10-K405 1 1994 EMC INSURANCE GROUP INC 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required] For the Fiscal Year Ended December 31, 1994 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from to ------------ ----------- Commission File Number: 0-10956 EMC INSURANCE GROUP INC. -------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Iowa 42-6234555 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 717 Mulberry Street, Des Moines, Iowa 50309 ----------------------------------------- ---------- (Address of Principal Executive Office) (Zip Code) Registrant's telephone number, including area code: (515) 280-2581 --------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $1.00 ----------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 1, 1995 was $36,799,499. The number of shares outstanding of the registrant's common stock, $1.00 par value, on March 1, 1995, was 10,589,368. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission on or before April 30, 1995, are incorporated by reference under Part III. PART I ------ ITEM 1. BUSINESS. ------- -------- GENERAL ------- EMC Insurance Group Inc. is an insurance holding company incorporated in Iowa in 1974. EMC Insurance Group Inc. is approximately 67 percent owned by Employers Mutual Casualty Company (Employers Mutual), a multiple-line property and casualty insurance company organized as an Iowa mutual insurance company in 1911 that is licensed in all 50 states and the District of Columbia. EMC Insurance Group Inc. and its subsidiaries are referred to herein as the "Company". Employers Mutual and all of its subsidiaries (including the Company), which collectively have assets totaling $1,289,722,903 and written premiums of $583,288,995, are referred to as the "EMC Insurance Companies". The Company conducts its insurance business through four business segments as follows: ............................... : : : EMC INSURANCE GROUP INC. : :.............................: : Excess and Property and : Nonstandard Surplus Lines Casualty : Risk Automobile Insurance Insurance Reinsurance : Insurance Agency ................................:................................. : : : : : : : : EMCASCO Insurance EMC Farm and City EMC Company (EMCASCO) Reinsurance Insurance Underwriters, Illinois EMCASCO Company Company Ltd. Insurance Company (Illinois EMCASCO) Dakota Fire Insurance Company (Dakota Fire) EMCASCO was formed in Iowa in 1958, Illinois EMCASCO was formed in Illinois in 1976 and Dakota Fire was formed in North Dakota in 1957 for the purpose of writing property and casualty insurance lines. These companies are licensed to write insurance in a total of 35 states and are participants in a pooling agreement with Employers Mutual. (See "Property and Casualty Insurance - Pooling Agreement"). The reinsurance subsidiary was formed in 1981 to assume reinsurance business of Employers Mutual. The company assumes 95 percent of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts, and is licensed to do business in 11 states. The nonstandard risk automobile insurance subsidiary was purchased in 1984. The company was formed in Iowa in 1962 to write nonstandard risk automobile insurance and is licensed in 5 states. The excess and surplus lines insurance agency was acquired in 1985. The company was formed in Iowa in 1975 as a broker for excess and surplus lines insurance and acts as managing underwriter for such lines for several of the property and casualty pool members. (See "Property and Casualty Insurance - Pooling Agreement"). FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS --------------------------------------------- For information concerning the Company's revenues, operating income and identifiable assets attributable to each of its industry segments over the past three years, see note 9 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. PROPERTY AND CASUALTY INSURANCE ------------------------------- POOLING AGREEMENT The three property and casualty insurance subsidiaries of the Company and two subsidiaries of Employers Mutual (Union Insurance Company of Providence and American Liberty Insurance Company) are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business 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 unaffiliated 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 22 percent. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment programs and income tax liabilities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to reduce the risk of an exposure insured by any of the pool participants by spreading it 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 and lines of insurance written and the variety of rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all six companies in the pool. Prior to December 31, 1993, the parties to the pooling agreement recorded amounts assumed from the National Workers' Compensation Reinsurance Pool on a net basis. Under this approach, reserves for outstanding losses and unearned premiums were reported as liabilities under "Indebtedness to Related Party" in the Company's consolidated financial statements. Effective December 31, 1993, the parties to the pooling agreement began recording these amounts as outstanding losses and unearned premiums and restated all prior year consolidated financial statements for comparative purposes. There was no income effect from this reclassification. In connection with this gross-up of balances, amounts due from Employers Mutual increased $13,147,831 at December 31, 1993. Under the terms of the pooling agreement, these balances were settled in the first quarter of 1994. PRINCIPAL PRODUCTS The Company's property and casualty insurance subsidiaries and the other parties to the pooling agreement underwrite both commercial and personal lines of insurance. The following table sets forth the aggregate direct written premiums of all parties to the pooling agreement for the three years ended December 31, 1994. The pooling agreement is continuous but may be amended or terminated at the end of any calendar year as to any one or more parties. Percent Percent Percent of of of Line of Business 1994 Total 1993 Total 1992 Total ---------------- -------- ----- -------- ----- -------- ----- (Dollars in thousands) Commercial Lines: Automobile ............ $ 91,674 17.0% $ 83,415 16.0% $ 77,102 14.9% Property .............. 81,358 15.1 72,743 13.9 71,856 13.9 Workers' compensation 133,621 24.7 134,529 25.8 141,245 27.2 Liability ............. 100,844 18.7 99,976 19.1 98,029 18.9 Other ................. 13,405 2.5 11,948 2.3 11,858 2.3 -------- ----- -------- ----- -------- ----- Total commercial lines 420,902 78.0 402,611 77.1 400,090 77.2 -------- ----- -------- ----- -------- ----- Personal Lines: Automobile ............ 80,694 14.9 83,068 15.9 82,346 15.9 Property .............. 38,107 7.1 36,515 7.0 35,785 6.9 Liability ............. - - - - 200 - Other ................. 56 - 56 - 57 - -------- ----- -------- ----- -------- ----- Total personal lines 118,857 22.0 119,639 22.9 118,388 22.8 -------- ----- -------- ----- -------- ----- Total ............ $539,759 100.0% $522,250 100.0% $518,478 100.0% ======== ===== ======== ===== ======== ===== MARKETING Marketing of insurance by the parties to the pooling agreement is conducted through 18 offices located throughout the United States and approximately 2,350 independent agents. These offices maintain close contact with the local market conditions and are able to react rapidly to change. Each office employs underwriting, claims, marketing and risk improvement representatives, as well as field auditors and branch administrative technicians. The offices are supported by Employers Mutual technicians and specialists. Systems are in place to monitor the underwriting results of each office and to maintain guidelines and policies consistent with the underwriting and marketing environment in each region. The following table sets forth the geographic distribution of the aggregate direct written premiums of all parties to the pooling agreement for the three years ended December 31, 1994. 1994 1993 1992 ---- ---- ---- Arizona ............................ 3.8% 3.7% 3.6% Colorado ........................... 3.3 2.8 2.7 Illinois ........................... 6.7 6.8 7.0 Iowa ............................... 23.0 26.2 26.7 Kansas ............................. 8.2 7.4 7.1 Michigan ........................... 3.8 3.1 2.8 Minnesota .......................... 5.3 5.3 5.3 Nebraska ........................... 8.0 7.5 7.6 North Carolina ..................... 3.8 3.3 3.3 Rhode Island ....................... 3.3 3.2 2.9 Texas .............................. 2.7 2.8 3.2 Wisconsin .......................... 5.7 6.7 7.0 Other * ............................ 22.4 21.2 20.8 ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== ===== * Includes all other jurisdictions, none of which accounted for more than 3%. COMPETITION The property and casualty insurance business is highly competitive. The Company's property and casualty insurance subsidiaries and the other pool members compete in the United States insurance market with numerous insurers, many of which have greater financial resources. Competition in the types of insurance in which the property and casualty insurance subsidiaries are engaged is based on many factors, including the perceived overall financial strength of the insurer, premiums charged, contract terms and conditions, services offered, speed of claim payments, reputation and experience. In this competitive environment, insureds have tended to favor large, financially strong insurers and the Company faces the risk that insureds may become more selective and may seek larger and/or more highly rated insurers. BEST'S RATING A.M. Best rates insurance companies based on their relative financial strength and ability to meet their contractual obligations. The "A" (Excellent) rating assigned to the Company's property and casualty insurance subsidiaries and the other pool members is based on the pool members' 1993 operating results and financial condition as of December 31, 1993. Best's reevaluates its ratings from time to time (normally on an annual basis) and there can be no assurance that the Company's property and casualty insurance subsidiaries and the other pool members will maintain their current rating in the future. Management believes that a Best's rating of "A" (Excellent) or better is important to the Company's business since many insureds require that companies with which they insure be so rated. Best's publications indicate that these ratings are assigned to companies which Best's believes have achieved excellent overall performance and have a strong ability to meet their obligations over a long period of time. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. REINSURANCE CEDED The parties to the pooling agreement cede insurance in the ordinary course of business for the purpose of limiting their maximum loss exposure through diversification of their risks. The pool participants also purchase catastrophe reinsurance to cover multiple losses arising from a single event. All major reinsurance treaties, with the exception of the pooling agreement and a boiler treaty, are on an "excess of loss" basis whereby the reinsurer agrees to reimburse the primary insurer for covered losses in excess of a predetermined amount, up to a stated limit. The boiler treaty provides for 100 percent reinsurance of the pool's direct boiler coverage written. Facultative reinsurance from approved domestic markets, which provides reinsurance on an individual risk basis and requires specific agreement of the reinsurer as to the limits of coverage provided, is purchased when coverage by an insured is required in excess of treaty capacity or where a high-risk type policy could expose the treaty reinsurance programs. Retention levels are adjusted according to reinsurance market conditions and the surplus position of Employers Mutual. The intercompany pooling arrangement aids efficient buying of reinsurance since it allows for higher retention levels and correspondingly decreased dependence on the reinsurance marketplace. A summary of the reinsurance treaties benefiting the parties to the pooling agreement follows: Type of Coverage Retention Limits ---------------- --------- ------ Property per risk ........... $2,000,000 100 percent of $18,000,000 Property catastrophe ........ $9,000,000 95 percent of $51,000,000 Casualty .................... $2,000,000 100 percent of $44,000,000 Umbrella .................... $5,000,000 100 percent of $ 5,000,000 Fidelity .................... $ 500,000 100 percent of $ 3,500,000 Surety ...................... $ 500,000 100 percent of $ 5,300,000 Boiler ...................... $ 0 100 percent of $50,000,000 Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer.The primary insurer would only reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreements. The collectability of reinsurance is subject to the solvency of the reinsurers. The major participants in the pool members' reinsurance programs are presented below. The percentages represent the reinsurers' share of the total reinsurance protection under all coverages. Each type of coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within these coverages. The property per risk, property catastrophe and casualty reinsurance programs are handled by a reinsurance intermediary (broker). The reinsurance of those programs is syndicated to approximately 90 domestic and foreign reinsurers. Percent of Total 1994 Property per risk, property Reinsurance Best's catastrophe and casualty coverages: Protection Rating ----------------------------------- ----------- ------ Underwriters at Lloyd's of London .................... 