872,000 - ------------ ------------ Funded status ..................................... (28,588,000) (35,326,000) Unrecognized net actuarial (gain) loss ............ (1,988,000) 5,904,000 Unrecognized prior service costs .................. 1,678,000 2,249,000 Employer contributions ............................ - 1,471,000 ------------ ------------ Liability for postretirement benefits ........... $(28,898,000)$(25,702,000) ============ ============ The components of net periodic postretirement benefit cost for the Employers Mutual postretirement benefit plans is as follows: Year ended December 31, ------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Service cost ......................... $ 2,370,000 $ 1,321,000 $ 1,040,000 Interest cost ........................ 2,350,000 1,871,000 1,518,000 Expected return on assets ............ (38,000) - - Amortization of net gain ............. 191,000 - (147,000) Amortization of prior service costs .. 571,000 571,000 571,000 ------------ ------------ ------------ Net periodic postretirement benefit cost ............................. $ 5,444,000 $ 3,763,000 $ 2,982,000 ============ ============ ============ The assumed weighted average annual rate of increase in the per capita cost of covered health care benefits (i.e. the health care cost trend rate) for 1999 is 8 percent, and is assumed to decrease gradually to 5 percent in 2002 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, a one-percentage-point increase in the assumed health care cost trend rate for each future year would increase the accumulated postretirement benefit obligation as of December 31, 1999 by $4,656,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1999 by $938,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.75 percent for 1999, 6.75 percent for 1998 and 7.25 percent for 1997. The Company's net periodic postretirement benefit cost for the years ended December 31, 1999, 1998 and 1997 was $1,278,700, $883,270 and $677,336, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 13. STOCK PLANS STOCK BASED COMPENSATION The Company has no stock based compensation plans of its own; however, Employers Mutual has several stock plans which utilize the common stock of the Company. The Company receives the current fair value for any shares issued under the plans and all expenses (the excess of current fair value over the participant's price) of the plans are borne by Employers Mutual or the company employing the individual optionees. As a result of this arrangement, the Company is not subject to the accounting requirements of Accounting Principles Board Opinion No. 25 or SFAS 123, "Accounting for Stock-Based Compensation." Under the current terms of the pooling agreement (note 2), the Company's property and casualty insurance subsidiaries incur 23.5 percent of the expenses recognized by Employers Mutual relating to these plans. The Company also incurs 100 percent of any expense of these plans that is associated with optionees working for its other subsidiaries. Total expenses incurred by the Company relating to the Employers Mutual stock plans amounted to $59,379, $97,763, and $84,058 for 1999, 1998 and 1997, respectively. (a) INCENTIVE STOCK OPTION PLANS During 1999, Employers Mutual maintained two separate stock option plans for the benefit of officers and key employees of Employers Mutual and its subsidiaries. A total of 600,000 shares have been reserved for the 1982 Employers Mutual Casualty Company Incentive Stock Option Plan (1982 Plan) and a total of 500,000 shares of the Company's common stock were initially reserved for issuance under the 1993 Employers Mutual Casualty Company Incentive Stock Option Plan (1993 Plan). Effective January 30, 1998, an additional 500,000 shares were registered under the 1993 Plan. There is a ten year time limit for granting options under the plans. Options can no longer be granted under the 1982 Plan and the time period for granting options under the 1993 Plan expires on December 31, 2002. Options granted under the plans have a vesting period of two, three, four or five years with options becoming exercisable in equal annual cumulative increments. Options have been granted to 57 individuals under the 1982 Plan and 95 individuals under the 1993 Plan. As of February 24, 2000, 20 eligible participants remained in the 1982 Plan and 71 eligible participants remained in the 1993 Plan. The Senior Executive Compensation and Stock Option Committee (the "Committee") of Employers Mutual's Board of Directors (the "Board") is the administrator of the plans. Option prices are determined by the Committee but can not be less than the fair value of the stock on the date of grant. During 1999, 71,700 options were granted under the 1993 Plan to eligible participants at a price of $12.69 and 43,336 options were exercised under the plans at prices ranging from $11.09 to $13.31. A summary of Employers Mutual's incentive stock option plans is as follows: Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- Options outstanding, beginning of year .. 