-----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, P8TLtv8N7iUzp51RwuswF60aQHsu4WBaQQLPGK1ZoAxLTfOjJfe7XW7fst49TnYI edikgsOvBa/TECy4lzp2Mw== 0000356130-02-000003.txt : 20020415 0000356130-02-000003.hdr.sgml : 20020415 ACCESSION NUMBER: 0000356130-02-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 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: 1934 Act SEC FILE NUMBER: 000-10956 FILM NUMBER: 02594270 BUSINESS ADDRESS: STREET 1: 717 MULBERRY ST CITY: DES MOINES STATE: IA ZIP: 50309 BUSINESS PHONE: 5152802902 MAIL ADDRESS: STREET 1: 717 MULBERRY STREET CITY: DES MOINES STATE: IA ZIP: 50309 10-K 1 bus01.txt BUSINESS SECTION 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, 2001 [ ] 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. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 1, 2002 was $38,110,841. The number of shares outstanding of the registrant's common stock, $1.00 par value, on March 1, 2002, were 11,342,700. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the registrant's annual report to stockholders for the year ended December 31, 2001 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 17, 2002, are incorporated by reference under Part III. TABLE OF CONTENTS Part I Item 1. Business ........................................................ 2 Item 2. Properties ...................................................... 25 Item 3. Legal Proceedings ............................................... 25 Item 4. Submission of Matters to a Vote of Security Holders ............. 25 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................................. 26 Item 6. Selected Financial Data ......................................... 26 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .......................... 26 Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...... 26 Item 8. Financial Statements and Supplementary Data ..................... 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .......................... 27 Part III Item 10. Directors and Executive Officers of the Registrant .............. 28 Item 11. Executive Compensation .......................................... 29 Item 12. Security Ownership of Certain Beneficial Owners and Management ............................................... 29 Item 13. Certain Relationships and Related Transactions .................. 29 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .................................................. 30 Index to Financial Statement Schedules ................................... 30 Signatures ............................................................... 33 Index to Exhibits ........................................................ 43 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 79.5 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 (including the Company) and an affiliate, 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 and was redomesticated to Iowa in 2001, 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 37 states and are participants in a pooling agreement with Employers Mutual (see "Property and Casualty Insurance - Pooling Agreement"). EMC Reinsurance Company was formed in 1981 to assume reinsurance business from Employers Mutual. The company assumes a 100 percent quota share 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. The aggregate participation of the Company's property and casualty insurance subsidiaries is 23.5 percent. 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. 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. 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, 2001. Percent Percent Percent of of of Line of Business 2001 total 2000 total 1999 total - ---------------- -------- ----- -------- ----- -------- ----- (Dollars in thousands) Commercial Lines: Automobile ............ $216,371 21.7% $177,937 21.2% $157,095 20.8% Property .............. 162,670 16.4 135,639 16.2 118,939 15.8 Workers' compensation 208,652 21.0 155,752 18.6 126,285 16.7 Liability ............. 176,774 17.8 141,184 16.8 122,528 16.2 Other ................. 19,325 1.9 17,380 2.0 16,666 2.2 -------- ----- -------- ----- -------- ----- Total commercial lines 783,792 78.8 627,892 74.8 541,513 71.7 -------- ----- -------- ----- -------- ----- Personal Lines: Automobile ............ 126,280 12.7 134,763 16.1 138,168 18.3 Property .............. 81,124 8.2 73,996 8.8 73,380 9.7 Liability ............. 3,284 0.3 2,634 0.3 2,280 0.3 -------- ----- -------- ----- -------- ----- Total personal lines 210,688 21.2 211,393 25.2 213,828 28.3 -------- ----- -------- ----- -------- ----- Total ............ $994,480 100.0% $839,285 100.0% $755,341 100.0% ======== ===== ======== ===== ======== ===== Effective January 1, 2001, the pool participants began recording the full-term written premium at the inception of insurance policies that are billed on an installment basis. Previously, such amounts were recorded as each installment became due. As a result, written premiums for 2001 increased $59,083,000, primarily in the commercial lines of business. Earned premiums were not affected by this change, as unearned premiums were increased by the same amount. 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 17 branch offices located throughout the United States and approximately 3,200 independent agents. These branch offices allow the Company to respond quickly to changes in local market conditions. Each branch office employs underwriting, claims, marketing and risk improvement representatives, as well as field auditors and branch administrative technicians. The branch offices are supported by technicians and specialists that operate out of Employers Mutual's home office. Systems are in place to monitor the underwriting results of each branch 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 Independent Agency System using approximately 725 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, 2001. 2001 2000 1999 ---- ---- ---- Alabama ............................ 2.8% 3.2% 3.7% Arizona ............................ 3.8 3.8 3.7 Illinois ........................... 5.1 4.8 4.8 Iowa ............................... 16.8 17.4 18.1 Kansas ............................. 8.8 8.2 7.8 Michigan ........................... 4.2 4.0 3.7 Minnesota .......................... 3.5 3.5 3.6 Nebraska ........................... 7.0 6.9 6.9 North Carolina ..................... 3.1 2.9 2.9 North Dakota ....................... 2.6 3.1 3.2 Texas .............................. 5.2 5.3 4.9 Wisconsin .......................... 5.0 4.5 4.3 Other * ............................ 32.1 32.4 32.4 ----- ----- ----- 100.0% 100.0% 100.0% * Includes all other jurisdictions, none of which accounted for more than 3 percent. COMPETITION The property and casualty insurance business is very 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. Because the insurance products of the pool members are marketed exclusively through independent agencies, the Company faces competition to retain qualified independent agencies, as well as competition within the agencies. The pool members also compete with direct writers, who utilize salaried employees and generally offer their products at a lower cost, exclusive agencies who write insurance business for only one company, and to a lesser extent Internet-based enterprises. The pool members utilize a profit-sharing plan as an incentive for the independent agencies to place high-quality insurance business with them. BEST'S RATING A.M. Best Company rates insurance companies based on their relative financial strength and ability to meet their contractual obligations. A.M. Best announced on July 10, 2001 that their rating of the EMC Insurance Companies, which includes the Company's property and casualty insurance subsidiaries, was changed from "A" (Excellent) to "A-" (Excellent). This rating action reflects A.M. Best's opinion of the EMC Insurance Companies' underwriting performance and operating losses during the three years ended December 31, 2000. Despite this rating action, A.M. Best stated that the EMC Insurance Companies' "Excellent" rating reflects its strong capitalization, conservative operating strategies and local-market presence. 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 that 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. 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. During 1999 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 was not renewed for 2000 and subsequent years. A summary of the reinsurance treaties benefiting the parties to the pooling agreement as of December 31, 2001 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 ........ $12,500,000 96 percent of $60,000,000 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(1) 100 percent of $ 8,600,000 Fidelity .................... $ 750,000(2) 95 percent of $ 4,250,000 Surety (other than select accounts) ................. $ 1,750,000(3) 100 percent of $13,037,500 Surety (select accounts) .... $ 4,000,000(4) 100 percent of $26,000,000 Boiler ...................... $ 0 100 percent of $50,000,000 (1) An annual aggregate deductible of $3,600,000 must be reached before the reinsurers may be petitioned. (2) Subject to annual aggregate limits for all losses of $14,000,000. (3) Subject to annual aggregate limits for all losses of $14,000,000 in the first layer and $15,000,000 in the second layer. (4) Subject to annual aggregate limits for all losses of $10,500,000 in the first layer, $15,000,000 in the second layer and $15,000,000 in the third layer. 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, 2001 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 type of 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 40 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 2001 Property per risk, property catastrophe reinsurance Best's and casualty coverages: protection rating - --------------------------------------- ---------- ------ Underwriters at Lloyd's of London .................... 20.3% A Mutual Reinsurance Bureau ............................ 13.0 (2) Transatlantic Reinsurance Company .................... 8.2 A++ AXA Corporate Solutions .............................. 7.5 A- XL Reinsurance America, Inc. ......................... 6.8 A+ Zurich Reinsurance (North America), Inc .............. 6.0 A+ X.L. Mid Ocean Reinsurance Company, Ltd .............. 3.3 (1) Workers' compensation excess coverage: - -------------------------------------- American United Life Insurance Company ............... 50.0 A+ Transatlantic Reinsurance Company .................... 50.0 A++ Umbrella coverage: - ------------------ General Reinsurance Corporation ...................... 100.0 A++ Fidelity and surety coverages: - ------------------------------ SCOR Reinsurance Company ............................. 42.0 A+ Berkley Insurance Company ............................ 20.0 A Partner Reinsurance Company of the U.S. .............. 20.0 A+ Gerling Global Reinsurance Corp of America ........... 18.0 A Boiler coverage: - ---------------- Hartford Steam Boiler Inspection and Insurance Company 100.0 A+ (1) Not rated. (2) Mutual Reinsurance Bureau (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, on an equal and joint basis, 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. 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, 2001 are presented below. Each type of reinsurance coverage is purchased in layers, and an individual reinsurer may participate in more than one type of coverage and at various layers within the coverages. Since each layer of 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..................... $ 6,806,274 $ 1,599,474 Hartford Steam Boiler Inspection & Insurance Company 4,178,787 982,015 AXA Reassurance Corporation ........................ 2,171,987 510,417 XL Reinsurance America Inc. ........................ 1,902,015 446,974 Gerling Global Reinsurance Corp of America ......... 1,367,106 321,270 SCOR Reinsurance Company ........................... 1,215,794 285,712 Hartford Fire Insurance Company .................... 1,203,987 282,937 Managing Agency Partners ........................... 687,804 161,634 Tempest Reinsurance Co., LTD ....................... 624,691 146,802 Amlin Underwriting ................................. 599,337 140,844 Other Reinsurers ................................... 8,462,742 1,988,744 ----------- ------------ Total ............................................ $29,220,524 $ 6,866,823 =========== ============ 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, 2001 are presented below. Premiums ceded by ------------------------ Property and casualty All pool insurance Reinsurer members subsidiaries - --------- ----------- ------------ National Workers' Compensation Reinsurance Pool .... $ 8,618,024 $ 2,025,236 Wisconsin Compensation Rating Bureau ............... 8,203,016 1,927,709 North Carolina Reinsurance Facility ................ 1,494,757 351,268 Other Reinsurers ................................... 77,410 18,191 ----------- ------------ Total ............................................ $18,393,207 $ 4,322,404 =========== ============ 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." The September 11, 2001 terrorist attack on the World Trade Center has had a significant impact on the pricing and terms of reinsurance coverage for 2002. The parties to the pooling agreement were not immune to these factors and experienced significantly higher costs and increased retentions when their reinsurance program was renewed in January 2002. In addition, the parties to the pooling agreement elected to purchase separate terrorism coverage for 2002, in order to provide limited protection from future terrorist exposures, as all standard reinsurance policies now excluded coverage for terrorist activities. RELATIONSHIP BETWEEN NET PREMIUMS WRITTEN AND SURPLUS The amount of insurance a property and casualty insurance company writes under industry standards is commonly expressed as 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, ------------------------------ 2001 2000 1999 ---- ---- ---- Employers Mutual .................... 1.35 1.01 .86 EMCASCO ............................. 2.25 2.39 2.03 Illinois EMCASCO .................... 2.20 2.46 2.18 Dakota Fire ......................... 2.23 2.46 2.17 Farm and City ....................... 2.70 2.32 2.04 EMC Property & Casualty Company ..... .97 .87 .80 Union Insurance Company of Providence .96 .86 .79 Hamilton Mutual Insurance Company ... 2.34 1.94 1.69 The 2001 ratios for three of the Company's property and casualty insurance subsidiaries (EMCASCO, Illinois EMCASCO and Dakota Fire) reflect the issuance of an aggregate of $25,000,000 of surplus notes to Employers Mutual on December 28, 2001. Surplus notes are considered to be a component of surplus for statutory reporting purposes; however, under generally accepted accounting principals, surplus notes are considered to be debt and are reported as a liability in the Company's financial statements. OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The property and casualty insurance subsidiaries' reserve information is included in the property and casualty loss reserve development for 2001. 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 100 percent 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 of $1,500,000 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. 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, 2001. Percent Percent Percent of of of Line of Business 2001 total 2000 total 1999 total - ---------------- ------- ----- ------- ----- ------- ----- (Dollars in thousands) Pro rata reinsurance: Property and Casualty $18,975 28.6% $14,441 30.4% $12,642 29.0% Property ............. 9,092 13.7 7,399 15.6 7,461 17.1 Crop ................. 2,372 3.6 4,188 8.8 4,727 10.8 Casualty ............. 8,720 13.1 5,319 11.2 4,771 11.0 Marine/aviation ...... 5,678 8.6 1,869 3.9 2,289 5.3 Other ................ 3,973 6.0 374 0.8 261 0.6 ------- ----- ------- ----- ------- ----- Total pro rata Reinsurance ...... 48,810 73.6 33,590 70.7 32,151 73.8 ------- ----- ------- ----- ------- ----- Excess reinsurance: Excess per risk reinsurance: Property ............. 3,430 5.2 3,011 6.3 2,298 5.3 Casualty ............. 3,981 6.0 3,882 8.2 1,979 4.6 Other ................ 1,571 2.4 856 1.8 754 1.7 ------- ----- ------- ----- ------- ----- Total excess per risk reinsurance 8,982 13.6 7,749 16.3 5,031 11.6 ------- ----- ------- ----- ------- ----- Excess catastrophe/ aggregate reinsurance: Property ............. 7,494 11.3 5,357 11.3 5,674 13.0 Crop ................. 392 0.6 297 0.6 330 0.8 Marine/aviation ...... 5 - 19 - 20 - Other ................ 604 0.9 518 1.1 341 0.8 ------- ----- ------- ----- ------- ----- Total excess catastrophe/ aggregate reinsurance ...... 8,495 12.8 6,191 13.0 6,365 14.6 ------- ----- ------- ----- ------- ----- Total excess Reinsurance ...... 17,477 26.4 13,940 29.3 11,396 26.2 ------- ----- ------- ----- ------- ----- Total .............. $66,287 100.0% $47,530 100.0% $43,547 100.0% ======= ===== ======= ===== ======= ===== 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 generally considered to be very competitive; however, competition for reinsurance business has declined significantly as a result of the September 11, 2001 terrorist attack on the World Trade Center. Industry wide rate increases for January 2002 renewals averaged 20.5 percent for excess of loss business with increased retentions and exclusions for terrorist activities being commonplace. The market for terrorism coverage is still evolving, but is becoming more available with the exclusion of nuclear, biological and chemical perils. The current trend is to have terrorism coverage written on a stand-alone basis, but this may change in the future. New reinsurance capacity, primarily from Bermuda, has entered the reinsurance marketplace to take advantage of higher reinsurance pricing, which could lead to increased rate competition in the future. Employers Mutual competes in the global reinsurance market with numerous reinsurance companies, many of which have greater financial resources. Competition for reinsurance business is based on many factors, including financial strength, industry ratings, stability in products offered and licensing status. During the last several years, reinsurance brokers have tended to favor large, financially strong reinsurance companies who are able to provide "mega" line capacity for all lines of business. The Company faces the risk that reinsurance brokers may become more selective and may seek larger and/or more highly rated reinsurance companies. REINSURANCE CEDED The reinsurance subsidiary does not purchase outside reinsurance protection due to the $1,500,000 cap on losses assumed per event under the terms of the quota share agreement with Employers Mutual. The reinsurance subsidiary pays an annual override commission to Employers Mutual for this protection and 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 $2,496,000 in 2001. BEST'S RATING The most recent Best's Property Casualty Key Rating Guide gives the reinsurance subsidiary an "A-" (Excellent) 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 2001. 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 statutory combined ratios of the Company's insurance subsidiaries and the property and casualty insurance industry averages for the five years ended December 31, 2001. 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, -------------------------------------- 2001 2000 1999 1998 1997 Property and casualty insurance ------ ------ ------ ------ ------ Loss ratio ................... 83.0% 82.2% 83.6% 83.5% 74.3% Expense ratio ................ 28.5 30.8 32.0 33.3 32.8 ------ ------ ------ ------ ------ Combined ratio ............. 111.5% 113.0% 115.6% 116.8% 107.1% ====== ====== ====== ====== ====== Reinsurance Loss ratio ................... 86.6% 86.1% 83.1% 75.4% 68.4% Expense ratio ................ 29.1 29.1 30.6 31.1 34.1 ------ ------ ------ ------ ------ Combined ratio ............. 115.7% 115.2% 113.7% 106.5% 102.5% ====== ====== ====== ====== ====== Total insurance operations Loss ratio ................... 83.8% 83.0% 83.5% 81.9% 73.1% Expense ratio ................ 28.6 30.5 31.7 32.9 33.1 ------ ------ ------ ------ ------ Combined ratio ............. 112.4% 113.5% 115.2% 114.8% 106.2% ====== ====== ====== ====== ====== Property and casualty insurance industry averages (1) Loss ratio ................... 90.1% 81.5% 78.6% 76.3% 72.8% Expense ratio ................ 26.9 28.9 29.2 29.4 28.8 ------ ------ ------ ------ ------ Combined ratio ............. 117.0% 110.4% 107.8% 105.7% 101.6% ====== ====== ====== ====== ====== (1) As reported by A.M. Best Company. The ratio for 2001 is an estimate; the actual combined ratio is not currently available. The 2001 expense ratios for "property and casualty insurance" and "total insurance operations" are distorted by $13,884,000 of additional written premiums that were recorded in 2001 in connection with a change in the recording of installment based insurance policies. Excluding this adjustment, the expense ratios would have been 30.2 percent and 30.0 percent, respectively. 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, 2001: 2001 Amount Percent Best's recoverable of total rating ----------- -------- ------ Wisconsin Compensation Rating Bureau .. $ 3,707,762 22.1% (1) National Workers' Compensation Reinsurance Pool .................... 3,036,475 18.1 (1) General Reinsurance Corporation ....... 1,592,911 9.5 A++ Hartford Fire Insurance Company ....... 790,892 4.7 A+ Hartford Steam Boiler Insp. & Ins. .... 547,484 3.3 A+ AXA Reassurance ....................... 527,281 3.1 A+ Minnesota Workers' Comp Reins Assoc ... 512,606 3.1 (2) Zurich Reinsurance (North America) Inc. 492,468 2.9 A+ American Re-Insurance Company ......... 385,398 2.3 A++ XL Reinsurance America ................ 359,050 2.1 A+ Other Reinsurers ...................... 4,824,240 28.8 ----------- ------ Total ........................... $16,776,567(3) 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 total amount recoverable at December 31, 2001 represented $2,652,739 in paid losses and settlement expenses, $11,848,597 in unpaid losses and settlement expenses and $2,275,231 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, 2001 is presented below. Year ended December 31, ---------------------------------------- 2001 2000 1999 Premiums written: ------------ ------------ ------------ Direct ........................ $272,027,823 $249,896,499 $228,588,440 Assumed from nonaffiliates .... 1,898,509 1,220,442 781,225 Assumed from affiliates ....... 299,990,245 244,762,032 221,051,986 Ceded to nonaffiliates ........ (11,189,227) (8,347,822) (7,270,696) Ceded to affiliates ........... (272,027,823) (249,896,499) (228,588,440) ------------ ------------ ------------ Net premiums written ........ $290,699,527 $237,634,652 $214,562,515 ============ ============ ============ Premiums earned: Direct ........................ $255,764,274 $245,078,165 $223,593,165 Assumed from nonaffiliates .... 1,786,132 1,194,835 873,710 Assumed from affiliates ....... 274,352,821 237,946,894 217,416,300 Ceded to nonaffiliates ........ (10,859,095) (7,683,287) (7,191,869) Ceded to affiliates ........... (255,764,274) (245,078,165) (223,593,165) ------------ ------------ ------------ Net premiums earned ......... $265,279,858 $231,458,442 $211,098,141 ============ ============ ============ Losses and settlement expenses incurred: Direct ........................ $221,314,633 $208,604,970 $183,031,797 Assumed from nonaffiliates .... 1,336,824 400,360 429,244 Assumed from affiliates ....... 227,650,959 194,017,734 182,375,574 Ceded to nonaffiliates ........ (7,069,033) (4,896,420) (5,928,570) Ceded to affiliates ........... (221,314,633) (208,604,970) (183,031,797) ------------ ------------ ------------ Net losses and settlement expenses incurred ......... $221,918,750 $189,521,674 $176,876,248 ============ ============ ============ 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 reinsurance 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 that 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 operating results in 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, 2001 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, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Gross reserves at beginning of year $286,489,028 $266,514,024 $245,610,323 Ceded reserves at beginning of year (11,224,797) (10,260,815) (15,563,600) ------------ ------------ ------------ Net reserves at beginning of year .. 275,264,231 256,253,209 230,046,723 ------------ ------------ ------------ Incurred losses and settlement expenses: Provision for insured events of the current year ............ 216,752,003 191,425,036 182,609,687 Increase (decrease) in provision for insured events of prior years .......................... 5,166,747 (1,903,362) (5,733,439) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 221,918,750 189,521,674 176,876,248 ------------ ------------ ------------ Payments: Losses and settlement expenses attributable to insured events of the current year ............ 94,983,112 82,912,082 72,970,531 Losses and settlement expenses attributable to insured events of prior years ................. 99,529,878 87,598,570 77,699,231 ------------ ------------ ------------ Total payments ............. 194,512,990 170,510,652 150,669,762 ------------ ------------ ------------ Net reserves at end of year ........ 302,669,991 275,264,231 256,253,209 Ceded reserves at end of year ...... 11,848,597 11,224,797 10,260,815 ------------ ------------ ------------ Gross reserves at end of year ...... $314,518,588 $286,489,028 $266,514,024 ============ ============ ============ 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 less favorable development in the provision for insured events of prior years. The majority of this decline in favorable development has come from the property and casualty insurance subsidiaries, although the reinsurance subsidiary has experienced similar declines. During 2001, both the property and casualty insurance segment and the reinsurance segment experienced adverse development in the provision for insured events of prior years. The adverse development in the property and casualty insurance segment is attributed to the revaluation of individual claim liabilities in select lines of business, a revaluation of formula based settlement expense reserves and an increase in paid settlement expenses. The adverse development in the reinsurance segment is attributed to construction defect claims arising from a reinsurance pool that the reinsurance subsidiary participates in. The Company has historically experienced favorable development in its reserves and reserving practices have not been changed; however, the amount of development experienced will fluctuate from year to year as individual claims are settled and additional information becomes available on open claims.