22.0% (1) Insurance Company of North America ................... 7.2 A- Prudential Reinsurance Company ....................... 6.2 A NAC Reinsurance Corporation .......................... 3.4 A Hartford Fire Insurance Company ...................... 3.1 A+ Hannover Ruckversicherung AG ......................... 3.0 (2) AXA Reinsurance Company .............................. 2.5 A Umbrella coverage: ------------------ General Reinsurance Corporation ...................... 100.0 A++ Fidelity and surety coverages: ------------------------------ Allstate Insurance Company ........................... 42.0 A- Kemper Reinsurance Company ........................... 20.0 A- Signet Star Reinsurance Company ...................... 20.0 A Winterthur Reinsurance Corporation of America ........ 18.0 A Boiler coverage: ---------------- Hartford Steam Boiler Inspection and Insurance Company 100.0 A+ (1) Not rated; however, the individual members of the Lloyd's organization are required to pledge their entire net worth toward the satisfaction of their liabilities. In response to reported losses of $3.8 billion, $4.2 billion, $4.9 billion and $1.5 billion (estimated) in 1989, 1990, 1991 and 1992, respectively, Lloyd's has developed a business plan to improve its profitability. The plan is described in detail in the "Rowland" report published by Lloyd's in April, 1993 and Lloyd's began implementation of the plan in 1994. For the 1993 underwriting year, Chatset (a publication that is considered a guide to syndicate run-offs) is predicting an overall profit of $1.2 billion for Lloyds. In addition, standing behind the means of individual members is the Lloyd's Central Fund. This fund is considered by Lloyd's to be a safety net, whereby Lloyd's membership as a whole can be compelled to make up deficiencies caused by individual names defaulting. Currently, there are significant earmarkings against the Central Fund for these deficiencies. There is also a multi-billion dollar trust fund to secure Lloyd's obligations to United States policyholders which applies on a several, not joint basis, to each syndicate's obligations for U.S. business. As of January 31, 1995, the amount in the Lloyd's American Trust Fund is $10.9 billion. (2) Not rated. Premiums ceded by all parties to the pooling agreement and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1994 are presented below. Each type of reinsurance coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within these coverages. Since each layer of each coverage is priced separately, with the lower layers being more expensive than the upper layers, a reinsurer's overall participation in a reinsurance program does not necessarily correspond to the amount of premiums it receives. Premiums Ceded By ------------------------ Property All Pool and Casualty Reinsurer Members Subsidiaries --------- ----------- ------------ General Reinsurance Corporation ...................... $ 2,789,369 $ 613,662 Underwriters at Lloyd's of London .................... 1,845,726 406,060 Hartford Steam Boiler Inspection and Insurance Company 1,208,938 265,966 Hartford Fire Insurance Company ...................... 751,492 165,328 AXA Reinsurance Company .............................. 537,038 118,148 PMA Reinsurance Corporation .......................... 503,346 110,736 American Reinsurance Company ......................... 454,115 99,905 NAC Reinsurance Corporation .......................... 403,359 88,739 Prudential Reinsurance Company ....................... 346,385 76,205 Hannover Ruckversicherung AG ......................... 333,774 73,430 Other Reinsurers ..................................... 5,276,408 1,160,810 ----------- ------------ Total ............................................. $14,449,950 $ 3,178,989 =========== ============ The parties to the pooling agreement also cede reinsurance on both a voluntary and a mandatory basis to state and national organizations in connection with various workers' compensation and assigned risk programs and to private organizations established to handle large risks. Premiums ceded by all parties to the pooling agreement and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1994 are presented below. Premiums Ceded By ------------------------ Property All Pool and Casualty Reinsurer Members Subsidiaries --------- ----------- ------------ Wisconsin Compensation Rating Bureau ................. $ 9,925,061 $ 2,183,514 National Workers' Compensation Reinsurance Pool ...... 9,313,774 2,049,030 Improved Risk Mutual ................................. 4,848,249 1,066,615 North Carolina Reinsurance Facility .................. 1,400,527 308,116 Other Reinsurers ..................................... 472,072 103,855 ----------- ------------ $25,959,683 $ 5,711,130 =========== ============ In formulating reinsurance programs, Employers Mutual is selective in its choice of reinsurers. Employers Mutual selects reinsurers on the basis of financial stability and long-term relationships, as well as price of the coverage. Reinsurers are generally required to have a Best's rating of "A-" or higher and policyholders' surplus of $50,000,000 ($100,000,000 for casualty reinsurance). For information concerning amounts due the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums and the effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred, see "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Reinsurance Ceded." RELATIONSHIP BETWEEN NET PREMIUMS WRITTEN AND SURPLUS The volume of insurance which a property and casualty insurance company writes under industry standards is a multiple of its surplus calculated in accordance with statutory accounting practices. Generally, a ratio of 3 to 1 or less is considered satisfactory. The ratios of the pool members for the past three years are as follows: Year ended December 31, ------------------------------ 1994 1993 1992 ---- ---- ---- Employers Mutual .................. 1.28 1.33 1.32 EMCASCO ........................... 2.18 2.51 2.56 Illinois EMCASCO .................. 2.18 2.44 2.65 Dakota Fire ....................... 1.98 2.18 2.49 American Liberty .................. 1.26 1.38 1.38 Union ............................. .77 1.63 1.68 The decrease in Union's 1994 ratio is primarily due to a significant increase in surplus resulting from the demutualization of Union in the first quarter of 1994. OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The property and casualty insurance subsidiaries' reserve information is included in the property and casualty loss reserve development for 1994. See "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Outstanding Losses and Settlement Expenses." REINSURANCE ----------- The reinsurance subsidiary is a property and casualty treaty reinsurer with a concentration in property lines. The reinsurance subsidiary began its operations in 1981 with a five percent quota share assumption of Employers Mutual's assumed reinsurance business. The quota share percentage has been gradually increased over the years and since 1988 the reinsurance subsidiary has assumed a 95 percent quota share of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary receives 95 percent of all premiums and assumes 95 percent of all related losses and settlement expenses of this business. Since 1993, losses in excess of $1,000,000 per event are retained by Employers Mutual. 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. MARKETING Operations for the last two years reflect a shift from catastrophe excess of loss business to pro rata business. During 1995, more emphasis will be placed on writing excess of loss business in non-hurricane prone areas and on increasing participation on existing contracts that have favorable terms. Pro rata business will continue to be written, but the focus will be on properly structured regional accounts rather than large national accounts. This gradual movement towards excess of loss business is prompted by a deterioration of pro rata rates and a greater control over the pricing of excess of loss business. COMPETITION The reinsurance marketplace is very competitive. Employers Mutual competes in the global reinsurance market with numerous reinsurers, many of which have greater financial resources. In this competitive environment, reinsurance brokers have tended to favor large, financially strong reinsurers who are able to provide "mega" line capacity for all lines of business. The Company faces the risk that reinsurance brokers may become more selective and may seek larger and/or more highly rated reinsurers. REINSURANCE CEDED The reinsurance subsidiary has an aggregate excess of loss treaty with Employers Mutual which provides protection from a large accumulation of retentions resulting from multiple catastrophes in any one calendar year. The coverage provided is $2,000,000 excess of $2,500,000 aggregate losses retained, excess of $200,000 per event. Maximum recovery is limited to $4,000,000 per accident year. The reinsurance subsidiary recovered $0, $143,501 and $4,221,444 under this treaty and paid reinstatement premiums of $0, $208,470 and $744,561 in 1994, 1993 and 1992, respectively. Total premiums paid to Employers Mutual amounted to $557,842, $708,445 and $1,124,561 in 1994, 1993 and 1992, respectively. Effective January 1, 1995, the aggregate excess of loss treaty was amended to increase the aggregate losses retained to $3,000,000 and to decrease the maximum recovery limit to $2,000,000 per accident year. For information concerning amounts due the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums and the effect of reinsurance on premiums written and earned and losses and settlement expenses incurred, see "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Reinsurance Ceded." OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The reinsurance subsidiary's reserve information is included in the property and casualty loss reserve development for 1994. See "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Outstanding Losses and Settlement Expenses." BEST'S RATING The most recent Best's Property Casualty Key Rating Guide gives the reinsurance subsidiary a "B+" (Very Good) policyholders' rating. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. NONSTANDARD RISK AUTOMOBILE INSURANCE ------------------------------------- The Company's nonstandard risk automobile insurance subsidiary specializes in insuring private passenger automobile risks that are found to be unacceptable in the normal automobile market. MARKETING The nonstandard risk automobile insurance subsidiary is licensed in a five state area that includes Iowa, Kansas, Nebraska, North Dakota and South Dakota. Personal lines automobile policies are solicited through the American Agency System and are written for two, three or six month terms. Limits of liability are offered equal to the state financial responsibility laws. Physical damage coverages are written at normal insurance deductibles. The nonstandard risk automobile insurance subsidiary expects to begin writing business in the state of Missouri in late 1995. During 1994, the nonstandard risk automobile insurance subsidiary elected to emphasize profitability over premium volume and did not reduce rates in order to retain business. Production is expected to remain relatively flat in 1995 as the company will continue to emphasize profitability over market share. Profitable underwriting results in the future are likely to be more dependent upon successful niche marketing rather than full coverage programs. COMPETITION The nonstandard risk marketplace is very competitive. Policies are written for relatively short periods of time and insureds search for the best rates available. Recently, the larger standard insurance companies have begun to develop rate tiers that are geared toward retaining nonstandard risk customers, rather than passing them into the nonstandard market. This additional availability in the standard market has resulted in increased competition within the nonstandard market. REINSURANCE CEDED The nonstandard risk automobile insurance subsidiary has a reinsurance treaty on an excess of loss basis with Employers Mutual, which provides reinsurance for 100 percent of each loss in excess of $100,000, up to $1,000,000. Recoveries under this treaty totaled $71,567, $0 and $0 in 1994, 1993 and 1992, respectively. Premiums paid to Employers Mutual amounted to $49,659, $42,065 and $35,377 in 1994, 1993 and 1992, respectively. For information concerning amounts due the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums and the effect of reinsurance on premiums written and earned and losses and settlement expenses incurred, see "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Reinsurance Ceded." OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The nonstandard risk automobile insurance subsidiary's reserve information is included in the property and casualty loss reserve development for 1994. See "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Outstanding Losses and Settlement Expenses." BEST'S RATING The most recent Best's Property Casualty Key Rating Guide gives the nonstandard risk automobile insurance subsidiary an "A" (Excellent) policyholders' rating. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. PROPERTY AND CASUALTY INSURANCE SUBSIDIARIES, REINSURANCE SUBSIDIARY AND ------------------------------------------------------------------------ NONSTANDARD RISK AUTOMOBILE INSURANCE SUBSIDIARY ------------------------------------------------ SERVICES PROVIDED BY EMPLOYERS MUTUAL Employers Mutual provides various services to all of it's subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are charged to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not charged to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. STATUTORY COMBINED RATIOS The following table sets forth the Company's insurance subsidiaries' statutory combined ratios and the property and casualty insurance industry averages for the five years ended December 31, 1994. The combined ratios below are the sum of the following: the loss ratio, calculated by dividing losses and settlement expenses by net premiums earned, and the expense ratio, calculated by dividing underwriting expenses by net premiums written and policyholder dividends by net premiums earned. Generally, if the combined ratio is below 100 percent, a company has an underwriting profit; if it is above 100 percent, a company has an underwriting loss. Year ended December 31, -------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------ Property and casualty insurance Loss ratio .................... 67.2% 72.6% 76.1% 76.8% 73.8% Expense ratio ................. 31.1 30.9 30.1 30.5 30.8 ------ ------ ------ ------ ------ Combined ratio .............. 98.3% 103.5% 106.2% 107.3% 104.6% ====== ====== ====== ====== ====== Reinsurance Loss ratio .................... 82.0% 77.7% 109.1% 82.9% 92.6% Expense ratio ................. 30.4 33.1 34.8 36.6 37.2 ------ ------ ------ ------ ------ Combined ratio .............. 112.4% 110.8% 143.9% 119.5% 129.8% ====== ====== ====== ====== ====== Nonstandard risk automobile insurance Loss ratio .................... 71.5% 94.3% 92.3% 72.4% 77.8% Expense ratio ................. 24.4 23.7 23.7 25.2 24.7 ------ ------ ------ ------ ------ Combined ratio .............. 95.9% 118.0% 116.0% 97.6% 102.5% ====== ====== ====== ====== ====== Total insurance operations Loss ratio .................... 70.9% 75.6% 83.4% 77.8% 78.0% Expense ratio ................. 30.4 30.7 30.5 31.4 31.5 ------ ------ ------ ------ ------ Combined ratio .............. 101.3% 106.3% 113.9% 109.2% 109.5% ====== ====== ====== ====== ====== Property and casualty insurance industry averages (1) Loss ratio .................... 82.0% 79.5% 88.1% 81.2% 82.3% Expense ratio ................. 27.4 27.4 27.6 27.7 27.3 ------ ------ ------ ------ ------ Combined ratio .............. 109.4% 106.9% 115.7% 108.9% 109.6% ====== ====== ====== ====== ====== (1) As reported by A.M. Best Company. The ratio for 1994 is an estimate; the actual combined ratio is not currently available. REINSURANCE CEDED The following table presents amounts due to the Company from reinsurers for losses and settlement expenses and prepaid reinsurance premiums as of December 31, 1994: 1994 Amount Percent Best's Recoverable of Total Rating ----------- -------- ------ Wisconsin Compensation Rating Bureau .. $ 7,507,636 44.0% (1) National Workers' Compensation Reinsurance Pool .................... 2,558,657 15.0 (1) General Reinsurance Corporation ....... 968,459 5.7 A++ Improved Risk Mutual (IRM) ............ 780,179 4.6 (2) American Re-Insurance Company ......... 633,168 3.7 A+ Minnesota Workers' Compensation Reinsurance Association ............. 480,229 2.8 (3) North Carolina Reinsurance Facility ... 426,218 2.5 (4) Mutual Reinsurance Bureau (MRB)........ 406,627 2.4 (5) New England Reinsurance Corporation ... 396,829 2.3 (6) Hartford Fire Insurance Company ....... 338,510 2.0 A+ Other Reinsurers ...................... 2,559,569 15.0 ----------- -------- Total ........................... $17,056,081(7) 100.0% =========== ======== (1) Amounts recoverable reflect the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to these organizations by Employers Mutual in connection with its role as "service carrier". Under these arrangements, Employers Mutual writes business for these organizations on a direct basis and then cedes 100 percent of the business to these organizations. Credit risk associated with these amounts is minimal as all companies participating in these organizations are responsible for the liabilities of such organizations on a pro rata basis. (2) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this underwriting association by the pool members. IRM was formed to underwrite property insurance for large commercial risks and is composed of Employers Mutual and 14 other nonaffiliated property and casualty insurance companies. Each of the 15 insurance companies cede insurance to IRM and assume back a percentage of this business. Participation ranges from 3.2 percent to a maximum of 10.0 percent (Employers Mutual has a 10.0 percent share of this business). Each member company benefits from the increased capacity, as well as risk improvement and other services provided by IRM. IRM is backed by the financial strength of the 15 member companies. All of the members of IRM were assigned an "A-" (Excellent) or better rating by the most recent Best's Property Casualty Key Ratings Guide. (3) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this association by the pool members under a reinsurance contract that provides protection for workers' compensation losses in excess of $430,000 per occurrence. Credit risk associated with this amount is minimal as all companies writing direct workers' compensation business in the state of Minnesota are responsible for the liabilities of this association on a pro rata basis. (4) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this organization by the pool members in conjunction with the state run assigned risk program ("state fund"). Under this program, all insurers writing direct business in the state of North Carolina are required by law to write insurance for risks that are not insurable in the normal marketplace. Business written under this program is ceded 100 percent to the state fund and each respective company assumes from the state fund its share of such business in proportion to its direct writings in the state. Credit risk associated with this amount is minimal as all companies writing direct business in the state are responsible for the liabilities of this organization on a pro rata basis. (5) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this underwriting organization by Employers Mutual. MRB is composed of Employers Mutual and five other nonaffiliated mutual insurance companies. Each of the six members cede primarily property insurance to MRB and assume equal proportionate shares of this business. Each member benefits from the increased capacity provided by MRB. MRB is backed by the financial strength of the six member companies. All of the members of MRB were assigned an "A" (Excellent) or better rating by the most recent Best's Property Casualty Key Ratings Guide. (6) Not rated. (7) The total amount at December 31, 1994 represented $788,174 in paid losses and settlement expenses recoverable, $14,146,874 in unpaid losses and settlement expenses recoverable and $2,121,033 in unearned premiums recoverable. The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred for the three years ended December 31, 1994 is presented below. Amounts for the years ended December 31, 1994 and 1993 reflect (1) the change in the property and casualty insurance subsidiaries' pooling agreement whereby effective January 1, 1993, the voluntary assumed reinsurance business written by Employers Mutual is no longer subject to cession to the pool members and (2) the amendment to the reinsurance subsidiary's quota share agreement whereby effective January 1, 1993 losses in excess of $1,000,000 per event are retained by Employers Mutual and the reinsurance subsidiary therefore no longer purchases catastrophe protection. (See notes 2 and 3 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K). Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Premiums written: Direct ......................... $143,444,388 $135,277,129 $138,829,576 Assumed from nonaffiliates ..... 5,843,091 6,636,942 16,467,613 Assumed from affiliates ........ 158,646,332 147,620,705 150,070,741 Ceded to nonaffiliates ......... (8,890,119) (10,701,482) (17,721,207) Ceded to affiliates ............ (132,100,537) (120,898,914) (129,826,840) ------------ ------------ ------------ Net premiums written ........ $166,943,155 $157,934,380 $157,819,883 ============ ============ ============ Premiums earned: Direct ......................... $140,012,247 $137,141,457 $142,391,771 Assumed from nonaffiliates ..... 5,988,228 6,758,364 14,980,642 Assumed from affiliates ........ 156,839,482 148,366,487 140,442,245 Ceded to nonaffiliates ......... (9,601,270) (11,507,217) (16,775,394) Ceded to affiliates ............ (128,409,308) (124,321,553) (133,628,977) ------------ ------------ ------------ Net premiums earned ......... $164,829,379 $156,437,538 $147,410,287 ============ ============ ============ Losses and settlement expenses incurred: Direct ......................... $113,680,306 $ 97,842,980 $112,579,261 Assumed from nonaffiliates ..... 2,774,689 6,575,099 17,415,319 Assumed from affiliates ........ 108,594,530 107,369,274 114,359,445 Ceded to nonaffiliates ......... (3,077,305) (5,845,414) (16,862,082) Ceded to affiliates ............ (105,028,166) (85,586,640) (105,404,110) ------------ ------------ ------------ Net losses and settlement expenses incurred ......... $116,944,054 $120,355,299 $122,087,833 ============ ============ ============ OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The Company maintains reserves for losses and settlement expenses with respect to both reported and unreported claims. The amount of reserves for reported claims is primarily based upon a case-by-case evaluation of the specific type of claim, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of loss. Reserves on assumed business are the amounts reported by the ceding company. The amount of reserves for unreported claims is determined on the basis of statistical information for each line of insurance with respect to the probable number and nature of claims arising from occurrences which have not yet been reported. Established reserves are closely monitored and are frequently recomputed using a variety of formulas and statistical techniques for analyzing current actual claim cost, frequency data and other economic and social factors. The Company does not discount reserves. Inflation is implicitly provided for in the reserving function through analysis of cost trends, reviews of historical reserving results and projections of future economic conditions. Large ($25,000 and over) incurred and reported gross reserves are reviewed regularly for adequacy. In addition, long-term and lifetime medical claims are periodically reviewed for cost trends and the applicable reserves are appropriately revised. Loss reserves are estimates at a given time of what the insurer expects to pay on incurred losses, based on facts and circumstances then known. During the loss settlement period, which may be many years, additional facts regarding individual claims become known, and accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim. Settlement expense reserves are intended to cover the ultimate cost of investigating claims and defending lawsuits arising from claims. These reserves are established each year based on previous years' experience to project the ultimate cost of settlement expenses. To the extent that adjustments are required to be made in the amount of outstanding loss reserves each year, settlement expense reserves are correspondingly revised. Estimating reserves for asbestos and environmental related claims is very difficult due to the following uncertainties surrounding these types of claims: the legal definition of asbestos and environmental damage is still evolving, the assignment of responsibility varies widely by state, defense costs are often much greater than the claim costs and claims often emerge long after the policy has expired, making 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. Despite the inherent uncertainties of estimating insurance company loss and settlement expense reserves, management believes that the Company's reserves are being calculated in accordance with sound actuarial practices and, based upon current information, that the Company's reserves for losses and settlement expenses at December 31, 1994 are adequate. The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the property and casualty insurance subsidiaries, the reinsurance subsidiary and the nonstandard risk automobile insurance subsidiary. Amounts presented are on a net basis, with a reconciliation of beginning and ending reserves to the gross amounts presented in the consolidated financial statements in accordance with SFAS 113. (See note 1 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K.) Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, beginning of year .......................... $197,121,852 $215,388,865 $158,814,130 Ceded reserves for losses and settlement expenses, beginning of year .......................... 17,454,679 25,253,507 13,951,033 ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year .......................... 179,667,173 190,135,358 144,863,097 ------------ ------------ ------------ Incurred losses and settlement expenses: ---------------------- Provision for insured events of the current year ............ 123,343,829 119,896,526 116,615,951 (Decrease) increase in provision for insured events of prior years .......................... (6,399,775) 458,773 5,471,882 ------------ ------------ ------------ Total incurred losses and settlement expenses ........ $116,944,054 $120,355,299 $122,087,833 ------------ ------------ ------------ Year ended December 31, ---------------------------------------- Payments: 1994 1993 1992 --------- ------------ ------------ ------------ Losses and settlement expenses attributable to insured events of the current year ............ $ 48,771,573 $ 47,600,851 $ 46,436,360 Losses and settlement expenses attributable to insured events of prior years ................. 