10-Q 1 q10q_3rd02.txt THIRD QUARTER 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 (x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2002 --------------------------------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- ------------------ Commission File Number: 0-10956 -------- EMC INSURANCE GROUP INC. ---------------------------------------------------- (Exact name of registrant as specified in its charter) Iowa 42-6234555 ------------------------------ ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 717 Mulberry Street, Des Moines, Iowa 50309 ------------------------------------- -------- (Address of principal executive office) (Zip Code) (515) 280-2902 -------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at October 31, 2002 ----- ------------------------------- Common stock, $1.00 par value 11,393,499 ---------- Total pages 28 ---- PART I. FINANCIAL INFORMATION ------- --------------------- ITEM 1. FINANCIAL STATEMENTS ------- -------------------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 30, December 31, 2002 2001 ------------ ------------ (Unaudited) ASSETS Investments: Fixed maturities: Securities held-to-maturity, at amortized cost (fair value $30,006,515 and $35,502,755) ... $ 28,339,998 $ 33,572,602 Securities available-for-sale, at fair value (amortized cost $372,750,283 and $384,410,393) .............................. 396,979,110 390,214,177 Fixed maturity securities on loan: Securities held-to-maturity, at amortized cost (fair value $36,841,170 and $35,962,133) ... 31,455,510 32,505,305 Securities available-for-sale, at fair value (amortized cost $56,026,658 and $27,325,968) 57,156,389 28,436,008 Equity securities available-for-sale, at fair value (cost $37,196,341 and $28,686,321) ..... 33,961,095 33,322,767 Other long-term investments, at fair value (cost $3,629,500 and $0) ..................... 3,629,500 - Short-term investments, at cost ................ 26,668,157 17,724,458 ------------ ------------ Total investments ......................... 578,189,759 535,775,317 Cash ............................................. (289,238) 558,073 Indebtedness of related party .................... 17,443,377 - Accrued investment income ........................ 7,512,262 8,659,008 Accounts receivable (net of allowance for uncollectible accounts of $0 and $573,502) ..... 592,252 1,081,024 Income taxes recoverable ......................... 235,035 100,614 Reinsurance receivables .......................... 10,873,749 14,501,336 Deferred policy acquisition costs ................ 26,543,235 21,363,528 Deferred income taxes ............................ 14,369,173 18,328,807 Goodwill, at cost less accumulated amortization of $2,616,234 and $2,616,234 ................... 941,586 941,586 Prepaid reinsurance premiums ..................... 3,540,913 2,275,231 Securities lending collateral .................... 96,485,845 66,809,518 Other assets ..................................... 1,813,984 1,170,655 ------------ ------------ Total assets .......................... $758,251,932 $671,564,697 ============ ============ See accompanying Notes to Interim Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 30, December 31, 2002 2001 ------------ ------------ (Unaudited) LIABILITIES Losses and settlement expenses ................... $323,846,952 $314,518,588 Unearned premiums ................................ 124,191,980 99,382,176 Other policyholders' funds ....................... 1,036,038 472,952 Surplus notes payable ............................ 36,000,000 25,000,000 Indebtedness to related party .................... - 2,684,418 Postretirement benefits .......................... 7,438,373 6,967,484 Securities lending ............................... 96,485,845 66,809,518 Other liabilities ................................ 14,891,938 15,271,938 ------------ ------------ Total liabilities ......................... 603,891,126 531,107,074 ------------ ------------ STOCKHOLDERS' EQUITY Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,392,184 shares in 2002 and 11,329,987 shares in 2001 ... 11,392,184 11,329,987 Additional paid-in capital ....................... 67,165,042 66,013,203 Accumulated other comprehensive income ........... 14,380,153 7,507,672 Retained earnings ................................ 61,423,427 55,606,761 ------------ ------------ Total stockholders' equity ................ 154,360,806 140,457,623 ------------ ------------ Total liabilities and stockholders' equity $758,251,932 $671,564,697 ============ ============ See accompanying Notes to Interim Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three months ended Nine months ended September 30, September 30, ----------------------- ------------------------- 2002 2001 2002 2001 ----------- ----------- ------------ ------------ REVENUES: Premiums earned ..........$74,979,176 $69,138,856 $216,837,256 $192,548,093 Investment income, net ... 7,934,259 7,932,760 24,539,285 23,082,657 Realized investment (losses) gains ......... (1,340,914) (39,421) (4,441,374) 562,317 Other income ............. 190,584 148,046 567,859 590,002 ----------- ----------- ------------ ------------ 81,763,105 77,180,241 237,503,026 216,783,069 ----------- ----------- ------------ ------------ LOSSES AND EXPENSES: Losses and settlement expenses ............... 52,335,783 57,796,154 152,102,635 162,802,872 Dividends to policyholders 567,313 471,493 2,319,931 1,060,241 Amortization of deferred policy acquisition costs 15,685,552 13,932,628 47,175,214 39,864,489 Other underwriting expenses ............... 6,420,699 5,573,609 18,927,655 15,248,838 Interest expense ......... 484,575 - 1,156,294 - Other expenses ........... 