Year ended December 31, ------------------------------------------------------------------------------------------------ (Dollars in thousands) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Statutory reserves for losses and settlement expenses .... $139,317 180,797 182,072 191,514 196,293 191,892 205,606 230,937 257,201 276,103 303,643 Reclassification of reserve amounts associated with the National Workers' Compensation Reinsurance Pool ....................... 6,830 11,364 - - - - - - - - - Retroactive restatement of reserves in conjunction with admittance of new participants into the pooling agreement .......... 4,364 5,314 5,248 6,603 6,809 7,018 3,600 - - - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Statutory reserves after reclassification ........... 150,511 197,475 187,320 198,117 203,102 198,910 209,206 230,937 257,201 276,103 303,643 GAAP adjustments: Salvage and subrogation .... (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) (839) (973) -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Reserves for losses and settlement expenses ........ 149,227 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 Paid (cumulative) as of: One year later ............. 31,577 78,000 60,162 57,247 62,012 59,856 62,949 77,699 87,599 99,530 - Two years later ............ 79,619 109,985 89,153 88,831 92,626 92,191 99,870 119,620 138,701 - - Three years later .......... 97,152 127,885 107,372 106,691 112,985 113,343 122,455 147,561 - - - Four years later ........... 107,114 137,783 116,856 118,705 124,450 126,507 136,975 - - - - Five years later ........... 112,598 143,876 123,843 126,384 132,044 135,321 - - - - - Six years later ............ 116,670 148,518 128,931 130,977 137,522 - - - - - - Seven years later .......... 119,699 151,895 132,036 134,923 - - - - - - - Eight years later .......... 121,817 154,160 135,007 - - - - - - - - Nine years later ........... 123,494 156,276 - - - - - - - - - Ten years later ............ 125,129 - - - - - - - - - - Reserves reestimated as of: End of year ................ 149,227 195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 One year later ............. 155,537 197,008 179,527 179,818 183,760 188,579 197,271 224,313 254,350 280,431 - Two years later ............ 152,771 192,318 170,653 173,162 182,285 185,465 194,287 225,288 256,111 - - Three years later .......... 148,867 186,730 166,778 172,118 179,797 181,392 193,505 227,010 - - - Four years later ........... 148,017 186,133 166,133 170,570 176,176 180,686 192,824 - - - - Five years later ........... 148,098 186,319 165,548 167,763 175,465 179,898 - - - - - Six years later ............ 148,686 186,095 163,406 166,764 174,695 - - - - - - Seven years later .......... 148,991 184,174 161,985 166,280 - - - - - - - Eight years later .......... 147,579 183,821 160,459 - - - - - - - - Nine years later ........... 147,260 181,840 - - - - - - - - - Ten years later ............ 145,903 - - - - - - - - - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Cumulative redundancy (Deficiency) ............... $ 3,324 13,609 24,456 29,358 25,309 15,826 15,524 3,037 142 (5,167) - ======== ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Gross loss and settlement expense reserves - end of year (A) ............................ $220,703 202,370 209,785 212,231 209,521 221,378 245,610 266,514 286,489 314,519 Reinsurance receivables ............... 25,254 17,455 14,147 12,227 13,797 13,030 15,563 10,261 11,225 11,849 -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net loss and settlement expense reserves - end of year .............. $195,449 184,915 195,638 200,004 195,724 208,348 230,047 256,253 275,264 302,670 ======== ======= ======= ======= ======= ======= ======= ======= ======= ======= Gross re-estimated reserves - latest (B) .......................... $204,016 175,860 180,307 189,431 196,740 208,006 242,663 265,929 291,609 314,519 Re-estimated reinsurance receivables - latest .............................. 22,176 15,401 14,027 14,736 16,842 15,182 15,653 9,818 11,178 11,849 -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net re-estimated reserves - latest .... $181,840 160,459 166,280 174,695 179,898 192,824 227,010 256,111 280,431 302,670 ======== ======= ======= ======= ======= ======= ======= ======= ======= ======= Gross cumulative redundancy (deficiency) (A-B) .................. $ 16,687 26,510 29,478 22,800 12,781 13,372 2,947 585 (5,120) - ======== ======= ======= ======= ======= ======= ======= ======= ======= =======
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 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 a 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, 2001 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, -------------------------------- 2001 2000 1999 Losses and settlement expenses incurred: ---------- ---------- ---------- Asbestos: Property and casualty insurance ........ $ 64,451 $ 518,480 $ 125,687 Reinsurance ............................ (9,167) (135,695) (25,971) ---------- ---------- ---------- 55,284 382,785 99,716 ---------- ---------- ---------- Environmental: Property and casualty insurance ........ (120,610) 96,828 11,227 Reinsurance ............................ 20,615 167,238 223,996 ---------- ---------- ---------- (99,995) 264,066 235,223 ---------- ---------- ---------- Total losses and settlement expenses incurred ................ $ (44,711)$ 646,851 $ 334,939 ========== ========== ========== Loss and settlement expense reserves: Asbestos: Property and Casualty insurance ........ $ 719,590 $ 715,472 $ 259,148 Reinsurance ............................ 566,477 589,518 753,481 ---------- ---------- ---------- 1,286,067 1,304,990 1,012,629 ---------- ---------- ---------- Environmental: Property and casualty insurance ........ 454,460 711,690 724,662 Reinsurance ............................ 824,988 812,572 710,520 ---------- ---------- ---------- 1,279,448 1,524,262 1,435,182 ---------- ---------- ---------- Total loss and settlement expense reserves ......................... $2,565,515 $2,829,252 $2,447,811 ========== ========== ========== 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, 2001, approximately 46 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). The Company participates 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, primarily cash, equal to 102 percent of the market value of the loaned securities. The securities on loan to others have been segregated from the other invested assets on the Company's balance sheet. In addition, the assets and liabilities of the Company have been grossed up to reflect the collateral held under the securities lending program and the obligation to return this collateral upon the return of the loaned securities. During 2000 and 1999, the Company sold approximately $55,000,000 and $14,000,000, respectively, 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. The Company's equity investment holdings include common stocks and preferred stocks. Investments of the Company's insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments that may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages. The Company believes that it is in compliance with these laws. The investments of EMC Insurance Group Inc. and its subsidiaries are supervised by an investment committee 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, 2001 and 2000. 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, -------------------------------------------- 2001 2000 --------------------- --------------------- 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 ............. $ 57,443,480 11.0% $102,230,946 22.4% Mortgage-backed securities 8,634,427 1.6 13,480,647 2.9 Total securities held- ------------ ------- ------------ ------- to-maturity ............ 66,077,907 12.6 115,711,593 25.3 ------------ ------- ------------ ------- Securities available-for-sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. 53,080,155 10.1 6,603,794 1.4 Obligations of states and political subdivisions ... 77,746,658 14.8 79,782,459 17.5 Mortgage-backed securities ............... 24,993,733 4.8 43,416,386 9.5 Debt securities issued by foreign governments ...... 6,481,973 1.2 6,480,421 1.4 Public utilities ........... 59,510,559 11.4 16,540,299 3.6 Corporate securities ....... 189,923,283 36.2 136,626,121 29.9 Total fixed maturity ------------ ------- ------------ ------- securities ............. 411,736,361 78.5 289,449,480 63.3 ------------ ------- ------------ ------- Equity securities: Common stocks .............. 27,689,811 5.3 26,748,905 5.9 Non-redeemable preferred stocks ................... 996,510 0.2 1,994,010 0.4 ------------ ------- ------------ ------- Total equity securities .. 28,686,321 5.5 28,742,915 6.3 ------------ ------- ------------ ------- Total securities available-for-sale ..... 440,422,682 84.0 318,192,395 69.6 ------------ ------- ------------ ------- Short-term investments ......... 17,724,458 3.4 23,388,027 5.1 ------------ ------- ------------ ------- Total investments ........ $524,225,047 100.0% $457,292,015 100.0% ============ ======= ============ ======= 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, 2001. Securities Securities held-to-maturity available-for-sale (at amortized cost) (at fair value) --------------------- --------------------- Amount Percent Amount Percent Rating(1) ------------ ------- ------------ ------- AAA ..................... $ 66,077,907 100.0% $129,630,035 31.0% AA ...................... - - 94,485,422 22.6 A ....................... - - 157,808,230 37.7 BAA ..................... - - 33,521,121 8.0 BA ...................... - - 1,805,377 .4 CAA ..................... - - 1,400,000 .3 ------------ ------- ------------ ------- Total fixed maturities $ 66,077,907 100.0% $418,650,185 100.0% ============ ======= ============ ======= (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, 2001, 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 ................... $ - $ - Due after one year through five years ..... 39,962,077 44,168,660 Due after five years through ten years .... 11,489,373 12,098,320 Due after ten years ....................... 5,992,032 6,115,170 Mortgage-backed securities ................ 8,634,425 9,082,738 ------------ ------------ Totals .................................. $ 66,077,907 $ 71,464,888 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 39,266,534 $ 39,333,099 Due after one year through five years ..... 16,524,878 17,064,621 Due after five years through ten years .... 104,477,883 108,344,057 Due after ten years ....................... 226,473,331 227,679,715 Mortgage-backed securities ................ 24,993,735 26,228,693 ------------ ------------ Totals .................................. $411,736,361 $418,650,185 ============ ============ The mortgage-backed securities shown in the above table include $32,181,060 of securities issued by government corporations and agencies and $1,447,100 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, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Average invested assets (1) ........ $490,758,529 $448,437,675 $432,606,548 Investment income (2) .............. $ 30,969,630 $ 29,006,316 $ 25,760,561 Average yield ...................... 6.31% 6.47% 5.96% Realized investment gains (3) ...... $ 800,582 $ 1,557,870 $ 276,673 (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 amounts for 2000 and 1999 reflect realized gains of $531,352 and $1,589,953, respectively, resulting from the sale of tax-exempt fixed maturity securities. The proceeds from the sale 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. EMPLOYEES - --------- EMC Insurance Group Inc. and its subsidiaries have no employees. The Company's business activities are conducted by the 2,128 employees of Employers Mutual. EMC Insurance Group Inc., EMC Reinsurance Company and Underwriters, LLC are charged their proportionate share of salary and employee benefit costs based on time allocations. Costs not allocated to these companies are charged to the participants in the pooling agreement. 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 state of domicile, 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. In 1998, the National Association of Insurance Commissioners (NAIC) adopted a comprehensive Codification of Statutory Accounting Principles (Codification) to replace the Accounting Practices and Procedures Manual as the NAIC's primary guidance on statutory accounting. Codification is intended to provide a consistent and comprehensive basis of statutory accounting for all insurance companies and became effective in most states, including the states of domicile of the Company's insurance subsidiaries, on January 1, 2001. The adoption of Codification resulted in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory financial statements. One of the more significant changes was the recording of deferred income taxes. As a result of the adoption of Codification, the statutory surplus of the Company's insurance subsidiaries increased by approximately $9,110,000 on January 1, 2001. 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. North Dakota imposes similar restrictions on the payment of dividends and distributions. At December 31, 2001, $12,647,639 was available for distribution in 2002 to the Company without prior approval. See note 6 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. The 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, 2001, 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 $382,000 and $283,000 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, 2001, which is included as Exhibit 13(d) to this Form 10-K, is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. - ------- ------------------------ The "Selected Financial Data" section from the Company's Annual Report to Stockholders for the year ended December 31, 2001, 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, 2001, 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, 2001, 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, 2001, 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. ------------------------------------ On October 18, 2000, the Board of Directors of EMC Insurance Group Inc. (the "Company") approved the dismissal of KPMG LLP (KPMG) as the Company's independent auditors. This dismissal was recommended by the Audit Committee of the Board of Directors and was effective upon issuance of KPMG's reports on the consolidated financial statements of the Company and Subsidiaries for the year ended December 31, 2000. The audit reports of KPMG on the consolidated financial statements of the Company and Subsidiaries for the years ended December 31, 2000 and 1999 did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. During the audits of the years ended December 31, 2000 and 1999 and the interim periods preceding their dismissal, there were no disagreements with KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. The Company requested that KPMG furnish it with a letter addressed to the Securities and Exchange Commission (SEC) stating whether or not KPMG agrees with the above statements. A copy of KPMG's letter to the SEC dated March 23, 2001 is filed as Exhibit 16 to this Form 10-K. The Board of Directors of EMC Insurance Group Inc. approved the engagement of Ernst & Young LLP as the Company's new independent auditors effective January 1, 2001. 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 21, 2002, 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 48 President and Chief Executive Officer of the Company and of Employers Mutual since 1992. Treasurer of Employers Mutual from 1996 until 2000 and the Company from 1996 until February 2001. He was President and Chief Operating Officer of the Company and Employers Mutual from 1991 to 1992 and was Executive Vice President of the Company and Employers Mutual from 1989 to 1991. He has been employed by Employers Mutual since 1985. William A. Murray 55 Executive Vice President and Chief Operating Officer of the Company and Employers Mutual since 2001. He was Resident Vice President and Branch Manager of Employers Mutual from 1992 until 2001. He has been employed by Employers Mutual since 1985. Ronald W. Jean 52 Executive Vice President for Corporate Development of the Company and Employers Mutual since 2000. He was Senior Vice President - Actuary of the Company and Employers Mutual from 1997 until 2000. He was Vice President - Actuary of the Company and Employers Mutual from 1985 until 1997. He has been employed by Employers Mutual since 1979. John D. Isenhart 64 Senior Vice President of the Company since 1997 and of Employers Mutual since 1992. He has been employed by Employers Mutual since 1963. Raymond W. Davis 56 Senior Vice President - Investments of the Company and Employers Mutual since 1998. Treasurer of the Company since 2001 and of Employers Mutual since 2000. He was Vice President - Investments of the Company and of Employers Mutual from 1985 until 1998. He has been employed by Employers Mutual since 1979. NAME AGE POSITION Donald D. Klemme 56 Senior Vice President - Administration and Secretary of the Company since 1998. Senior Vice President - Administration of Employers Mutual since 1998. He was Vice President - Administration and Secretary of the Company from 1996 until 1998 and was Vice President - Director of Internal Audit prior to that. He has been employed by Employers Mutual since 1972. David O. Narigon 49 Senior Vice President - Claims of the Company and of Employers Mutual since 1998. He was Vice President - Claims of the Company from 1988 until 1998. He has been employed by Employers Mutual since 1983. Mark E. Reese 44 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. Section 16(a) Beneficial Ownership Reporting Compliance Dr. John H. Kelley, a director of Employers Mutual, was designated as a Section 16 reporting person in 1991. In June of 1992, the transfer agent was directed to distribute 30 shares from his account and a Form 4 was filed to reflect this. Due to an error, this transaction never took place and his direct holdings have been understated since that date. This was corrected with a late report filed in February 2002. For the period from January 1997 to January 2002, Dr. Kelley also held an indirect ownership interest in 5,233 shares that participated in the Company's Amended and Restated Dividend Reinvestment and Common Stock Purchase Plan and were inadvertently not reported on Form 4. As a result, twenty dividend reinvestment purchase transactions were not reported. In February 2002, Dr. Kelley filed a report reflecting the purchase of 1,497 shares and his current indirect ownership of 6,730 shares. 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 21, 2002, 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 and Directors" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 21, 2002, 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 21, 2002, 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. 1. Financial Statements Page ------ Report of Ernst & Young LLP, Independent Auditor ............ 15* Report of KPMG LLP, Independent Auditor ..................... 16* Consolidated Balance Sheets, December 31, 2001 and 2000 ..... 17* Consolidated Statements of Income for the Years ended December 31, 2001, 2000 and 1999 ......................... 18* Consolidated Statements of Comprehensive Income for the Years ended December 31, 2001, 2000 and 1999 ............. 18* Consolidated Statements of Stockholders' Equity for the Years ended December 31, 2001, 2000 and 1999 ............. 19* Consolidated Statements of Cash Flows for the Years ended December 31, 2001, 2000 and 1999 ......................... 20* Notes to Consolidated Financial Statements .................. 22-41* * Refers to the respective page of the financial information insert of EMC Insurance Group Inc.'s 2001 Annual Report to Stockholders. The Consolidated Financial Statements and Independent Auditors' Reports 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. 2. Schedules Form 10-K Page ------ Report of Ernst & Young LLP, Independent Auditors, On Schedules .............................................. 34 Report of KPMG LLP, Independent Auditors, On Schedules ...... 35 Schedule I - Summary of Investments ....................... 36 Schedule II - Condensed Financial Information of Registrant 37 Schedule III - Supplementary Insurance Information .......... 40 Schedule IV - Reinsurance .................................. 44 Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations ..... 42 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. 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. Exhibit 10(m). EMCC Option It! Deferred Bonus Compensation Plan. Exhibit 10(n). EMCC Board of Directors Option It! Deferred Compensation Plan. Exhibit 10(o). Employers Mutual Casualty Company Excess Deferral 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) By-Laws of the Company, as amended. 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, 2000.) (b) 1999 Senior Executive Compensation Bonus Program. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1999.) (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, 2000.) (m) EMCC Option It! Deferred Bonus Compensation Plan. (n) EMCC Board of Directors Option It! Deferred Compensation Plan. (o) Employers Mutual Casualty Company Excess Deferral Plan. 13. Annual Report to Security Holders. (a) Selected Financial Data from the Company's 2001 Annual Report to Stockholders. (b) Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's 2001 Annual Report to Stockholders. (c) Consolidated Financial Statements from the Company's 2001 Annual Report to Stockholders. (d) Stockholder Information from the Company's 2001 Annual Report to Stockholders. 16. Letter from KPMG LLP to Securities and Exchange Commission. 21. Subsidiaries of the Registrant. 23. Consent of Experts and Counsel. (a) Consent of Ernst & Young 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). (b) 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, 2002. EMC INSURANCE GROUP INC. /s/ Bruce G. Kelley ------------------------- Bruce G. Kelley President 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, 2002. /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 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS, ON SCHEDULES We have audited the consolidated financial statements of EMC Insurance Group Inc. and subsidiaries as of December 31, 2001, and for the year then ended, and have issued our report thereon dated February 26, 2002 (included elsewhere in this Annual Report on Form 10-K). Our audits also included the financial statement schedules listed in Item 14.(a)2. of this Annual Report on Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. The financial statement schedules as of December 31, 2000 and for each of two years in the period ended December 31, 2000, were audited by other auditors whose report dated February 27, 2001, expressed an opinion that such financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, presented fairly, in all material respects, the information set forth therein. In our opinion, the 2001 financial statement schedules referred to above, when considered in relation to the 2001 basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP February 26, 2002 Des Moines, Iowa EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule I - Summary of Investments - Other Than Investments in Related Parties December 31, 2001 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 .............. $ 57,443,480 $ 62,382,150 $ 57,443,480 Mortgage-backed securities ..... 8,634,427 9,082,738 8,634,427 Total fixed maturity ------------ ------------ ------------ securities ............. 66,077,907 71,464,888 66,077,907 ------------ ------------ ------------ Securities available-for-sale: Fixed maturities: United States Government and government agencies and authorities .............. 53,080,155 53,171,059 53,171,059 States, municipalities and political subdivisions ....... 77,746,658 79,765,300 79,765,300 Mortgage-backed securities ..... 24,993,733 26,228,693 26,228,693 Debt securities issued by foreign governments .......... 6,481,973 7,144,865 7,144,865 Public utilities ............... 59,510,559 58,905,987 58,905,987 Corporate securities ........... 189,923,283 193,434,281 193,434,281 Total fixed maturity ------------ ------------ ------------ securities ............. 411,736,361 418,650,185 418,650,185 ------------ ------------ ------------ Equity securities: Common stocks Public utilities ............. 585,337 698,077 698,077 Banks, trusts and insurance companies .................. 2,665,914 3,530,354 3,530,354 Industrial, miscellaneous and all other .................. 24,438,560 28,159,271 28,159,271 Non-redeemable preferred stocks ..................... 996,510 935,065 935,065 ------------ ------------ ------------ Total equity securities .. 28,686,321 33,322,767 33,322,767 ------------ ------------ ------------ Short-term investments ............. 17,724,458 17,724,458 17,724,458 ------------ ------------ ------------ Total investments ...... $524,225,047 $541,162,298 $535,775,317 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule II - Condensed Financial Information of Registrant Condensed Balance Sheets December 31, -------------------------- 2001 2000 ASSETS ------------ ------------ - ------ Investment in common stock of subsidiaries (equity method) .................. $137,738,931 $144,797,218 Fixed maturity investments: Securities available-for-sale, at market value 1,556,475 1,530,000 Short-term investments .......................... 988,555 2,157,665 Cash ............................................ 227,541 27,383 Accrued investment income ....................... 41,333 41,333 Income taxes recoverable ........................ 3,259 6,000 Accounts receivable ............................. - 216 Deferred income taxes ........................... 103,490 6,640 ------------ ------------ Total assets ............................... $140,659,584 $148,566,455 ============ ============ LIABILITIES - ----------- Accounts payable ................................ $ 163,416 $ 142,103 Indebtedness to related party ................... 38,545 31,036 ------------ ------------ Total liabilities .......................... 201,961 173,139 ------------ ------------ STOCKHOLDERS' EQUITY - -------------------- Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,329,987 shares in 2001 and 11,294,220 shares in 2000 ......... 11,329,987 11,294,220 Additional paid-in capital ...................... 66,013,203 65,546,963 Accumulated other comprehensive income .......... 7,507,672 7,051,920 Retained earnings ............................... 55,606,761 64,500,213 ------------ ------------ Total stockholders' equity ................. 140,457,623 148,393,316 ------------ ------------ Total liabilities and stockholders' equity $140,659,584 $148,566,455 ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule II - Condensed Financial Information of Registrant, Continued Condensed Statements of Income Years ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Equity in undistributed losses of subsidiaries ..................... $(7,497,130) $(3,995,078) $(7,577,404) Dividends received from subsidiaries .. 5,525,096 6,375,104 6,800,055 Investment income ..................... 194,326 345,597 364,042 Realized investment gains ............. - 536 - Other income .......................... - - 52 ----------- ----------- ----------- (1,777,708) 2,726,159 (413,255) Operating expenses .................... 438,687 401,527 390,894 ----------- ----------- ----------- (Loss) income before income tax benefit .......................... (2,216,395) 2,324,632 (804,149) Income tax benefit .................... (110,263) (4,399) (164) ----------- ----------- ----------- Net (loss) income ....... $(2,106,132) $ 2,329,031 $ (803,985) =========== =========== =========== Condensed Statements of Comprehensive Income Years ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Net (loss) income .................. $ (2,106,132) $ 2,329,031 $ (803,985) ------------ ------------ ------------ Other Comprehensive Income: Unrealized holding gains (losses) arising during the period, net of deferred income tax expense (benefit) ...................... 962,453 11,708,349 (11,527,264) Reclassification adjustment for gains included in net (loss) income, net of income tax expense ........................ (506,701) (1,031,166) (177,370) ------------ ------------ ------------ Other comprehensive income (loss) ..................... 455,752 10,677,183 (11,704,634) ------------ ------------ ------------ Total comprehensive (loss) income ..................... $ (1,650,380) $ 13,006,214 $(12,508,619) ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule II - Condensed Financial Information of Registrant, Continued Condensed Statements of Cash Flows Years ended December 31, ------------------------------------- 2001 2000 1999 Net cash provided by ----------- ----------- ----------- operating activities ................ $ 5,316,361 $ 6,371,690 $ 6,740,085 Cash flows from investing activities: Disposals of fixed maturity securities held-to-maturity ....... - 2,000,000 2,000,000 Purchases of fixed maturity securities available-for-sale ..... - - (1,500,000) Net sales (purchases) of short-term investments ...................... 1,169,110 (1,820,140) 2,215,419 ----------- ----------- ----------- Net cash provided by investing activities ........... 1,169,110 179,860 2,715,419 ----------- ----------- ----------- Cash flows from financing activities: Issuance of common stock ........... 502,007 242,265 278,794 Dividends paid to stockholders ..... (6,787,320) (6,771,440) (6,793,061) Repurchase of common stock ......... - - (2,998,677) ----------- ----------- ----------- Net cash used in financing activities ..................... (6,285,313) (6,529,175) (9,512,944) ----------- ----------- ----------- Net increase (decrease) in cash ....... 200,158 22,375 (57,440) Cash at beginning of year ............. 27,383 5,008 62,448 ----------- ----------- ----------- Cash at end of year ................... $ 227,541 $ 27,383 $ 5,008 =========== =========== =========== Income taxes (received) paid .......... $ (6,588) $ 189 $ 31,952 Interest (received) paid .............. $ (123) $ - $ 285 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule III - Supplementary Insurance Information For Years Ended December 31, 2001, 2000 and 1999 Deferred Loss and policy settlement acquisition expense Unearned Segment costs reserves premiums ------- ----------- ------------ ----------- Year ended December 31, 2001: Property and casualty insurance $18,536,512 $221,986,108 $86,532,102 Reinsurance ................... 2,827,016 92,532,480 12,850,074 Parent company ................ - - - ----------- ------------ ----------- Consolidated ............. $21,363,528 $314,518,588 $99,382,176 =========== ============ =========== Year ended December 31, 2000: Property and casualty insurance $13,777,831 $209,365,347 $65,228,769 Reinsurance ................... 1,858,922 77,123,681 8,449,645 Parent company ................ - - - ----------- ------------ ----------- Consolidated ............. $15,636,753 $286,489,028 $73,678,414 =========== ============ =========== 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 =========== ============ =========== Losses and Net settlement Premium investment expenses Segment revenue income incurred ------- ------------ ----------- ------------ Year ended December 31, 2001: Property and casualty insurance $203,392,845 $22,457,799 $168,344,370 Reinsurance ................... 61,887,013 8,317,505 53,574,380 Parent company ................ - 194,326 - ------------ ----------- ------------ Consolidated ............. $265,279,858 $30,969,630 $221,918,750 ============ =========== ============ Year ended December 31, 2000: Property and casualty insurance $184,985,620 $20,787,679 $149,518,346 Reinsurance ................... 46,472,822 7,873,040 40,003,328 Parent company ................ - 345,597 - ------------ ----------- ------------ Consolidated ............. $231,458,442 $29,006,316 $189,521,674 ============ =========== ============ 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 ============ =========== ============ Amortization of deferred policy Other acquisition underwriting Premiums Segment costs expenses written (1) ------- ------------ ------------ ------------ Year ended December 31, 2001: Property and casualty insurance $ 42,062,510 $ 17,990,128 $224,412,085 Reinsurance ................... 13,624,505 4,749,785 66,287,442 Parent company ................ - - - ------------ ------------ ------------ Consolidated ............. $ 55,687,015 $ 22,739,913 $290,699,527 ============ ============ ============ Year ended December 31, 2000: Property and casualty insurance $ 40,675,773 $ 15,439,286 $190,104,541 Reinsurance ................... 10,612,706 3,040,206 47,530,111 Parent company ................ - - - ------------ ------------ ------------ Consolidated ............. $ 51,288,479 $ 18,479,492 $237,634,652 ============ ============ ============ 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 ============ ============ ============ (1) Written premiums for 2001 include $13,884,423 of additional premiums from a change in the recording of installment based policies. See note 12 of Notes to Consolidated Financial Statements which is included as Exhibit 13(c) of this Form 10-K. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule IV - Reinsurance For years ended December 31, 2001, 2000 and 1999
Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------------ ------------ ------------ ------------ ---------- Year ended December 31, 2001: Consolidated earned premiums ........... $255,764,274 $266,623,369 $276,138,953 $265,279,858 104.1% ============ ============ ============ ============ ========== Year ended December 31, 2000: Consolidated earned premiums ........... $245,078,165 $252,761,452 $239,141,729 $231,458,442 103.3% ============ ============ ============ ============ ========== Year ended December 31, 1999: Consolidated earned premiums ........... $223,593,165 $230,785,034 $218,290,010 $211,098,141 103.4% ============ ============ ============ ============ ==========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule VI - Supplemental Insurance Information Concerning Property-Casualty Insurance Operations For Years Ended December 31, 2001, 2000 and 1999
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, 2001: $21,363,528 $314,518,588 $ -0- $99,382,176 $265,279,858 $30,775,304 =========== ============ ======== =========== ============ =========== Year ended December 31, 2000: $15,636,753 $286,489,028 $ -0- $73,678,414 $231,458,442 $28,660,719 =========== ============ ======== =========== ============ =========== Year ended December 31, 1999: $13,619,192 $266,514,024 $ -0- $64,991,129 $211,098,141 $25,396,519 =========== ============ ======== =========== ============ ===========
Losses and settlement expenses Amortization incurred related to of deferred Paid -------------------------- policy losses and Consolidated property- Current Prior acquisition settlement Premiums casualty entities Year Years costs expenses Written(1) - ---------------------- ------------ ----------- ------------ ------------ ------------ Year ended December 31, 2001: $216,752,003 $ 5,166,747 $ 55,687,015 $194,512,990 $290,699,527 ============ =========== ============ ============ ============ Year ended December 31, 2000: $191,425,036 ($ 1,903,362) $ 51,288,479 $170,510,652 $237,634,652 ============ =========== ============ ============ ============ Year ended December 31, 1999: $182,609,687 ($ 5,733,439) $ 48,056,918 $150,669,762 $214,562,515 ============ =========== ============ ============ ============