574,391 550,444 538,012 Granted ................................. 71,700 87,700 88,050 Exercised ............................... (43,336) (63,753) (71,068) Expired ................................. (7,500) - (4,550) -------- -------- -------- Options outstanding, end of year ........ 595,255 574,391 550,444 ======== ======== ======== Options exercisable, end of year ........ 361,055 331,771 308,354 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (b) EMPLOYEE STOCK PURCHASE PLAN A total of 500,000 shares of the Company's common stock have been reserved for issuance under the Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. Any employee who is employed by Employers Mutual or its subsidiaries on the first day of the month immediately preceding any option period is eligible to participate in the plan. Participants pay 85 percent of the fair market value of the stock purchased, which is fully vested on the date purchased. The plan is administered by the Board of Employers Mutual and the Board has the right to amend or terminate the plan at any time; however, no such amendment or termination shall adversely affect the rights and privileges of participants with unexercised options. During 1999, 148 employees participated in the plan and exercised a total of 27,655 options at prices of $11.88 and $9.16. Activity under the plan was as follows: Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- Shares available for purchase, beginning of year ...................... 380,009 402,982 424,922 Shares purchased under plan .............. (27,655) (22,973) (21,940) -------- -------- -------- Shares available for purchase, end of year 352,354 380,009 402,982 ======== ======== ======== (c) NON-EMPLOYEE DIRECTOR STOCK PURCHASE PLAN A total of 200,000 shares of the Company's common stock have been reserved for issuance under the Employers Mutual Casualty Company Non-Employee Director Stock Purchase Plan. All non-employee directors of Employers Mutual and its subsidiaries who are not serving on the "Disinterested Director Committee" of the Board as of the beginning of the option period are eligible for participation in the plan. Each eligible director can purchase shares of common stock at 75 percent of the fair value of the stock in an amount equal to a minimum of 25 percent to a maximum of 100 percent of their annual cash retainer. The plan will continue through the option period for options granted at the 2002 annual meetings. The plan is administered by the Disinterested Director Committee of the Board. The Board may amend or terminate the plan at any time; however, no such amendment or termination shall adversely affect the rights and privileges of participants with unexercised options. During 1999, nine directors participated in the plan and exercised a total of 10,738 options at prices ranging from $9.50 to $12.41. Activity under the plan was as follows: Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- Shares available for purchase, beginning of year ...................... 162,928 170,368 176,252 Shares purchased under plan .............. (10,738) (7,440) (5,884) -------- -------- -------- Shares available for purchase, end of year 152,190 162,928 170,368 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued DIVIDEND REINVESTMENT PLAN The Company maintains a dividend reinvestment and common stock purchase plan which provides stockholders with the option of reinvesting cash dividends in additional shares of the Company's common stock. Participants may also purchase additional shares of common stock without incurring broker commissions by making optional cash contributions to the plan and may sell shares of common stock through the plan. Since the third quarter of 1998, all shares of common stock issued under the plan have been purchased in the open market through the Company's transfer agent. On December 17, 1997, an additional 1,000,000 shares of stock were registered for issuance under the dividend reinvestment plan. During the second quarter of 1999, Employers Mutual elected to increase its participation in the Company's dividend reinvestment plan. As a result, Employers Mutual is now reinvesting 100 percent of its dividends in additional shares of the Company's common stock. Prior to the second quarter of 1999, Employers Mutual was reinvesting 50 percent of its dividends in additional shares of the Company's common stock. Activity under the plan was as follows: Year ended December 31, --------------------------------- 1999 1998 1997 --------- --------- --------- Shares available for purchase, beginning of year .................. 792,325 980,904 176,489 Additional shares registered ......... - - 1,000,000 Shares purchased under plan .......... (392,696) (188,579) (195,585) --------- --------- --------- Shares available for purchase, end of year ........................ 