297,403 173,266 860,891 921,473 ----------- ----------- ------------ ------------ 75,791,325 77,947,150 222,542,620 219,897,913 ----------- ----------- ------------ ------------ Income (loss) before income tax expense (benefit) ............ 5,971,780 (766,909) 14,960,406 (3,114,844) ----------- ----------- ------------ ------------ INCOME TAX EXPENSE (BENEFIT): Current ................ 617,981 (8,480) 3,765,588 (142,528) Deferred ............... 1,052,614 (694,901) 259,070 (2,128,076) ----------- ----------- ------------ ------------ 1,670,595 (703,381) 4,024,658 (2,270,604) ----------- ----------- ------------ ------------ Net income (loss) ..$ 4,301,185 $ (63,528)$ 10,935,748 $ (844,240) =========== =========== ============ ============ Net income (loss) per common share - basic and diluted ........$ .38 $ (.01)$ .96 $ (.07) =========== =========== ============ ============ Dividends per common share $ .15 $ .15 $ .45 $ .45 =========== =========== ============ ============ Average number of common shares outstanding - basic and diluted ........ 11,391,128 11,316,708 11,369,014 11,308,273 =========== =========== ============ ============ See accompanying Notes to Interim Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) Three months ended Nine months ended September 30, September 30, ----------------------- ----------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Net income (loss) .......... $ 4,301,185 $ (63,528)$10,935,748 $ (844,240) ----------- ----------- ----------- ----------- OTHER COMPREHENSIVE INCOME: Unrealized holding gains arising during the period, before deferred income tax expense ..... 8,911,347 2,872,383 6,131,668 3,539,740 Deferred income tax expense ................ 3,118,971 976,612 2,146,080 1,203,516 ----------- ----------- ----------- ----------- 5,792,376 1,895,771 3,985,588 2,336,224 ----------- ----------- ----------- ----------- Reclassification adjustment for losses (gains) included in net income (loss) before income tax (benefit) expense ................ 1,349,804 39,421 4,441,374 (552,108) Income tax (benefit) expense ................ (472,431) (13,403) (1,554,481) 187,717 ----------- ----------- ----------- ----------- 877,373 26,018 2,886,893 (364,391) ----------- ----------- ----------- ----------- Other comprehensive income ........... 6,669,749 1,921,789 6,872,481 1,971,833 ----------- ----------- ----------- ----------- Total comprehensive income ........... $10,970,934 $ 1,858,261 $17,808,229 $ 1,127,593 =========== =========== =========== =========== See accompanying Notes to Interim Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine months ended September 30, -------------------------- 2002 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ............................. $ 10,935,748 $ (844,240) ------------ ------------ Adjustments to reconcile net income (loss) to net cash provided by operating activities: Losses and settlement expenses ............ 9,328,364 20,611,071 Unearned premiums ......................... 24,809,804 19,652,702 Other policyholders' funds ................ 563,086 (362,928) Deferred policy acquisition costs ......... (5,179,707) (6,467,825) Indebtedness of related party ............. (20,127,795) (4,439,934) Accrued investment income ................. 1,146,746 263,041 Accrued income taxes: Current ................................. (134,421) (334,703) Deferred ................................ 259,069 (2,128,080) Realized investment losses (gains) ........ 4,441,374 (562,317) Postretirement benefits ................... 470,889 818,918 Reinsurance receivables ................... 3,627,587 (2,295,656) Prepaid reinsurance premiums .............. (1,265,682) (1,597,201) Amortization of deferred income ........... - (39,859) Other, net ................................ (807,329) 8,546,944 ------------ ------------ 17,131,985 31,664,173 Cash provided by the property and casualty insurance subsidiaries' change in recording the full-term premium amount on policies billed on an installment basis (note 2) .......................... - 11,880,803 ------------ ------------ Net cash provided by operating activities ................ $ 28,067,733 $ 42,700,736 ------------ ------------ EMC INSURANCE GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited) Nine months ended September 30, -------------------------- 2002 2001 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Maturities of fixed maturity securities held-to-maturity ............................ $ 6,304,505 $ 35,808,699 Purchases of fixed maturity securities available-for-sale .......................... (162,124,817) (95,881,016) Disposals of fixed maturity securities available-for-sale .......................... 142,278,735 26,112,612 Purchases of equity securities available-for-sale .......................... (31,416,776) (19,489,793) Disposals of equity securities available-for-sale .......................... 21,521,555 20,157,569 Purchase of other long-term investments ....... (4,061,808) - Disposals of other long-term investments ...... 432,308 - Net purchases of short-term investments ....... (8,943,700) (4,405,377) ------------ ------------ Net cash used in investing activities ....... (36,009,998) (37,697,306) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock ...................... 1,214,036 357,877 Dividends paid to stockholders ................ (5,119,082) (5,089,054) Issuance of surplus note (note 5) ............. 11,000,000 - ------------ ------------ Net cash provided by (used in) financing activities .................... 7,094,954 (4,731,177) ------------ ------------ NET (DECREASE) INCREASE IN CASH ................. (847,311) 272,253 Cash at beginning of year ....................... 