(1) Written premiums for 2001 include $13,884,423 of additional premiums from a change in the recording of installment based policies. See note 12 of Notes to Consolidated Financial Statements which is included as Exhibit 13(c) of this Form 10-K. EMC Insurance Group Inc. and Subsidiaries Index to Exhibits Exhibit number Item Page number ------ ---- ----------- 3(b) By-Laws of the Company. 44-55 10(m) EMCC Option It! Deferred Bonus Compensation Plan. 56-62 10(n) EMCC Board of Directors Option It! Deferred Compensation Plan. 63-70 10(o) Employers Mutual Casualty Company Excess Deferral Plan. 71-87 13(a) Selected Financial Data. 88 13(b) Management's Discussion and Analysis of Financial Condition and Results of Operations. 89-103 13(c) Consolidated Financial Statements and Supplementary Data. 104-139 13(d) Stockholder Information. 140 16 Letter from KPMG LLP to Securities and Exchange Commission. 141 21 Subsidiaries of the Registrant. 142 23(a) Consent of Ernst & Young LLP with respect to Forms S-8 and Form S-3. 143 23(b) Consent of KPMG LLP with respect to Forms S-8 and Form S-3. 144 24 Power of Attorney. 145 EX-3 3 exh3b.txt BY-LAWS EXHIBIT 3(b) ----------- BY-LAWS OF EMC INSURANCE GROUP INC. ARTICLE I. OFFICES The principal office of the corporation in the State of Iowa shall be located in the City of Des Moines, County of Polk. The corporation may have such other offices, either within or without the State of Iowa, as the board of directors may designate or as the business of the corporation may require from time to time. The registered office of the corporation required by The Iowa Business Corporation Act to be maintained in the State of Iowa may be, but need not be, identical with the principal office in the State of Iowa, and the address of the registered office may be changed from time to time by the board of directors. ARTICLE II. SHAREHOLDERS Section 1. Annual Meeting. The regular annual meeting of the shareholders shall be held at 9:00 o'clock A.M. on the third Wednesday in the month of May in each year, or at such other time on said day or on such other day within such month as shall be fixed by the chief executive officer or the Board of Directors, for the purpose of electing directors and for the transaction of such other business as may come before the meeting. If the day fixed for the annual meeting shall be a legal holiday in the State of Iowa, such meeting shall be held on the next succeeding business day. If the election of directors shall not be held on the day designated herein for any annual meeting of the shareholders, or at any adjournment thereof, the board of directors shall cause the election to be held at a special meeting of the shareholders as soon thereafter as conveniently may be. Section 2. Special Meetings. Special meetings of the shareholders, for any purpose or purposes, unless otherwise prescribed by statute, may be called by the chief executive officer or by the board of directors, and shall be called by the chief executive officer at the request of the holders of not less than one-tenth of all the outstanding shares of the corporation entitled to vote at the meeting. Section 3. Place of Meeting. The chief executive officer or the board of directors may designate any place, either within or without the State of Iowa as the place of meeting for any annual meeting or for any special meeting. A waiver of notice signed by all shareholders entitled to vote at a meeting may designate any place, either within or without the State of Iowa, as the place for the holding of such meeting. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the registered office of the corporation in the State of Iowa. Section 4. Notice of Meeting. Written or printed notice stating the place, day and hour of the meeting and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall, unless otherwise prescribed by statute, be delivered not less than ten nor more than sixty days before the date of the meeting, either personally or by mail, by or at the direction of the chief executive officer, the secretary, or the officer or persons calling the meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the stock transfer books of the corporation, with postage thereon prepaid. Section 5. Closing of Transfer Books or Fixing of Records Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the board of directors of the corporation may provide that the stock transfer books shall be closed for a stated period but not to exceed, in any case, sixty days. If the stock transfer books shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such books shall be closed for at least ten days immediately preceding such meeting. In lieu of closing the stock transfer books, the board of directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than sixty days, and, in case of a meeting of shareholders, not less than ten days prior to the date on which the particular action, requiring such determination of shareholders, is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the board of directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at the meeting of shareholders has been made as provided in this section, such determination shall apply to any adjournment thereof, except where the determination has been made through closing of the stock transfer books and the stated period of closing has expired. Section 6. Voting Record. The officer or agent having charge of the stock transfer books for shares of the corporation shall make, at least ten days before each meeting of shareholders, a complete list of the shareholders entitled to vote at such meeting, or adjournment thereof, arranged in alphabetical order, with the address of and the number of shares held by each, which list, for a period of ten days prior to such meeting, shall be kept on file at the registered office of the corporation and shall be subject to inspection by any shareholder at any time during usual business hours. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting. The original stock transfer book shall be prima facie evidence as to who are the shareholders entitled to examine such list or transfer books or to vote at any meeting of shareholders. Section 7. Quorum. A majority of the outstanding shares of the corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. If less than a majority of the outstanding shares are represented at a meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. The shareholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum. Section 8. Proxies. At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or his duly authorized attorney in fact. Such proxy shall be filed with the Secretary of the corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. Section 9. Voting of Shares. Each outstanding share entitled to vote shall be entitled to one vote upon such matter submitted to a vote at a meeting of shareholders, and the vote of a majority of the shares voted at a meeting of shareholders, duly held at which a quorum is present, shall be sufficient to take or authorize the action upon any matter which may properly come before the meeting except as otherwise provided by law or by these By- Laws. There shall be no right of cumulative voting. Section 10. Voting of Shares by Certain Holders. Shares standing in the name of another corporation may be voted by such officer, agent or proxy as the by-laws of such corporation may prescribe, or, in the absence of such provision, as the board of directors of such other corporation may determine. Shares held by an administrator, executor, guardian or conservator may be voted by him either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a trustee may be voted by him either in person or by proxy, but no trustee shall be entitled to vote shares held by him without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority so to do be contained in an appropriate order of the court by which such receiver was appointed. A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. Neither treasury shares of its own stock held by the corporation, nor shares held by another corporation if a majority of the shares entitled to vote for the election of directors of such other corporation are held by the corporation, shall be voted at any meeting or counted in determining the total number of outstanding shares at any given time for the purposes of any meeting. Section 11. Informal Action by Shareholders. Any action required or permitted to be taken at a meeting of the shareholders, may be taken without a meeting if a consent in writing, setting forth the action so taken shall be signed by all the shareholders entitled to vote with respect to the subject matter thereof. Section 12. Preemptive Rights. The shareholders shall have no preemptive right to acquire unissued or treasury shares of the corporation, or securities of the corporation convertible into or carrying a right to subscribe to or acquire shares. ARTICLE III. BOARD OF DIRECTORS Section 1. Powers and Duties. Except as may be otherwise provided by the Iowa Business Corporation Act, all corporate powers shall be exercised by or under authority of, and the business and affairs of the corporation shall be managed under the direction of the board of directors. A. Director shall perform his duties as a director, including his duties as a member of any committee of the board upon which he may serve, in good faith, in a manner he believes to be in the best interests of the corporation, and with such care as an ordinarily prudent person in a like position would use under similar circumstances. In performing his duties, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by: (a) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented, (b) counsel, public accountants or other persons as to matters which the director reasonable believes to be within such person's professional or expert competence, or (c) a committee of the board upon which he does not serve, duly designated in accordance with a provision of the articles of incorporation or by-laws, as to matters within its designated authority, which committee the director reasonable believes to merit confidence, but he shall not be considered to be acting in good faith if he has knowledge concerning the matter in question that would cause such reliance to be unwarranted. A person who so performs his duties, shall have no liability by reason of being or having been a director of the corporation. Section 2. Number, Tenure and Qualifications. The number of directors of the corporation shall be fixed at seven. Each director shall hold office until the next annual meeting of shareholders and until his successor shall have been elected and qualified. Directors need not be residents of the State of Iowa or shareholders of the corporation, but shall be subject to other qualifications, if any, as to age or otherwise as these by-laws may provide. Section 3. Regular Meetings. A regular meeting of the board of directors shall be held without other notice than this by-law immediately after, and at the same place as, the annual meeting of shareholders. Such additional regular meetings, if any, of the board of directors shall be held on call of the chief executive officer or the executive committee at such time and place within or without the State of Iowa and upon such notice as he or it shall determine. Section 4. Special Meetings. Special meetings of the board of directors may be called by the chief executive officer or by the Executive Committee and shall be called by him or it at the request of any four of the directors, at such locality within or without the State of Iowa, and on such time and date as he or it shall determine. Five (5) days written notice thereof shall be given, by regular mail, specifying the date, time, place and purpose thereof, such five day period to begin on date of mailing such notice. Such notice shall not be necessary when all of the directors have executed written waivers consenting to the meeting and when a quorum of directors is present. Attendance of a director at a meeting shall constitute a waiver of notice of such meeting. Section 5. Quorum. A majority of the directors shall constitute a quorum for the transaction of business at any meeting of the board of directors, but if less than such majority is present at a meeting, a majority of the directors present may adjourn the meeting from time to time without further notice. Section 6. Manner of Acting. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors. Section 7. Action Without a Meeting. Any action required or permitted to be taken by the board of directors at a meeting may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all the directors. Section 8. Vacancies. Any vacancy occurring in the board of directors may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the board of directors. A director elected to fill a vacancy shall be elected for the unexpired term of his predecessor in office. Any directorship to be filled by reason of an increase in the number of directors may be filled by the board of directors for a term of office continuing only until the next election of directors by the shareholders. Section 9. Compensation. Compensation of directors shall be fixed by the shareholders of the corporation, or by its board of directors. The basis for such compensation may be (1) a fixed amount for attendance at each directors' meeting, in which case, no compensation shall be allowed or paid at any given meeting to any director not in attendance, or (2) a stated annual fee, or (3) a combination of both (1) and (2). In no case shall a director receive such fee if such director draws a salary from the corporation, or any affiliated company, as an officer or employee. A director attending any meeting of the board of directors held without the city within which said director resides shall, in addition to such fixed compensation, if any, be paid an amount, to be approved by the chief executive officer, sufficient to reimburse him for his expenses in attending such meeting. Notwithstanding the foregoing, directors shall also be eligible to participate in certain benefit plans which may be provided by the corporation, including but not limited to stock option and retirement plans, if such benefit plans have been approved by the shareholders of the corporation or by its board of directors, and if the directors are eligible pursuant to the terms of such benefit plan(s). Section 10. Presumption of Assent. A director of the corporation who is present at a meeting of the board of directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered or certified mail to the secretary of the corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor, of such action. Section 11. Age Eligibility of Directors. No person shall be nominated for or elected a director of the Company after he has attained the age of seventy-two. However, this section shall not apply to persons serving as directors of the Company on November 1, 1981. Section 12. Removal. At a meeting called expressly for that purpose, directors may be removed in the manner provided in this section. Any director or the entire board may be removed, with or without cause, by a vote of the holders of a majority of the shares then entitled to vote at an election of directors. Section 13. Telephone Meetings. Members of the board of directors may participate in a meeting of the board or such committee by conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to the provisions of this section shall constitute presence in person at such meeting. ARTICLE IV. OFFICERS Section 1. Executive Officers. The executive officers of the corporation shall be a chairman, a president, a chief executive officer, a chief operating officer, one or more executive vice presidents, one or more senior vice presidents, one or more vice presidents, a secretary, a treasurer, and a general counsel, each of whom shall be elected by the board of directors. Any executive office, except that of president, one vice president, treasurer and secretary may be left unfilled, as the board of directors may, from time to time, determine. Any two or more offices may be held by the same person except the offices of president and secretary. Other Officers. The board of directors may elect or appoint, a vice chairman, one or more resident vice presidents, a controller, and any assistant officers it may deem necessary. Section 2. Election and Term of Office. The executive officers of the corporation shall be elected annually by the board of directors at its regular annual meeting. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as conveniently may be. Any unfilled executive office may, from time to time, be filled at any meeting of the board of directors. Other officers may be elected by the board of directors at such annual meeting or from time to time. Each officer shall hold office until his successor shall have been duly elected and shall have qualified, or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. Section 3. Removal. Any officer or agent may be removed, with or without cause, by the board of directors whenever in its judgment, the best interests of the corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of an officer or agent shall not of itself create contract rights. Section 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the board of directors for the unexpired portion of the term. Section 5. Chairman. The Chairman of the Board shall be the Chief Executive officer of the corporation. Section 6. Vice Chairman. The Vice Chairman of the board of directors, if any, shall perform such duties as may, from time to time, be assigned to him by the board of directors. Section 7. President. The President, except at such times as the office of the office of Chairman of the Board of directors is not vacant, shall be the chief operating officer of the corporation. At such times as the office of chairman of the board of directors is vacant he shall be the chief executive officer. Section 8. Chief Executive Officer. The chief executive officer of the corporation, subject to the control of the board of directors, shall, in general, supervise and control all of the business and affairs of the corporation. He shall, when present, preside at all meetings of the members and the board of directors. He or she shall sign, with the secretary, an assistant secretary, or any other proper officers of the corporation thereunto authorized by the board of directors, deeds, mortgages, bonds, contracts, or other instruments which the board of directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the board of directors or by these By-laws to some other officer or agent of the corporation, or shall be required by law to be otherwise signed or executed; and in general shall perform all duties incident to the office of chief executive officer and such other duties as may be prescribed by the board of directors from time to time. Section 9. Chief Operating Officer. The chief operating officer of the corporation shall, subject to the express direction of the board of directors and the chairman, perform all duties incident to that office and as may from time to time be assigned to him by the board of directors or by the chairman. Section 10. Executive Vice Presidents. The executive vice presidents, if any, shall perform such duties as may, from time to time, be assigned to him, her or them by the board of directors or by the chief executive officer. Section 11. The Vice Presidents. The vice presidents shall act under the direction of the chief executive officer. They shall perform such other duties and have such other powers as the chief executive officer or the board of directors may from time to time prescribe. The board of directors may designate one or more executive vice presidents, and/or one or more senior vice presidents, or may otherwise specify the order of seniority of the vice presidents. The duties and powers of the chief executive officer shall, in the absence of the chief operating officer and the president, descend to the vice presidents in such specified order of seniority. Section 12. The Secretary. The secretary shall act under the direction of the chief executive officer. Subject to the direction of the chief executive officer he shall attend all meetings of the board of directors and all meetings of the shareholders and record the proceedings. He shall perform like duties for the standing and other committees when required. He shall give, or cause to be given, notice of all meetings of the shareholders and special meetings of the board of directors, and shall perform such other duties as may be prescribed by the chief executive officer or the board of directors. He shall keep in safe custody the seal of the corporation and when authorized by the chief executive officer or the board of directors, cause it to be affixed to any instrument requiring it. Section 13. The Assistant Secretaries. The assistant secretaries shall act under the direction of the chief executive officer. In the order of their seniority, unless otherwise determined by the chief executive officer or the board of directors, they shall, in the absence or disability of the secretary, perform the duties and exercise the powers of the secretary. They shall perform such other duties as the chief executive officer or the board of directors may from time to time prescribe. Section 14. The Treasurer. The treasurer shall act under the direction of the chief executive officer. Subject to his direction he shall have custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may by designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the chief executive officer or the board of directors, taking proper vouchers for such disbursements, and shall render to the chief executive officer and the board of directors, at its regular meeting, or when the board of directors so requires, an account of all his transactions as treasurer and of the financial condition of the corporation. He may affix or cause to be affixed the seal of the corporation to documents so requiring. If required by the board of directors, the treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the board of directors shall determine. The board of directors may, by resolution, delegate the duties of the treasurer to an assistant treasurer or and executive officer of the company. Section 15. The Assistant Treasurers. The assistant treasurers in the order of their seniority, unless otherwise determined by the chief executive officer or the board of directors, shall, in the absence or disability of the treasurer, perform the duties and exercise the powers of the treasurer. They shall perform such other duties and have such other powers as the chief executive officer or the board of directors may from time to time prescribe. Section 16. Salaries. The salaries of the executive officers shall be fixed from time to time by the board of directors. The salaries of other officers shall be fixed, from time to time, by the chief executive officer. No officer shall be prevented from receiving a salary by reason of the fact he or she is also a director of the corporation. ARTICLE V. COMMITTEES Section 1. Appointment. The board of directors shall, at its regular annual meeting, appoint an executive committee, and may at such meeting, or from time to time, appoint such other committees, with such name or names as it may determine. The appointment of any such committee and the delegation thereto of authority shall not relieve the board of directors, or any member thereof, of any responsibility imposed by law. Section 2. Composition. All committees shall consist of three or more directors. The chief executive officer of the corporation shall be a member and chairman of the executive committee, and may be a member of any other committee. Section 3. Authority. The executive committee, when the board of directors is not in session shall have and may exercise all of the authority of the board of directors not otherwise delegated to other committees and except to the extent, if any, that such authority shall be limited by the resolution appointing the executive committee and except also that the executive committee shall not have the authority of the board of directors in reference to amending the articles of incorporation, adopting a plan of merger or consolidation, to appoint or remove executive officers, recommending to the shareholders the sale, lease or other disposition of all or substantially all of the property and assets of the corporation otherwise than in the usual and regular course of its business, recommending to the shareholders a voluntary dissolution of the corporation or revocation thereof, or amending the by-laws of the corporation. All other committees shall, when the board of directors is not in session, perform the duties and exercise the powers delegated to it in the resolution designating and constituting the same. Section 4. Tenure and Qualifications. Each member of any committee shall hold office until the next regular annual meeting of the board of directors following his designation and until his successor is designated as a member of such committee and is elected and qualified. Section 5. Meetings. Regular meetings of any committee may be held without notice at such times and places as the committee may fix from time to time by resolution. Special meetings of any committee may be called by any member thereof, or by the chief executive officer of the corporation, upon not less than one day's notice stating the place, date and hour of the meeting, which notice may be written or oral, and if mailed shall be deemed to be delivered when deposited in the United States mail addressed to the member of such committee at his business address. Any member of the committee may waive notice of any meeting and no notice of any meeting need be given to any member thereof who attends in person. The notice of a meeting of any committee need not state the business proposed to be transacted at the meeting. Section 6. Quorum. A majority of the members of any committee shall constitute a quorum for the transaction of business at any meeting thereof and action of any committee must be authorized by the affirmative vote of a majority of the members present at a meeting at which a quorum is present. Section 7. Action without a Meeting. Any action required or permitted to be taken by any committee at a meeting may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the members of such committee. Section 8. Vacancies. Any vacancy in any committee may be filled by a resolution adopted by a majority of the full board of directors. Section 9. Resignations and Removal. Any member of any committee may be removed at any time with or without cause by resolution adopted by a majority of the full board of directors. Any member of any committee may resign from such committee at any time by giving written notice to the chief executive officer or secretary of the corporation, and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 10. Procedure. Each committee, except the executive committee, shall elect a presiding officer from its members and may fix its own rules of procedure which shall not be inconsistent with these By-Laws. It shall keep regular minutes of its proceedings and report the same to the board of directors for its information at the meeting thereof held next after the proceedings shall have been taken. Section 11. Compensation. The compensation, if any, and expense allowance, if any, to be paid to members of a committee shall be fixed by the board of directors, provided, however, no committee member shall receive compensation for his services as such if he draws a salary from the corporation, or any affiliated corporation, as an officer or employee. ARTICLE VI. TRANSFERS, FUNDS, SECURITIES AND CONTRACTS Section 1. Transfers. The chief executive officer, the treasurer, a vice president or any officer authorized by the board of directors shall have authority to transfer registered bonds or stocks; to assign or satisfy mortgages and to execute deeds or other instruments affecting real estate on behalf of the corporation, and to affix the corporate seal thereto when customary or required; and all instruments affecting real estate shall be attested by the secretary or by any assistant secretary when required by the laws of the State in which the real estate is located. In all transactions any officer of the corporation is hereby authorized to receive and receipt for all money due and payable to the corporations and to endorse checks, drafts and other orders in its name and on its behalf, and to give full discharge for the same. Section 2. Funds. The funds of the corporation shall be deposited in the name of the corporation in such depositories as the board of directors shall designate; and shall be disbursed only upon checks, drafts or other orders bearing such personal or facsimile signatures as may be authorized by resolution of the board of directors or as may be authorized by the chief executive officer or treasurer or by such other officers as the board of directors may designate. Section 3. Securities. All securities owned by the corporation shall be deposited for safe-keeping in such safety deposit vault or vaults as the board of directors may designate and approve, or the law may require, and access thereto shall be only by such officer or officers, or employee or employees, together with such additional officer or officers, or employee or employees, as may from time to time be designated by resolution of the board of directors; provided, however such securities may, if the board of directors shall deem advisable, be deposited for safe keeping and servicing in one or more legal custodianships, with one or more banks or trust companies, designated by the board of directors, under such usual regulations, restrictions and safeguards as the board of directors by resolution shall fix. Unless other provisions are made by the board of directors, the chief executive officer or the secretary is empowered to vote such securities either in person or by proxy. Section 4. Contracts. The board of directors may authorize any officer or officers, agent or agents, to enter into a contract or execute and deliver any instrument on behalf of the corporation, and such authority may be general or confined to specific instances. Section 5. Loan. No loans or borrowings shall be contracted on behalf of the corporation and no evidence of indebtedness shall be issued in its name unless authorized by resolution of the board of directors. Such authority may be general or confined to specific instances. ARTICLE VII. BY-LAWS AND OTHER POWERS IN EMERGENCY The Emergency By-Laws provided in this Article VII shall be operative during any emergency in the conduct of the business of the corporation resulting from an attack on the United States or any nuclear or atomic disaster, notwithstanding any difference provision in the preceding Articles of the By-Laws or in the Articles of Incorporation of the corporation. To the extent not inconsistent with the provisions of this Article, the By-Laws provided in the preceding Articles shall remain in effect during such emergency and upon its termination the Emergency By-Laws shall cease to be operative. During any such emergency: (a) A meeting of the board of directors may be called by an officer or director of the corporation. Notice of the time an place of the meeting shall be given by the person calling the meeting to such of the directors as it may be feasible to reach by any available means of communication. Such notice shall be given at such time in advance of the meeting as circumstances permit in the judgment of the person calling the meeting. (b) At any such meeting of the board of directors, a quorum shall consist of three (3). (c) The board of directors, either before or during any such emergency, may provide, and from time to time modify, lines of succession in the event that during such an emergency any of all officers or agents of the corporation shall for any reason be rendered incapable of discharging their duties. (d) The board of directors, either before or during any such emergency, may, effective in the emergency, change the head office or designate several alternative head offices or regional offices, or authorize the officers so to do. No officer, director or employee acting in accordance with these Emergency By-Laws shall be liable except for willful misconduct. These Emergency By-Laws shall be subject to repeal or change by further action of the board of directors or by action of the shareholders, but no such repeal or change shall modify the provisions of the next preceding paragraph with regard to action taken prior to the time of such repeal or change. Any amendment of these Emergency By-Laws may make any further or different provision that may be practical and necessary for the circumstances of the emergency. ARTICLE VIII. DIRECTOR CONFLICTS OF INTERESTS No contract or other transaction between the corporation and one or more of its directors or any other corporation, firm, association or entity in which one or more of its directors are directors or officers or are financially interested, shall be either void or voidable because of such relationship or interest or because such director or directors are present at the meeting of the board of directors or a committee thereof which authorizes, approves or ratifies the contract or transaction by a vote or consent sufficient for the purpose without counting the votes or consents of such interest directors; or (b) the fact of such relationship or interest is disclosed or known to the shareholders entitled to vote and they authorize, approve or ratify such contract or transaction by vote or written consent; or (c) the contract or transaction is fair and reasonable to the corporation. Common or interest directors may be counted in determining the presence of a quorum at a meeting of the board of directors or a committee thereof which authorizes, approves or ratifies such contract or transaction. ARTICLE IX. INDEMNIFICATION OF OFFICERS DIRECTORS, EMPLOYEE OR AGENTS The corporation shall indemnify officer, directors, employees, or agents, possessing all rights and powers with respect thereto: (a) now or hereafter permitted by Section 4A of the Iowa Business Corporation Act, or (b) otherwise permitted by law ARTICLE X. DIVIDENDS The board of directors may from time to time declare, and the corporation may pay, dividends on its outstanding shares in cash, property or its own shares, pursuant to law and subject to the Articles of Incorporation. ARTICLE XI. GENERAL PROVISIONS Section 1. Seal. The corporation shall have a seal upon which shall be inscribed its name and the state of its incorporation. Section 2. Fiscal Year. The fiscal year of the corporation shall begin on the first day of January of each year and end on the thirty-first day of December of each year. ARTICLE XII. AMENDMENTS These By-Laws may be altered, amended or repealed and new By-Laws may be adopted by the board of directors or by the shareholders at any regular or special meeting. EX-10 4 exh10m.txt DEFERRED BONUS COMPENSATION PLAN EXHIBIT 10(m) ------------ EMCC Option It! --------------- Deferred Bonus Compensation Plan -------------------------------- 1. Purpose of the Plan. This Plan was formerly known as the Deferred Bonus Compensation Plan for Employers Mutual Casualty Company and Subsidiary and Affiliated Companies effective as of November 1, 1985 (the "Prior Plan"). Pursuant to the terms of the Prior Plan, which permit its amendment at any time by the Board of Directors, this document is a restatement, in its entirety, of the Plan, generally effective January 1, 2001. This Plan shall be known as the EMCC Option It! Deferred Bonus Compensation Plan. The purpose of the Plan is to allow key employees of Employers Mutual Casualty Company ("EMCC" or "Company") to defer bonus income until retirement. This Plan will aid the Company in retaining its present management and, should circumstances require it, to attract additions to management. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" shall mean the Board, or the person or persons appointed by Board to serve under paragraph 17, below. (b) "Award Date" shall mean the effective date of the Participant's Option Agreement. (c) "Board" shall mean the Board of Directors of Employers Mutual Casualty Company. (d) "Code" shall mean the Internal Revenue Code of 1986, as amended. (e) "Company" shall mean Employers Mutual Casualty Company. (f) "Employee" shall mean any employee of the Company. (g) "Immediate Family" shall mean the Participant's spouse, a child or children, a grandchild or grandchildren, a parent, or a brother and sister. For purposes of this definition, a legally adopted child of a Participant shall be treated as a child of such individual by blood. (h) "Option" shall mean an option granted pursuant to this Plan to purchase one or more Shares. (i) "Option Agreement" means the written agreement evidencing the award of an Option under the Plan. (j) "Participant" shall mean any Employee who receives an Option under the Plan, as evidenced by an Option Agreement entered into between such Employee and the Company. (k) "Plan" shall mean the EMCC Option It! Deferred Bonus Compensation Plan, as amended from time to time. (l) "Shares" shall mean the shares of mutual funds, shares of common or preferred stock of a corporation listed or reported on a national securities exchange or quotation system, or shares of a regulated investment company, as designated and amended by the Board and referenced in Exhibit A. Shares may include stock or other equity interest or bonds in the Company or any company related to the Company if so permitted by the Board. In no way, however, may Shares include units of any money market funds or other cash equivalents. Shares subject to purchase pursuant to any Option shall also include any earnings and appreciation on such shares subsequent to the Award Date. 3. Term of Plan. The Plan shall become effective on the date it is adopted by the Board and shall continue in effect as amended from time to time until terminated pursuant to paragraph 19. 4. Shares Subject to the Plan. The aggregate number and type of Shares subject to Options will be fully described in each Option Agreement. 5. Eligibility. All Employees of the Company who are both in the group of employees determined to be part of the select group of management or highly compensated employees and are also a participant under a participating company's bonus income plan are eligible to receive options under the plan. Employees of subsidiaries or affiliated corporations shall be eligible to participate in the Plan provided that such subsidiary or affiliated corporation, by action of its Board of Directors and with the approval of the Board of Directors of the Company, agrees to adopt the provisions of the Plan for the benefit of its eligible Employees. 6. Grant of Options. The Board shall determine the number of Shares to be offered from time to time and grant Options under the Plan based on the portion of his or her bonus that he or she elects to defer. The grant of Options shall be evidenced by written Option Agreements containing such terms and provisions as are approved by the Board. The administrator of the Plan shall execute the Option Agreements on behalf of the Company upon instructions from the Board. 7. Time of Grant of Options. The date of grant of an Option under the Plan shall, for all purposes, be the date on which the Board awards the Option, as evidenced by the execution of an Option Agreement. 8. Option Price. The Option Price for each Share shall be expressed in each Option Agreement, provided, however, the Option Price shall be no lower than 25 percent of the fair market value of a Share on the date of grant of the Option. Fair market value on any day of reference shall be the closing price of the Share on such date, unless the Board, in its sole discretion shall determine otherwise in a fair and uniform manner. For this purpose, the closing price of the Share on any business day shall be (i) if the Share is listed or admitted for trading on any United States national securities exchange, the last reported sale price of the Share on such exchange, as reported in any newspaper of general circulation, (ii) if the Share is not listed or admitted for trading on any United States national securities exchange, the average of the high and low sale prices of the Share for such day reported on the NASDAQ SmallCap Market or a comparable consolidated transaction reporting system, or if no sales are reported for such day, such average for the most recent business day within five business days before such day which sales are reported, or (iii) if neither clause (i) or (ii) is applicable, the average between the lowest bid and highest asked quotations for the Share on such day as reported by the NASDAQ SmallCap Market or the National Quotation Bureau, Incorporated, if at least two securities dealers have inserted both bid and asked quotations for the Share on at least 5 of the 10 preceding business days. 9. Exercise. Except as otherwise provided in an Option Agreement, all Options granted under the Plan will be vested at grant and therefore may be exercisable immediately, unless stated otherwise by the Board. The Option may be exercised in full or in part from the date of the grant as determined by the Option Agreement. Reinvested dividends shall be attributed proportionally to the property subject to the Option awards and will be purchased when the underlying award is exercised. For example, if an original grant of an Option to purchase 500 shares (after the payment of the exercise price) generated 100 additional shares on such 500 shares from reinvested dividends, an exercise of one-fourth of the originally granted options will result in the purchase (after the payment of the exercise price) of 150 shares in order to proportionally include the resulting reinvested dividends. In addition, all Options granted under the Plan may only be exercised subject to any other terms specified in the Option Agreement and if such terms conflict with the terms of this Plan, the terms of the Option Agreement control. 10. Limitations on Option Disposition. Any Option granted under the Plan and the rights and privileges conferred therewith shall not be sold, transferred, encumbered, hypothecated or otherwise anticipated by the Participant other than by will or the laws of descent and distribution. Options shall not be subject to, in whole or in part, the debts, contracts, liabilities, or torts of the Participant, nor shall they be subject to garnishment, attachment, execution, levy or other legal or equitable process. However, a Participant may, after the consent of the Administrator has been obtained, transfer by gift any Option or part thereof to (a) a member or members of the Participant's Immediate Family and/or to a trust established for the benefit of an Immediate Family member or members, as defined in the Plan, or (b) a charitable organization described in Section 170(c) of the Internal Revenue Code of 1986, as amended from time to time, provided such transfer is irrevocable, is made without consideration, and each Option so transferred by the Participant remains subject after transfer to the provisions of the Plan. 11. Limitations on Option Exercise and Distribution. In the event that the listing, registration or qualification of an Option or Shares on any securities exchange or under any state or federal law, or the consent of approval of any governmental regulatory body, or the availability of any exemption therefrom, is necessary as a condition of, or in connection with, the exercise of an Option, then the Option shall not be exercised in whole or in part until such listing, registration, qualification, consent or approval has been effected or obtained. Notwithstanding any provision of the Plan to the contrary, the Company shall have no obligation or liability to deliver any Shares under the Plan unless such delivery would comply with all applicable laws and all applicable requirements of any securities exchange or similar entity. 12. Option Financing. Upon the exercise of any Option granted under the Plan, the Participant may instruct the Administrator to sell or deem to sell a number of Shares otherwise deliverable to the Participant and attributable to the exercise of the Option in order to pay the exercise price of the Option. The Board may, in its sole discretion, make financing available to the Participant to facilitate the exercise of the Option, subject to such terms as the Board may specify. 13. Withholding of Taxes. The Company may make such provisions and take such steps as it may deem necessary or appropriate for the withholding of any taxes which is required by any law or regulation of any governmental authority, whether federal, state or local, domestic or foreign, to withhold in connection with any Option including, but not limited to, the withholding of the issuance of all or any portion of such Shares until the Participant reimburses the Company for the amount the Company is required to withhold with respect to such taxes, canceling any portion of such issuance in an amount sufficient to reimburse itself for the amount it is required to so withhold, or taking any other action reasonably required to satisfy the Company's withholding obligation. 14. Modification of Option or Plan. At any time and from time to time the Board may execute an instrument providing for the modification, extension, or renewal of any outstanding Option and or the Plan. 15. Substitution of Option. If a Participant has been granted an Option to purchase Shares under an Option Agreement, then except as limited by the terms of the Option Agreement, the Participant may direct that the Option be converted into an Option to purchase other Shares as permitted by the Option Agreement. Such substitution shall only be allowed to the extent that, immediately following the substitution, the difference between the fair market value of the Shares subject to the substituted Option and the exercise price of the substituted Option is no greater than the difference which existed immediately prior to the substitution between the fair market value of the Shares subject to the original Option and the exercise price of the original Option. 16. Prior Plan Participants. Any Participant in the Prior Plan who has begun to receive benefits as of the effective date of this Plan shall continue to receive such benefits at such time and in such amounts as determined under the terms and conditions set forth in the Prior Plan. Any Participant in the Prior Plan who has not begun to receive benefits as of the effective date of this Plan shall receive an Option where the difference between the fair market value of the Shares subject to the Option and the exercise price of the Option is equal to the fair market value of the Deferred Compensation Units and interest credited thereon under the terms of the prior plan. 17. Administration of the Plan. The Board, in its sole discretion, is authorized to select the Employees who will receive Options and to determine the number of Options and the number of Shares under each Option. The Board, or the person or persons appointed by the Board to serve as Administrator, shall be the Administrator of the Plan. The Administrator, in its sole discretion, is authorized to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to the Plan and to the Options granted under the Plan, to determine the form and content of Options to be issued under the Plan, and to make such other determinations and exercise such other power and authority as may be necessary or advisable for the administration of the Plan. No fee or compensation shall be paid to any person for services as the Administrator (but this does not prevent the payment of salary otherwise payable to an employee of EMCC for other services as an employee of the Company). The Administrator in its sole discretion may delegate and pay compensation for services rendered relating to the ministerial duties of plan administration including, but not limited to, selection of investments available under the Plan. Any determination made by the Administrator pursuant to the powers set forth herein are final, binding and conclusive upon each Participant and upon any other person affected by such decision, subject to the claims procedure hereinafter set forth. The Administrator shall decide any question which may arise regarding the rights of Directors, Participants and beneficiaries, and the amounts of their respective interests, adopt such rules and to exercise such powers as the Administrator may deem necessary for the administration of the Plan, and exercise any other rights, powers or privileges granted to the Administrator by the terms of the Plan. The Administrator shall maintain full and complete records of its decisions. Its records shall contain all relevant data pertaining to the Participant and his rights and duties under the Plan. The Administrator shall have the duty to maintain Account records for all Participants. The Administrator shall cause the principal provisions of the Plan to be communicated to the Participants, and a copy of the Plan and other documents shall be available at the principal office of the Company for inspection by the Participants at reasonable times determined by the Administrator. 18. Continued Employment Not Presumed. Nothing in the Plan or any document describing it nor the grant of an Option via an Option Agreement shall give any Participant the right to continue in employment with the Company or affect the right of the Company to terminate the employment of any such person with or without cause. 19. Amendment and Termination of the Plan or Option Agreement The Board, in its sole discretion, may amend, suspend or discontinue the Plan or Option Agreement. No amendment, suspension, or discontinuance shall impair the rights of any Participant except to the extent necessary to comply with any provision of federal or applicable state laws or except to the extent necessary to prevent detriment to the Company as so determined by the Board. 20. Governing Law. The Plan shall be governed by and construed in accordance with the laws of Iowa. 21. Severability of Provisions. Should any provision of the Plan be determined to be invalid, illegal or unenforceable, such invalidity, illegality or unenforceability shall not affect the remaining provisions of the Plan, but shall be fully severable, and the Plan shall be construed and enforced as if such provision had never been inserted herein. 22. Hedge of Liability Created by the Option Plan. At the sole discretion of the Board, the liability created by the exercise of the Options issued pursuant to the Plan may be offset by the Company entering into a hedging transaction. The hedging transaction may consist of the Company purchasing all or part of the Shares subject to the Options issued pursuant to the Plan, at date of grant of the Options or at any time during the Option exercise period. 23. Claims Procedure. In general, any claim for benefits under the Plan shall be filed by the Participant or beneficiary ("claimant") on the form prescribed for such purpose with the Administrator. If a claim for benefits under the Plan is wholly or partially denied, notice of the decision shall be furnished to the claimant by the Administrator within a reasonable period of time after receipt of the claim by the Administrator. The claims procedure shall be as follows: (a) Any claimant who is denied a claim for benefits shall be furnished written notice setting forth: (i) The specific reason or reasons for the denial; (ii) Specific reference to the pertinent provision of the Plan upon which the denial is based; (iii) A description of any additional material or information necessary for the claimant to perfect the claim; and (iv) An explanation of the claim review procedure under the Plan. (b) In order that a claimant may appeal a denial of a claim, the claimant or the claimant's duly authorized representative may: (i) Request a review by written application to the Administrator, or its designate, no later than sixty (60) days after receipt by the claimant of written notification of denial of a claim; (ii) Review pertinent documents; and (iii) Submit issues and comments in writing. (c) A decision on review of a denied claim shall be made not later than sixty (60) days after receipt of a request for review, unless special circumstances require an extension of time for processing, in which case a decision shall be rendered within a reasonable period of time, but not later than one hundred and twenty (120) days after receipt of a request for review. The decision on a review shall be in writing and shall include the specific reason(s) for the decision and the specific reference(s) to the pertinent provisions of the Plan on which the decision is based. 24. Designation of Beneficiary. A Participant, by filing the prescribed form with the Administrator, may designate one or more beneficiaries and successor beneficiaries who shall be given the right to exercise Options in accordance with the terms of the Plan in the event of the Participant's death. In the event the Participant does not file a form designating one or more beneficiaries, or no designated beneficiary survives the Participant, the Option shall be exercisable by the individual to whom such right passes by will or the laws or descent and distribution. 25. Intent. The Plan is intended to be unfunded and maintained by the Company solely to provide options to a select group of management or highly compensated employees as such group is described under Sections 201(2), 301(a)(3), and 401(a)(1) of the Employee Retirement Income Security Act of 1974 ("ERISA") as interpreted by the U.S. Department of Labor. The Plan is not intended to be a plan described in Sections 01(a) or 457 of the Code. The obligation of the Company to deliver Shares subject to the Options granted under this Plan constitutes nothing more than an unsecured promise of the Company to fulfill such obligations and any property of the Company that may be set aside to permit it to fulfill such obligations under the Plan shall, in the event of the Company's bankruptcy or insolvency, remain subject to the claims of the Company's general creditors until such Options are exercised. ****************** As evidence of its adoption of the Plan, the Company has caused this instrument to be signed by its officer of representative duly authorized on this 1 day of July, 2000. ---- ---- Employers Mutual Casualty Company By: /s/Doug Zmolek --------------------- Title: Vice President -------------- Exhibit A Shares Available by the Company for Grant or Substitution Description - ----------- See attached list. EX-10 5 exh10n.txt DIRECTORS DEFERRED COMPENSATION PLAN EXHIBIT 10(n) ------------- EMCC Board of Directors Option It! ---------------------------------- Deferred Compensation Plan -------------------------- 1. Purpose of the Plan. This Plan was formerly known as the Deferred Compensation Plan for Directors of Employers Mutual Casualty Company effective as of January 1, 1986 (the "Prior Plan"). Pursuant to the terms of the Prior Plan, which permit its amendment at any time by the Board of Directors, this document is a restatement, in its entirety, of the Plan, generally effective January 1, 2001. This Plan shall be known as the EMCC Board of Directors Option It! Deferred Compensation Plan. The purpose of the Plan is to attract and retain qualified individuals to serve on the Board of Directors of Employers Mutual Casualty Company ("EMCC" or "Company") so as to promote the continued success of the Company. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" shall mean the Board, or the person or persons appointed by Board to serve under paragraph 17, below. (b) "Award Date" shall mean the effective date of the Participant's Option Agreement. (c) "Board" shall mean the Board of Directors of Employers Mutual Casualty Company. (d) "Code" shall mean the Internal Revenue Code of 1986, as amended. (e) "Company" shall mean Employers Mutual Casualty Company. (f) "Director" shall mean an individual appointed or elected to manage and direct the affairs of the Company or its subsidiaries or affiliated corporations as provided under the articles of incorporation, bylaws, or applicable law. (g) "Immediate Family" shall mean the Participant's spouse, a child or children, a grandchild or grandchildren, a parent, or a brother or sister. For purposes of this definition, a legally adopted child of a Participant shall be treated as a child of such individual by blood. (h) "Option" shall mean an option granted pursuant to this Plan to purchase one or more Shares. (i) "Option Agreement" means the written agreement evidencing the award of an Option under the Plan. (j) "Participant" shall mean any Board member who receives an Option under the Plan, as evidenced by an Option Agreement entered into between such Director and the Company. (k) "Plan" shall mean the EMCC Board of Directors Option It! Deferred Compensation Plan, as amended from time to time. (l) "Shares" shall mean the shares of mutual funds, shares of common or preferred stock of a corporation listed or reported on a national securities exchange or quotation system, or shares of a regulated investment company, as designated and amended by the Board and referenced in Exhibit A. Shares may include stock or other equity interest or bonds in the Company or any company related to the Company if so permitted by the Board. In no way, however, may Shares include units of any money market funds or other cash equivalents. Shares subject to purchase pursuant to any Option shall also include any earnings and appreciation on such shares subsequent to the Award Date. 3. Term of Plan. The Plan shall become effective on the date it is adopted by the Board and shall continue in effect as amended from time to time until terminated pursuant to paragraph 19. 4. Shares Subject to the Plan. The aggregate number and type of Shares subject to Options will be fully described in each Option Agreement. 5. Eligibility. All Board members of the Company who are not employees of the Company or its subsidiaries or affiliated corporations shall be eligible to participate in the Plan. Board members of subsidiaries or affiliated corporations shall also be eligible to participate in the Plan provided that such subsidiary or affiliated corporation, by action of its Board of Directors and with the approval of the Board of Directors of the Company, agrees to adopt the provisions of the Plan for the benefit of its eligible Directors. 6. Grant of Options. The Board shall determine the number of Shares to be offered from time to time and grant Options under the Plan based on the portion of his or her Director fees (including annual retainer fee, if any, and Board and committee meeting fees) that he or she elects to defer. The grant of Options shall be evidenced by written Option Agreements containing such terms and provisions as are approved by the Board. The administrator of the Plan shall execute the Option Agreements on behalf of the Company upon instructions from the Board. 7. Time of Grant of Options. The date of grant of an Option under the Plan shall, for all purposes, be the date on which the Board awards the Option, as evidenced by the execution of an Option Agreement. 8. Option Price. The Option Price for each Share shall be expressed in each Option Agreement, provided, however, the Option Price shall be no lower than 25 percent of the fair market value of a Share on the date of grant of the Option. Fair market value on any day of reference shall be the closing price of the Share on such date, unless the Board, in its sole discretion shall determine otherwise in a fair and uniform manner. For this purpose, the closing price of the Share on any business day shall be (i) if the Share is listed or admitted for trading on any United States national securities exchange, the last reported sale price of the Share on such exchange, as reported in any newspaper of general circulation, (ii) if the Share is not listed or admitted for trading on any United States national securities exchange, the average of the high and low sale prices of the Share for such day reported on the NASDAQ SmallCap Market or a comparable consolidated transaction reporting system, or if no sales are reported for such day, such average for the most recent business day within five business days before such day which sales are reported, or (iii) if neither clause (i) or (ii) is applicable, the average between the lowest bid and highest asked quotations for the Share on such day as reported by the NASDAQ SmallCap Market or the National Quotation Bureau, Incorporated, if at least two securities dealers have inserted both bid and asked quotations for the Share on at least 5 of the 10 preceding business days. 9. Exercise. Except as otherwise provided in an Option Agreement, all Options granted under the Plan will be vested at grant and therefore may be exercisable immediately, unless stated otherwise by the Board. The Option may be exercised in full or in part from the date of the grant as determined by the Option Agreement. Reinvested dividends shall be attributed proportionally to the property subject to the Option awards and will be purchased when the underlying award is exercised. For example, if an original grant of an Option to purchase 500 shares (after the payment of the exercise price) generated 100 additional shares on such 500 shares from reinvested dividends, an exercise of one-fourth of the originally granted options will result in the purchase (after the payment of the exercise price) of 150 shares in order to proportionally include the resulting reinvested dividends. In addition, all Options granted under the Plan may only be exercised subject to any other terms specified in the Option Agreement and if such terms conflict with the terms of this Plan, the terms of the Option Agreement control. 10. Limitations on Option Disposition. Any Option granted under the Plan and the rights and privileges conferred therewith shall not be sold, transferred, encumbered, hypothecated or otherwise anticipated by the Participant other than by will or the laws of descent and distribution. Options shall not be subject to, in whole or in part, the debts, contracts, liabilities, or torts of the Participant, nor shall they be subject to garnishment, attachment, execution, levy or other legal or equitable process. However, a Participant may, after the consent of the Administrator has been obtained, transfer by gift any Option or part thereof to (a) a member or members of the Participant's Immediate Family and/or to a trust established for the benefit of an Immediate Family member or members, as defined in the Plan, or (b) a charitable organization described in Section 170(c) of the Internal Revenue Code of 1986, as amended from time to time, provided such transfer is irrevocable, is made without consideration, and each Option so transferred by the Participant remains subject after transfer to the provisions of the Plan. 11. Limitations on Option Exercise and Distribution. In the event that the listing, registration or qualification of an Option or Shares on any securities exchange or under any state or federal law, or the consent of approval of any governmental regulatory body, or the availability of any exemption therefrom, is necessary as a condition of, or in connection with, the exercise of an Option, then the Option shall not be exercised in whole or in part until such listing, registration, qualification, consent or approval has been effected or obtained. Notwithstanding any provision of the Plan to the contrary, the Company shall have no obligation or liability to deliver any Shares under the Plan unless such delivery would comply with all applicable laws and all applicable requirements of any securities exchange or similar entity. 12. Option Financing. Upon the exercise of any Option granted under the Plan, the Participant may instruct the Administrator to sell or deem to sell a number of Shares otherwise deliverable to the Participant and attributable to the exercise of the Option in order to pay the exercise price of the Option. The Board may, in its sole discretion, make financing available to the Participant to facilitate the exercise of the Option, subject to such terms as the Board may specify. 13. Withholding of Taxes. The Company may make such provisions and take such steps as it may deem necessary or appropriate for the withholding of any taxes which is required by any law or regulation of any governmental authority, whether federal, state or local, domestic or foreign, to withhold in connection with any Option including, but not limited to, the withholding of the issuance of all or any portion of such Shares until the Participant reimburses the Company for the amount the Company is required to withhold with respect to such taxes, canceling any portion of such issuance in an amount sufficient to reimburse itself for the amount it is required to so withhold, or taking any other action reasonably required to satisfy the Company's withholding obligation. 14. Modification of Option or Plan. At any time and from time to time the Board may execute an instrument providing for the modification, extension, or renewal of any outstanding Option and or the Plan. 15. Substitution of Option. If a Participant has been granted an Option to purchase Shares under an Option Agreement, then except as limited by the terms of the Option Agreement, the Participant may direct that the Option be converted into an Option to purchase other Shares as permitted by the Option Agreement. Such substitution shall only be allowed to the extent that, immediately following the substitution, the difference between the fair market value of the Shares subject to the substituted Option and the exercise price of the substituted Option is no greater than the difference which existed immediately prior to the substitution between the fair market value of the Shares subject to the original Option and the exercise price of the original Option. 16. Prior Plan Participants. Any Participant in the Prior Plan who has begun to receive benefits as of the effective date of this Plan shall continue to receive such benefits at such time and in such amounts as determined under the terms and conditions set forth in the Prior Plan. Any Participant in the Prior Plan who has not begun to receive benefits as of the effective date of this Plan shall receive an Option where the difference between the fair market value of the Shares subject to the Option and the exercise price of the Option is equal to the fair market value of the Deferred Compensation Units and interest credited thereon under the terms of the prior plan. 17. Administration of the Plan. The Board, in its sole discretion, is authorized to determine the number of Options and the number of Shares under each Option. The Board, or the person or persons appointed by the Board to serve as Administrator, shall be the Administrator of the Plan. The Administrator, in its sole discretion, is authorized to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to the Plan and to the Options granted under the Plan, to determine the form and content of Options to be issued under the Plan, and to make such other determinations and exercise such other power and authority as may be necessary or advisable for the administration of the Plan. No fee or compensation shall be paid to any person for services as the Administrator (but this does not prevent the payment of salary otherwise payable to an employee of EMCC for other services as an employee of the Company). The Administrator in its sole discretion may delegate and pay compensation for services rendered relating to the ministerial duties of plan administration including, but not limited to, selection of investments available under the Plan. Any determination made by the Administrator pursuant to the powers set forth herein are final, binding and conclusive upon each Participant and upon any other person affected by such decision, subject to the claims procedure hereinafter set forth. The Administrator shall decide any question which may arise regarding the rights of Directors, Participants and beneficiaries, and the amounts of their respective interests, adopt such rules and to exercise such powers as the Administrator may deem necessary for the administration of the Plan, and exercise any other rights, powers or privileges granted to the Administrator by the terms of the Plan. The Administrator shall maintain full and complete records of its decisions. Its records shall contain all relevant data pertaining to the Participant and his rights and duties under the Plan. The Administrator shall have the duty to maintain Account records for all Participants. The Administrator shall cause the principal provisions of the Plan to be communicated to the Participants, and a copy of the Plan and other documents shall be available at the principal office of the Company for inspection by the Participants at reasonable times determined by the Administrator. 18. Continued Service Not Presumed. Nothing in the Plan or any document describing it nor the grant of an Option via an Option Agreement shall give any Participant the right to continue in service with the Company as a Director or affect the right of the Company or its shareholders to remove any such Director as provided in articles of incorporation, corporate bylaws, or under applicable law. 19. Amendment and Termination of the Plan or Option Agreement The Board, in its sole discretion, may amend, suspend or discontinue the Plan or Option Agreement. No amendment, suspension, or discontinuance shall impair the rights of any Participant except to the extent necessary to comply with any provision of federal or applicable state laws or except to the extent necessary to prevent detriment to the Company as so determined by the Board. 20. Governing Law. The Plan shall be governed by and construed in accordance with the laws of Iowa. 21. Severability of Provisions. Should any provision of the Plan be determined to be invalid, illegal or unenforceable, such invalidity, illegality or unenforceability shall not affect the remaining provisions of the Plan, but shall be fully severable, and the Plan shall be construed and enforced as if such provision had never been inserted herein. 22. Hedge of Liability Created by the Plan. At the sole discretion of the Board, the liability created by the exercise of the Options issued pursuant to the Plan may be offset by the Company entering into a hedging transaction. The hedging transaction may consist of the Company purchasing all of part of the Shares subject to the Options issued pursuant to the Plan, at date of grant of the Options or at any time during the Option exercise period. 23. Claims Procedure. In general, any claim for benefits under the Plan shall be filed by the Participant or beneficiary ("claimant") on the form prescribed for such purpose with the Administrator. If a claim for benefits under the Plan is wholly or partially denied, notice of the decision shall be furnished to the claimant by the Administrator within a reasonable period of time after receipt of the claim by the Administrator. The claims procedure shall be as follows: (a) Any claimant who is denied a claim for benefits shall be furnished written notice setting forth: (i) The specific reason or reasons for the denial; (ii) Specific reference to the pertinent provision of the Plan upon which the denial is based; (iii) A description of any additional material or information necessary for the claimant to perfect the claim; and (iv) An explanation of the claim review procedure under the Plan. (b) In order that a claimant may appeal a denial of a claim, the claimant or the claimant's duly authorized representative may: (i) Request a review by written application to the Administrator, or its designate, no later than sixty (60) days after receipt by the claimant of written notification of denial of a claim; (ii) Review pertinent documents; and (iii) Submit issues and comments in writing. (c) A decision on review of a denied claim shall be made not later than sixty (60) days after receipt of a request for review, unless special circumstances require an extension of time for processing, in which case a decision shall be rendered within a reasonable period of time, but not later than one hundred and twenty (120) days after receipt of a request for review. The decision on a review shall be in writing and shall include the specific reason(s) for the decision and the specific reference(s) to the pertinent provisions of the Plan on which the decision is based. 