399,629 792,325 980,904 ========= ========= ========= Range of purchase prices ............. $ 9.47 $11.25 $11.88 to to to $12.81 $15.13 $13.50 STOCK REPURCHASE PLAN During the second quarter of 1999 the Company completed a $3,000,000 common stock repurchase plan that was approved by the Company's Board of Directors on November 20, 1998. The repurchase plan authorized the Company to make repurchases in the open market or through privately negotiated transactions. The timing and terms of the purchases were determined by management based on market conditions and were conducted in accordance with the applicable rules of the Securities and Exchange Commission. During 1999, 254,950 shares of common stock were repurchased under this plan at an average cost of $11.76 per share. There were no repurchases of common stock during 1998. 14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash, indebtedness of/to related party, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. The estimated fair value of the Company's investments are summarized as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services (note 9). Carrying Estimated December 31, 1999 amount fair value ----------------- ------------ ------------ Fixed maturity securities: Held-to-maturity ......................... $127,204,160 $126,679,065 Available-for-sale ....................... 256,181,429 256,181,429 Equity securities available-for-sale ....... 32,408,272 32,408,272 Short-term investments ..................... 20,164,210 20,164,210 December 31, 1998 ----------------- Fixed maturity securities: Held-to-maturity ......................... $164,926,190 $174,623,439 Available-for-sale ....................... 217,499,600 217,499,600 Equity securities available-for-sale ....... 32,785,429 32,785,429 Short-term investments ..................... 22,660,011 22,660,011 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 15. 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 reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings. The members of the pooling agreement have purchased annuities to fund future payments that are fixed pursuant to specific claim settlement provisions. The Company, under the current terms of the pooling agreement, is a 23.5 percent participant in these annuities (note 2). The Company is contingently liable to various claimants in the amount of $734,586 in the event that the issuing company would be unable to fulfill its obligations. 16. UNAUDITED INTERIM FINANCIAL INFORMATION Three months ended, ----------------------------------------------------- March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ 1999 - ---- Total revenues (1) .... $56,872,232 $57,711,432 $61,284,746 $63,461,127 =========== =========== =========== =========== Income (loss) before income tax benefit .. $ 1,572,517 $(3,638,168) $ 85,728 $(4,011,351) Income tax benefit .... (209,226) (1,906,001) (706,930) (2,365,132) ----------- ----------- ----------- ----------- Net income (loss) $ 1,781,743 $(1,732,167) $ 792,658 $(1,646,219) =========== =========== =========== =========== Net income (loss) per share - basic and diluted* $ .15 $ (.15) $ .07 $ (.15) =========== =========== =========== =========== 1998 - ---- Total revenues (1) .... $52,301,140 $53,276,556 $62,864,880 $58,262,272 =========== =========== =========== =========== Income (loss) before income tax expense (benefit) ........... $ 6,013,327 $(4,824,800) $ 3,367,120 $ (881,791) Income tax expense (benefit) ........... 1,534,693 (2,058,639) 578,621 (2,393,684) ----------- ----------- ----------- ----------- Net income (loss) $ 4,478,634 $(2,766,161) $ 2,788,499 $ 1,511,893 =========== =========== =========== =========== Net income (loss) per share - basic and diluted* $ .39 $ (.24) $ .24 $ .13 =========== =========== =========== =========== 1997 - ---- Total revenues (1) .... $48,478,016 $50,302,117 $52,561,207 $54,779,586 =========== =========== =========== =========== Income before income tax expense ......... $ 2,070,552 $ 1,922,904 $ 3,064,442 $ 9,744,835 Income tax expense .... 322,653 231,301 399,790 2,632,422 ----------- ----------- ----------- ----------- Net income ....... $ 1,747,899 $ 1,691,603 $ 2,664,652 $ 7,112,413 =========== =========== =========== =========== Net income per share - basic and diluted* $ .16 $ .15 $ .24 $ .63 =========== =========== =========== =========== (1) Amounts previously reported in prior consolidated financial statements have been reclassified to conform to current presentation. * Since the weighted average shares for the quarters are calculated independent of the weighted average shares for the year, quarterly net income (loss) per share may not total to annual net income (loss) per share. EX-13.D 6 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED EXHIBIT 13(d) - ------------------------------------------------- ------------- STOCKHOLDER MATTERS. - -------------------- The Company's common stock trades on the NASDAQ National Market tier of the NASDAQ Stock Market under the symbol EMCI. The following table shows the high and low sales prices, as reported by Nasdaq, and the dividends paid for each quarter within the two most recent years. 