59,491,875 45,508,460 53,810,715 Payment related to the commutation of the reinsurance subsidiary's catastrophe and aggregate excess of loss reinsurance treaties ... (686,962) - - Payment related to the change in the property and casualty insurance subsidiaries' pooling agreement ...................... - 4,373,629 (23,431,503) Payment related to the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement ...................... - 21,904,001 - Adjustment related to the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool .. - 11,436,543 - ------------ ------------ ------------ Total payments .............. 107,576,486 130,823,484 76,815,572 ------------ ------------ ------------ Net reserves for losses and settlement expenses, end of year 189,034,741 179,667,173 190,135,358 Ceded reserves for losses and settlement expenses, end of year 14,146,874 17,454,679 25,253,507 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, end of year $203,181,615 $197,121,852 $215,388,865 ============ ============ ============ The following table shows the calendar year development of the unpaid loss and settlement expense reserves of the property and casualty insurance subsidiaries, the reinsurance subsidiary and the nonstandard risk automobile insurance subsidiary. Amounts presented are on a net basis with (i) a reconciliation of the net loss and settlement expense reserves at the end of 1992, 1993 and 1994 to the gross amounts presented in the consolidated financial statements in accordance with SFAS 113 and (ii) disclosure of the gross re-estimated loss and settlement expense reserves as of the end of 1992, 1993 and 1994 and the related re-estimated reinsurance receivables. Reflected in this table is (1) the increase in the reinsurance subsidiary's quota share assumption of Employers Mutual's assumed reinsurance business from 75 percent in 1987 to 95 percent in 1988, (2) the increase in the property and casualty insurance subsidiaries' collective participation in the pool from 17 percent to 22 percent in 1992, (3) the change in the pooling agreement whereby effective January 1, 1993 the voluntary reinsurance business written by Employers Mutual is no longer subject to cession to the pool members, (4) the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement in 1993, (5) the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool at December 31, 1993 and (6) the reinsurance subsidiary's commutation of all outstanding reinsurance balances ceded to Employers Mutual under catastrophe and aggregate excess of loss reinsurance treaties related to accident years 1991 through 1993 in 1994. In evaluating the table, it should be noted that each cumulative redundancy (deficiency) amount includes the effects of all changes in reserves for prior periods. Conditions and trends that have affected development of the liability in the past, such as the time lag in the reporting of assumed reinsurance business and the high rate of inflation associated with medical services and supplies, may not necessarily occur in the future. Accordingly, it may not be appropriate to project future development of reserves based on this table.
Year ended December 31, ------------------------------------------------------------------------------------------------- (Dollars in thousands) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- STATUTORY RESERVES FOR LOSSES AND SETTLEMENT EXPENSES ...... $ 71,775 67,921 90,357 109,088 121,667 127,870 131,623 139,317 180,797 182,072 191,514 RECLASSIFICATION OF RESERVE AMOUNTS ASSOCIATED WITH THE NATIONAL WORKERS' COMPENSATION REINSURANCE POOL ............. 949 1,028 1,561 2,378 2,911 3,855 4,338 6,830 11,364 - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- STATUTORY RESERVES AFTER RECLASSIFICATION ............. 72,724 68,949 91,918 111,466 124,578 131,725 135,961 146,147 192,161 182,072 191,514 GAAP ADJUSTMENTS: SALVAGE AND SUBROGATION ...... (950) (1,130) (1,000) (930) (930) (930) (1,203) (1,284) (2,026) (1,804) (1,799) STATUTORY SETTLEMENT EXPENSE PORTION OF POSTRETIREMENT BENEFIT OBLIGATION ......... - - - - - - - - - (601) (680) ------- ------- ------- ------- ------- ------- -------- ------- -------- ------- ------- RESERVES FOR LOSSES AND SETTLEMENT EXPENSES .......... 71,774 67,819 90,918 110,536 123,648 130,795 134,758 144,863 190,135 179,667 189,035 PAID (CUMULATIVE) AS OF: One year later ............... 34,055 27,040 25,874 23,805 34,648 42,357 42,601 30,379 77,589 58,805 - Two years later .............. 47,026 41,667 36,199 44,662 57,511 65,965 58,242 78,096 108,253 - - Three years later ............ 56,283 48,477 52,014 61,052 72,121 76,356 95,154 94,851 - - - Four years later ............. 59,882 59,885 63,902 71,550 79,092 106,432 104,324 - - - - Five years later ............. 68,147 69,214 71,859 77,230 105,513 112,100 - - - - - Six years later .............. 72,860 75,371 76,748 101,714 108,764 - - - - - - Seven years later ............ 76,570 79,141 97,533 103,948 - - - - - - - Eight years later ............ 78,102 96,470 99,179 - - - - - - - - Nine years later ............. 88,952 97,448 - - - - - - - - - Ten years later .............. 89,677 - - - - - - - - - - RESERVES REESTIMATED AS OF: End of year .................. 71,774 67,819 90,918 110,536 123,648 130,795 134,758 144,863 190,135 179,667 189,035 One year later ............... 73,823 80,888 98,127 109,099 123,628 134,453 139,385 150,335 190,594 173,267 - Two years later .............. 79,445 91,452 97,465 111,212 124,011 136,972 140,764 147,388 186,543 - - Three years later ............ 85,566 91,927 100,437 113,588 125,957 136,902 139,421 144,340 - - - Four years later ............. 86,460 95,199 104,024 116,995 127,964 137,510 139,054 - - - - Five years later ............. 88,958 99,649 107,784 119,332 128,434 136,912 - - - - - Six years later .............. 92,681 103,157 110,961 120,147 127,908 - - - - - - Seven years later ............ 95,051 106,671 111,988 120,343 - - - - - - - Eight years later ............ 97,294 107,681 112,433 - - - - - - - - Nine years later ............. 97,799 108,082 - - - - - - - - - Ten years later .............. 98,052 - - - - - - - - - - ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- CUMULATIVE REDUNDANCY (DEFICIENCY) ................. $(26,278) (40,263) (21,515) (9,807) (4,260) (6,117) (4,296) 523 3,592 6,400 - ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= GROSS LOSS AND SETTLEMENT EXPENSE RESERVES - END OF YEAR (A) ........................................... $215,389 197,122 203,182 REINSURANCE RECEIVABLES ................................................................................ 25,254 17,455 14,147 -------- ------- ------- NET LOSS AND SETTLEMENT EXPENSE RESERVES - END OF YEAR ................................................. $190,135 179,667 189,035 ======== ======= ======= GROSS RE-ESTIMATED RESERVES - LATEST (B) ............................................................... $208,938 188,412 203,182 RE-ESTIMATED REINSURANCE RECEIVABLES - LATEST .......................................................... 22,395 15,145 14,147 -------- ------- ------- NET RE-ESTIMATED RESERVES - LATEST ..................................................................... $186,543 173,267 189,035 ======== ======= ======= GROSS CUMULATIVE REDUNDANCY (DEFICIENCY) (A-B) ......................................................... $ 6,451 8,710 - ======== ======= =======
Underwriting results of the Company are significantly influenced by estimates of loss and settlement expense reserves. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. During 1992, the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary strengthened prior year reserves on certain lines of business and the reinsurance subsidiary experienced a time lag in the reporting of assumed reinsurance business. During 1993, the property and casualty insurance companies continued to strengthen reserves on certain lines of business while the reinsurance subsidiary experienced adverse development on losses associated with Hurricane Andrew. These reserve increases in 1992 and 1993 were partially offset by reserve decreases on other lines of business, resulting in a net increase in the provision for insured events of prior years of $5,471,882 in 1992 and $458,773 in 1993. During 1994, the reinsurance subsidiary experienced adverse development on certain contracts. These reserve increases were offset by significant reserve decreases in the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary. As a result, the provision for insured events of prior years decreased $6,399,775. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" under Item 7 of this Form 10-K. Environmental Claims The Company's environmental claims activity is predominately from hazardous waste and pollution-related claims. The parties to the pooling agreement have not written primary coverage for the major oil or chemical companies; the greatest exposure arises out of commercial general liability and umbrella policies issued to municipalities during the 1970s which allegedly cover contamination emanating from closed landfills. The remaining exposure is for claims from small regional operations or local businesses involved with disposing wastes at dump sites or having pollution on their own property due to hazardous material use or leaking underground storage tanks. These insureds include small manufacturing operations, tool makers, automobile dealerships, contractors, gasoline stations and real estate developers. Claims related to misdeliveries or minor spills of petroleum products covered under properly endorsed commercial auto policies are not considered environmental claims since coverage is normally not disputed, damages are readily determinable and settlement normally occurs over a short period of time. The Company's reinsurance subsidiary assumes reinsurance business that has environmental exposures. At December 31, 1994, reserves for reported claims totaled $950. The reinsurance subsidiary's environmental exposures declined substantially in 1993 due to the commutation of a reinsurance contract with Employers Mutual. Outstanding losses and settlement expenses related to the commuted contract totaled $319,211 in 1992. Losses and settlement expenses incurred related to the commuted contract totaled $197,859 and $161,693 in 1993 and 1992, respectively. The following table presents selected data on environmental losses and settlement expenses incurred and reserves outstanding for the Company. The amounts for 1993 and 1992 have been restated to exclude claims associated with misdeliveries or minor spills of petroleum products. As a result of this restatement, incurred losses and settlement expenses decreased $189,192 and $349,122, loss and settlement expense reserves decreased $426,981 and $389,806 and the number of outstanding claims decreased 21 and 26 for the years 1993 and 1992, respectively. Year Ended December 31, ------------------------------- 1994 1993 1992 --------- --------- --------- Total losses incurred ....................... $ (31,616) $ 292,440 $ 199,992 Total settlement expenses incurred .......... 36,378 88,847 58,383 --------- --------- --------- Total losses and settlement expenses incurred ................................ $ 4,762 $ 381,287 $ 258,375 ========= ========= ========= Loss reserves ............................... $ 257,038 $ 316,341 $ 579,770 Settlement expense reserves ................. 164,626 168,615 101,524 --------- --------- --------- Total loss and settlement expense reserves $ 421,664 $ 484,956 $ 681,294 ========= ========= ========= Number of outstanding claims ................ 46 42 48 ========= ========= ========= The negative incurred loss amount in 1994 reflects the settlement of several claims for less than the reserves carried and a reduction in the amount of reserves carried for several other claims. The Company has one policyholder which has filed claims at three separate sites in connection with the transportation of hazardous waste to landfills. Another policyholder has filed claims at two separate sites related to the generation of waste disposed of at hazardous waste facilities. Included in the above table at December 31, 1994 are four pollution sites which involve multiple policyholders as follows: Number Pollution site of claims -------------- --------- Closed landfill ................... 6 Closed landfill ................... 3 Closed landfill ................... 2 Transformer reclamation facility .. 2 Coverage is being disputed in 44 of the 45 claims which were outstanding at December 31, 1994. The coverage disputes relate to claims involving the removal of underground storage tanks or the clean up of (i) underground storage tank sites, (ii) landfills based on ownership of the landfill or the generation of waste disposed of at landfills or (iii) insured property. Asbestos Claims --------------- The Company's asbestos claim activity primarily relates to bodily injury claims where an insured has been named as one of multiple defendants covering exposure over many years. The Company's reinsurance subsidiary assumes reinsurance business that has asbestos related exposures. At December 31, 1994, reserves for reported claims totaled $79,666. The reinsurance subsidiary's asbestos related exposures declined substantially in 1993 due to the commutation of a reinsurance contract with Employers Mutual. Outstanding losses and settlement expenses related to the commuted contract totaled $904,834 in 1992. Losses and settlement expenses incurred related to the commuted contract totaled $226,470 and $330,653 in 1993 and 1992, respectively. The following table presents selected data on asbestos related losses and settlement expenses incurred and reserves outstanding for the Company: Year Ended December 31, ------------------------------- 1994 1993 1992 ---------- ---------- ---------- Total losses incurred ....................... $ 210,776 $ 198,267 $ 347,764 Total settlement expenses incurred .......... 