558,073 490,226 ------------ ------------ Cash at end of quarter .......................... $ (289,238) $ 762,479 ============ ============ Income taxes paid ............................... $ 3,900,010 $ 191,684 Interest paid (received) ........................ $ 19,232 $ (79,232) See accompanying Notes to Interim Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS September 30, 2002 (Unaudited) 1. BASIS OF PRESENTATION The results of operations for the interim periods reported are not necessarily indicative of the results to be expected for the year. The information reflects all adjustments (which include only normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of the results for the interim periods. Certain amounts previously reported in prior years' consolidated financial statements have been reclassified to conform to current year presentation. In reading these financial statements, reference should be made to the Company's 2001 Form 10-K or the 2001 Annual Report to Shareholders for more detailed footnote information. 2. INSTALLMENT BASIS PREMIUMS Effective January 1, 2001, the Company began recording the full-term premium amount due on policies that are billed on an installment basis. Previously, such amounts were recorded as each installment became due. As a result, on January 1, 2001 written premiums and unearned premiums increased $13,884,423, 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. 3. 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. Property Three months ended and casualty Parent September 30, 2002 insurance Reinsurance company Consolidated -------------------- ------------ ------------ ------------ ------------ Premiums earned ...... $ 58,178,665 $ 16,800,511 $ 74,979,176 Underwriting gain (loss) ............. 957,755 (987,926) (30,171) Net investment income 5,634,157 2,276,683 $ 23,419 7,934,259 Realized investment (losses) gains ..... (1,371,512) 30,598 - (1,340,914) Other income ......... 190,584 - - 190,584 Interest expense ..... (339,014) (145,561) - (484,575) Other expense ........ (227,871) - (69,532) (297,403) ------------ ------------ ------------ ------------ Income (loss) before income tax expense (benefit) .......... $ 4,844,099 $ 1,173,794 $ (46,113) $ 5,971,780 ============ ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) September 30, 2002 Property Three months ended and casualty Parent September 30, 2001 insurance Reinsurance company Consolidated -------------------- ------------ ------------ ------------ ------------ Premiums earned ...... $ 51,637,788 $ 17,501,068 $ 69,138,856 Underwriting loss .... (6,358,566) (2,276,462) (8,635,028) Net investment income 5,793,272 2,094,020 $ 45,468 7,932,760 Realized investment losses ............. (35,210) (4,211) - (39,421) Other income ......... 136,547 11,499 - 148,046 Other expense ........ (100,587) - (72,679) (173,266) ------------ ------------ ------------ ------------ Loss before income tax benefit ........ $ (564,544) $ (175,154) $ (27,211) $ (766,909) ============ ============ ============ ============ Property Nine months ended and casualty Parent September 30, 2002 insurance Reinsurance company Consolidated -------------------- ------------ ------------ ------------ ------------ Premiums earned ...... $165,989,988 $ 50,847,268 $216,837,256 Underwriting loss .... (839,626) (2,848,553) (3,688,179) Net investment income 17,669,191 6,775,603 $ 94,491 24,539,285 Realized investment (losses) gains ..... (3,427,908) (1,018,779) 5,313 (4,441,374) Other income ......... 567,859 - - 567,859 Interest expense ..... (1,005,986) (150,308) - (1,156,294) Other expense ........ (558,528) - (302,363) (860,891) ------------ ------------ ------------ ------------ Income (loss) before income tax expense (benefit) .......... $ 12,405,002 $ 2,757,963 $ (202,559) $ 14,960,406 ============ ============ ============ ============ Property Nine months ended and casualty Parent September 30, 2001 insurance Reinsurance company Consolidated -------------------- ------------ ------------ ------------ ------------ Premiums earned ...... $150,458,463 $ 42,089,630 $192,548,093 Underwriting loss .... (20,206,176) (6,222,171) (26,428,347) Net investment income 16,737,370 6,190,239 $ 155,048 23,082,657 Realized investment gains (losses) ..... 576,633 (14,316) - 562,317 Other income ......... 550,143 39,859 - 590,002 Other expense ........ (536,953) - (384,520) (921,473) ------------ ------------ ------------ ------------ Loss before income tax benefit ........ $ (2,878,983) $ (6,389) $ (229,472) $ (3,114,844) ============ ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) September 30, 2002 4. INCOME TAXES The actual income tax expense (benefit) for the three and nine months ended September 30, 2002 and 2001 differed from the "expected" tax expense (benefit) for those periods (computed by applying the United States federal corporate tax rate of 35 percent for 2002 and 34 percent for 2001 to income (loss) before income tax expense (benefit)) as follows: Three months ended Nine months ended September 30, September 30, ------------------------ ------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Computed "expected" tax expense (benefit) ...... $ 2,090,123 $ (260,749) $ 5,236,142 $(1,059,047) Increases (decreases) in tax resulting from: Tax-exempt interest income ............. (392,798) (361,910) (1,117,967) (1,108,768) Proration of tax-exempt interest and dividends received deduction 40,605 41,451 123,422 125,021 Other, net ........... (67,335) (122,173) (216,939) (227,810) ----------- ----------- ----------- ----------- Income tax expense (benefit) ...... $ 1,670,595 $ (703,381) $ 4,024,658 $(2,270,604) =========== =========== =========== =========== 5. SURPLUS NOTES On June 27, 2002, EMC Reinsurance Company, a subsidiary of the Company, issued a surplus note in the amount of $11,000,000 to Employers Mutual Casualty Company. The surplus note bears an annual interest rate of 5.25 percent and does not have a maturity date. All payments of interest and principal must be approved in advance by the Iowa Insurance Commissioner and can only be made out of EMC Reinsurance Company's statutory surplus earnings. The surplus note is subordinate and junior in right of payment to all obligations or liabilities of EMC Reinsurance Company. EMC INSURANCE GROUP INC. AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) September 30, 2002 6. