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.