24. Designation of Beneficiary. A Participant, by filing the prescribed form with the Administrator may designate one or more beneficiaries and successor beneficiaries who shall be given the right to exercise Options in accordance with the terms of the Plan in the event of the Participant's death. In the event the Participant does not file a form designating one or more beneficiaries, or no designated beneficiary survives the Participant, the Option shall be exercisable by the individual to whom such right passes by will or the laws of descent and distribution. 25. Intent. The Plan is intended to be unfunded and maintained by the Company solely to provide options to members of the Board. The Plan is not intended to be a plan described in Sections 401(a) or 457 of the Code. The obligation of the Company to deliver Shares subject to the Options granted under this Plan constitutes nothing more than an unsecured promise of the Company to fulfill such obligations and any property of the Company that may be set aside to permit it to fulfill such obligations under the Plan shall, in the event of the Company's bankruptcy or insolvency, remain subject to the claims of the Company's general creditors until such Options are exercised. ****************** As evidence of its adoption of the Plan, the Company has caused this instrument to be signed by its officer of representative duly authorized on this 1 day of July , 2001. ------ -------- Employers Mutual Casualty Company By: Robert L. Link --------------------- Title: Corporate Secretary -------------------- Exhibit A Shares Available by the Company for Grant or Substitution Description - ----------- See attached list. EX-10 6 exh10o.txt EXECUTIVE EXCESS DEFERRAL PLAN EXHIBIT 10(o) ------------- EMPLOYERS MUTUAL CASUALTY COMPANY --------------------------------- EXCESS DEFERRAL PLAN -------------------- TABLE OF CONTENTS INTRODUCTION ARTICLE 1 DEFINITIONS Section 1.01 ---- Format Section 1.02 ---- Definitions ARTICLE 11 PARTICIPATION Section 2.01 ---- Active Participant Section 2.02 ---- Inactive Participant Section 2.03 ---- Cessation of Participation ARTICLE III CONTRIBUTIONS Section 3.01 ---- Employee Contributions Section 3.02 ---- Employer Contributions ARTICLE IV INVESTMENT OF CONTRIBUTIONS ARTICLE V BENEFITS Section 5.01 ---- Retirement Benefits Section 5.02 ---- Death Benefits Section 5.03 ---- Disability Benefits Section 5.04 ---- Voluntary Termination Benefits Section 5.05 ---- Involuntary Termination Benefits Section 5.06 ---- When Benefits Start ARTICLE VI DISTRIBUTION OF BENEFITS Section 6.01 ---- Automation Forms of Distribution Section 6.02 ---- Optional Forms of Distribution Section 6.03 ---- Election Procedures Section 6.04 ---- In-Service Withdrawals ARTICLE VII GENERAL PROVISIONS Section 7.01 ---- Amendments Section 7.02 ---- Merger of the Plan Section 7.03 ---- Provisions Relating to the Insurer and Other Parties Section 7.04 ---- Employment Status Section 7.05 ---- Rights to Plan Assets Section 7.06 ---- Nonalienation of Benefits Section 7.07 ---- Construction Section 7.08 ---- Beneficiary Designation Section 7.09 ---- Legal Actions Section 7.10 ---- Work Usage Section 7.11 ---- Termination of the Plan Section 7.12 ---- Governing Law PLAN EXECUTION INTRODUCTION Employers Mutual Casualty Company, referred to in this Plan document as the "Employer", is establishing a nonqualified excess deferral plan effective January 1, 2001. This plan has been designed as, and is intended to be, an unfunded plan for purposes of the Employee Retirement Income Security Act of 1974, as amended, and a nonqualified plan under the Internal Revenue Code of 1986, including any later amendments to the Code. The Employer agrees to operate the Plan according to the terms, provisions and conditions set forth in this document. Any funds accumulated for purposes of providing benefits under this Plan are fully available to satisfy the claims of the Employer's creditors. Participants have no greater rights with regard to such funds than any other general creditor of the Employer. ARTICLE I FORMAT AND DEFINITIONS SECTION 1.01 - FORMAT Words and phrases defined in the DEFINITIONS SECTION of Article I shall have that defined meaning when used in the Plan, unless the context clearly indicates otherwise. These words and phrases have an initial capital letter to aid in identifying them as defined terms. SECTION 1.02 - DEFINITIONS ACCOUNT means, for a Participant, the account to which Employee and Employer Contributions are credited. A Participant's Account shall be reduced by any distribution of his Account. A Participant's Account will participate in the earnings credited, expenses charged and any appreciation or depreciation of the Measurement Fund used to value the Account. ACTIVE PARTICIPANT means an Eligible Employee who is actively participating in the Plan according to the provisions in the ACTIVE PARTICIPANT SECTION of Article II. BENEFICIARY means the person or persons named by the Participant to receive any promised benefits under this Plan upon the Participant's death. BENEFIT DATE means, for a Participant, the first day of the first period for which an amount of benefit is payable to him under this Plan. See Article V - BENEFITS. BOARD means the Board of Directors of the Company. The Board shall have full power and authority to interpret this Plan. The Board's interpretations and construction of any provision or action taken under this Plan, including any valuation of the Participant's Account, shall be binding and conclusive on all persons for all purposes. No member of the Board shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Plan unless attributable to the member's willful misconduct or lack of good faith. CODE means the Internal Revenue Code of 1986, as amended. COMMITTEE means those individuals appointed by the Employer to administer the Plan. COMPENSATION means the total earnings paid or made available to an Employee by the Employer during any specified period. (Earnings in this definition mean an Employee's W-2 earnings.) CONTRIBUTIONS means Employee and Employer Contributions as set out in Article III, unless the context clearly indicates otherwise. DEFERRED COMPENSATION means the amount of Compensation not yet earned during the Plan Year that the Participant and Employer mutually agree shall be deferred for the Plan Year. EARLY RETIREMENT means retirement from the service of the Employer that becomes effective on the first day of any month the Participant selects for the start of his retirement benefit before the Participant's Normal Retirement Date. This day shall be on or after the date on which he ceases to be an Employee and the date he has attained age 55. ELIGIBLE EMPLOYEE means any Employee of the Employer who is invited to participate in the Plan and who represents a selected group of highly compensated or management employees, as determined by the Employer. EMPLOYEE means an individual who is employed by the Employer. EMPLOYER means Employers Mutual Casualty Company and affiliates. ENTRY DATE means the date an Eligible Employee first enters the Plan as an Active Participant. See Article II - PARTICIPATION. ERISA means the Employee Retirement Income Security Act of 1974, as amended. FISCAL YEAR means the Employer's taxable year. The last day of the Fiscal Year is December 31st. INACTIVE PARTICIPANT means a former Active Participant that has an Account. See Article II. INVOLUNTARY TERMINATION OF EMPLOYMENT means the ceasing of employment, which is initiated by the Employer, excluding reduction in force. LATE RETIREMENT DATE means the first day of any month that is after a Participant's Normal Retirement Date and on which retirement benefits begin. If a Participant continues to work for the Employer after his Normal Retirement Date, his Late Retirement Date shall be the earliest first day of the month on or after he ceases to be an Employee. LEAVE OF ABSENCE means that the Committee may, in its sole discretion, permit the Participant to take a leave of absence for a period not to exceed 12 months. During this time the Participant will still be considered to be in the employ of Employers Mutual Casualty Company for purposes of this Plan. MEASUREMENT FUNDS mean the funds upon on which to base the crediting rates for the purpose of crediting or debiting amounts of the Participant's Account balance for a Plan Year. The Measurement Funds are to be selected by the Committee and can be changed at the sole discretion of the Committee. NORMAL RETIREMENT AGE means age 65 for a Participant. NORMAL RETIREMENT DATE means the first day of the month on or after the date the Participant meets the following requirement(s): (a) He has ceased to be an Employee. (b) He has attained age 65. PARTICIPANT means an Eligible Employee who is actively participating or has participated in the Plan and has an account balance. PLAN means the unfunded and unsecured nonqualified retirement Plan of the Employer set forth in this document, including any later amendments to it. PLAN YEAR means a period beginning on a Yearly Date and ending on the day before the next Yearly Date. QUALIFIED PLAN means a pension or profit sharing plan that meets the requirements of the Internal Revenue Code and the regulations and rulings that interpret this section of the law. REENTRY DATE means the date a former Participant reenters the Plan. See Article II - PARTICIPATION. SERVICE means an Employee's period of service with the Employer, expressed as whole years and fractional parts of a year (to two decimal places) on the basis that 365 days equal one year. TOTALLY AND PERMANENTLY DISABLED means that a Participant is disabled, as a result of a sickness or injury, to the extent that he is prevented from engaging in any substantial gainful activity, and is eligible for and receives a disability benefit under Title II of the Federal Social Security Act. If a Participant is not covered under Title II of the Federal Social Security Act, Totally Disabled means that a Participant is disabled as a result of sickness or injury, to the extent that he is completely prevented from performing any work, engaging in any occupation for wage or profit and has been continuously disabled for six months. Initial written proof that the disability exists and has continued for at least six months must be furnished to the Committee by the Participant within one year after the date the disability begins. The Committee, upon receipt of any notice of proof of a Participant's total disability, shall have the right and opportunity to have a physician it designates examine the Participant when and as often as it may reasonably require, but not more than once each year after the disability has continued uninterruptedly for at least two years beyond the date of furnishing the first proof. VESTED ACCOUNT means the part of a Participant's Account in which he has a vested interest. A Participant is always 100% vested in the Account balance attributable to Employee Contributions. The Participant's Vested Account is equal to the sum of (a) and (b) below: (a) The part of the Participant's Account that results from Employee Contributions. (b) The balance of the Participant's Account in excess of the amount in (a) above, multiplied by the percentage shown in the following schedule which corresponds to his years of Service: (whole years) Percentage Less than 5 0% 5 or more 100 A Participant is 100% vested in both Employee and Employer Contributions at: retirement. death. disability. plan termination. VOLUNTARY TERMINATION OF EMPLOYMENT means the ceasing of employment, which is initiated by the Employee. Reduction in force is also to be treated as a voluntary termination. YEARLY DATE means January 1 and the same day of each following year. ARTICLE II PARTICIPATION SECTION 2.01 - ACTIVE PARTICIPANT An Eligible Employee shall first become a Participant (begin active participation in the Plan) on the earliest date on or after on which he is an Eligible Employee. This date is his Entry Date A former Participant shall again become a Participant (resume active participation in the Plan) on the date he again performs an hour of service as an Eligible Employee. This date is the Reentry Date. SECTION 2.02 - INACTIVE PARTICIPANT An Active Participant will become an Inactive Participant on the earlier of the following: (a) The date which he ceases to be an Eligible Employee. (b) The effective date of complete termination of the Plan. SECTION 2.03 - CESSATION OF PARTICIPATION A Participant shall cease to be a Participant on the date he is no longer an Eligible Employee and the value of his Account is zero. ARTICLE III CONTRIBUTIONS SECTION 3.01 - EMPLOYEE CONTRIBUTIONS Employee Contributions for each Plan Year will be as follows: (a) Salary Deferral Contributions. An Eligible Employee may elect to defer, in whole percentages (up to 17%) of his Compensation for the pay period. An Employee who is eligible to participate in the Plan may file a deferral agreement with the Employer. The deferral agreement will only be in effect if the Eligible Employee is contributing the maximum amount allowed under the Qualified Plan. The deferral agreement to start Salary Deferral Contributions may be effective on a Participant's Entry Date (Reentry Date, if applicable) or any following Yearly Date. The initial deferral agreement must be in writing and effective immediately upon being asked to join the Plan. Salary Deferral Contributions shall be offset by any savings contributions the Employee makes to the Qualified Plan of the Employer under its contribution formula. Employee Contributions include contributions the Employee would have made to the Qualified Plan of the Employer under its contribution formula but for the additional restrictions imposed by such plan to meet the qualification requirements of the Internal Revenue Code. The deferral agreement will remain in effect until a new agreement is filed with the Employer in accordance with the terms and conditions specified herein or until the Participant ceases to be an Eligible Employee. The Participant's deferral agreement to stop employee Contributions or to make a change shall only be effective for future employee Contributions. SECTION 3.02 - EMPLOYER CONTRIBUTIONS. Employer Contributions for each Plan Year will be equal to the Employer Contributions as described below. Matching Contributions. The amount of each Matching Contribution made by the Employer for a Participant eligible for an allocation shall be equal to 50% of Salary Deferral Contributions for the pay period offset by any matching contributions the Employer makes to the Qualified Plan of the employer. However, Salary Deferral Contributions in excess of 6% of Compensation will not be matched. Matching Contribution shall be made for a Participant if he is an Active Participant at any time during the pay period. Discretionary Contributions. The amount of each Discretionary Contribution for the Participant shall be made and determined by the Employer, in its sole discretion. The Employer may, but is not required to, designate any dollar amount or percentage that it desires. The amount designated may vary among the Participants, and the amount designated for any Participant may be zero even if other Participants have been designated a Discretionary Contribution. ARTICLE IV INVESTMENT OF CONTRIBUTIONS SECTION 4.01 - INVESTMENT OF CONTRIBUTIONS To the extent permitted by the Employer, the Participant, with the consent of the Employer, shall direct the Contributions of his Account among the Measurement Funds selected by the Employer and may request the transfer of assets resulting from those Contributions between such Measurement Funds. To the extent that a Participant does not direct the investment of his Account, such Account shall be invested ratably in the Measurement Funds available under Plan in the same manner as the undirected Accounts of all other Participants. The Accounts of all inactive Participants may be segregated and invested separately from the Accounts of all other Participants. The Participant's Account shall be valued at current fair market value on a daily basis. The valuation shall take into consideration investment earnings credited, expenses charged, payments made and changes in the value of the Measurement Fund held in the Participant's Account. The Account of a Participant shall be credited with its share of the gains and losses of the Measurement Fund. Since the Plan is merely a promise to pay benefits in the future, the Measurement Funds are to be used as a measuring device only. It should not be considered an actual investment of the Participant's Account since a nonqualified deferred compensation Plan is merely a promise to pay. If the Employer or Trustee chooses to informally fund the Plan, the Participant does not have any right to these assets. Any funds accumulated for the purposes of providing benefits under this Plan are fully available to satisfy the claims of the Employer's creditors. Participants have no greater right with regard to such fund than any other general creditor of the Employer. All investments made by the Employer under this Plan will be for the purpose of aiding the Employer in meeting its obligations under this Plan. The Employer or Trustee will be named sole owner of all such investments and of all rights and privileges conferred by the terms of the instruments evidencing such investments. The terms of this Plan place no obligation upon the Employer to invest or to continue to invest any portion of the amount in the Account, to invest in or to continue to invest in any specific asset, to liquidate any particular investment, or to apply in any specific manner the proceeds from the sale, liquidation, or maturity of any particular investment. Finally, nothing stated herein will cause such investments to be treated as anything but the general assets of the Employer, nor will anything stated herein cause such investments to represent the vested, secured, or preferred interest of the Participant or his/her beneficiaries designated to receive benefits under this Plan. ARTICLE V BENEFITS SECTION 5.01 - RETIREMENT BENEFITS. On a Participant's Retirement Date, his Vested Account shall be distributed to him according to the distribution of benefits provisions of Article VI. This date shall be a Participant's Benefit Date. SECTION 5.02 - DEATH BENEFITS. If a Participant dies before his Retirement Date, his Vested Account shall be distributed according to the distribution of benefits provisions of Article VI. This date shall be a Participant's Benefit Date. SECTION 5.03 - DISABILITY BENEFITS. If a Participant becomes Totally and Permanently Disabled before his Normal Retirement Date, his Vested Account shall be distributed according to the distribution of benefits provisions of Article VI. This date shall be a Participant's Benefit Date. SECTION 5.04 - VOLUNTARY TERMINATION OF BENEFITS. If a Participant ceases to be an Employee, by Voluntary Termination of Employment, before his Retirement Date, provided he has not again become an Employee, his Vested Account shall be distributed according to the distribution of benefits provisions of Article VI. This date shall be a Participant's Benefit Date. SECTION 5.05 - INVOLUNTARY TERMINATION OF BENEFITS. If a Participant ceases to be an Employee, by Involuntary Termination of Employment, before his Retirement Date, provided he has not again become an Employee, his Vested Account shall be distributed according to the distribution of benefits provisions of Article VI. This date shall be a Participant's Benefit Date. SECTION 5.06 - WHEN BENEFITS START. Benefits under this Plan begin when a Participant retires, dies, is disabled or ceases to be an Employee, whichever applies, as provided in the preceding sections of this article. The Participant may elect to have his benefits begin after the latest date for beginning benefits described above (except for death, involuntary termination or disability), subject to the provisions of this section. The Participant shall make the election in writing and deliver the signed statement of election to the Employer at least 12 months prior to Retirement Date or the date he ceases to be an Employee, if later. The election must describe the form of distribution and the date the benefits will begin. At which time the value of the Account at retirement or Voluntary Termination of Employment, plus interest on the Account, shall be paid in the same manner and to the same extent as provided in Article VI of this Plan. [If the Participant's Vested Account is less than $50,000 at time of retirement or voluntary termination of employment he will receive his benefit in single sum as soon practicable following his date of retirement or voluntary termination of employment.] [If the Participant has elected to defer payment of the Account but dies, involuntarily terminates employment or becomes disabled before reaching Normal Retirement Age, then payment of the Account shall be made in the same manner and to the same extent as set forth in Article VI of this Plan.] ARTICLE VI DISTRIBUTION OF BENEFITS SECTION 6.01 - AUTOMATIC FORMS OF DISTRIBUTION. Unless an election of an optional form of benefit has been made according to the ELECTION PROCEDURES SECTION of Article VI, the automatic form of benefit payable to or on behalf of a Participant is determined as follows: (a) The automatic form of retirement, disability, death or voluntary termination benefit shall be a single sum payment to the Participant or the Participant's named Beneficiary. (b) The automatic form of involuntary termination benefit shall be a single sum payment to the Participant. SECTION 6.02 - OPTIONAL FORMS OF DISTRIBUTION. An election of an optional form of benefit may be made by the Participant (see the ELECTION PROCEDURES SECTION of Article VI). (a) The optional forms of retirement, disability, death and voluntary termination benefit shall be the following: a single sum payment or annual installments over a period of 5 years or 10 years. Annual installments are to commence on the first day of the month (or as soon as administratively possible) after which he ceases to be an Eligible Employee. Payment shall be determined based on the remaining Account divided by the remaining number of outstanding payments. Election of an optional form is subject to the election provisions of Article VI. The Participant may elect a combination of both forms of benefit (see the ELECTION PROCEDURES SECTION of Article VI). In order to exercise the installment method, the Participant's Vested Account balance must be equal to or greater than $50,000 at the time of the Benefit Date. Amounts under $50,000 will be paid in the automatic form single sum. (b) The optional forms of involuntary termination benefit are a single sum payment. SECTION 6.03 - ELECTION PROCEDURES. The Participant shall make any election under this section in writing. The Employer may require such individual to complete and sign any necessary documents as to the provisions to be made. (a) Retirement, disability, death or voluntary termination benefits. A Participant may elect his Beneficiary and may elect to have retirement, disability, or voluntary termination benefits distributed under any of the optional forms of retirement, disability, or voluntary termination benefits described in the OPTIONAL FORMS OF DISTRIBUTION SECTION of Article VI. (b) Involuntary termination benefits. A Participant may elect his Beneficiary and may elect to have involuntary termination benefits distributed under any of the optional forms of death benefit described in the OPTIONAL FORMS OF DISTRIBUTION SECTION of Article VI. The participant shall elect the form of benefit payment prior to entering the Plan. A participant who fails to complete an election will default to the automatic form of payment option described in the AUTOMATIC FORMS OF DISTRIBUTION SECTION of Article VI. The election may be changed at any time up until 12 months prior to the Participant's Benefit Date by providing a written request to the Committee. SECTION 6.04 - IN-SERVICE WITHDRAWALS (a) Haircut Provision. The Employer may allow a distribution of all or a portion of the Vested Account Balance. The participant may receive all, or a portion of, his Vested Account balance as soon as practicable following the approval from the Committee. The withdrawal is subject to a 10% penalty, which the Employer keeps. (b) Unforseen Emergency. The Committee may allow a distribution of all or a portion of the Account balance up to the amount of the financial hardship for Participants that experience an unanticipated emergency. The emergency must be beyond the control of the Participant and result in severe financial hardship if a withdrawal is not permitted. Payout shall be made as soon as practicable following the date of approval. The Participant may also request the Committee to suspend any deferrals for the remaining Plan Year. ARTICLE VII GENERAL PROVISIONS SECTION 7.01 - AMENDMENTS. The Board may amend this Plan at any time, including any remedial retroactive changes (within the specified period of time as may be determined by Internal Revenue Service regulations) to comply with the requirements of any law or regulation issued by any governmental agency to which the Employer is subject. SECTION 7.02 - MERGER OF PLAN. The Board may merge this Plan at any time and its related trust with another deferred compensation Plan maintained by the Employer or controlled group of the Employer. SECTION 7.03 - PROVISIONS RELATING TO THE INSURER AND OTHER PARTIES. Any issuer or distributor of the Measurement Funds selected is governed solely by the terms of its policies, written investment contract, prospectuses, security instruments, and any other written agreements entered into with the Employer. Such insurer, issuer or distributor is not a party to the Plan, nor bound in any way by the Plan provisions. Such parties shall not be required to look to the terms of this Plan, nor to determine whether the Employer, have the authority to act in any particular manner or to make any contract or agreement. Until notice of any amendment or termination of this Plan has been received by the insurer at its home office or an issuer or distributor at their principal address, they are and shall be fully protected in assuming that the Plan has not been amended or terminated. and in dealing with any party acting as Trustee according to the latest information which they have received at their home office or principal address. SECTION 7.04 - EMPLOYMENT STATUS. Nothing contained in this Plan gives an Employee the right to be retained in the Employer's employ or to interfere with the Employer's right to discharge any Employee. SECTION 7.05 - RIGHTS TO PLAN ASSETS. No Active Participant shall have any right to or interest in any assets used to informally fund the Plan upon termination of his employment or otherwise except as specifically provided under this Plan, and then only to the extent of the benefits payable to such Active Participant in accordance with Plan provisions. An Active Participant holds an unsecured and unfunded promise to pay future benefits. Any final payment or distribution to a Participant or his legal representative or to any Beneficiaries or spouse of such Participant under the Plan provisions shall be in full satisfaction of all claims against the Plan, the Committee, the insurer, and the Employer arising under or by virtue of the Plan. SECTION 7.06 - NONALIENATION OF BENEFITS. Benefits payable under the Plan are not subject to the claims of any creditor of any Participant, Beneficiary or spouse. A Participant, Beneficiary or spouse does not have any rights to alienate, anticipate, commute, pledge, encumber, sell, transfer, attach, garnish or assign any of such benefits. The preceding sentences shall also apply to the creation, assignment, or recognition of a right to any benefit payable with respect to a Participant according to a domestic relations order, unless such order is determined by the Committee to be a qualified domestic relations order, as defined in ERISA Act Section 206(d), or any domestic relations order entered before January 1, 1985. SECTION 7.07 - CONSTRUCTION. The validity of the Plan or any of its provisions is determined under and construed according to Federal law and, to the extent permissible, according to the laws of the state in which the Employer has its principal office. In case any provision of this Plan is held illegal or invalid for any reason, such determination shall not affect the remaining provisions of this Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had never been included. In the event of any conflict between the provisions of the Plan and the terms of any contract or policy issued hereunder, the provisions of the Plan control the operation and administration of the Plan. SECTION 7.08 - BENEFICIARY DESIGNATION. If a Participant fails to designate a Beneficiary, the Committee will direct the Employer to pay the benefits in the following order: (a) To the Participant's surviving spouse. (b) If no surviving spouse, to the Participant's estate If a Beneficiary dies prior to receiving the full benefit payout, the Committee will continue payments to the person or persons designated by the Participant to receive the remaining payments. The designation must be in writing and given to the Employer prior to the death of the Beneficiary. If no designation was made, the remainder shall be paid to the Beneficiary's estate. If the Committee shall find that any person to whom any payment is payable under this Plan is unable to care for his/her affairs because of illness or accident or is a minor, any payment due (unless a prior claim therefore shall have been made by a duly appointed guardian, committee, or other legal representative) may be paid to the spouse, a child, parent, or brother or sister, or to any person deemed by the Committee to have incurred expense for such person otherwise entitled to payment, in accordance with the applicable provisions of this Plan. Any such payment shall be a complete discharge of the Employer's liabilities under this Plan. SECTION 7.09 - LEGAL ACTIONS. The Plan and the Committee are the necessary parties to any action or proceeding involving the assets held with respect to informally funding the Plan or administration of the Plan. No person employed by the Employer, no Participant, former Participant or their Beneficiaries or any other person having or claiming to have an interest in the Plan is entitled to any notice of process. A final judgment entered in any such action or proceeding shall be binding and conclusive on all persons having or claiming to have an interest in the Plan. SECTION 7.10 - WORD USAGE. The masculine gender, where used in this Plan, shall include the feminine gender and the singular words as used in this Plan may include the plural, unless the context indicates otherwise. SECTION 7.11 - TERMINATION OF THE PLAN. The Employer expects to continue the Plan indefinitely but reserves the right to terminate the Plan in whole or in part at any time upon giving written notice to all parties concerned. The Board may at anytime terminate the Plan with respect to new Contributions or in its entirety if the continuance of the Plan would not be in the best interest of the Employer. If the Plan is terminated each Participant will be 100% vested in their Account. Each Participant will receive a single sum payment as soon as practicable following the termination date. SECTION 7.12 - GOVERNING LAW The provisions of this Plan shall be interpreted according to state of Iowa. By executing this Plan, the Primary Employer acknowledges having counseled to the extent necessary with selected legal and tax advisors regarding the Plan's legal and tax implications. Executed this 20th day of December, 2000. ------ --------------- By: /s/Doug Zmolek ------------------- Vice President - HR ------------------- Title ACKNOWLEDGED as a member of the Committee this 20th day of December, ------ --------- 2000. - ----- By: /s/ Betty J. Woodburn --------------------- Assistant Secretary --------------------- Title EX-13 7 exh13a.txt SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA. EXHIBIT 13(a) - ------------------------ -------------
Year ended December 31, ----------------------------------- 2001 2000 1999 1998 -------- -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $265,280 $231,459 $211,098 $194,244 Investment income, net ........... 30,970 29,006 25,761 24,859 Realized investment gains ........ 800 1,558 277 5,901 Other income ..................... 774 1,473 2,194 1,701 -------- -------- -------- -------- Total revenues .............. 297,824 263,496 239,330 226,705 Losses and expenses .............. 303,366 262,431 245,321 223,031 -------- -------- -------- -------- (Loss) income before income tax (benefit) expense .......... (5,542) 1,065 (5,991) 3,674 Income tax (benefit) expense ..... (3,436) (1,264) (5,187) (2,339) -------- -------- -------- -------- (Loss) income from: Continuing operations ......... (2,106) 2,329 (804) 6,013 Discontinued operations ....... - - - - Accounting changes ............ - - - - -------- -------- -------- -------- Net (loss) income .......... $ (2,106)$ 2,329 $ (804)$ 6,013 ======== ======== ======== ======== Net (loss) income per common share - basic and diluted: Continuing operations ....... $ (.19)$ .21 $ (.07)$ .53 Discontinued operations ..... - - - - Accounting changes .......... - - - - -------- -------- -------- -------- Total ...................... $ (.19)$ .21 $ (.07)$ .53 ======== ======== ======== ======== Premiums earned by segment: Property and casualty insurance $203,393 $184,986 $167,265 $155,523 Reinsurance .................... 61,887 46,473 43,833 38,721 -------- -------- -------- -------- Total .......................$265,280 $231,459 $211,098 $194,244 ======== ======== ======== ======== Balance Sheet Data Total assets ..................... $671,565 $587,676 $542,395 $496,046 ======== ======== ======== ======== Stockholders' equity ............. $140,458 $148,393 $141,916 $163,938 ======== ======== ======== ======== Other Data Average return on equity ......... (1.5)% 1.6% (.5)% 3.7% ======== ======== ======== ======== Book value per share ............. $ 12.40 $ 13.14 $ 12.60 $ 14.26 ======== ======== ======== ======== Dividends paid per share ......... $ .60 $ .60 $ .60 $ .60 ======== ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 23.5% 23.5% 23.5% 23.5% ======== ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 100% 100% 100% 100% ======== ======== ======== ======== Closing stock price ..............$ 17.15 $ 11.75 $ 9.13 $ 12.75 ======== ======== ======== ======== Net investment yield (pre-tax) .... 6.31% 6.47% 5.96% 6.02% ======== ======== ======== ======== Cash dividends to closing stock price ............ 3.5% 5.1% 6.6% 4.7% ======== ======== ======== ======== Common shares outstanding ........ 11,330 11,294 11,265 11,496 ======== ======== ======== ======== Statutory trade combined ratio ... 113.9% 113.5% 115.2% 114.8% ======== ======== ======== ========