59,750 (3,299) 7,995 ---------- ---------- ---------- Total losses and settlement expenses incurred ................................ $ 270,526 $ 194,968 $ 355,759 ========== ========== ========== Loss reserves ............................... $ 255,799 $ 49,161 $ 982,197 Settlement expense reserves ................. 70,286 16,616 20,966 ---------- ---------- ---------- Total loss and settlement expense reserves $ 326,085 $ 65,777 $1,003,163 ========== ========== ========== Number of outstanding claims ................ 70 39 44 ========== ========== ========== The incurred and reserve amounts for 1994 reflect a workers' compensation claim involving an employee of an insured who alleges exposure to asbestos. The insured asserts that the employee was not exposed to asbestos while in their employment. While the Company has established a loss reserve for this claim, management does not anticipate a workers' compensation award being upheld for the employee. The increase in the number of outstanding claims in 1994 is primarily due to an insured being named as one of serval defendants in a case involving twenty claimants who were allegedly exposed to asbestos. The Company's initial investigation failed to find a link between the claimants and our insured. Management does not expect to have a large exposure and has established nominal reserve amounts related to these claims. Based upon current facts, management believes the reserves established for environmental and asbestos related claims at December 31, 1994 are adequate. Although future changes in the legal and political environment may result in adjustments to these reserves, management believes any adjustments will not have a material impact on the financial condition or operations of the Company. EXCESS AND SURPLUS LINES INSURANCE AGENCY ----------------------------------------- The excess and surplus lines insurance agency was acquired by the Company in 1985. Incorporated in 1974, the agency provides access to the excess and surplus lines markets through independent agents and managing general agents. The agency also functions as managing underwriter for such lines for several of the pool members and represents several major excess and surplus lines companies, including Lloyd's of London. Lines of insurance handled range from relatively straight forward property and casualty insurance to the more exotic hole-in-one, kidnap and ransom, ocean marine, aircraft and professional liability lines. Income is derived from fees and commissions and not from underwriting the risk. INVESTMENTS ----------- Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115) "Accounting for Certain Investments in Debt and Equity Securities." SFAS 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the consolidated financial statements. Debt and equity securities that are held for current resale are classified as trading securities and are carried at market value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the above two categories are classified as securities available-for-sale and are carried at market value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of tax. Adoption of this statement had no effect on the income of the Company. Unrealized holding (losses) gains on securities available-for- sale had the effect of (decreasing) increasing stockholders' equity by ($1,316,596) and $2,048,651 at December 31, 1994 and 1993, respectively, net of income taxes of $0 and $1,055,365. At December 31, 1994 and 1993, the Company had no investments classified as trading securities. Prior to December 31, 1993, investments in fixed maturities were carried at amortized cost and equity securities were carried at market value. Changes in the unrealized holding gains and losses resulting from the revaluation of equity securities were reported as direct increases and decreases in stockholders' equity. Unrealized holding gains and losses on fixed maturities were not recognized in the consolidated financial statements. The assets of the property and casualty insurance subsidiaries, the reinsurance subsidiary and the nonstandard risk automobile insurance subsidiary are primarily invested in government bonds. At December 31, 1994, approximately 82 percent of the Company's fixed maturity bonds were invested in government or government agency issued securities. Investments in bonds categorized as held-to-maturity are purchased with the intent of being held to maturity. A variety of maturities are maintained in the Company's portfolio to assure adequate liquidity. The maturity structure of bond investments is also established by the relative attractiveness of yields on short, intermediate, and long-term bonds. The Company does not invest in any high-yield debt investments (commonly referred to as junk bonds). The Company intends to increase its investment in equity securities during 1995. Approximately $13,500,000 of short-term funds will be reinvested in equity securities classified as available-for-sale during the first six months of 1995. The overall liquidity position of the Company will not be affected by this change. Investments of the Company's insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages. The Company believes it is in compliance with these laws. Failure to comply could result in administrative supervision. The National Association of Insurance Commissioners (NAIC) is in the process of developing model legislation to govern insurance company investments. An exposure draft was released in August of 1994 and a model law may be adopted by the NAIC in 1995. This model law is not expected to have a material impact on the operations of the Company's insurance subsidiaries. The investments of the Company are supervised by an investment committee of the Board of Directors of the Company, which includes one individual who is an officer of the Company. The bond portfolios for each of the subsidiaries are managed by an internal staff which is composed of employees of Employers Mutual. Investment expenses are based on actual expenses incurred by each of the Company's subsidiaries plus an allocation of other investment expenses incurred by Employers Mutual, which is based on a weighted average of total assets and investment transactions of each subsidiary. The following table shows the composition of the Company's investment portfolio (at amortized cost), by type of security, as of December 31, 1994 and 1993. In the Company's consolidated financial statements, securities held-to-maturity are carried at amortized cost; securities available-for-sale are carried at market value. Year ended December 31, -------------------------------------------- 1994 1993 --------------------- --------------------- Amortized Amortized Cost Percent Cost Percent ------------ ------- ------------ ------- Securities held-to-maturity: Fixed maturity securities: United States government agencies and authorities .. $102,480,740 30.4% $109,895,914 36.4% States and political subdivisions .............. 78,423,605 23.2 18,374,003 6.1 Foreign governments ......... 583,309 .2 587,060 .2 Public utilities ............ 8,622,154 2.5 8,813,202 2.9 Corporate securities ........ 13,052,550 3.9 17,050,988 5.7 Mortgage-backed securities .. 40,487,362 12.0 36,289,456 12.0 ------------ ------- ------------ ------- Total fixed maturity securities .............. 243,649,720 72.2 191,010,623 63.3 ------------ ------- ------------ ------- Securities available-for-sale: Fixed maturity securities: U.S. Treasury securities .... 15,835,019 4.7 26,803,980 8.9 States and political subdivisions .............. 55,274,052 16.4 58,431,008 19.4 Foreign governments ......... 1,994,980 .6 - - Corporate securities ........ 4,250,000 1.3 7,496,245 2.5 Other debt securities ....... 454,941 .1 486,941 .2 ------------ ------- ------------ ------- Total fixed maturity securities .............. 77,808,992 23.1 93,218,174 31.0 ------------ ------- ------------ ------- Equity securities ............. - - 505,000 .2 ------------ ------- ------------ ------- Short-term investments ........ 16,029,426 4.7 16,729,390 5.5 ------------ ------- ------------ ------- Total investments ........ $337,488,138 100.0% $301,463,187 100.0% ============ ======= ============ ======= Fixed maturity securities held by the Company generally have an investment quality rating of "A" or better by independent rating agencies. The following table shows the composition of the Company's fixed maturity securities, by rating, as of December 31, 1994. Securities Securities held-to-maturity available-for-sale (at amortized cost) (at market value) --------------------- --------------------- Amount Percent Amount Percent ------------ ------- ------------ ------- Rating(1) Aaa ..................... $177,634,659 72.9% $ 37,805,573 49.4% Aa ...................... 29,632,708 12.2 26,852,122 35.1 A ....................... 32,412,444 13.3 10,459,216 13.7 Baa ..................... 3,471,265 1.4 1,375,485 1.8 Ba ...................... 498,644 .2 - - ------------ ------- ------------ ------- Total fixed maturities $243,649,720 100.0% $ 76,492,396 100.0% ============ ======= ============ ======= (1) Ratings for preferred stocks and fixed maturity securities with initial maturities greater than one year are assigned by Moody's Investor's Services, Inc. Moody's rating process seeks to evaluate the quality of a security by examining the factors that affect returns to investors. Moody's ratings are based on quantitative and qualitative factors, as well as the economic, social and political environment in which the issuing entity exists. The quantitative factors include debt coverage, sales and income growth, cash flows and liquidity ratios. Qualitative factors include management quality, access to capital markets and the quality of earnings and balance sheet items. Ratings for securities with initial maturities less than one year are based on an evaluation of the underlying assets or the credit rating of the issuer's parent company. The amortized cost and estimated market value of fixed maturity securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized Market Cost Value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 11,767,723 $ 11,920,042 Due after one year through five years ..... 83,119,839 82,556,120 Due after five years through ten years .... 79,969,324 77,390,645 Due after ten years ....................... 28,305,472 27,544,307 Mortgage-backed securities ................ 40,487,362 39,310,374 ------------ ------------ Totals .................................. $243,649,720 $238,721,488 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 20,884,351 $ 20,896,089 Due after one year through five years ..... 16,762,627 16,297,903 Due after five years through ten years .... 25,213,287 25,595,670 Due after ten years ....................... 14,948,727 13,702,734 ------------ ------------ Totals .................................. $ 77,808,992 $ 76,492,396 ============ ============ The mortgage-backed securities shown in the above table include $23,034,688 of securities issued by government corporations and agencies and $17,452,674 of collateralized mortgage obligations (CMOs). CMOs are securities backed by mortgages on real estate which come due at various times. The Company has attempted to minimize the prepayment risks associated with mortgage-backed securities by not investing in "principal only" and "interest only" CMOs. The CMOs that the Company has invested in are designed to reduce the risk of prepayment by providing predictable principal payment schedules within a designated range of prepayments. Investment yields may vary from those anticipated due to changes in prepayment patterns of the underlying collateral. Investment results of the Company for the periods indicated are shown in the following table: Year Ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Average invested assets (1) ........ $319,475,663 $306,387,058 $288,433,650 Investment income (2) .............. 20,929,680 20,779,951 21,539,597 Average yield ...................... 