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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 was 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 amortization of the Company's carried goodwill, adoption of these statements did not have an impact on the operating results of the Company. Goodwill amortization expense amounted to approximately $34,000 and $101,000 for the three and nine months ended September 30, 2001, respectively and $135,000 for the twelve months ended December 31, 2001. On an after tax basis, these amounts totaled approximately $22,000, $67,000 and $87,000, respectively. Due to the immaterial amounts involved, the Company has not presented prior year net income or earnings per share information that has been adjusted to exclude this expense. 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 did not have any effect on the operating results of the Company. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- (Unaudited) OVERVIEW EMC Insurance Group Inc., a 79.6 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 76.6 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, 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 inter-company balances with Employers Mutual, which are settled on a quarterly basis. The reinsurance subsidiary pays an annual override commission to Employers Mutual in connection with the $1,500,000 cap on losses assumed per event. The override commission rate is charged at 4.50 percent of written premiums. 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) Premium rate increases continued to grow progressively larger during the first nine months of 2002. Based on current projections, premium rates for most lines of business will approach adequate levels by year-end for the first time in nearly a decade. While management expects to implement additional rate increases in 2003, those increases will likely be smaller and will be focused on specific territories and lines of business. 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. Underwriting profitability is considered to be the Company's number one priority, especially in light of the declining stock markets and the low interest rate environment. Existing accounts and agencies are being evaluated to ensure that business with a reasonable expectation of profitability is retained. In addition, new business is generally being limited to that which fits within the Company's core competencies and can be priced adequately. 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 during 2001. Premiums earned increased 8.4 percent for the three months and 12.6 percent for the nine months ended September 30, 2002 from the same periods in 2001. These increases primarily reflect rate increases that were implemented during the last two years; however, the increase for the three months ended September 30, 2002 was limited by a large amount of reinstatement premium that was recognized by the reinsurance subsidiary in the third quarter of 2001 in connection with the World Trade Center catastrophe. Despite rising premium rates, retention levels have remained fairly constant, evidence of the movement of the insurance industry towards more adequate rate levels. 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. Losses and settlement expenses decreased 9.4 percent for the three months and 6.6 percent for the nine months ended September 30, 2002 from the same periods in 2001, primarily due to a significant decline in catastrophe and storm losses from the unusually large amount experienced during 2001. Other factors contributing to the decline in losses and settlement expenses include the implementation of more stringent underwriting standards and a decline in large losses. Adverse development on prior years' reserves during the third quarter of 2002 offset much of the favorable development that had been recognized through the first six months of 2002. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) Acquisition and other expenses increased 13.5 percent for the three months and 21.8 percent for the nine months ended September 30, 2002 from the same periods in 2001. The increase for the nine months ended September 2002 is primarily attributed to increases in both commission and contingent commission expenses, reflecting the large increase in premium volume as well as the significant improvement in underwriting results. The increase for the three months ended September 30, 2002 reflects substantial growth in commission expense, but little impact from contingent commissions and policyholder dividends. Other influences impacting acquisition and other expenses for 2002 include the discontinuation of an assigned risk program during 2001 that produced commission income and an increase in employee benefit costs. Acquisition and other expenses for the first nine months of 2001 include approximately $101,000 of goodwill amortization expense. In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", which became effective January 1, 2002, the Company's carried goodwill is no longer subject to amortization and must instead be tested for impairment on a periodic