Year ended December 31, ----------------------------------- 1997 1996 1995 1994 -------- -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $177,218 $165,191 $162,266 $164,829 Investment income, net ........... 23,780 24,007 23,204 21,042 Realized investment gains ........ 4,100 1,891 1,043 520 Other income ..................... 1,023 904 1,005 1,128 -------- -------- -------- -------- Total revenues .............. 206,121 191,993 187,518 187,519 Losses and expenses .............. 189,318 171,324 163,202 168,842 -------- -------- -------- -------- (Loss) income before income tax (benefit) expense .......... 16,803 20,669 24,316 18,677 Income tax (benefit) expense ..... 3,586 5,635 6,967 5,171 -------- -------- -------- -------- (Loss) income from: Continuing operations ......... 13,217 15,034 17,349 13,506 Discontinued operations ....... - - - - Accounting changes ............ - - - - -------- -------- -------- -------- Net (loss) income .......... $ 13,217 $ 15,034 $ 17,349 $ 13,506 ======== ======== ======== ======== Net (loss) income per common share - basic and diluted: Continuing operations ....... $ 1.18 $ 1.37 $ 1.62 $ 1.29 Discontinued operations ..... - - - - Accounting changes .......... - - - - -------- -------- -------- -------- Total ...................... $ 1.18 $ 1.37 $ 1.62 $ 1.29 ======== ======== ======== ======== Premiums earned by segment: Property and casualty insurance $143,113 $128,516 $126,440 $127,573 Reinsurance .................... 34,105 36,675 35,826 37,256 -------- -------- -------- -------- Total ...................... $177,218 $165,191 $162,266 $164,829 ======== ======== ======== ======== Balance Sheet Data Total assets ..................... $459,110 $430,328 $412,881 $387,370 ======== ======== ======== ======== Stockholders' equity ............. $162,346 $148,729 $136,889 $116,727 ======== ======== ======== ======== Other Data Average return on equity ......... 8.5% 10.5% 13.7% 11.9% ======== ======== ======== ======== Book value per share ............. $ 14.30 $ 13.42 $ 12.66 $ 11.03 ======== ======== ======== ======== Dividends paid per share ......... $ .60 $ .57 $ .53 $ .52 ======== ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 22% 22% 22% 22% ======== ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 100% 95% 95% 95% ======== ======== ======== ======== Closing stock price ............. $ 13.25 $ 12.00 $ 13.75 $ 9.50 ======== ======== ======== ======== Net investment yield (pre-tax) .... 6.15% 6.54% 6.65% 6.59% ======== ======== ======== ======== Cash dividends to closing stock price ............ 4.5% 4.8% 3.9% 5.5% ======== ======== ======== ======== Common shares outstanding ........ 11,351 11,084 10,814 10,577 ======== ======== ======== ======== Statutory trade combined ratio ... 106.2% 103.6% 99.6% 101.3% ======== ======== ======== ========
Year ended December 31, -------------------------- 1993 1992 1991 -------- -------- -------- ($ in thousands, except per share amounts) Income Statement Data Insurance premiums earned ........ $156,438 $147,410 $113,419 Investment income, net ........... 20,936 21,586 20,223 Realized investment gains ........ 684 384 65 Other income ..................... 668 701 860 -------- -------- -------- Total revenues .............. 178,726 170,081 134,567 Losses and expenses .............. 169,707 169,106 124,135 -------- -------- -------- (Loss) income before income tax (benefit) expense .......... 9,019 975 10,432 Income tax (benefit) expense ..... 1,885 759 3,124 -------- -------- -------- (Loss) income from: Continuing operations ......... 7,134 216 7,308 Discontinued operations ....... - - 1,853 Accounting changes ............ 2,621 - - -------- -------- -------- Net (loss) income .......... $ 9,755 $ 216 $ 9,161 ======== ======== ======== Net (loss) income per common share - basic and diluted: Continuing operations ....... $ .70 $ .02 $ .73 Discontinued operations ..... - - .18 Accounting changes .......... .26 - - -------- -------- -------- Total ...................... $ .96 $ .02 $ .91 ======== ======== ======== Premiums earned by segment: Property and casualty insurance $123,114 $120,795 $ 88,410 Reinsurance .................... 33,324 26,615 25,009 -------- -------- -------- Total ...................... $156,438 $147,410 $113,419 ======== ======== ======== Balance Sheet Data Total assets ..................... $368,936 $372,807 $311,001 ======== ======== ======== Stockholders' equity ............. $109,634 $100,911 $105,144 ======== ======== ======== Other Data Average return on equity ......... 9.3% .2% 8.9% ======== ======== ======== Book value per share ............. $ 10.63 $ 9.98 $ 10.47 ======== ======== ======== Dividends paid per share ......... $ .52 $ .52 $ .52 ======== ======== ======== Property and casualty insurance subsidiaries aggregate pool percentage ..................... 22% 22% 17% ======== ======== ======== Reinsurance subsidiary quota share percentage ............... 95% 95% 95% ======== ======== ======== Closing stock price ............. $ 9.50 $ 8.50 $ 9.50 ======== ======== ======== Net investment yield (pre-tax) ... 6.83% 7.50% 8.02% ======== ======== ======== Cash dividends to closing stock price ............ 5.5% 6.1% 5.5% ======== ======== ======== Common shares outstanding ........ 10,317 10,112 10,046 ======== ======== ======== Statutory trade combined ratio ... 106.3% 113.9% 109.2% ======== ======== ========
Amounts previously reported in prior consolidated financial statements have been reclassified to conform to current presentation. EX-13 8 exh13b.txt MANAGEMENT DISCUSSION & ANALYSIS 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., a 79.5 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 76.7 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. Employers Mutual and all of its subsidiaries (including the Company) and an affiliate, are referred to as the "EMC Insurance Companies." 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. The aggregate participation of the Company's property and casualty insurance subsidiaries is 23.5 percent. Operations of the pool give rise to inter-company 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. The Company's reinsurance subsidiary assumes a 100 percent quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. This includes all premiums and related losses and settlement expenses of this business, subject to a maximum loss of $1,500,000 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 inter-company balances with Employers Mutual, which are settled on a quarterly basis. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The reinsurance subsidiary pays an annual override commission to Employers Mutual in connection with the $1,500,000 cap on losses assumed per event. Effective January 1, 2000, the override commission rate was reduced to 4.50 percent of written premiums from 5.25 percent of written premiums because of good loss experience. 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, excluding reinstatement premiums. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary. CRITICAL ACCOUNTING POLICIES The following accounting policies are considered by management to be critically important in the preparation and understanding of the Company's financial statements and related disclosures. The assumptions utilized in the application of these accounting policies are complex and require a significant amount of subjective judgment. Loss and settlement expense reserves 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. The amount of loss and settlement expense reserves reflected in the Company's financial statements is determined based on an estimation process that is very complex and uses information obtained from both Company specific and industry data, as well as general economic information. The most significant assumptions used in the estimation process, which vary by line of business, include determining the trend in loss costs, the expected consistency in the frequency and severity of claims, changes in the timing of the reporting of losses from the loss date to the notification date and expected costs to settle unpaid claims. Established reserves are closely monitored and are frequently recomputed using a variety of formulas and statistical techniques. The Company develops a range of expected reserves based on the results of this analysis to determine the reasonableness of the carried reserves. Should currently unknown or unidentified trends emerge that would indicate that a change has occurred in the data supporting the assumptions utilized in the estimation process, the Company would react accordingly, which could result in upward adjustments to the Company's reserves. Deferred Policy Acquisition Costs and Related Amortization Deferred policy acquisition costs are used to match the expenses incurred in the production of insurance business to the income earned on this business. This adjustment is necessary because statutory accounting principals require that expenses incurred in the production of insurance business be expensed immediately, while premium income is recognized ratably over the terms of the underlying insurance policies. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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. Amortization of deferred policy acquisition costs is calculated as the difference between the beginning and ending amounts of deferred policy acquisition costs plus the amount of costs deferred during the current year. Deferred policy acquisition costs and related amortization are calculated separately for the property and casualty insurance segment and the reinsurance segment. Deferred policy acquisition costs were not subject to limitation at December 31, 2001; however, the reinsurance segment could be subject to such a limitation in the next two years if underwriting results do not improve. Management does not consider this limitation to be likely due to the improving rate environment for both the reinsurance segment and the reinsurance industry. Deferred Income Taxes The realization of the deferred income tax asset is based upon projections that indicate that a sufficient amount of future taxable income will be earned to utilize the tax deductions that will reverse in the future. These projections are based on the Company's history of producing significant amounts of taxable income, the improving premium rate environment for both the property and casualty insurance segment and the reinsurance segment and loss and expense control initiatives that have been implemented during the last two years. In addition, management has formulated tax-planning strategies that could be implemented to generate taxable income if needed. Should the projected taxable income and tax planning strategies not provide sufficient taxable income to recover the deferred tax asset, a valuation allowance would be required. CONSOLIDATED RESULTS OF OPERATIONS Operating results for the three years ended December 31, 2001 are as follows: ($ in thousands) 2001 2000 1999 -------- -------- -------- Premiums earned .......................... $265,280 $231,459 $211,098 Losses and settlement expenses ........... 221,919 189,522 176,876 Acquisition and other expenses ........... 80,251 71,401 66,760 -------- -------- -------- Underwriting loss ........................ (36,890) (29,464) (32,538) Net investment income .................... 30,970 29,006 25,760 Other (loss) income ...................... (422) (35) 510 -------- -------- -------- Operating loss before income tax benefit (6,342) (493) (6,268) Realized investment gains ................ 800 1,558 277 -------- -------- -------- (Loss) income before income tax benefit .. (5,542) 1,065 (5,991) Income tax benefit ....................... (3,436) (1,264) (5,187) -------- -------- -------- Net (loss) income ........................ $ (2,106) $ 2,329 $ (804) ======== ======== ======== Incurred losses and settlement expenses: Insured events of current year ......... $216,752 $191,425 $182,609 Increase (decrease) in provision for insured events of prior years ........ 5,167 (1,903) (5,733) -------- -------- -------- Total losses and settlement expenses $221,919 $189,522 $176,876 ======== ======== ======== Catastrophe and storm losses ............. $ 22,947 $ 8,604 $ 11,162 ======== ======== ======== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Operating results before income taxes declined significantly in 2001 despite continued improvement in overall premium rate adequacy. This decline is primarily attributed to a record amount of catastrophe and storm losses and an unusually large amount of adverse development on prior years' reserves which was evident in both the property and casualty insurance segment and the reinsurance segment. In addition, the results for 2001 were negatively impacted by $1,328,000 of surety bond losses in the reinsurance segment stemming from the Enron collapse. The improvement in the operating results for 2000 was attributed to the property and casualty insurance segment, which experienced a decline in loss frequency and a moderate increase in overall premium rate adequacy. Inadequate premium rates, which resulted from several years of intense rate competition within the insurance industry, continued to hamper the Company's performance during 2001. After bottoming out in 1998, premium rate levels have shown moderate, but steady, improvement over the last three years. During 2000 and 2001, implemented rate increases have grown progressively larger as a result of industry-wide movement toward adequate premium rate levels and this trend of progressively larger rate increases is expected to intensify through 2002. Based on these trends and current projections, management believes that premium rates could approach adequate levels for the first time in nearly a decade in 2003. The improvement that has been achieved in premium rate adequacy over the last three years will have a positive impact on future operating results, but the unpredictable nature of catastrophe and storm losses will remain. In the meantime, management continues to work toward improving profitability through focused underwriting programs for the existing book of business, reviews of the agency force and controlled usage of discretionary rate credits. Effective January 1, 2001, the Company began recording the full-term written premium and related commission expense at the inception of insurance policies that are billed on an installment basis. Previously, such amounts were recorded as each installment became due. As a result, written premiums and unearned premiums increased $13,884,000, invested assets increased $11,881,000 and the Company incurred $1,706,000 of commission expense and $297,000 of premium tax expense. These expenses were offset by a $3,054,000 increase in deferred policy acquisition costs, resulting in $1,051,000 of non- recurring income that was amortized into operations on a quarterly basis. Operating results for 2001 were not materially impacted by the terrorist attack on the World Trade Center. The property and casualty insurance segment incurred losses of $56,000 from this event while the reinsurance segment's losses were capped at $1,500,000 under the quota share agreement with Employers Mutual. The reinsurance segment recorded $2,001,000 of reinstatement premium income and $190,000 of commission expense on its assumed book of business but was not required to pay the reinstatement premiums on Employers Mutual's outside reinsurance protection, which totaled $2,450,000, under the terms of the quota share agreement. Reinstatement premiums are a common provision in catastrophe reinsurance contracts that allow reinsurance coverage that has been depleted to be "reinstated" for the remainder of the contract term through the payment of additional premium. In addition, the World Trade Center loss resulted in the elimination of a $310,000 contingent commission income accrual that had been established in the second quarter of 2001 by the reinsurance segment due to good loss experience on the outside reinsurance program. The net impact reflected in the Company's financial statements for the World Trade Center catastrophe was a loss of $55,000. The operating results reported for 2000 include earnings of $1,517,000 associated with a change in the property and casualty insurance segment's estimate of additional premium income expected on policies, primarily workers' compensation, subject to audit. This change in estimate was prompted by additional research that was conducted in connection with a required change in the tax accounting method used for recognizing audit-based premiums. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Premiums earned increased 14.6 percent in 2001, 9.6 percent in 2000 and 8.7 percent in 1999. Both the property and casualty insurance segment and the reinsurance segment achieved significant growth in 2001 through a combination of implemented rate increases and increased exposures. Applications for insurance coverage continued at high levels during 2001 despite rising premium rates due to the fact that some of the Company's competitors have withdrawn from certain markets or implemented larger rate increases. The Company continues to be selective in the insurance risks that it accepts and has been able to price both new and renewal business at more adequate levels. Policy counts remained relatively steady in the commercial lines of business during 2001 and decreased slightly in the personal lines of business. Losses and settlement expenses increased 17.1 percent in 2001, 7.1 percent in 2000 and 12.0 percent in 1999. Active storm patterns during 2001 produced a record amount of catastrophe and storm losses for the Company and kept catastrophe and storm losses at an elevated level for the third time in the last four years, compounding the impact of the inadequate premium rate levels that have existed during this time period. In addition, the Company experienced a significant amount of adverse development on prior years' reserves in 2001, which contributed to the large increase in losses and settlement expenses. The Company has historically experienced favorable development in its reserves and its reserving practices have not changed; however, the amount of development experienced will fluctuate from year to year as individual claims are settled and new information becomes available on open claims. The results for 2000 reflect a decline in overall loss frequency in the property and casualty insurance segment, but this improvement was partially offset by increased loss experience in the reinsurance segment. Results for 1999 reflect an unusually large increase in both the frequency and severity of losses unrelated to catastrophe and storm activity. The catastrophe and storm loss amounts reported for 1999 reflect ceded reinsurance recoveries of $3,825,000 related to an aggregate excess of loss catastrophe reinsurance agreement that was in effect that year for the property and casualty insurance segment. Due to substantial changes in both the terms and the cost of the coverage, this reinsurance protection was not renewed for 2000 and subsequent years. Acquisition and other expenses increased 12.4 percent in 2001, 7.0 percent in 2000 and 5.0 percent in 1999. These increases are primarily attributed to the higher premium levels reported for these years. The increase for 2001 was limited by the increase in deferred policy acquisition costs that resulted from the change in the recording of installment based premiums. The increase in 2000 was limited by a $824,000 decline in contingent commission expense in the reinsurance subsidiary. Net investment income increased 6.8 percent in 2001, 12.6 percent in 2000 and 3.6 percent in 1999. The increase for 2001 is primarily attributed to a higher average invested balance in fixed maturity securities. During 2001 the Company experienced a significant amount of call activity on its fixed maturity securities due to the large decline in interest rates. Proceeds from this call activity were reinvested at lower current interest rates, which will have a negative impact on future investment income. The large increase in 2000 reflects both a higher average invested balance in fixed maturity securities and an increase in the average rate of return earned on the fixed maturity portfolio. During 2000 and 1999, the Company sold approximately $69,000,000 of tax-exempt securities and reinvested the proceeds into taxable securities in order to achieve a better rate of return after taxes. The increase in 1999 is attributed to an increase in the average invested asset balance. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Realized investment gains have fluctuated considerably over the last three years due to changes in the Company's investment strategies and the bond and equity markets. Realized investment gains for 2001 include $563,000 from the Company's equity portfolio, net of $310,000 of realized losses associated with the sale of Enron stock, with the remainder coming primarily from calls on taxable fixed maturity securities. The realized investment gains of 2000 include $531,000 from the disposal of tax-exempt fixed maturity securities, $531,000 from the disposal of other fixed maturity securities and $496,000 from the Company's equity portfolio. The realized investment gains for 1999 reflected $1,590,000 of gains from the disposal of tax-exempt fixed maturity securities, but these gains were mostly offset by realized losses of $1,321,000 that were recognized on the Company's equity portfolio. Income tax benefits have fluctuated during the last three years in conjunction with the Company's operating results and a decline in the amount of tax-exempt interest income earned. Due to the change in the allocation of the Company's investment portfolio noted above, tax-exempt interest decreased from $6,784,000 in 1999 to $4,922,000 in 2000 and $4,314,000 in 2001. The income tax benefit for 2000 reflects $470,000 of benefit from the elimination of an accrual that had been carried for potential tax examination adjustments and $775,000 of expense associated with required changes in the tax accounting methods used to recognize audit-based premiums and installment premiums. The income tax benefit for 1999 includes $800,000 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. In December of 2001, three of the Company's property and casualty insurance subsidiaries issued an aggregate of $25,000,000 of surplus notes with an interest rate of 5.38 percent to Employers Mutual. These surplus notes were issued in response to leverage concerns raised by certain regulatory authorities. The amount of insurance that a property and casualty insurance company writes under industry standards is commonly expressed as a multiple of its surplus calculated in accordance with statutory accounting practices. Generally, a ratio of 3 to 1 is considered satisfactory by regulatory authorities. The surplus position of these three companies had declined over the last three years due to substandard operating results and the payment of dividends to the parent company. A preliminary analysis of the 2001 operating results indicated that the writings to surplus ratio for these three companies would likely exceed the 3 to 1 level at December 31, 2001 if surplus notes were not issued. It should be noted that surplus notes are considered to be a component of surplus for statutory reporting purposes due to the fact that the notes have no maturity date and all payments of interest and principal must be approved in advance by the insurance commissioner of the state of domicile of the respective insurance company; however, under generally accepted accounting principals, surplus notes are considered to be debt and are reported as a liability in the Company's financial statements. A.M. Best Company, an insurance industry rating agency, announced on July 10, 2001 that their rating of the EMC Insurance Companies, which includes the Company's property and casualty insurance subsidiaries, was changed from "A" (Excellent) to "A-" (Excellent). This rating action reflects A.M. Best's opinion of the EMC Insurance Companies' underwriting performance and operating losses during the three years ended December 31, 2000. Despite this rating action, A.M. Best stated that the EMC Insurance Companies' "Excellent" rating reflects its strong capitalization, conservative operating strategies and local-market presence. Management does not believe that the new rating will have a material impact on the Company's operations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The September 11, 2001 terrorist attack on the World Trade Center had a significant impact on the operating results of the insurance industry in 2001, but the repercussions of this atrocious act will last well beyond 2001. Limitations of coverage, exclusions for terrorist activities and significant increases in pricing were commonplace for reinsurance policies renewing in January 2002. The Company's property and casualty insurance subsidiaries were not immune to these factors and experienced significantly higher costs and increased retentions when their reinsurance program was renewed for 2002. Due to the lack of action by Congress to address the need for a federal government reinsurance program for terrorist acts, most states, with the exception of California and New York, have adopted changes to their laws which allow insurance companies to exclude terrorism coverage on commercial lines of business if reinsurance protection is not available. To date, the Company's property and casualty insurance subsidiaries have not implemented across-the- board terrorism exclusions on their commercial lines of business and has chosen instead to evaluate each commercial risk for terrorism exposures. State insurance laws do not allow terrorism exclusions for workers' compensation or personal lines of business. The property and casualty insurance subsidiaries have purchased separate terrorism coverage for 2002 in order to provide limited protection from future terrorist exposures, as all standard reinsurance policies now exclude coverage for terrorist activities., SEGMENT RESULTS Property and Casualty Insurance Operating results for the three years ended December 31, 2001 are as follows: ($ in thousands) 2001 2000 1999 -------- -------- -------- Premiums earned .......................... $203,393 $184,986 $167,265 Losses and settlement expenses ........... 168,344 149,519 140,481 Acquisition and other expenses ........... 61,877 57,748 53,310 -------- -------- -------- Underwriting loss ........................ (26,828) (22,281) (26,526) Net investment income .................... 22,458 20,788 18,283 Other (loss) income ...................... (62) 286 781 -------- -------- -------- Operating loss before income taxes ....... $ (4,432) $ (1,207) $ (7,462) ======== ======== ======== Incurred losses and settlement expenses: Insured events of current year ......... $167,152 $152,360 $145,806 Increase (decrease) in provision for insured events of prior years ........ 1,192 (2,841) (5,325) -------- -------- -------- Total losses and settlement expenses $168,344 $149,519 $140,481 ======== ======== ======== Catastrophe and storm losses ............. $ 15,813 $ 7,945 $ 7,389 ======== ======== ======== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Premiums earned increased 10.0 percent in 2001, 10.6 percent in 2000 and 7.6 percent in 1999. The majority of the growth for 2001 is attributed to rate increases that were implemented during the last two years and an increase in the exposure base of the commercial lines of business. Premium rate levels for property and casualty insurance continued to improve during 2001 as average rate level increases ranging from six to eighteen percent were implemented in virtually all lines of business, with larger increases for individual accounts. Premium rate increases have grown progressively larger during the last two years and this trend is expected to intensify through 2002. Based on current trends and projections, management anticipates that premium rates could approach adequate levels by early 2003. It should be noted, however, that it takes a considerable amount of time for implemented rate increases to have a noticeable impact on underwriting results due to the timing of policy renewals and the fact that premiums are earned ratably over the life of the policy. The growth in premium income during 2000 and 1999 was driven primarily by an increase in policy count, which resulted from an improved retention rate on renewal business and a steady amount of new business. Results for 2000 also benefited from an increase in the exposure base on commercial lines of business as well as rate increases in most lines of business. The premium income amount for 2000 includes $1,727,000 of income associated with a change in the estimate of additional premium income expected on policies, primarily workers' compensation, subject to audit as of December 31, 2000. This change in estimate was prompted by additional research that was conducted in connection with a required change in the tax accounting method used for recognizing audit-based premiums. Losses and settlement expenses increased 12.6 percent in 2001, 6.4 percent in 2000 and 9.2 percent in 1999. The increase for 2001 reflects a record amount of catastrophe and storm losses, an unusually large amount of adverse development on prior years' reserves and an increase in both large losses and loss severity. Catastrophe and storm losses have had an unusually large impact on operating results in three of the last four years due to the persistence of active storm patterns that began in 1998. During 2001, these active storm patterns produced large areas of wind and hail damage in the Midwest where the Company has a concentration of property exposures. During the fourth quarter of 2001, the property and casualty insurance segment experienced an unusually large amount of adverse development on prior years' reserves, which resulted in adverse development being reported for the year. This adverse development is attributed to the revaluation of individual claim liabilities in select lines of business, a revaluation of formula based settlement expense reserves and an increase in paid settlement expenses. The property and casualty insurance subsidiaries have historically experienced favorable development in their reserves and reserving practices have not been changed; however, the amount of development experienced will fluctuate from year to year as individual claims are settled and additional information becomes available on open claims. The improvement in 2000 results was primarily attributed to a substantial decline in loss frequency from the elevated levels experienced in 1999. Acquisition and other expenses increased 7.2 percent in 2001, 8.3 percent in 2000 and 3.6 percent in 1999. These increases are primarily related to the growth in premium income reported for these years. The increase for 2001 was limited by the increase in deferred policy acquisition costs associated with the change in the recording of installment based policies. in addition, acquisition and other expenses for 2001 include $688,000 of estimated guaranty fund assessments stemming from the Reliance Insurance Company insolvency, which is the largest insolvency in the history of the property and casualty insurance industry. When an insurance company is declared insolvent, claims that can not be satisfied through the defunct insurance company's assets are turned over to state guaranty funds for payment through assessments against the solvent companies writing business in their state. These assessments are payable over a number of years and most states permit a portion of these assessments to be used as an offset in the calculation of premium taxes. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The property and casualty insurance segment has reported a substantial amount of underwriting losses during the last three years due to a combination of inadequate premium rates, increasing levels of catastrophe and storm losses, less favorable development of prior years' reserves and increased loss severity and frequency. Underwriting results for 2001 did benefit from an improvement in premium rate adequacy; however, this improvement was overshadowed by a record amount of catastrophe and storm losses and an unusually large amount of adverse development on prior years' reserves. Premium rates are expected to continue to improve during 2002 and approach adequate levels in 2003. The improvement that has been, and is expected to be, achieved in premium rate adequacy will have a positive impact on future operating results, but the unpredictable nature of catastrophe and storm losses will remain. Management continues to work toward improving profitability through focused underwriting programs for the existing book of business, reviews of the agency force and controlled usage of discretionary rate credits. Reinsurance Operating results for the three years ended December 31, 2001 are as follows: ($ in thousands) 2001 2000 1999 Premiums earned ............................ $ 61,887 $ 46,473 $ 43,833 Losses and settlement expenses ............. 53,575 40,003 36,395 Acquisition and other expenses ............. 18,374 13,653 13,450 -------- -------- -------- Underwriting loss .......................... (10,062) (7,183) (6,012) Net investment income ...................... 8,318 7,873 7,114 Other income ............................... 78 80 119 -------- -------- -------- Operating (loss) income before income taxes $ (1,666) $ 770 $ 1,221 ======== ======== ======== Incurred losses and settlement expenses: Insured events of current year ........... $ 49,600 $ 39,065 $ 36,803 Increase (decrease) in provision for insured events of prior years .......... 3,975 938 (408) -------- -------- -------- Total losses and settlement expenses $ 53,575 $ 40,003 $ 36,395 ======== ======== ======== Catastrophe and storm losses ............... $ 7,134 $ 659 $ 3,773 ======== ======== ======== Premium income increased 33.2 percent in 2001, 6.0 percent in 2000 and 13.2 percent in 1999. The large increase for 2001 reflects the addition of a new marine syndicate account and several new contracts, growth in the exposure base of existing contracts, modest rate increases and approximately $2,001,000 of reinstatement premiums associated with the World Trade Center catastrophe. Industry premium rates, which started to rebound in 2000, continued to show accelerating growth during 2001. Aggressive rate increases were placed on all classes of assumed reinsurance business during the January 2002 renewal season, which is when the majority of the reinsurance subsidiary's contracts renew. These rate increases are in line with the movement of the reinsurance industry as a whole towards more adequate rate levels, particularly in light of the World Trade Center terrorist attack. The increase for 2000 was produced by growth in the exposure base on existing contracts and the addition of several new contracts. Premium rate increases had a very minor impact on premium growth in 2000, as renewal rates were flat during the January 2000 renewal season. It should be noted that the production increases reported for 2000 and 1999 were distorted by the delayed reporting of several foreign reinsurance contracts that were written in 1998 but were included in 1999 results. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Losses and settlement expenses increased 33.9 percent in 2001, 9.9 percent in 2000 and 24.6 percent in 1999. The increase in 2001 is primarily attributed to a substantial increase in catastrophe and storm losses and an unusually large amount of adverse development on prior years' reserves. Catastrophe and storm losses for 2001 included two large Midwest wind and hail storms, flood losses from tropical storm Allison and losses from the terrorist attack on the World Trade Center. The losses associated with these four events were capped at $1,500,000 each under the terms of the quota share agreement with Employers Mutual. The adverse development reported for 2001 is primarily associated with construction defect claims arising from a reinsurance pool that the reinsurance subsidiary participates in. The results for 2001 also include $1,328,000 of surety bond losses stemming from the Enron collapse. Results for 2000 benefited from a significant decline in catastrophe and storm losses; however, this benefit was partially offset by adverse development on prior years' reserves, including those established for 1999 European storms, increased loss severity on several aggregate treaties and property contracts, and increased loss frequency in the workers' compensation line of business. Results for 1999 reflect a large decline in the amount of favorable development experienced on prior years' reserves, heavy storm losses in Europe and large losses on several property per-risk, property pro-rata and aggregate excess of loss contracts. Acquisition and other expenses increased 34.6 percent in 2001, 1.5 percent in 2000 and 11.2 percent in 1999. These increases are primarily related to the production increases noted above. The reinstatement premiums recognized during 2001 resulted in the recognition of approximately $100,000 of commission expense and $90,000 of override commission expense. Commission rates on reinstatement premiums are much lower than the rates imposed on the base premium. The relatively small increase for 2000 is attributed to two transactions that produced a $824,000 decline in contingent commission expense. The first transaction was the receipt of $420,000 of profit share commission income associated with the outside reinsurance protection that the reinsurance subsidiary pays for to protect Employers Mutual from catastrophic losses on its assumed book of business. The second transaction was a $404,000 decline in contingent commission expense that was recognized by a reinsurance pool that the reinsurance subsidiary participates in. Underwriting results have declined steadily over the last three years due to inadequate premium rates, higher levels of catastrophe and storm losses, adverse development on prior years' reserves and increased loss severity. Industry premium rate levels bottomed out in 1999 and have slowly improved over the last two years. The September 11 terrorist attack on the World Trade Center has accelerated the pace of premium rate increases across the industry and the reinsurance subsidiary was able to implement aggressive rate increases on all classes of assumed reinsurance business during the January 2002 renewal season. These rate increases, coupled with increased retentions and coverage exclusions (primarily exclusions for terrorism losses), are expected to push reinsurance rates to an adequate level by the end of 2002. Underwriting results should benefit from this improved rate adequacy, but it is unknown whether the trend of increased loss frequency and severity will continue. Parent Company The parent company reported operating losses before income taxes of $244,000, $56,000, and $27,000 in 2001, 2000 and 1999, respectively. These declining operating results are primarily attributed to a reduction in investment income associated with a decline in the average invested asset balance. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 amounted to $2,566,000 at December 31, 2001. Approximately $1,392,000 of these reserves are attributed to the reinsurance business assumed by the Company's reinsurance subsidiary with the remaining $1,174,000 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. The Company considers itself to be a long-term investor and generally purchases fixed maturity investments with the intent to hold them to maturity. Despite this intent, the Company has historically classified a portion of its fixed maturity investments as available-for-sale securities to provide flexibility in the management of the portfolio. Since the third quarter of 1999, all newly acquired fixed maturity investments have been classified as available-for-sale securities to provide increased management flexibility. The Company had an unrealized holding gain on fixed maturity securities available-for-sale of $4,494,000 at December 31, 2001 compared to an unrealized holding gain of $3,107,000 at December 31, 2000 and an unrealized holding loss of $7,539,000 at December 31, 1999. The fluctuation in the market value of these investments is primarily due to changes in the interest rate environment during this time period. 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 the Company established a valuation allowance of $1,233,000 for the deferred tax asset associated with the unrealized holding losses on the Company's available-for-sale securities. This valuation allowance was established due to uncertainties concerning the future realization of the tax benefit. During 2000, the valuation allowance was eliminated as the Company had a net unrealized holding gain on its available-for-sale securities. The majority of the Company's assets are invested in fixed maturity securities. These investments provide a substantial amount of investment income that supplements underwriting results and contributes to net earnings. As these investments mature, or are called, the proceeds 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. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company participates 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, primarily cash, equal to 102 percent of the market value of the loaned securities. During 1999 and 2000 the Company sold approximately $55,000,000 and $14,000,000, respectively, 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. 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, interest and principal payments on debt and investment purchases. The Company generated positive cash flows from operations of $47,087,000 in 2001, $21,519,000 in 2000 and $22,457,000 in 1999. The amount for 2001 includes $11,880,803 received from Employers Mutual in connection with a change in the recording of written premiums and commissions on policies billed on an installment basis. 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. Employers Mutual continued to reinvest 100 percent of its dividends in additional shares of the Company's common stock during 2001. 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. Employers Mutual has advised the Company that it intends to reinvest 25 percent of its dividends in additional shares of the Company's common stock during 2002. As a result of this dividend reinvestment activity, the Company expects to become an 80 percent owned subsidiary of Employers Mutual during 2002. At that time the Company will begin filing a consolidated tax return with Employers Mutual and its subsidiaries. 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 investment committees of the respective boards of directors for each of the Company's subsidiaries. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. 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. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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, 2001 would result in a corresponding pre-tax decrease in the fair value of the fixed maturity portfolios of approximately $27,960,000 or 5.4 percent. In addition, a hypothetical one percent decrease in interest rates at December 31, 2001 would result in a corresponding decrease in pre-tax income over the next twelve months of approximately $1,098,000, based on current maturity and prepayment patterns and assuming that all securities with applicable call provisions would be redeemed and that the proceeds would be reinvested at the lower rate. 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, 2001 was 5.15 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 index as of December 31, 2001 would result in a corresponding pre-tax decrease in the fair value of the Company's equity portfolio of approximately $2,805,000. The Company invests in high quality fixed maturity securities, thus minimizing credit quality risk. At December 31, 2001, the portfolio of long- term fixed maturity securities consists of 8.3 percent U.S. Treasury, 7.3 percent government agency, 6.8 percent mortgage-backed, 15.7 percent municipal, and 61.9 percent corporate securities. At December 31, 2000, the portfolio of long-term fixed maturity securities consisted of 12.5 percent U.S. Treasury, 12.2 percent government agency, 12.3 percent mortgage-backed, 19.1 percent municipal, and 43.9 percent corporate securities. The Company has one bond series (Southern California Edison) that has gone into default. The bond's market value has since recovered, and it is currently being carried at its book and market value of $1,400,000. 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, 2001, the effective duration of the mortgage- backed securities is 2.62 years with an average life and current yield of 4.6 years and 7.3 percent, respectively. At December 31, 2000, the effective duration of the mortgage-backed securities was 3.9 years with an average life and current yield of 5.4 years and 7.4 percent, respectively. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 premium writings in 2002 after the issuance of the $25,000,000 of surplus notes in December 2001. As previously noted, all payments of interest and principal on the surplus notes must be approved in advance by the insurance commissioner of the state of domicile of the respective insurance company. Interest payments are due January 1 of each year and, like the principal amount of the notes, can only be paid out of surplus earnings of the respective companies. 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, 2001, 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 insurance 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 $5,525,000, $6,375,000 and $6,800,000 of dividends from its insurance subsidiaries and paid cash dividends to its stockholders totaling $6,787,000, $6,771,000 and $6,793,000 in 2001, 2000 and 1999, respectively. As of December 31, 2001, 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. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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 deferred the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB statement No. 133." SFAS No. 138 addresses a limited number of Statement No. 133 implementation issues, and was effective for fiscal years beginning after June 15, 2000. Currently, the Company's investment strategy does not include investments in derivative instruments or hedging activities. Therefore, adoption of this statement did not have any effect on the operating results of the Company. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires the purchase method of accounting for all business combinations initiated after June 30, 2001 and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 addresses accounting for intangible assets, eliminates the amortization of goodwill and provides specific steps for testing the impairment of goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, the amortization provisions apply to goodwill and intangible assets acquired after June 30, 2001. Other than the requirement to eliminate the future amortization of the Company's carried goodwill, which has amounted to $135,000 per year, adoption of these statements is not expected to have an impact on the operating results of the Company. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective for fiscal years beginning after December 15, 2001. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. Adoption of this statement will not have any effect on the operating results of the Company. DEVELOPMENTS IN INSURANCE REGULATION In 1998, in a move to provide a consistent and comprehensive basis of statutory accounting for all insurance companies, the NAIC adopted a comprehensive Codification of Statutory Accounting Principles (Codification). Codification became effective in most states, including the states of domicile of the Company's insurance subsidiaries, on January 1, 2001, and replaced the then current Accounting Practices and Procedures Manual as the NAIC's primary guidance on statutory accounting. The adoption of Codification resulted in changes to the accounting practices that the Company's insurance subsidiaries were using to prepare their statutory financial statements. One of the more significant changes was the recording of deferred income taxes. As a result of the adoption of Codification, the statutory surplus of the Company's insurance subsidiaries increased by approximately $9,110,000 on January 1, 2001. 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; terrorist activities and federal solutions to make available insurance coverage for acts of terrorism; timely collection of amounts due under ceded reinsurance contracts; rating agency actions; and other risks and uncertainties inherent in the Company's business. EX-13 9 exh13c.txt FINANCIAL STATEMENTS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 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 accounting principles generally accepted in the United States and include amounts that are based on management's estimates and judgments where necessary. The Company's financial statements have been audited by Ernst & Young LLP, independent certified public accountants. Management has made available to Ernst & Young 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 Ernst & Young 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 the independent auditors 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, 2001, 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 auditors to review and discuss audit findings and other financial and accounting matters. The independent auditors and the internal auditors have free access to the Audit Committee, with and without management present, to discuss the results of their audit work. /s/ Bruce G. Kelley /s/ Mark E. Reese - ----------------------- ----------------------- Bruce G. Kelley Mark E. Reese President and Vice President and Chief Executive Officer Chief Financial Officer Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Stockholders EMC Insurance Group Inc. We have audited the accompanying consolidated balance sheet of EMC Insurance Group Inc. and Subsidiaries as of December 31, 2001, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated balance sheet of EMC Insurance Group Inc. and Subsidiaries as of December 31, 2000 and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2000, were audited by other auditors whose report dated February 27, 2001 expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion. In our opinion, the 2001 financial statements referred to above present fairly, in all material respects, the consolidated financial position of EMC Insurance Group Inc. and Subsidiaries at December 31, 2001 and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. /s/Ernst & Young LLP February 26, 2002 Des Moines, Iowa Report of KPMG LLP, Independent Auditors The Board of Directors and Stockholders EMC Insurance Group Inc.: We have audited the accompanying consolidated balance sheet of EMC Insurance Group Inc. and Subsidiaries as of December 31, 2000, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 2000. 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 auditing standards generally accepted in The United States of America. 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, 2000, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2000, in conformity with accounting principles generally accepted in The United States of America. /s/ KPMG LLP Des Moines, Iowa February 27, 2001 EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, -------------------------- 2001 2000 ASSETS ------------ ------------ Investments (notes 1 and 9): Fixed maturities: Securities held-to-maturity, at amortized cost (fair value $35,502,755 and $70,975,728) ..... $ 33,572,602 $ 70,202,394 Securities available-for-sale, at fair value (amortized cost $384,410,393 and $279,770,031) 390,214,177 284,400,891 Equity securities available-for-sale, at fair value (cost $28,686,321 and $28,742,915) ...... 33,322,767 34,720,458 Short-term investments, at cost ................. 17,724,458 23,388,027 Fixed maturity securities on loan: Securities held-to-maturity, at amortized cost (fair value $35,962,133 and $48,599,702) .... 32,505,305 45,509,199 Securities available-for-sale, at fair value (amortized cost $27,325,968 and $9,679,449) 28,436,008 9,755,774 ------------ ------------ Total investments ........................... 535,775,317 467,976,743 Cash .............................................. 558,073 490,226 Indebtedness of related party (note 2) ............ - 3,799,671 Accrued investment income ......................... 8,659,008 7,345,363 Accounts receivable (net of allowance for uncollectible accounts of $573,502 and $633,000) 1,081,024 274,014 Income taxes recoverable .......................... 100,614 735,911 Reinsurance receivables (note 3) .................. 14,501,336 11,925,355 Deferred policy acquisition costs (note 12) ....... 21,363,528 15,636,753 Deferred income taxes (note 10) ................... 18,328,807 15,445,251 Intangible assets, including goodwill, at cost less accumulated amortization of $2,616,234 and $2,481,721 .................................. 941,586 1,076,099 Prepaid reinsurance premiums (note 3) ............. 2,275,231 1,945,099 Securities lending collateral (note 1) ............ 66,809,518 60,254,637 Other assets ...................................... 1,170,655 770,552 ------------ ------------ Total assets ................................ $671,564,697 $587,675,674 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, -------------------------- 2001 2000 LIABILITIES ------------ ------------ Losses and settlement expenses (notes 2, 4 and 5) $314,518,588 $286,489,028 Unearned premiums (notes 2 and 12) ............... 99,382,176 73,678,414 Other policyholders' funds ....................... 472,952 728,653 Surplus notes payable (note 11) .................. 25,000,000 - Indebtedness to related party (note 2) ........... 2,684,418 - Postretirement benefits (note 13) ................ 6,967,484 6,848,512 Deferred income .................................. - 78,212 Securities lending obligation (note 1) ........... 66,809,518 60,254,637 Other liabilities ................................ 15,271,938 11,204,902 ------------ ------------ Total liabilities .......................... 531,107,074 439,282,358 ------------ ------------ STOCKHOLDERS' EQUITY (notes 6, 7 and 14) Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,329,987 shares in 2001 and 11,294,220 shares in 2000 .......... 11,329,987 11,294,220 Additional paid-in capital ....................... 66,013,203 65,546,963 Accumulated other comprehensive income ........... 7,507,672 7,051,920 Retained earnings ................................ 55,606,761 64,500,213 ------------ ------------ Total stockholders' equity ................. 140,457,623 148,393,316 ------------ ------------ Contingent liabilities (notes 3 and 16) Total liabilities and stockholders' equity $671,564,697 $587,675,674 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year ended December 31, ---------------------------------------- 2001 2000 1999 REVENUES: ------------ ------------ ------------ Premiums earned (notes 2 and 3) .... $265,279,858 $231,458,442 $211,098,141 Investment income, net (note 9) .... 30,969,630 29,006,316 25,760,561 Realized investment gains (note 9) 800,582 1,557,870 276,673 Other income ....................... 774,169 1,473,113 2,194,162 ------------ ------------ ------------ 297,824,239 263,495,741 239,329,537 ------------ ------------ ------------ LOSSES AND EXPENSES (note 2): Losses and settlement expenses (notes 3, 4 and 5) ...... 221,918,750 189,521,674 176,876,248 Dividends to policyholders ......... 1,823,970 1,632,961 1,237,368 Amortization of deferred policy acquisition costs ......... 55,687,015 51,288,479 48,056,918 Other underwriting expenses ........ 22,739,913 18,479,492 17,465,822 Other expenses ..................... 1,196,470 1,508,523 1,684,455 ------------ ------------ ------------ 303,366,118 262,431,129 245,320,811 ------------ ------------ ------------ (Loss) income before income tax benefit ................ (5,541,879) 1,064,612 (5,991,274) ------------ ------------ ------------ INCOME TAX BENEFIT (note 10): Current ........................ (142,405) (307,677) (1,599,826) Deferred ....................... (3,293,342) (956,742) (3,587,463) ------------ ------------ ------------ (3,435,747) (1,264,419) (5,187,289) ------------ ------------ ------------ Net (loss) income ............ $ (2,106,132) $ 2,329,031 $ (803,985) ============ ============ ============ Net (loss) income per common share - basic and diluted .............. $ (.19) $ .21 $ (.07) ============ ============ ============ Average number of shares outstanding - basic and diluted .............. 11,312,063 11,284,885 11,330,705 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Net (loss) income .................. $ (2,106,132) $ 2,329,031 $ (803,985) ------------ ------------ ------------ OTHER COMPREHENSIVE INCOME (note 9): Unrealized holding gains (losses) arising during the period, before deferred income tax expense (benefit) .............. 1,645,082 15,872,363 (15,597,992) Deferred income tax expense (benefit) ...................... 682,629 4,164,014 (4,070,728) ------------ ------------ ------------ 962,453 11,708,349 (11,527,264) ------------ ------------ ------------ Reclassification adjustment for gains included in net (loss) income, before income tax expense ........................ (779,540) (1,562,372) (268,742) Income tax expense ............... 272,839 531,206 91,372 ------------ ------------ ------------ (506,701) (1,031,166) (177,370) ------------ ------------ ------------ Other comprehensive income (loss) ..................... 455,752 10,677,183 (11,704,634) ------------ ------------ ------------ Total comprehensive (loss) income ..................... $ (1,650,380) $ 13,006,214 $(12,508,619) ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Year ended December 31, -------------------------------------- 2001 2000 1999 COMMON STOCK: ------------ ------------ ------------ Beginning of year .................. $ 11,294,220 $ 11,265,232 $ 11,496,389 Issuance of common stock through stock option plans ............... 35,767 28,988 23,793 Repurchase of common stock (note 14) - - (254,950) ------------ ------------ ------------ End of year ........................ 11,329,987 11,294,220 11,265,232 ------------ ------------ ------------ ADDITIONAL PAID-IN CAPITAL: Beginning of year .................. 65,546,963 65,333,686 67,822,412 Issuance of common stock through stock option plans ............... 466,240 213,277 255,001 Repurchase of common stock ......... - - (2,743,727) ------------ ------------ ------------ End of year ........................ 66,013,203 65,546,963 65,333,686 ------------ ------------ ------------ ACCUMULATED OTHER COMPREHENSIVE INCOME: Beginning of year .................. 7,051,920 (3,625,263) 8,079,371 Change in other comprehensive income ........................... 455,752 10,677,183 (11,704,634) ------------ ------------ ------------ End of year ........................ 7,507,672 7,051,920 (3,625,263) ------------ ------------ ------------ RETAINED EARNINGS: Beginning of year .................. 64,500,213 68,942,622 76,539,668 Net (loss) income .................. (2,106,132) 2,329,031 (803,985) Cash dividends on common stock ($.60 per share in 2001, 2000 and 1999) ............................ (6,787,320) (6,771,440) (6,793,061) ------------ ------------ ------------ End of year ........................ 55,606,761 64,500,213 68,942,622 ------------ ------------ ------------ Total stockholders' equity ....... $140,457,623 $148,393,316 $141,916,277 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income ................... $(2,106,132) $ 2,329,031 $ (803,985) Adjustments to reconcile net (loss) income to net cash provided by operating activities: Losses and settlement expenses .. 28,029,560 19,975,004 20,903,701 Unearned premiums ............... 13,822,959 8,687,285 3,527,078 Other policyholders' funds ...... (255,701) (364,601) (858,429) Deferred policy acquisition costs (5,726,775) (2,017,561) (1,263,710) Indebtedness of related party ... 6,484,089 (7,686,230) (1,976,126) Accrued investment income ....... (1,313,645) (458,424) (1,021,632) Accrued income taxes: Current ....................... 635,297 801,089 1,687,000 Deferred ...................... (3,293,342) (956,742) (3,587,463) Realized investment gains ....... (800,582) (1,557,870) (276,673) Postretirement benefits ......... 118,972 80,293 750,654 Reinsurance receivables ......... (2,575,981) (795,990) 5,498,426 Prepaid reinsurance premiums .... (330,132) (664,535) (78,827) Amortization of deferred income (78,212) (80,619) (119,023) Accounts receivable ............. (807,010) 3,019,523 (514,496) Other, net ...................... 3,403,024 1,209,447 590,972 ----------- ----------- ----------- 37,312,521 19,190,069 23,261,452 Cash provided by the property and casualty insurance subsidiaries' change in recording of full-term premium amount on policies billed on an installment basis (note 12) ... 11,880,803 - - ----------- ----------- ----------- Net cash provided by operating activities .... $47,087,192 $21,519,100 $22,457,467 ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED Year ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturity securities held-to-maturity .... $ - $ - $(13,459,272) Maturities of fixed maturity securities held-to-maturity .... 49,692,313 11,529,551 51,260,724 Purchases of fixed maturity securities available-for-sale .. (166,403,259) (52,060,772) (135,872,298) Disposals of fixed maturity securities available-for-sale .. 44,693,688 27,499,407 81,893,552 Purchases of equity securities available-for-sale ............. (26,769,001) (23,203,788) (24,924,562) Disposals of equity securities available-for-sale ............. 27,388,659 23,451,046 25,037,159 Net sales (purchases) of short-term investments ......... 5,663,568 (3,223,821) 2,495,796 ------------ ------------ ------------ Net cash used in investing activities ............. (65,734,032) (16,008,377) (13,568,901) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock ......... 502,007 242,265 278,794 Dividends paid to stockholders ................... (6,787,320) (6,771,440) (6,793,061) Issuance of surplus notes (note 11) ...................... 25,000,000 - - Repurchase of common stock (note 14) ................ - - (2,998,677) ------------ ------------ ------------ Net cash provided (used) in financing activities .... 18,714,687 (6,529,175) (9,512,944) ------------ ------------ ------------ Net increase (decrease) in cash .... 67,847 (1,018,452) (624,378) Cash at beginning of year .......... 490,226 1,508,678 2,133,056 ------------ ------------ ------------ Cash at end of year ................ $ 558,073 $ 490,226 $ 1,508,678 ============ ============ ============ Income taxes recovered ............. $ 778,316 $ 1,108,766 $ 3,294,499 Interest (received) paid ........... $ (79,232) $ (23,722) $ 89,032 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., a 79.5 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 accounting principles generally accepted in the United States (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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. 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 reinsurance 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). EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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 (see note 2) 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. 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 are 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, 2001 and 2000 are securities on deposit with various regulatory authorities as required by law amounting to $12,448,310 and $12,444,903, respectively. The Company participates 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. The securities on loan to others have been segregated from the other invested assets on the Company's balance sheet. In addition, the assets and liabilities of the Company have been grossed up to reflect the collateral held under the securities lending program and the obligation to return this collateral upon the return of the loaned securities. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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 deferred the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB statement No. 133". SFAS 138 addresses a limited number of Statement 133 implementation issues, and became effective for 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 these statements did not have any effect on the operating results of the Company. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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 under two different formulas, depending on an employee's age and date of service. 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. Employers Mutual maintains two Voluntary Employee Beneficiary Association (VEBA) trusts which 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. 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. The Company expects to become an 80 percent owned subsidiary of Employers Mutual during 2002. At that time the Company will begin filing a consolidated tax return with Employers Mutual and its subsidiaries. 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 (Loss) Income Per Share - Basic and Diluted The Company's basic and diluted net (loss) income per share are computed by dividing net (loss) income by the weighted average number of common shares outstanding during each year. The Company had no potential common shares outstanding during 2001, 2000 and 1999 that would have been dilutive to net (loss) income per share. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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 recoverability of goodwill would be impacted if projected future operating cash flows are not achieved. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets". SFAS No. 141 requires the purchase method of accounting for all business combinations initiated after June 30, 2001 and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 addresses accounting for intangible assets, eliminates the amortization of goodwill and provides specific steps for testing the impairment of goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001; however, the amortization provisions apply to goodwill and intangible assets acquired after June 30, 2001. Other than the requirement to eliminate the future amortization of the Company's carried goodwill, which has amounted to $134,513 per year, adoption of these statements is not expected to have an impact on the operating results of the Company. 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. The aggregate participation of the Company's property and casualty insurance subsidiaries is 23.5 percent. 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. 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Reinsurance Subsidiary The Company's reinsurance subsidiary assumes a 100 percent quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. This includes all premiums and related losses and settlement expenses of this business, subject to a maximum loss of $1,500,000 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. Premiums assumed by the reinsurance subsidiary from Employers Mutual amounted to $66,287,442, $47,530,111 and $43,546,796 in 2001, 2000 and 1999, 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 $15,892,684, $10,795,106 and $10,156,159 in 2001, 2000 and 1999, 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. Effective January 1, 2000, the override commission rate was reduced to 4.50 percent of written premiums from 5.25 percent of written premiums because of good loss experience. Total override commission paid to Employers Mutual amounted to $2,982,935, $2,138,855 and $2,286,207 in 2001, 2000 and 1999, respectively. Employers Mutual retained losses and settlement expenses under this agreement totaling $14,442,561 in 2001, $373,847 in 2000 and $(6,484) in 1999. 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, excluding reinstatement premiums. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary and amounted to $2,495,794, $2,122,248 and $1,660,950 in 2001, 2000 and 1999, respectively. 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 accordance with 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED As of December 31, 2001, reinsurance ceded to two nonaffiliated reinsurers aggregated $6,744,237, 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 effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, for the three years ended December 31, 2001 is presented below. Year ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Premiums written Direct ......................... $272,027,823 $249,896,499 $228,588,440 Assumed from nonaffiliates ..... 1,898,509 1,220,442 781,225 Assumed from affiliates (note 12) .................... 299,990,245 244,762,032 221,051,986 Ceded to nonaffiliates ......... (11,189,227) (8,347,822) (7,270,696) Ceded to affiliates ............ (272,027,823) (249,896,499) (228,588,440) ------------ ------------ ------------ Net premiums written ......... $290,699,527 $237,634,652 $214,562,515 ============ ============ ============ Premiums earned Direct ......................... $255,764,274 $245,078,165 $223,593,165 Assumed from nonaffiliates ..... 1,786,132 1,194,835 873,710 Assumed from affiliates ........ 274,352,821 237,946,894 217,416,300 Ceded to nonaffiliates ......... (10,859,095) (7,683,287) (7,191,869) Ceded to affiliates ............ (255,764,274) (245,078,165) (223,593,165) ------------ ------------ ------------ Net premiums earned .......... $265,279,858 $231,458,442 $211,098,141 ============ ============ ============ Losses and settlement expenses incurred Direct ......................... $221,314,633 $208,604,970 $183,031,797 Assumed from nonaffiliates ..... 1,336,824 400,360 429,244 Assumed from affiliates ........ 227,650,959 194,017,734 182,375,574 Ceded to nonaffiliates ......... (7,069,033) (4,896,420) (5,928,570) Ceded to affiliates ............ (221,314,633) (208,604,970) (183,031,797) ------------ ------------ ------------ Net losses and settlement expenses incurred .......... $221,918,750 $189,521,674 $176,876,248 ============ ============ ============ 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, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Gross reserves at beginning of year $286,489,028 $266,514,024 $245,610,323 Ceded reserves at beginning of year (11,224,797) (10,260,815) (15,563,600) ------------ ------------ ------------ Net reserves at beginning of year .. 275,264,231 256,253,209 230,046,723 ------------ ------------ ------------ Incurred losses and settlement expenses: Provision for insured events of the current year ............ 216,752,003 191,425,036 182,609,687 Increase (decrease) in provision for insured events of prior years .......................... 5,166,747 (1,903,362) (5,733,439) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 221,918,750 189,521,674 176,876,248 ------------ ------------ ------------ Payments: Losses and settlement expenses attributable to insured events of the current year ............ 94,983,112 82,912,082 72,970,531 Losses and settlement expenses attributable to insured events of prior years ................. 99,529,878 87,598,570 77,699,231 ------------ ------------ ------------ Total payments ............. 194,512,990 170,510,652 150,669,762 ------------ ------------ ------------ Net reserves at end of year ........ 302,669,991 275,264,231 256,253,209 Ceded reserves at end of year ...... 