1999 1998 ---------------------------- ---------------------------- High Low Dividends High Low Dividends ------- ------- --------- ------- ------- --------- 1st Quarter $12 7/8 $10 5/8 $ .15 $14 1/2 $12 1/4 $ .15 2nd Quarter 12 3/4 9 1/4 .15 15 7/8 13 1/4 .15 3rd Quarter 13 3/8 9 5/8 .15 15 11 3/4 .15 4th Quarter 10 1/2 9 .15 13 1/4 9 .15 At December 31 9 1/8 12 3/4 On March 2, 2000, there were approximately 1,274 registered stockholders of the Company's common stock. There are certain regulatory restrictions relating to the payment of dividends by the Company's insurance subsidiaries (see note 6 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K). It is the present intention of the Company's Board of Directors to declare quarterly cash dividends, but the amount and timing thereof, if any, is to be determined by the Board of Directors at its discretion. A dividend reinvestment and common stock purchase plan provides stockholders with the option of receiving additional shares of common stock instead of cash dividends. Participants may also purchase additional shares of common stock without incurring broker commissions by making optional cash contributions to the plan and may sell shares of common stock through the plan. See note 13 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. During the second quarter of 1999, Employers Mutual elected to increase its participation in the Company's dividend reinvestment plan. As a result, Employers Mutual is now reinvesting 100 percent of its dividends in additional shares of the Company's common stock. Prior to the second quarter of 1999, Employers Mutual was reinvesting 50 percent of its dividends in additional shares of the Company's common stock. EX-21 7 Exhibit 21 ---------- EMC INSURANCE GROUP INC. ORGANIZATIONAL CHART ............................... : : : EMC INSURANCE GROUP INC. : :.............................: : : : ......................:................................ : : : : Illinois EMCASCO Insurance Company EMC Dakota Fire Insurance Company Reinsurance Farm and City Insurance Company Company EMCASCO Insurance Company : : EMC Underwriters, LLC. EX-23 8 Exhibit 23 ---------- CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders EMC Insurance Group Inc.: We consent to incorporation by reference in Registration Statement Nos. 2-93738, 33-49335, 33-49337, 33-49339 and 333-45279 on Forms S-8 and No. 33-34499 on Form S-3 of EMC Insurance Group Inc. of our reports dated February 24, 2000, relating to the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows and related financial statement schedules for each of the years in the three-year period ended December 31, 1999, which reports appear in the December 31, 1999 annual report on Form 10-K of EMC Insurance Group Inc. /s/ KPMG LLP Des Moines, Iowa March 28, 2000 EX-24 9 Exhibit 24 ---------- POWER OF ATTORNEY KNOW EVERYONE BY THESE PRESENTS, that each director whose signature appears below constitutes and appoints Mark E. Reese and Bruce G. Kelley, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities related to signing and filing the Form 10-K (annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934) for the year ending December 31, 1999, and all other related filings with the Securities and Exchange Commission, and hereby ratifies and confirms all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. SIGNATURE TITLE - --------- ----- /s/ George C. Carpenter III - --------------------------- George C. Carpenter III Director /s/ E. H. Creese - --------------------------- E. H. Creese Director /s/ David J. Fisher - --------------------------- David J. Fisher Director /s/ Bruce G. Kelley - --------------------------- Bruce G. Kelley Director /s/ George W. Kochheiser - --------------------------- Chairman of the Board of George W. Kochheiser Directors /s/ Raymond A. Michel - --------------------------- Raymond A. Michel Director /s/ Fredrick A. Schiek - --------------------------- Fredrick A. Schiek Director February 24, 2000 EX-27 10 DECEMBER 31, 1999
7 This schedule contains summary financial information extracted from the 12/31/99 balance sheet and income statement and is qualified in its entirety by reference. YEAR DEC-31-1999 DEC-31-1999 256,181,429 127,204,160 126,679,065 32,408,272 0 0 435,958,071 1,508,678 11,129,365 13,619,192 496,575,978 266,514,024 64,991,129 0 1,093,254 0 0 0 11,265,232 130,651,045 496,575,978 211,098,141 25,760,561 276,673 2,194,162 176,876,248 48,056,918 17,465,822 (5,991,274) (5,187,289) (803,985) 0 0 0 (803,985) (0.07) (0.07) 245,610,323 182,609,687 (5,733,439) 72,970,531 77,699,231 266,514,024 (5,733,439)
-----END PRIVACY-ENHANCED MESSAGE-----