basis. Net investment income was flat for the three months and increased 6.3 percent for the nine months ended September 30, 2002 from the same periods in 2001. The Company has experienced a significant increase in fixed maturity security investments in 2002 due to the issuance of $25,000,000 of surplus notes in December 2001 and another $11,000,000 in June 2002; however, this increase in invested assets has not produced a significant increase in investment income due to the declining interest rate environment. In addition, the Company experienced a significant amount of call activity on its portfolio of fixed maturity securities during 2001 due to the large decline in interest rates. Proceeds from this call activity, and from maturing securities, were reinvested at lower current interest rates, resulting in less investment income for 2002. The Company currently has $36,000,000 of surplus notes issued to Employers Mutual. These surplus notes were issued in response to statutory capital adequacy concerns raised by certain rating agencies because the statutory surplus position of the Company's insurance and reinsurance subsidiaries had declined over the last three years due to unfavorable operating results and the payment of dividends to the parent company. It should be noted that surplus notes are considered to be a component of surplus for statutory reporting purposes because 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 issuing 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. The Company incurred $1,156,000 of interest expense on these surplus notes during the first nine months of 2002. This interest expense did not have a material impact on operating results as the proceeds of the surplus notes were invested in government agencies and corporate bonds and earned a similar amount of interest income. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) The realized investment losses for the nine months ended September 30, 2002 primarily reflect an "other than temporary" security impairment write down of the Company's investment in MCI Communications Corporation corporate bonds totaling $3,821,000 in the second quarter. MCI Communications Corporation is owned by WorldCom Inc., whose corporate bonds were downgraded to junk status in May when it reported the detection of accounting irregularities. The MCI bonds are supported by the assets of MCI; however, the magnitude of the WorldCom collapse has cast doubt on the prospect of collecting the entire amount of principal and interest payments due the Company. As a result, the Company determined that the decline in the market value of the MCI bonds was "other than temporary." The realized investment losses for the three months ended September 30, 2002 were generated from rebalancing activities in the Company's equity portfolio. The Company reported income tax expense for both the three months and nine months ended September 30, 2002, as compared to an income tax benefit for the same periods in 2001. This change in tax status primarily reflects the substantial improvement in pre-tax operating results experienced in 2002. At the time of this writing the United States Congress is working on a terrorism insurance bill, but no definitive legislation has been proposed. Meanwhile, exclusions for terrorist activities on the Company's primary reinsurance coverage have left the Company exposed to terrorism losses on its direct business. To address this exposure, the Company has implemented limitations of coverage where allowed, attempted to recognize and minimize terrorism exposures, and obtained limited stand-alone reinsurance coverage for terrorism losses. However, due to its very nature, losses from terrorism cannot be underwritten with any degree of confidence. Losses from asbestos and mold related claims continue to hamper the insurance industry as a whole. Employers Mutual has taken steps to more fully understand and limit these risks. In the case of asbestos, Employers Mutual has appointed a task force to study the company's exposure to additional asbestos claims. In the case of mold, the EMC Insurance Companies are using exclusionary endorsements and sub-limits to control mold losses. In addition, an improved understanding of these types of claims has resulted in prompt attention to water damage losses. As a result, management does not consider the Company to have a significant exposure to mold related losses. Employers Mutual is currently analyzing the assumptions that will be utilized in the preparation of the year-end valuation reports for its pension and postretirement benefit plans. The assumptions utilized in these valuation reports will likely change, some significantly, due to the current interest rate environment and the continued escalation in the price of prescription drugs. The changes in these assumptions are expected to result in a large increase in both the year-end liabilities for these plans and the associated expense of these plans for 2003. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) SEGMENT RESULTS Property and Casualty Insurance Operating results for the three months and nine months ended September 30, 2002 and 2001 are as follows: Three months ended Nine months ended September 30, September 30, ----------------- ----------------- ($ in thousands) 2002 2001 2002 2001 -------- -------- -------- -------- Premiums earned ..................... $ 58,179 $ 51,638 $165,990 $150,458 Losses and settlement expenses ...... 39,601 42,972 114,691 126,593 Acquisition and other expenses ...... 17,620 15,025 52,138 44,072 -------- -------- -------- -------- Underwriting profit (loss) .......... 958 (6,359) (839) (20,207) Net investment income ............... 