11,848,597 11,224,797 10,260,815 ------------ ------------ ------------ Gross reserves at end of year ...... $314,518,588 $286,489,028 $266,514,024 ============ ============ ============ 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. The Company experienced a significant amount of adverse development on prior years' reserves in 2001, which contributed to the large increase in losses and settlement expenses. The adverse development in the property and casualty insurance segment is attributed to the revaluation of formula based settlement expense reserves and an increase in paid settlement expenses. The adverse development in the reinsurance segment is attributed to construction defect claims arising from a reinsurance pool that the reinsurance subsidiary participates in. The Company has historically experienced favorable development in its reserves and its reserving practices have not changed; however, the amount of development experienced will fluctuate from year to year as individual claims are settled and new information becomes available on open claims. 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 $2,565,515 and $2,829,252 at December 31, 2001 and 2000, 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. North Dakota imposes similar restrictions on the payment of dividends and distributions. At December 31, 2001, $12,647,639 was available for distribution to the Company in 2002 without prior approval. 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 insurers that are in, or are perceived as approaching, financial difficulty. This model establishes 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, 2001, 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 The Company's insurance subsidiaries are required to file financial statements with state regulatory authorities. The accounting principles used to prepare these statutory financial statements follow prescribed or permitted accounting practices that differ from GAAP. Prescribed statutory accounting principles include state laws, regulations and general administrative rules issued by the state of domicile as well as a variety of publications and manuals of the NAIC. Permitted accounting practices encompass all accounting practices not prescribed, but allowed by the state of domicile. The Company's insurance subsidiaries had no permitted accounting practices during 2001, 2000 and 1999. A reconciliation of net income and surplus from that reported on a statutory basis to that reported in the accompanying consolidated statements on a GAAP basis is as follows: Year ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Net loss from insurance subsidiaries, statutory basis .... $ (8,289,542) $ (1,599,085) $ (5,439,665) Change in deferred policy acquisition costs (note 12) ...... 5,726,775 2,017,561 1,263,710 Change in other policyholders' funds 255,701 364,601 858,429 Pension benefit cost ............... (338,933) (691,007) (516,880) Postretirement benefit cost ........ (471,088) (409,101) (583,380) Deferred income tax benefit ........ 3,186,926 946,154 3,585,061 Prior years' income tax expense and related interest ................. - 48,111 (96,134) Amortization of reserve discount on commutation of reinsurance contract ......................... 78,212 80,619 119,023 Change in recording of full-term premium amount on policies billed on an installment basis (note 12) (2,003,620) - - Change in estimate of audit-based premium income, net of expenses .. - 1,516,550 - Other, net ......................... (116,465) 105,623 32,487 ------------ ------------ ------------ Net (loss) income from insurance subsidiaries, GAAP basis ......... (1,972,034) 2,380,026 (777,349) Net loss from Parent Company........ (134,098) (50,995) (26,636) ------------ ------------ ------------ Net (loss) income, GAAP basis .... $ (2,106,132) $ 2,329,031 $ (803,985) ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Surplus from insurance subsidiaries, statutory basis .................. $128,735,605 $110,371,864 $116,151,399 Deferred policy acquisition costs .. 21,363,528 15,636,753 13,619,192 Other policyholders' funds payable (472,952) (728,653) (1,093,254) Pension benefit cost ............... 151,230 490,163 1,012,770 Postretirement benefit cost ........ (4,293,301) (3,822,213) (3,351,848) Deferred income tax asset .......... 8,884,702 15,438,611 18,115,065 Goodwill ........................... 941,586 1,076,099 1,210,612 Reserve discount on commutation of reinsurance contract ............. - (78,212) (158,831) Unrealized holding gains (losses) on available-for-sale securities .... 6,871,349 4,681,459 (7,495,349) Change in estimate of audit-based premium income, net of expenses .. - 1,516,550 - Surplus notes payable (note 11) .... (25,000,000) - - Other, net ......................... 557,184 214,797 157,632 ------------ ------------ ------------ Equity from insurance subsidiaries, GAAP basis ......... 137,738,931 144,797,218 138,167,388 Equity from Parent Company ......... 2,718,692 3,596,098 3,748,889 ------------ ------------ ------------ Stockholders' equity, GAAP basis .. $140,457,623 $148,393,316 $141,916,277 ============ ============ ============ In 1998, the NAIC adopted a comprehensive Codification of Statutory Accounting Principles (Codification) to replace the Accounting Practices and Procedures Manual as the NAIC's primary guidance on statutory accounting. Codification is intended to provide a consistent and comprehensive basis of statutory accounting for all insurance companies and became effective in most states, including the states of domicile of the Company's insurance subsidiaries, on January 1, 2001. The adoption of Codification resulted in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory financial statements. One of the more significant changes was the recording of deferred income taxes. As a result of the adoption of Codification, the statutory surplus of the Company's insurance subsidiaries increased by approximately $9,110,000 on January 1, 2001. Operating results for 2000 include earnings of $1,516,550 associated with a change in the estimate of additional/return premium income expected on policies, primarily workers' compensation, subject to audit in the property and casualty insurance segment. This change in estimate was prompted by additional research that was conducted in connection with a required change in the tax accounting method used for recognizing audit-based premiums. 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 note 1, Summary of Significant Accounting Policies. Summarized financial information for the Company's segments is as follows: Property Year ended and casualty Parent December 31, 2001 insurance Reinsurance company Consolidated - ----------------- ------------ ------------ ------------ ------------ Premiums earned ......... $203,392,845 $ 61,887,013 $ - $265,279,858 Underwriting loss ....... (26,828,133) (10,061,657) - (36,889,790) Net investment income ... 22,457,799 8,317,505 194,326 30,969,630 Realized gains .......... 681,349 119,233 - 800,582 Other income ............ 695,957 78,212 - 774,169 Other expenses .......... (757,783) - (438,687) (1,196,470) ------------ ------------ ------------ ------------ Loss before income tax benefit ........... $ (3,750,811)$ (1,546,707)$ (244,361)$ (5,541,879) ============ ============ ============ ============ Assets .................. $514,376,179 $157,360,388 $140,659,584 $812,396,151 Eliminations ............ - - (140,831,454)(140,831,454) ------------ ------------ ------------ ------------ Net assets ......... $514,376,179 $157,360,388 $ (171,870)$671,564,697 ============ ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Property Year ended and casualty Parent December 31, 2000 insurance Reinsurance company Consolidated - ----------------- ------------ ------------ ------------ ------------ Premiums earned ......... $184,985,620 $ 46,472,822 $ - $231,458,442 Underwriting loss ....... (22,280,746) (7,183,418) - (29,464,164) Net investment income ... 20,787,679 7,873,040 345,597 29,006,316 Realized gains .......... 1,242,233 315,101 536 1,557,870 Other income ............ 1,392,494 80,619 - 1,473,113 Other expenses .......... (1,106,996) - (401,527) (1,508,523) ------------ ------------ ------------ ------------ Income (loss) before income tax (benefit) expense ............... $ 34,664 $ 1,085,342 $ (55,394)$ 1,064,612 ============ ============ ============ ============ Assets .................. $442,300,700 $142,109,821 $148,566,455 $732,976,976 Eliminations ............ - - (145,301,302)(145,301,302) ------------ ------------ ------------ ------------ Net assets ......... $442,300,700 $142,109,821 $ 3,265,153 $587,675,674 ============ ============ ============ ============ Year ended December 31, 1999 - ----------------- 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 .... $ (7,466,483)$ 1,502,009 $ (26,800)$ (5,991,274) ============ ============ ============ ============ 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, 2001 and 2000 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 cost gains losses value ------------ ----------- ----------- ------------ December 31, 2001 - ----------------- Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $ 57,443,480 $ 4,938,670 $ - $ 62,382,150 Mortgage-backed securities ........... 8,634,427 448,311 - 9,082,738 ------------ ----------- ----------- ------------ Total securities held-to-maturity $ 66,077,907 $ 5,386,981 $ - $ 71,464,888 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $ 53,080,155 $ 171,555 $ (80,651)$ 53,171,059 Obligations of states and political subdivisions ......... 77,746,658 2,528,902 (510,260) 79,765,300 Mortgage-backed securities ........... 24,993,733 1,234,960 - 26,228,693 Debt securities issued by foreign governments 6,481,973 662,892 - 7,144,865 Public utilities ....... 59,510,559 578,124 (1,182,696) 58,905,987 Corporate securities ... 189,923,283 5,741,902 (2,230,904) 193,434,281 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... 411,736,361 10,918,335 (4,004,511) 418,650,185 ------------ ----------- ----------- ------------ Equity securities: Common stocks .......... 27,689,811 6,190,284 (1,492,393) 32,387,702 Non-redeemable preferred stocks ..... 996,510 6,055 (67,500) 935,065 ------------ ----------- ----------- ------------ Total equity securities ....... 28,686,321 6,196,339 (1,559,893) 33,322,767 ------------ ----------- ----------- ------------ Total securities available-for-sale $440,422,682 $17,114,674 $(5,564,404)$451,972,952 ============ =========== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value ------------ ----------- ----------- ------------ December 31, 2000 Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $102,230,946 $ 4,084,693 $ (581,938)$105,733,701 Mortgage-backed securities ........... 13,480,647 361,082 - 13,841,729 ------------ ----------- ----------- ------------ Total securities held-to-maturity $115,711,593 $ 4,445,775 $ (581,938)$119,575,430 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $ 6,603,794 $ 212,480 $ - $ 6,816,274 Obligations of states and political subdivisions ......... 79,782,459 2,607,857 (251,346) 82,138,970 Mortgage-backed securities ........... 43,416,386 1,506,514 - 44,922,900 Debt securities issued by foreign governments 6,480,421 307,986 - 6,788,407 Public utilities ....... 16,540,299 637,606 (13,691) 17,164,214 Corporate securities ... 136,626,121 1,951,900 (2,252,121) 136,325,900 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... 289,449,480 7,224,343 (2,517,158) 294,156,665 ------------ ----------- ----------- ------------ Equity securities: Common stocks .......... 26,748,905 8,480,378 (2,474,801) 32,754,482 Non-redeemable preferred stocks ..... 1,994,010 38,216 (66,250) 1,965,976 ------------ ----------- ----------- ------------ Total equity securities ....... 28,742,915 8,518,594 (2,541,051) 34,720,458 ------------ ----------- ----------- ------------ Total securities available-for-sale $318,192,395 $15,742,937 $(5,058,209)$328,877,123 ============ =========== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The amortized cost and estimated fair value of fixed maturity securities at December 31, 2001, 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 ................... $ - $ - Due after one year through five years ..... 39,962,077 44,168,660 Due after five years through ten years .... 11,489,373 12,098,320 Due after ten years ....................... 5,992,032 6,115,170 Mortgage-backed securities ................ 8,634,425 9,082,738 ------------ ------------ Totals ................................ $ 66,077,907 $ 71,464,888 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 39,266,534 $ 39,333,099 Due after one year through five years ..... 16,524,878 17,064,621 Due after five years through ten years .... 104,477,883 108,344,057 Due after ten years ....................... 226,473,331 227,679,715 Mortgage-backed securities ................ 24,993,735 26,228,693 ------------ ------------ Totals ................................ $411,736,361 $418,650,185 ============ ============ 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, ------------------------------------ 2001 2000 1999 ---------- ---------- ---------- Fixed maturity securities held-to-maturity: Gross realized investment gains ... $ 21,042 $ 536 $ 7,931 Gross realized investment losses .. - (5,038) - Fixed maturity securities available-for-sale: Gross realized investment gains ... 235,515 1,074,068 1,593,437 Gross realized investment losses .. (19,039) (7,237) (3,490) Equity securities available-for-sale: Gross realized investment gains ... 4,050,256 3,911,717 2,299,740 Gross realized investment losses .. (3,487,192) (3,416,176) (3,620,945) ---------- ---------- ---------- Totals .......................... $ 800,582 $1,557,870 $ 276,673 ========== ========== ========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED During 2000 and 1999, the Company sold approximately $14,000,000 and $55,000,000, respectively, 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 from the disposal of these tax-exempt fixed maturity securities amounted to $531,352 for 2000 and $1,589,953 for 1999. A summary of net investment income is as follows: Year ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Interest on fixed maturities .......... $29,507,515 $27,857,760 $24,504,253 Dividends on equity securities ........ 551,066 494,941 582,496 Interest on short-term investments .... 1,425,167 1,114,717 1,387,774 Fees from securities lending .......... 132,905 96,709 21,313 ----------- ----------- ----------- Total investment income ........... 31,616,653 29,564,127 26,495,836 Investment expenses ................... (647,023) (557,811) (735,275) ----------- ----------- ----------- Net investment income ............. $30,969,630 $29,006,316 $25,760,561 =========== =========== =========== A summary of net changes in unrealized holding gains (losses) on securities available-for-sale is as follows: Year ended December 31, ---------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Fixed maturity securities ......... $ 2,206,640 $ 12,246,089 $(16,923,379) Applicable deferred income tax expense (benefit) ............... 819,396 4,163,670 (5,753,949) ------------ ------------ ------------ Total fixed maturity securities 1,387,244 8,082,419 (11,169,430) ------------ ------------ ------------ Equity securities ................. (1,341,098) 2,063,902 1,056,645 Applicable deferred income tax (benefit) expense ............... (409,606) 701,728 359,259 ------------ ------------ ------------ Total equity securities ....... (931,492) 1,362,174 697,386 ------------ ------------ ------------ Deferred income tax valuation allowance ....................... - (1,232,590) 1,232,590 ------------ ------------ ------------ Total available-for-sale securities .................. $ 455,752 $ 10,677,183 $(11,704,634) ============ ============ ============ 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 income tax asset at December 31, 2001 and 2000 are as follows: Year ended December 31, ------------------------- 2001 2000 ----------- ----------- Loss reserve discounting .......................... $15,487,210 $14,278,749 Unearned premium reserve limitation ............... 6,520,646 4,833,178 Postretirement benefits ........................... 2,187,059 2,039,914 Other policyholders' funds payable ................ 165,533 247,742 Net operating loss carry forward .................. 3,481,087 1,060,347 Minimum tax credit ................................ 2,158,360 2,243,133 Other, net ........................................ 457,464 524,725 ----------- ----------- Total deferred income tax asset ............. 30,457,359 25,227,788 ----------- ----------- Deferred policy acquisition costs ................. (7,477,235) (5,316,496) Net unrealized holding gains ...................... (4,042,595) (3,632,808) Other, net ........................................ (608,722) (833,233) ----------- ----------- Total deferred income tax liability ......... (12,128,552) (9,782,537) ----------- ----------- Net deferred income tax asset ............. $18,328,807 $15,445,251 =========== =========== At December 31, 2001, the Company has $9,945,962 of net operating loss carry forwards, of which $4,809,789 and $5,136,173 will expire, if unused, in years 2020 and 2021, respectively. 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The actual income tax benefit for the years ended December 31, 2001, 2000 and 1999 differed from the "expected" tax (benefit) expense for those years (computed by applying the United States federal corporate tax rate of 35 percent (34 percent for 2000 and 1999) to (loss) income before income tax benefit) as follows: Year ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Computed "expected" tax (benefit) expense ............................. $(1,939,658) $ 361,968 $(2,037,033) Increases (decreases) in tax resulting from: Tax-exempt interest income ........ (1,509,839) (1,673,566) (2,306,517) Change in accrual of prior year taxes ........................... - (470,000) - Change in valuation allowance ..... - - (800,000) Proration of tax-exempt interest and dividends received deduction 37,740 193,123 150,159 Other, net ........................ (23,990) 324,056 (193,898) ----------- ----------- ----------- Income tax benefit .............. $(3,435,747) $(1,264,419) $(5,187,289) =========== =========== =========== During 1999 the valuation allowance was reduced as the result of the establishment of VEBA trusts that accelerated the postretirement benefit deductions and reduced the uncertainty of future realization of the tax benefits (see note 1). Comprehensive income tax (benefit) expense included in the consolidated financial statements for the years ended December 31, 2001, 2000 and 1999 is as follows: Year ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Income tax (benefit) expense on: Operations .......................... $(3,435,747) $(1,264,419) $(5,187,289) Unrealized holding gains (losses) on revaluation of securities available-for-sale ................ 409,790 3,632,808 (4,162,100) ----------- ----------- ----------- Comprehensive income tax (benefit) expense ............. $(3,025,957) $ 2,368,389 $(9,349,389) =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 11. SURPLUS NOTES On December 28, 2001, three of the Company's property and casualty insurance subsidiaries issued surplus notes totaling $25,000,000 to Employers Mutual. The surplus notes bear an annual interest rate of 5.38 percent and do not have a maturity date. Payment of interest and repayment of principal can only be repaid out of the issuing company's statutory surplus earnings and is subject to approval by the Insurance Commissioner of the issuing company's state of domicile. The surplus notes are subordinate and junior in right of payment to all obligations or liabilities of the issuing company. Accrued interest as of December 31, 2001 amounted to $11,055. 12. INSTALLMENT BASIS PREMIUMS Effective January 1, 2001, the Company began recording the full-term written premium and related commission expense at the inception of insurance policies that are billed on an installment basis. Previously, such amounts were recorded as each installment became due. As a result, written premiums and unearned premiums increased $13,884,423, invested assets increased $11,880,803 and the Company incurred $1,706,181 of commission expense and $297,439 of premium tax expense. These expenses were offset by a $3,054,573 increase in deferred policy acquisition costs, resulting in $1,050,953 of non- recurring income that was amortized into operations on a quarterly basis. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 13. EMPLOYEE RETIREMENT PLANS The following table sets forth the funded status of the Employers Mutual defined benefit retirement plan and postretirement benefit plans as of December 31, 2001 and 2000, based upon a measurement date of November 1, 2001 and 2000, respectively: Defined benefit plan Postretirement plans ------------------------ -------------------------- 2001 2000 2001 2000 Change in projected ----------- ----------- ------------ ------------ benefit obligation: Benefit obligation at beginning of year ... $88,601,838 $81,538,314 $ 34,715,000 $ 31,460,000 Service cost .......... 4,885,731 4,599,973 2,299,000 2,066,000 Interest cost ......... 6,640,491 6,097,377 2,644,000 2,396,000 Actuarial loss (gain) 5,242,814 753,446 8,406,000 (157,000) Benefits paid ......... (8,069,721) (7,008,595) (1,305,000) (1,050,000) Amendments ............ 707,097 2,621,323 - - ----------- ----------- ------------ ------------ Projected benefit obligation at end of year ......... 98,008,250 88,601,838 46,759,000 34,715,000 ----------- ----------- ------------ ------------ Change in plan assets: Fair value of plan assets at beginning of year ............. 95,116,686 95,824,343 3,353,000 2,872,000 Actual return on plan assets .............. (3,638,055) 6,300,938 (801,000) 81,000 Employer contributions - - 4,690,000 1,450,000 Benefits paid ......... (8,069,721) (7,008,595) (1,305,000) (1,050,000) ----------- ----------- ------------ ------------ Fair value of plan assets at end of year ......... 83,408,910 95,116,686 5,937,000 3,353,000 ----------- ----------- ------------ ------------ Funded status ......... (14,599,340) 6,514,848 (40,822,000) (31,362,000) Unrecognized net actuarial (gain) loss 7,209,026 (9,508,725) 6,442,000 (2,070,000) Unrecognized prior service costs ....... 5,586,284 5,660,230 535,000 1,107,000 Employer contributions - - 4,090,000 3,075,000 ----------- ----------- ------------ ------------ (Accrued) prepaid benefit cost .... $(1,804,030) $ 2,666,353 $(29,755,000) $(29,250,000) =========== =========== ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The components of net periodic pension cost for the Employers Mutual defined benefit retirement plan is as follows: Year ended December 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Service cost .......................... $ 4,885,731 $ 4,599,973 $ 4,359,955 Interest cost ......................... 6,640,491 6,097,377 5,426,633 Expected return on plan assets ........ (7,836,882) (7,436,949) (7,041,280) Recognized net actuarial gain ......... - (164,619) - Amortization of initial net asset ..... - (755,787) (1,049,705) Amortization of prior service costs ... 781,043 563,914 434,928 ----------- ----------- ----------- Net periodic pension benefit cost ... $ 4,470,383 $ 2,903,909 $ 2,130,531 =========== =========== =========== The weighted average discount rate used to measure the projected benefit obligation was 7.00 percent for 2001 and 7.75 percent for 2000 and 1999. The assumed long-term rate of return on plan assets was 8.50 percent for 2001 and 2000 and 8.00 percent for 1999. The rate of increase in future compensation levels used in measuring the projected benefit obligation was 5.96 percent in 2001 and 2000 and 5.95 percent in 1999. Pension expense for the Company amounted to $1,060,259, $691,007 and $516,880 in 2001, 2000 and 1999, respectively. The components of net periodic postretirement benefit cost for the Employers Mutual postretirement benefit plans is as follows: Year ended December 31, -------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Service cost ......................... $ 2,299,000 $ 2,066,000 $ 2,370,000 Interest cost ........................ 2,644,000 2,396,000 2,350,000 Expected return on assets ............ (318,000) (140,000) (38,000) Amortization of net (gain) loss ...... (1,000) (16,000) 191,000 Amortization of prior service costs .. 571,000 571,000 571,000 ------------ ------------ ------------ Net periodic postretirement benefit cost ............................. $ 5,195,000 $ 4,877,000 $ 5,444,000 ============ ============ ============ 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 2001 is 9 percent, and is assumed to decrease gradually to 5 percent in 2005 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, 2001 by $7,315,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2001 by $982,000. A one-percentage-point decrease in the assumed health care cost trend rate for each future year would decrease the accumulated postretirement benefit obligation as of December 31, 2001 by $5,840,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2001 by $765,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.00 percent for 2001 and 7.75 percent for 2000 and 1999. The Company's net periodic postretirement benefit cost for the years ended December 31, 2001, 2000 and 1999 was $1,214,255, $1,138,231 and $1,278,700, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 14. 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 exercise 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 (see note 2), the Company's property and casualty insurance subsidiaries incur 23.5 percent of the expenses recognized by the pool members 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 $90,681, $26,820 and $59,379 for 2001, 2000 and 1999, respectively. (a) Incentive Stock Option Plans Employers Mutual maintains 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 98 individuals under the 1993 Plan. As of February 26, 2002, 19 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED During 2001, 10,700 options were granted under the 1993 Plan to eligible participants at a price of $11.38 and 85,377 options were exercised under the plans at prices ranging from $8.75 to $18.30. A summary of Employers Mutual's incentive stock option plans is as follows: Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Options outstanding, beginning of year .. 809,882 595,255 574,391 Granted ................................. 10,700 265,775 71,700 Exercised ............................... (85,377) (47,748) (43,336) Expired ................................. (11,827) (3,400) (7,500) ------- ------- ------- Options outstanding, end of year ........ 723,378 809,882 595,255 ======= ======= ======= Options exercisable, end of year ........ 407,108 390,447 361,055 ======= ======= ======= (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 2001, 120 employees participated in the plan and exercised a total of 13,734 options at prices of $12.76 and $14.25. Activity under the plan was as follows: Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Shares available for purchase, beginning of year ...................... 327,489 352,354 380,009 Shares purchased under plan .............. (13,734) (24,865) (27,655) ------- ------- ------- Shares available for purchase, end of year 313,755 327,489 352,354 ======= ======= ======= EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (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 2001, no directors participated in the plan. Activity under the plan was as follows: Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Shares available for purchase, beginning of year ...................... 143,158 152,190 162,928 Shares purchased under plan .............. - (9,032) (10,738) ------- ------- ------- Shares available for purchase, end of year 143,158 143,158 152,190 ======= ======= ======= 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 September 15, 2000, an additional 1,000,000 shares of stock were registered for issuance under the dividend reinvestment plan. Employers Mutual has been reinvesting 100 percent of its dividends in additional shares of common stock under this plan since the second quarter of 1999. Employers Mutual has informed the Company that it will be reducing its participation in the dividend reinvestment plan to 25 percent for 2002. Activity under the plan was as follows: Year ended December 31, --------------------------------- 2001 2000 1999 --------- --------- --------- Shares available for purchase, beginning of year .................. 880,679 399,629 792,325 Additional shares registered ......... - 1,000,000 - Shares purchased under plan .......... (379,449) (518,950) (392,696) --------- --------- --------- Shares available for purchase, end of year ........................ 501,230 880,679 399,629 ========= ========= ========= Range of purchase prices ............. $11.50 $ 7.50 $ 9.47 to to to $17.25 $12.66 $12.81 EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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. 15. 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 (see note 9). Carrying Estimated amount fair value December 31, 2001 ------------ ------------ - ----------------- Fixed maturity securities: Held-to-maturity ............................ $ 33,572,602 $ 35,502,755 Available-for-sale .......................... 390,214,177 390,214,177 Equity securities available-for-sale .......... 33,322,767 33,322,767 Short-term investments ........................ 17,724,458 17,724,458 Fixed maturity securities on loan: Held-to-maturity ............................ 32,505,305 35,962,133 Available-for-sale .......................... 28,436,008 28,436,008 December 31, 2000 - ----------------- Fixed maturity securities: Held-to-maturity ............................ $ 70,202,394 $ 70,975,728 Available-for-sale .......................... 284,400,891 284,400,891 Equity securities available-for-sale .......... 34,720,458 34,720,458 Short-term investments ........................ 23,388,027 23,388,027 Fixed maturity securities on loan: Held-to-maturity ............................ 45,509,199 48,599,702 Available-for-sale .......................... 9,755,774 9,755,774 The estimated fair value of the Company's surplus notes is $25,000,000, which is the same as the carrying amount. The estimated fair value is based on the fact that the notes were issued on December 28, 2001 and are therefore current as regards interest payments. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 16. 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 contingently liable for 23.5 percent of these annuities (see note 2). The Company is contingently liable to various claimants in the amount of $740,582 in the event that the issuing company would be unable to fulfill its obligations. 17. UNAUDITED INTERIM FINANCIAL INFORMATION Three months ended, ----------------------------------------------------- March 31 June 30 September 30 December 31 2001 ----------- ----------- ----------- ----------- - ---- Total revenues ........ $68,295,006 $71,307,822 $77,180,241 $81,041,170 =========== =========== =========== =========== Income (loss) before income tax expense (benefit) ........... $ 2,677,827 $(5,025,762) $ (766,909) $(2,427,035) Income tax expense (benefit) ........... 612,674 (2,179,897) (703,381) (1,165,143) ----------- ----------- ----------- ----------- Net income (loss) $ 2,065,153 $(2,845,865) $ (63,528) $(1,261,892) =========== =========== =========== =========== Net income (loss) per share - basic and diluted* $ .18 $ (.25) $ (.01) $ (.11) =========== =========== =========== =========== 2000 - ---- Total revenues ........ $61,144,637 $62,917,075 $66,792,907 $72,641,122 =========== =========== =========== =========== Income (loss) before income tax expense (benefit) ........... $ 2,003,674 $ (293,962) $ 1,428,928 $(2,074,028) Income tax expense (benefit) ........... 386,504 (489,810) 224,712 (1,385,825) ----------- ----------- ----------- ----------- Net income (loss) $ 1,617,170 $ 195,848 $ 1,204,216 $ (688,203) =========== =========== =========== =========== Net income (loss) per share - basic and diluted* $ .14 $ .02 $ .11 $ (.06) =========== =========== =========== =========== 1999 - ---- Total revenues ........ $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) =========== =========== =========== =========== * 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 10 exh13d.txt STOCKHOLDER INFORMATION STOCKHOLDER INFORMATION EXHIBIT 13(d) - ----------------------- ------------ 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 bid prices, as reported by NASDAQ, and the dividends paid for each quarter within the two most recent years. 2001 2000 --------------------------- --------------------------- High Low Dividends High Low Dividends ------ ------ --------- ------ ------ --------- 1st Quarter $13.13 $10.19 $ .15 $10.00 $ 7.63 $ .15 2nd Quarter 15.85 11.72 .15 9.13 6.81 .15 3rd Quarter 16.00 13.34 .15 11.38 8.50 .15 4th Quarter 18.75 13.01 .15 12.13 9.25 .15 Close on Dec. 31 17.15 11.75 On February 12, 2002, there were approximately 1,250 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 14 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. Employers Mutual has been reinvesting 100 percent of its dividends in additional shares of common stock under this plan since the second quarter of 1999. Employers Mutual has informed the Company that it will be reducing its participation in the dividend reinvestment plan to 25 percent for 2002. EX-16 11 exh16.txt KPMG LETTER EXHIBIT 16 ---------- LETTER RE CHANGE IN CERTIFYING ACCOUNTANT March 23, 2001 Securities and Exchange Commission Washington, DC 20549 Ladies and Gentlemen: We were previously the principal accountants for EMC Insurance Group Inc. and, under the date of February 27, 2001, we reported on the consolidated financial statements of EMC Insurance Group Inc. and subsidiaries as of and for the years ended December 31, 2000 and 1999. On October 18, 2000, we were notified by the management of EMC Insurance Group Inc. that the client-auditor relationship would cease upon completion of our audit of EMC Insurance Group Inc.'s consolidated financial statements as of and for the year ended December 31, 2000, and the issuance of our report thereon. We have read EMC Insurance Group Inc.'s statements included under Item 9 of its Form 10-K dated March 23, 2001, and we agree with such statements, except that we are not in a position to agree or disagree with EMC Insurance Group Inc.'s statement that the change was approved by the board of directors. KPMG LLP EX-21 12 exh21.txt SUBSIDIARIES OF THE REGISTRANT 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 13 exh23a.txt CONSENT OF E & Y EXHIBIT 23(a) ------------- CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the 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 our reports dated February 26, 2002 with respect to the consolidated financial statements and schedules of EMC Insurance Group Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2001. /s/ Ernst & Young LLP Des Moines, Iowa March 27, 2002 EX-23 14 exh23b.txt CONSENT OF KPMG EXHIBIT 23(b) ------------- CONSENT OF KPMG LLP, INDEPENDENT AUDITORS 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 27, 2001, relating to the consolidated balance sheet of EMC Insurance Group Inc. and Subsidiaries as of December 31, 2000, 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 two-year period ended December 31, 2000, which reports appear in the December 31, 2001 annual report on Form 10-K of EMC Insurance Group Inc. /s/ KPMG LLP Des Moines, Iowa March 28, 2002 EX-24 15 exh24.txt POWER OF ATTORNEY 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, 2001, 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 - ----------------------------- George W. Kochheiser Chairman of the Board of Directors /s/ Raymond A. Michel - ----------------------------- Raymond A. Michel Director /s/ Fredrick A. Schiek - ----------------------------- Fredrick A. Schiek Director February 26, 2002 112 -----END PRIVACY-ENHANCED MESSAGE-----