5,634 5,794 17,669 16,738 Interest expense .................... (339) - (1,006) - Other (expense) income .............. (38) 35 9 13 -------- -------- -------- -------- Operating income (loss) before income taxes ...................... $ 6,215 $ (530) $ 15,833 $ (3,456) ======== ======== ======== ======== Incurred losses and settlement expenses: Insured events of current year .. $ 38,671 $ 42,532 $117,449 $130,873 Increase (decrease) in provision for insured events of prior years ......................... 930 440 (2,758) (4,280) -------- -------- -------- -------- Total losses and settlement expenses ....... $ 39,601 $ 42,972 $114,691 $126,593 ======== ======== ======== ======== Catastrophe and storm losses ........ $ 1,481 $ 3,808 $ 5,653 $ 14,812 ======== ======== ======== ======== Premiums earned increased 12.7 percent for the three months and 10.3 percent for the nine months ended September 30, 2002 from the same periods in 2001. These increases are primarily attributable to rate increases that were implemented during the last two years. Premium rate increases continued to grow progressively larger during the first nine months of 2002 and management expects to implement additional rate increases in the fourth quarter; however, rate increases are expected to level off in 2003. Based on current projections, premium rates for most lines of business will approach adequate levels by year-end. As a result, future premium rate increases will likely be focused on specific territories and lines of business. It should be noted 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 terms of the underlying policies. Losses and settlement expenses decreased 7.8 percent for the three months and 9.4 percent for the nine months ended September 30, 2002 from the same periods in 2001. The primary factor contributing to this improvement was a significant decline in catastrophe and storm losses from the unusually large amount experienced during the storm plagued first nine months of 2001. Other factors contributing to this improvement include more stringent underwriting standards and a decline in large losses. Loss frequency declined during the first nine months of 2002, continuing a trend that began in 2000, but the benefit to operating results was partially offset by an increase in loss severity. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) Acquisition and other expenses increased 17.3 percent for the three months and 18.3 percent for the nine months ended September 30, 2002 from the same periods in 2001. These increases are primarily related to the growth in premium income noted above, but also reflect an increase in policyholder dividends, the discontinuation of an assigned risk program during 2001 that produced commission income and higher employee benefit costs. Underwriting results for the three months and nine months ended September 30, 2002 improved substantially in comparison to the same periods in 2001. This improvement reflects an increase in overall premium rate adequacy and the implementation of more stringent underwriting standards, as well as a significant decline in catastrophe and storm losses from the unusually large amount experienced in 2001. The improvements that have been achieved in premium rate adequacy will continue to have an increasingly positive impact on future operating results, but the unpredictable nature of catastrophe and storm losses will remain. Underwriting for profitability is always stressed, but has become even more critical due to the declining stock markets and the low interest rate environment. Both new and renewal business is being closely scrutinized to ensure that there is potential for an underwriting profit. Reinsurance Operating results for the three months and nine months ended September 30, 2002 and 2001 are as follows: Three months ended Nine months ended September 30, September 30, ----------------- ----------------- ($ in thousands) 2002 2001 2002 2001 -------- -------- -------- -------- Premiums earned ..................... $ 16,800 $ 17,501 $ 50,847 $ 42,090 Losses and settlement expenses ...... 12,735 14,824 37,412 36,210 Acquisition and other expenses ...... 5,053 4,953 16,284 12,102 -------- -------- -------- -------- Underwriting loss ................... (988) (2,276) (2,849) (6,222) Net investment income ............... 2,277 2,093 6,776 6,190 Interest expense .................... (145) - (150) - Other income ........................ - 12 - 40 -------- -------- -------- -------- Operating income (loss) before income taxes ...................... $ 1,144 $ (171) $ 3,777 $ 8 ======== ======== ======== ======== Incurred losses and settlement expenses: Insured events of current year .. $ 11,681 $ 15,137 $ 35,401 $ 32,170 Increase (decrease) in provision for insured events of prior years ................ 1,054 (313) 2,011 4,040 -------- -------- -------- -------- Total losses and settlement expenses ....... $ 12,735 $ 14,824 $ 37,412 $ 36,210 ======== ======== ======== ======== Catastrophe losses .................. $ (356)$ 2,980 $ 291 $ 4,561 ======== ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) Premiums earned decreased 4.0 percent for the three months and increased 20.8 percent for the nine months ended September 30, 2002 from the same periods in 2001. The decrease for the three months ended September 30, 2002 is attributed to reinstatement premiums of approximately $2,001,000 that were recognized in the third quarter of 2001 in connection with the World Trade Center catastrophe, and a reduction of approximately $500,000 in the estimate of earned but not reported premiums during the third quarter of 2002 due to the loss of a block of business. The large increase for the nine months ended September 30, 2002 is attributed to rate increases implemented during the January 2002 renewal season, increased participation in a reinsurance pool and growth in a marine syndicate account. Sizable rate increases were placed on excess of loss contracts during the January 2002 renewal season and both excess of loss and pro-rata contracts have benefited from industry-wide rate increases being implemented at the primary company level. These rate increases have been realized in conjunction with a moderate decline in the related exposure base due to increased retention levels on many contracts and coverage exclusions for terrorist activities on most contracts. Premium income for the nine months ended September 30, 2002 also reflects a reduction of approximately $550,000 in the estimated amount of assumed reinstatement premiums to be received on the World Trade Center catastrophe. Losses and settlement expenses decreased 14.1 percent for the three months and increased 3.3 percent for the nine months ended September 30, 2002 from the same periods in 2001. The decrease for the three months and the relatively small increase for the nine months ended September 30, 2002 is primarily the result of a significant decline in catastrophe losses from the elevated levels experienced in 2001, which included Midwest wind and hail storms, flood losses from tropical storm Allison and losses associated with the terrorist attack on the World Trade Center. The reinsurance subsidiary has experienced a substantial amount of adverse development on prior year reserves during the last two years. The majority of this development has come from a reinsurance pool in which the reinsurance subsidiary participates, and is largely attributed to a high level of construction defect claims on an account that was discontinued on December 31, 1999. Acquisition and other expenses increased 2.0 percent for the three months and 34.6 percent for the nine months ended September 30, 2002 from the same periods in 2001. The increase for the nine months ended September 30, 2002 primarily reflects increases in both commission and contingent commission expenses associated with the significant increase in premium volume and good loss experience on certain reinsurance contracts. The increase for the three months ended September 30, 2002 also reflects a substantial increase in commission expense; however, this increase was largely offset by a decline in contingent commission expense and an increase in the amount of acquisition expenses deferred as a result of the large increase in unearned premiums. Commission expense for first nine months of 2002 also includes approximately $379,000 of expense incurred in connection with the increased participation in the reinsurance pool noted above. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) The improvement in the underwriting results of the reinsurance segment for the three and nine months ended September 30, 2002 is primarily attributed to improved rate adequacy, lower catastrophe losses, a decline in the amount of adverse development experienced on prior years' reserves and a decline in casualty losses. Although the reinsurance subsidiary was able to implement significant rate increases in 2002, the methodology utilized to establish loss and settlement expense reserves has limited the impact of these rate increases on the underwriting results of 2002. For a significant portion of the reinsurance book of business, loss and settlement expense reserves for the latest policy year are established by a formula-based process that produces a break-even result. This procedure is utilized until sufficient data is available to more formally project anticipated losses and settlement expenses. Reported reinsurance results are analyzed throughout the year and modifications are made to the formula-based reserves when appropriate. It is anticipated that the rate increases implemented during 2002 will mitigate the need to establish loss and settlement reserves in excess of the formula-based amounts, as has been required during the last several years. Such adjustments to the formula-based reserves totaled $3,400,000 in the first nine months of 2001 and $6,400,000 for the year ended December 31, 2001. In addition to pricing its reinsurance premiums at more adequate rates, Employers Mutual continues to work toward improving profitability on the assumed book of business by accepting larger shares of coverage on desirable programs, utilizing relationships with reinsurance intermediaries and monitoring exposures. Parent Company Operating loss before income taxes totaled $46,000 and $208,000 for the three months and nine months ended September 30, 2002 compared to losses of $26,000 and $229,000 for the same periods in 2001. The operating results of the Company were positively impacted by a decline in operating expenses for both the three months and nine months ended September 30, 2002 over the same periods in 2001. However, this improvement was offset by a decline in interest income, the Company's primary source of revenue. LIQUIDITY AND CAPITAL RESOURCES The Company maintains a portion of the 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) 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 $16,483,000 at September 30, 2002 compared to $4,494,000 at December 31, 2001. 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. 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. 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 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 $28,067,733 during the first nine months of 2002 compared to $42,700,736 for the same period in 2001. 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. Employers Mutual reinvested 25 percent of its dividends in additional shares of the Company's common stock during the first nine months of 2002. Prior to 2002, Employers Mutual was reinvesting 100 percent of its dividends in additional shares of the Company's common stock. Employers Mutual has indicated that it will increase its dividend reinvestment percentage to 50 percent in the first quarter of 2003. In addition, Employers Mutual may elect to fulfill its obligations under its incentive stock option plans by purchasing the Company's common stock on the open market, rather than requesting the Company to issue new shares. The combination of these two actions is expected to result in Employers Mutual achieving an 80 percent ownership of the Company by March 31, 2003. At that time, Employers Mutual will likely discontinue its participation in the Company's dividend reinvestment plan. Under this timeline, the Company will be included in a consolidated tax return with Employers Mutual and its subsidiaries effective April 1, 2003. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS, CONTINUED ---------------------------------------------- (Unaudited) NEW ACCOUNTING PRONOUNCEMENTS 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 did not 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 did not have any effect on the operating results of the Company. 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ------- ---------------------------------------------------------- (Unaudited) The main objectives in managing the investment portfolios of the Company are to maximize after-tax investment income and total investment return while minimizing credit risks, in order to provide maximum support for the underwriting operations. Investment strategies are developed based upon many factors including underwriting results and the Company's resulting tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are centrally managed by investment professionals and are supervised by the investment committees of the respective board of directors for each of the Company's subsidiaries. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks of the financial instruments of the Company relate to the investment portfolio, which exposes the Company to interest rate and equity price risk, and to a lesser extent credit quality and prepayment risk. Monitoring systems and analytical tools are in place to assess each of these elements of market risk. Two categories of influences on market risk exist as it relates to financial instruments. First are systematic aspects, which relate to the investing environment and are out of the control of the investment manager. Second are non-systematic aspects, which relate to the construction of the investment portfolio through investment policies and decisions, and are under the direct control of the investment manager. Due to systematic changes, several components of market risk have increased noticeably during the first nine months of 2002. As it relates to equity price risk, the poor performance of the markets during 2002 has resulted in declines in the values of the Company's equity investments. Credit quality risk has risen resulting in declines in the values of several bond investments stemming from the many high-profile bankruptcies and other downgrade activities during 2002. Prepayment risk has increased, primarily for the mortgage-backed securities, as declines in interest rates during 2002 have accelerated the payment of higher-interest rate mortgages through re-financing activity. And finally, to a lesser extent interest rate risk has increased due to interest rates bottoming-out during 2002. Future interest rate increases will result in declines in the values of fixed maturity securities from their current values. Throughout all these systematic changes, the Company continues its commitment to controlling non-systematic risk through sound investment policies and diversification. ITEM 4. CONTROLS AND PROCEDURES ------- ----------------------- Within the 90 days prior to the filing date of this report, the Company's management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are functioning effectively to provide reasonable assurance that the Company can meet its disclosure obligations. Since the date of the most recent evaluation of the Company's internal controls by the Chief Executive Officer and Chief Financial Officer there have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls. EMC INSURANCE GROUP INC. AND SUBSIDIARIES PART II. OTHER INFORMATION -------- ----------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ------- -------------------------------- (a) Exhibit 99.1. Certification of President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2. Certification of Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) No Form 8-K was filed by the registrant during the quarter ended September 30, 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EMC INSURANCE GROUP INC. Registrant /s/ Bruce G. Kelley ------------------------ Bruce G. Kelley President & Chief Executive Officer /s/ Mark Reese ------------------------ Mark Reese Vice President and Chief Financial Officer Date: November 13, 2002 CERTIFICATIONS I, Bruce G. Kelley, certify that: 1. I have reviewed this quarterly report on Form 10-Q of EMC Insurance Group Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 ----------------- /s/ Bruce G. Kelley ------------------------- Bruce G. Kelley President & Chief Executive Officer CERTIFICATIONS I, Mark Reese, certify that: 1. I have reviewed this quarterly report on Form 10-Q of EMC Insurance Group Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 ----------------- /s/ Mark Reese ------------------------- Mark Reese Vice President and Chief Financial Officer