6.55% 6.78% 7.47% Realized investment gains .......... $ 519,567 $ 684,445 $ 384,283 (1) Average of the aggregate invested amounts (amortized cost) at the beginning and end of the year. (2) Investment income is net of investment expenses and does not include realized gains or provision for income taxes. EMPLOYEES --------- EMC Insurance Group Inc. has no employees of its own, although approximately 12 employees of Employers Mutual perform administrative duties on a part-time basis. Otherwise, the Company's business activities are conducted by employees of Employers Mutual, the nonstandard risk automobile subsidiary, and one of the property and casualty insurance subsidiaries, which have 1,492 (plus 32 part-time), 14 (plus 1 part-time), and 60 employees, respectively. The property and casualty insurance subsidiaries share the costs associated with the pooling agreement in accordance with their pool participation percentages. See "Property and Casualty Insurance - Pooling Agreement." REGULATION ---------- The Company's insurance subsidiaries are subject to extensive regulation and supervision by their home states, as well as those in which they do business. The purpose of such regulation and supervision is primarily to provide safeguards for policyholders rather than to protect the interests of stockholders. The insurance laws of the various states establish regulatory agencies with broad administrative powers, including the power to grant or revoke operating licenses and to regulate trade practices, investments, premium rates, deposits of securities, the form and content of financial statements and insurance policies, accounting practices and the maintenance of specified reserves and capital for the protection of policyholders. Premium rate regulation varies greatly among jurisdictions and lines of insurance. In most states in which the Company's subsidiaries write insurance, premium rates for their lines of insurance are subject to either prior approval or limited review upon implementation. States require rates for property and casualty insurance that are adequate, not excessive, and not unfairly discriminatory. The Company's insurance subsidiaries are required to file detailed annual reports with the appropriate regulatory agency in each state where they do business based on applicable statutory regulations, which differ from generally accepted accounting principles. Their businesses and accounts are subject to examination by such agencies at any time. Since EMC Insurance Group Inc. and Employers Mutual are domiciled in Iowa, the State of Iowa exercises principal regulatory supervision, and Iowa law requires periodic examination. The Company's insurance subsidiaries are subject to examination by state insurance departments on a periodic basis as applicable law requires. State laws governing insurance holding companies also impose standards on certain transactions with related companies, which include, among other requirements, that all transactions be fair and reasonable and that an insurer's surplus as regards policyholders be reasonable and adequate in relation to its liabilities. Under Iowa law, dividends or distributions made by registered insurers are restricted in amount and may be subject to approval from the Iowa Commissioner of Insurance. "Extraordinary" dividends or distributions are subject to prior approval and are defined as dividends or distributions which exceed the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis. Both Illinois and North Dakota impose restrictions which are similar to those of Iowa on the payment of dividends and distributions. At December 31, 1994, $15,513,214 was available for distribution in 1995 to EMC Insurance Group Inc. without prior approval. See note 7 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. Under the insurance laws of all states in which the Company's insurance subsidiaries and Employers Mutual operate, insurers can be assessed up to prescribed limits for policyholder losses occasioned by the insolvency or liquidation of other insurance companies. Under these laws, the extent of any future assessments against the Company is uncertain. Most laws do provide, however, that an assessment may be excused or deferred if it would threaten a solvent insurer's financial strength. Such assessments totaled $128,576, $86,200 and $132,996 in 1994, 1993 and 1992, respectively. The NAIC adopted certain risk-based capital standards in 1994 for property and casualty insurance companies. Risk-based capital requirements attempt to measure minimum statutory capital needs based upon the risks in a company's mix of products and investment portfolio. The formula has been designed to help state regulators assess capital adequacy of insurance companies and identify property/casualty insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based upon the risks applicable to the operations of the individual insurer. The formula takes into consideration industry performance and individual insurer financial characteristics by examining a number of financial criteria to test its perceived levels of risk against assets available to bear such risks. The model act adopted by the NAIC provides a minimum level of capital at which a State Commissioner of Insurance may act to place an insurer under certain restraints or in the worst case, to place an insurer under his or her control. These risk-based capital rules are a quantitative measurement technique which purport to quantify the minimum amount of capital necessary to match the degree of financial risk. It is a method for specifying how much minimum capital an insurer must have, based on the risks it has assumed, to assure that it maintains an acceptably low probability of financial impairment. The risk-based capital requirements measure three major areas of risk facing property and casualty insurers: 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. The Company's insurance subsidiaries' ratio of total adjusted capital to risk-based capital at December 31, 1994 is well in excess of the minimum level required. ITEM 2. PROPERTIES. ------- ----------- Lease costs of the Company's two office facilities in West Des Moines, Iowa total approximately $73,000 and $31,000 annually. These leases expire March 31, 1998 and November 30, 1995, respectively. Lease costs of the Company's office facilities in Oak Brook, Illinois, and Bismarck, North Dakota, which total approximately $220,000 and $126,000 annually, are included as expenses under the pooling agreement. See "Property and Casualty Insurance - Pooling Agreement" under Item 1 of this Form 10-K. Expenses of office facilities owned by Employers Mutual are borne by the parties to the pooling agreement, less the rent received from the space used and paid for by non-insurance subsidiaries and outside tenants. Expenses totaling $1,714,082, $1,784,868 and $1,699,591 for the three years ended December 31, 1994, 1993 and 1992, respectively, were charged to the pool in connection with the rental of 229,770 and 63,450 square feet located in Des Moines and Ames, Iowa. ITEM 3. LEGAL PROCEEDINGS. ------- ------------------ The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business. The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations. The companies involved have reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ------- ---------------------------------------------------- None. PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED ------- ------------------------------------------------- STOCKHOLDER MATTERS. -------------------- The Company's common stock is traded on the NASDAQ National Market System under the symbol EMCI. The following table shows the range of high and low bid quotations and dividends paid for each quarter within the two most recent years. 1994 1993 ---------------------------- ---------------------------- High Low Dividends High Low Dividends ------- ------- --------- ------- ------- --------- 1st Quarter $ 9 3/4 $ 8 1/2 $.13 $10 3/4 $ 8 $.13 2nd Quarter 10 8 1/2 .13 11 1/4 9 1/2 .13 3rd Quarter 9 1/2 8 1/2 .13 10 1/4 9 1/4 .13 4th Quarter 10 3/4 8 3/4 .13 10 1/4 8 3/4 .13 At December 31 9 1/2 9 1/2 On March 6, 1995, there were approximately 791 holders of record of the Company's common stock. There are certain regulatory restrictions relating to the payment of dividends by the Company's insurance subsidiaries (see note 7 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K). It is the present intention of the Company's Board of Directors to declare quarterly cash dividends. A dividend reinvestment and common stock purchase plan provides stockholders with the option of receiving additional shares of common stock instead of cash dividends. Participants may also purchase additional shares of common stock without incurring broker commissions by making optional cash contributions to the Plan. See note 14(c) of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. During 1994 and 1993, Employers Mutual elected to receive 50 percent of its dividends in common stock under this plan. ITEM 6. SELECTED FINANCIAL DATA. ------- ------------------------ Year ended December 31, -------------------------------------------- 1994 1993 1992 1991 1990 -------- -------- -------- -------- -------- (In thousands, except per share amounts) Insurance premiums earned ...... $164,829 $156,438 $147,410 $113,419 $101,323 Investment income, net ......... 20,930 20,780 21,540 20,202 19,884 Realized investment gains ...... 520 684 384 65 48 Other income ................... 434 259 - - - -------- -------- -------- -------- -------- Total revenues ............ 186,713 178,161 169,334 133,686 121,255 Losses and expenses ............ 168,036 169,142 168,359 123,254 110,415 -------- -------- -------- -------- -------- Income before income taxes ..... 18,677 9,019 975 10,432 10,840 Income taxes ................... 5,171 1,885 759 3,124 2,894 -------- -------- -------- -------- -------- Income from continuing operations ................... 13,506 7,134 216 7,308 7,946 Income from discontinued operations ................... - - - 1,853 319 Income from accounting changes - 2,621 - - - -------- -------- -------- -------- -------- Net income ............... $ 13,506 $ 9,755 $ 216 $ 9,161 $ 8,265 ======== ======== ======== ======== ======== Earnings per common share: Income from continuing operations ................. $ 1.29 $ .70 $ .02 $ .73 $ .80 Income from discontinued operations ................. - - - .18 .03 Income from accounting changes .................... - .26 - - - -------- -------- -------- -------- -------- Total .................... $ 1.29 $ .96 $ .02 $ .91 $ .83 ======== ======== ======== ======== ======== Premiums earned by segment: Property and casualty ........ $115,412 $109,585 $109,139 $ 78,413 $ 70,597 Reinsurance .................. 37,256 33,324 26,615 25,009 20,696 Nonstandard risk automobile .. 12,161 13,529 11,656 9,997 10,030 -------- -------- -------- -------- -------- Total .................... $164,829 $156,438 $147,410 $113,419 $101,323 ======== ======== ======== ======== ======== Total assets ................... $387,370 $368,936 $372,807 $311,001 $296,126 ======== ======== ======== ======== ======== Stockholders' equity ........... $116,727 $109,634 $100,911 $105,144 $100,615 ======== ======== ======== ======== ======== Average return on equity ....... 11.9% 9.3% .2% 8.9% 8.4% ======== ======== ======== ======== ======== Book value per share ........... $ 11.03 $ 10.63 $ 9.98 $ 10.47 $ 10.04 ======== ======== ======== ======== ======== Dividends paid per share ....... $ .52 $ .52 $ .52 $ .52 $ .52 ======== ======== ======== ======== ======== ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------- ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS. ------------------------------------ OVERVIEW EMC Insurance Group Inc. (the "Company"), an approximately 67 percent owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance, reinsurance, nonstandard risk automobile insurance and excess and surplus lines insurance management. Property and casualty insurance is the most significant segment, representing 70.0 percent of consolidated premium income. The three property and casualty insurance subsidiaries of the Company and two subsidiaries 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 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 unaffiliated 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 22 percent. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment programs and income tax liabilities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to reduce the risk of an exposure insured by any of the pool participants by spreading it 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 and lines of insurance written and the variety of rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all six companies in the pool. The Company's reinsurance subsidiary assumes a 95 percent quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary receives 95 percent of all premiums and assumes 95 percent of all related losses and settlement expenses of this business. Since 1993, losses in excess of $1,000,000 per event are retained by Employers Mutual. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. The Company's nonstandard risk automobile insurance subsidiary specializes in insuring private passenger automobile risks that are found to be unacceptable in the normal automobile market. The excess and surplus lines insurance agency provides insurance companies with access to the excess and surplus lines markets and also functions as managing underwriter for such lines for Employers Mutual and several of the pool members. RESULTS OF OPERATIONS Operating results for the three years ended December 31, 1994 are as follows: ($ in thousands) 1994 1993 1992 -------- -------- -------- Premiums earned .......................... $164,829 $156,438 $147,410 Losses and settlement expenses ........... 116,944 120,355 122,088 Other expenses ........................... 51,092 48,787 46,271 -------- -------- -------- Underwriting loss ........................ (3,207) (12,704) (20,949) Net investment income .................... 20,930 20,780 21,540 Realized investment gains ................ 520 684 384 Other income ............................. 434 259 - -------- -------- -------- Operating income before income taxes ..... $ 18,677 $ 9,019 $ 975 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $123,344 $119,896 $116,616 (Decrease) increase in provision for insured events of prior years ........ (6,400) 459 5,472 -------- -------- -------- Total losses and settlement expenses .. $116,944 $120,355 $122,088 ======== ======== ======== Catastrophe losses ....................... $ 5,487 $ 8,513 $ 16,569 ======== ======== ======== Operating results before income taxes have improved significantly over the last three years. This improvement reflects a decrease in catastrophe losses and a decline in the loss and settlement expense provision for insured events of prior years. In 1994, all segments showed improved operating results, with the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary posting significant increases over 1993. Operating results for 1993 reflect greatly improved underwriting results in the property and casualty insurance subsidiaries and the reinsurance subsidiary. Operating results for 1992 were severely impacted by catastrophe losses associated with Hurricanes Andrew and Iniki. Premiums earned have increased steadily over the last three years despite the competitive market conditions. For the year 1994, production increases in the property and casualty insurance subsidiaries and the reinsurance subsidiary were partially offset by a production decrease in the nonstandard risk automobile insurance subsidiary. For the year 1993, production increased for the reinsurance subsidiary and the nonstandard risk automobile insurance subsidiary, while the property and casualty insurance subsidiaries remained relatively flat. Losses and settlement expenses have decreased over the last three years, reflecting a decline in catastrophe losses and the provision for insured events of prior years. During 1992, the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary strengthened prior year reserves on certain lines of business and the reinsurance subsidiary experienced a time lag in the reporting of assumed reinsurance business. During 1993, the property and casualty insurance subsidiaries continued to strengthen reserves on certain lines of business, while the reinsurance subsidiary experienced adverse development on losses associated with Hurricane Andrew. These reserve increases in 1992 and 1993 were partially offset by reserve decreases on other lines of business, resulting in a net increase in the Company's estimate of prior year reserves of $5,472,000 in 1992 and $459,000 in 1993. During 1994, the reinsurance subsidiary experienced adverse development on certain contracts. These reserve increases were offset by significant reserve decreases in the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary. As a result, the net decrease in the Company's prior year reserves in 1994 amounted to $6,400,000. In addition to the substantial amount of catastrophe losses incurred in 1992 and 1993, results for these years also reflect losses associated with two reinsurance contracts under the reinsurance subsidiary's quota share agreement that were commuted in 1993. Investment income increased in 1994 after experiencing a decrease in 1993. The decrease in 1993 is primarily due to a decline in invested assets resulting from the transfer of $24,853,000 to Employers Mutual in connection with the change in the property and casualty insurance subsidiaries' pooling agreement relating to the voluntary assumed reinsurance business and the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement. Realized gains on investments are primarily the result of calls and prepayments on fixed maturity securities. Other income amounts represent the amortization of deferred income related to reserve discounting on the commutation of one of the reinsurance subsidiary's reinsurance contracts under the quota share agreement in 1993. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits." Adoption of this statement had no effect on the operations of the Company. Effective December 31, 1994, the Company adopted Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." Adoption of this statement had no effect on current disclosures as the Company did not hold or issue any derivative financial instruments at December 31, 1994. In 1993, the Company adopted four new accounting standards and implemented an accounting change. The net impact of these items was an increase in net income of $2,621,000 ($.26 per share). Following is a brief explanation of each item: * Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions." The Company adopted SFAS 106 by recognizing the transition obligation as a cumulative effect adjustment to income. The Company's transition obligation amounted to $2,166,000 ($.21 per share), net of income tax benefits of $1,116,000. * Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes." The Company adopted SFAS 109 as a cumulative effect adjustment to income. The Company recognized a benefit of $5,595,000 ($.55 per share), net of a valuation allowance of $1,000,000. * Effective January 1, 1993, the property and casualty insurance subsidiaries changed their method of calculating unearned premiums from the monthly pro rata method to the daily method. The property and casualty insurance subsidiaries changed their accounting method because of management's belief that the new method provides for a more accurate matching of revenues and expenses over the terms of the underlying insurance policies. This change resulted in a cumulative increase in unearned premiums of $1,110,000 and a decrease in income of $808,000 ($.08 per share), net of income tax benefits of $302,000. * Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 113 (SFAS 113), "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." SFAS 113 requires a gross (rather than net) balance sheet presentation for ceded reinsurance amounts and addresses the recognition of gain or loss resulting from reinsurance transactions and appropriate financial statement disclosure of reinsurance activities. Adoption of this statement had no effect on the income of the Company. * Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities." SFAS 115 provides that investments in all debt securities and those equity securities with readily determinable market values are to be classified in one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold to maturity are classified as "securities held-to-maturity" and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the consolidated financial statements. Debt and equity securities that are held for current resale are classified as "trading securities" and are reported at market value, with unrealized holding gains and losses included in earnings. All other debt and equity securities are classified as "securities available-for-sale" and are carried at market value, with unrealized holding gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of tax. Adoption of this statement had no effect on the income of the Company. Unrealized holding (losses) gains on securities available-for- sale had the effect of (decreasing) increasing stockholders' equity by ($1,317,000) and $2,048,000 at December 31, 1994 and 1993, respectively, net of income taxes of $0 and $1,055,000. At December 31, 1994 and 1993, the Company did not have any investments categorized as trading securities. SEGMENT RESULTS Property and Casualty Insurance Following is an overview of recent changes that have affected the operations of the property and casualty insurance subsidiaries. Effective January 1, 1992, the aggregate participation of the property and casualty insurance subsidiaries was increased to 22 percent from 17 percent. In connection with this change in pool participation, the Company's liabilities increased $31,428,000 and invested assets increased $29,402,000. The Company reimbursed Employers Mutual $2,026,000 for commissions incurred to generate this business. As previously noted, Employers Mutual voluntarily assumes reinsurance business from nonaffiliated insurance companies and cedes 95 percent of this business to the Company's reinsurance subsidiary, exclusive of certain reinsurance contracts. Prior to 1993, amounts not ceded to the reinsurance subsidiary were retained by Employers Mutual and were subject to cession to the pool members. Effective January 1, 1993, the pooling agreement was amended so that the voluntary assumed reinsurance business written by Employers Mutual is no longer subject to cession to the pool members. As a result, amounts assumed by the Company from nonaffiliates have declined from the amounts assumed in 1992. In connection with this change in the pooling agreement, the Company's liabilities decreased $4,470,000 and invested assets decreased $4,427,000. Employers Mutual reimbursed the Company $43,000 for commissions incurred to generate this business. Prior to December 31, 1993, the parties to the pooling agreement recorded amounts assumed from the National Workers' Compensation Reinsurance Pool on a net basis. Under this approach, reserves for outstanding losses and unearned premiums were reported as liabilities under "Indebtedness to Related Party" in the Company's consolidated financial statements. Effective December 31, 1993, the parties to the pooling agreement began recording these amounts as outstanding losses and unearned premiums and restated all prior year consolidated financial statements for comparative purposes. There was no income effect from this reclassification. In connection with this gross-up of balances, amounts due from Employers Mutual increased $13,148,000 at December 31, 1993. Under the terms of the pooling agreement, these balances were settled in the first quarter of 1994. Operating results for the three years ended December 31, 1994 are as follows: ($ in thousands) 1994 1993 1992 -------- -------- -------- Premiums earned .......................... $115,412 $109,585 $109,139 Losses and settlement expenses ........... 77,872 79,777 82,314 Other expenses ........................... 36,606 33,621 33,994 -------- -------- -------- Underwriting gain (loss) ................. 934 (3,813) (7,169) Net investment income .................... 14,080 13,243 13,048 Realized investment gains ................ 334 405 285 -------- -------- -------- Operating income before income taxes ..... $ 15,348 $ 9,835 $ 6,164 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $ 84,204 $ 81,355 $ 80,900 (Decrease) increase in provision for insured events of prior years ........ (6,332) (1,578) 1,414 -------- -------- -------- Total losses and settlement expenses .. $ 77,872 $ 79,777 $ 82,314 ======== ======== ======== Catastrophe losses ....................... $ 4,063 $ 3,372 $ 4,631 ======== ======== ======== Production increases for the last three years have been hindered by rate competition and the continued shift of large commercial insureds to alternative risk mechanisms. In response to these difficult market conditions, the property and casualty insurance subsidiaries have implemented new marketing programs that emphasize property insurance. In addition to increasing the amount of property insurance written, these programs have also helped to highlight the subsidiaries' other products. Premium rate adequacy varied greatly by line of business in 1994, but overall rate adequacy improved. This improvement reflects many factors, including careful underwriting, significant reform measures implemented by several states to control the administrative costs of workers' compensation claims and internal cost management programs. During 1994, 11 states implemented rate reductions for the workers' compensation line of business ranging from .3 percent to 16.0 percent while 14 states implemented rate increases ranging from .1 percent to 12.6 percent. These rate changes did not have a material impact on 1994 production as they were implemented at various times throughout the year and they largely offset each other. Underwriting results have improved significantly over the last three years, primarily due to improved results in the workers' compensation line of business. Reform measures implemented by several states to control administrative costs related to workers' compensation insurance have been a major factor in this improvement. By monitoring this reform on a state by state basis and writing more business in states that show a potential for profit, management has been able to achieve improved results. Underwriting results for 1994 reflect a net decline of $6,332,000 in the estimate of prior year loss reserves. This decline reflects savings associated with the reform measures noted above. Underwriting results for 1993 and 1992 were negatively impacted by reserve strengthening in the workers' compensation line of business related to greater than expected increases in the price and usage of drugs, medical durables and medical services. Results for 1992 also reflect $1,427,000 of underwriting losses associated with the voluntary assumed reinsurance business written by Employers Mutual that effective January 1, 1993 is no longer subject to cession to the pool members. Investment income increased in each of the last three years. The large increase in 1994 reflects interest income earned on $13,148,000 received from Employers Mutual in connection with the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool in 1993. Reinsurance Following is an overview of recent changes that have affected the operations of the reinsurance subsidiary. Effective January 1, 1993, the quota share agreement was amended so that losses in excess of $1,000,000 per event are retained by Employers Mutual. The reinsurance subsidiary pays an annual override commission to Employers Mutual for this additional protection, which totaled $2,095,000 in 1994 and $1,809,000 in 1993. The reinsurance subsidiary also pays for 95 percent of the outside reinsurance protection Employers Mutual purchases to protect itself from catastrophic losses on the assumed reinsurance business. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary and amounted to $2,563,000 and $2,867,000 in 1994 and 1993, respectively. Employers Mutual retained losses and settlement expenses totaling $7,020,000 in 1994 and $615,000 in 1993 under this agreement. In conjunction with this amendment to the quota share agreement, the reinsurance subsidiary terminated its catastrophe reinsurance contracts with Employers Mutual and other nonaffiliated reinsurers. Effective January 1, 1993, the reinsurance subsidiary no longer cedes reinsurance to nonaffiliated reinsurers and only cedes reinsurance to Employers Mutual under an aggregate "excess of loss" treaty. Effective June 30, 1993, Employers Mutual commuted the portion of the quota share agreement that pertained to a casualty pool that is in a run-off position. In connection with this change in the quota share agreement, the Company's liabilities decreased $19,783,000 and invested assets decreased $17,806,000. The reserve discount amount of $1,977,000 was recorded as deferred income and is being amortized into operations over the estimated settlement period of the reserves, which is ten years. The amount recognized as income totaled $434,000 in 1994 and $259,000 in 1993. Effective October 31, 1993, Employers Mutual commuted the portion of the quota share agreement that pertained to a voluntary pool that handled large "highly protected" risks. In connection with this change in the quota share agreement, the Company's liabilities decreased $3,827,000 and invested assets decreased $2,620,000. Employers Mutual reimbursed the Company $1,207,000 for commissions incurred to generate this business. No reserve discount was calculated as this business involved short-tail property coverage. During 1994, the reinsurance subsidiary commuted all outstanding reinsurance balances ceded to Employers Mutual under catastrophe and aggregate excess of loss reinsurance treaties related to accident years 1991 through 1993. In connection with these commutations, the Company's assets and liabilities increased $687,000. There was no income effect from these commutations. The reinsurance subsidiary has an aggregate excess of loss treaty with Employers Mutual which provides protection from a large accumulation of retentions resulting from multiple catastrophes in any one year. The coverage provided is $2,000,000, excess of $2,500,000 aggregate loss retained, excess of $200,000 per event. Maximum recovery is limited to $4,000,000 per accident year. The reinsurance subsidiary recovered $0, $144,000 and $4,221,000 under this treaty and paid reinstatement premiums of $0, $280,000 and $745,000 in 1994, 1993 and 1992, respectively. Total premiums paid to Employers Mutual amounted to $558,000, $708,000 and $1,125,000 in 1994, 1993 and 1992, respectively. Operating results for the three years ended December 31, 1994 are as follows: ($ in thousands) 1994 1993 1992 -------- -------- -------- Premiums earned ............................ $ 37,256 $ 33,324 $ 26,615 Losses and settlement expenses ............. 30,565 27,872 29,047 Other expenses ............................. 11,408 11,492 9,472 -------- -------- -------- Underwriting loss .......................... (4,717) (6,040) (11,904) Net investment income ...................... 5,354 6,090 6,763 Realized investment gains .................. 116 201 52 Other income ............................... 434 259 - -------- -------- -------- Operating income (loss) before income taxes $ 1,187 $ 510 $ (5,089) ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ....... $ 29,270 $ 25,359 $ 25,608 Increase in provision for insured events of prior years .................. 1,295 2,513 3,439 -------- -------- -------- Total losses and settlement expenses .... $ 30,565 $ 27,872 $ 29,047 ======== ======== ======== Catastrophe losses ......................... $ 1,424 $ 5,141 $ 11,609 ======== ======== ======== Premiums earned have increased steadily over the last three years. Under the terms of the amended quota share agreement with Employers Mutual, the amounts for 1994 and 1993 reflect a reduction of $2,836,000 and $2,439,000, respectively, related to the reinsurance subsidiary's payment of 95 percent of the cost of the reinsurance protection purchased by Employers Mutual to protect itself from catastrophic losses. Prior to 1993, the reinsurance subsidiary purchased its own catastrophe protection. Premiums earned for 1992 reflect $6,481,000 in premiums ceded (including $3,149,000 of reinstatement premiums) to Employers Mutual and other nonaffiliated reinsurers for this catastrophe protection. Operations for 1994 and 1993 reflect a shift from catastrophe "excess of loss" business to "pro rata" business. Premiums earned for 1994 reflect an increased participation in a voluntary pool and additional premium volume on new and existing pro rata contracts. Rates for pro rata business deteriorated somewhat during 1994 due to competitive market conditions at the primary company level. Underwriting results have improved significantly over the last three years, primarily due to a decline in catastrophe losses. The large decrease in catastrophe losses in 1994 was partially offset by an increase in crop hail losses and a deterioration of results in the pro rata business. Incurred losses for the last three years reflect adverse development on prior year losses. The large amount in 1992 is primarily due to a time lag in the reporting of assumed reinsurance business. This time lag did not have a material effect on the underwriting results of the reinsurance subsidiary since the premium income associated with this business was recorded at the same time as the losses. The adverse development experienced in 1993 primarily relates to losses associated with Hurricane Andrew. Results for 1993 and 1992 reflect $1,678,000 and $2,246,000, respectively, of underwriting losses associated with two reinsurance contracts that were commuted in 1993. Expenses for 1994 and 1993 include $2,095,000 and $1,809,000, respectively, of commissions paid to Employers Mutual in connection with the $1,000,000 cap on catastrophe losses under the amended quota share agreement. The large decline in investment income in 1994 and 1993 is primarily attributable to the transfer of $20,426,000 to Employers Mutual during 1993 in connection with the commutation of two reinsurance contracts. This decline in investment income was partially offset by the recognition of deferred income totaling $434,000 in 1994 and $259,000 in 1993 related to reserve discounting on one of the commuted contracts. Due to poor underwriting results achieved over the last several years, four large national pro rata contracts with approximately $3,500,000 of earned premium were cancelled effective December 31, 1994. As a result of these cancellations, earned premiums for 1995 are expected to remain relatively flat. During 1995, more emphasis will be placed upon writing excess of loss business in non-hurricane prone areas and increasing participation on existing contracts that have favorable terms. Pro rata business will continue to be written, but the focus will be on properly structured regional accounts rather than large national accounts. This gradual movement towards excess of loss business is prompted by the continued deterioration of pro rata rates and a greater control over the pricing of excess of loss business. Nonstandard Risk Automobile Insurance Operating results for the three years ended December 31, 1994 are as follows: ($ in thousands) 1994 1993 1992 -------- -------- -------- Premiums earned ............................ $ 12,161 $ 13,529 $ 11,656 Losses and settlement expenses ............. 8,507 12,706 10,727 Other expenses ............................. 3,160 3,366 2,922 -------- -------- -------- Underwriting gain (loss) ................... 494 (2,543) (1,993) Net investment income ...................... 1,152 1,166 1,179 Realized investment gains .................. 75 109 47 -------- -------- -------- Operating income (loss) before income taxes $ 1,721 $ (1,268) $ (767) ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ....... $ 9,870 $ 13,182 $ 10,108 (Decrease) increase in provision for insured events of prior years .......... (1,363) (476) 619 -------- -------- -------- Total losses and settlement expenses .... $ 8,507 $ 12,706 $ 10,727 ======== ======== ======== Catastrophe losses ......................... $ - $ - $ 329 ======== ======== ======== The nonstandard risk marketplace is very competitive. Policies are written for relatively short periods of time and insureds continually search for the most attractive rates. In response to favorable results achieved in prior years, the company began increasing market share in 1992 by offering more competitive rates. The company experienced adverse selection in this new business as the standard market began to accept more of the marginal risks during this same time period. As a result, losses associated with this new business exceeded the premiums received. Premiums earned declined in 1994 as the company elected to emphasize profitability over premium volume and did not reduce rates in order to retain business. Recently, the larger standard companies have begun to develop rate tiers that are geared toward retaining nonstandard risk customers, rather than passing them into the nonstandard market. This additional availability in the standard market has resulted in increased competition in the nonstandard market. Production for 1995 is expected to remain relatively flat as the company will continue to emphasize profitability over market share. The company expects to begin writing business in the state of Missouri in late 1995 which should help to offset any production decreases experienced in existing markets. Underwriting results for 1994 reflect improved loss experience, favorable development on prior year loss reserves and rate increases that were implemented in all states during the later part of 1993 and the first part of 1994. Results for 1992 and 1993 were negatively impacted by increased loss frequency and severity associated with a new book of business and a strengthening of loss and settlement expense reserves. During 1992, this reserve strengthening was primarily directed toward prior year claims. During 1993, the reserve strengthening was primarily directed toward current year claims in response to increased loss frequency and severity on the new book of business. Profitable underwriting results in the future are likely to be more dependent upon successful niche marketing, rather than full coverage programs. The company is prepared to meet the needs of its consumers by offering selected coverages at prices deemed adequate for the risks insured. Investment income has declined slightly over the last three years. This decline is due to reduced interest rates available for current investments. Excess and Surplus Lines Insurance Management Agency Operating income before income taxes increased to $505,000 in 1994 from $103,000 in 1993 and $496,000 in 1992. The improvement in 1994 is the result of a new management plan put into effect which places more emphasis on writing excess and surplus lines business through Employers Mutual's agency force. Operating results for 1993 and 1992 were negatively impacted by the termination of business with a large agency that had previously represented over 50 percent of this segment's volume. Parent Company Operating loss before income taxes decreased to $84,000 in 1994 from $161,000 in 1993 and a profit of $171,000 in 1992. The improvement in 1994 reflects a decline in operating expenses and an increase in investment income. The large decline in 1993 reflects a substantial reduction in investment income. Invested assets decreased in 1993 due to a capital contribution made to the reinsurance subsidiary in 1992 and a reduction in the amount of dividends received from the insurance company subsidiaries. LOSS AND SETTLEMENT EXPENSE RESERVES Loss and settlement expense reserves are the Company's largest liability. Management continually reviews these reserves using a variety of statistical and actuarial techniques to analyze claim costs, frequency and severity data, and social and economic factors. Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of the loss. During the loss settlement period, additional facts regarding individual claims become known, and accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. Estimating asbestos and environmental related reserves is very difficult due to the following uncertainties surrounding these types of claims: the legal definition of asbestos and environmental damage is still evolving, the assignment of responsibility varies widely by state, defense costs are often much greater than the claim costs and claims often emerge long after the policy has expired, making 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. Over the last several years, the Company's financial results have not been materially affected by losses associated with environmental and asbestos claims. The Company's environmental claims activity is predominately from hazardous waste and pollution-related claims. The parties to the pooling agreement have not written primary coverage for the major oil or chemical companies; the greatest exposure arises out of commercial general liability and umbrella policies issued to municipalities during the 1970s which allegedly cover contamination emanating from closed landfills. The remaining exposure is for claims from small regional operations or local businesses involved with disposing wastes at dump sites or having pollution on their own property due to hazardous material use or leaking underground storage tanks. These insureds include small manufacturing operations, tool makers, automobile dealerships, contractors, gasoline stations and real estate developers. The Company's asbestos claims activity is predominately from insureds that have been named as one of multiple defendants covering exposure over many years. The Company has not found any evidence of injury as a result of exposure to the Company's insured's products during the policy periods. During 1994, Congress debated potential reforms to the "Superfund" law which included a new tax on commercial lines insurance companies. This tax would have been used to fund clean-up costs and settle lawsuits between potentially responsible parties and their insurers. This legislation was not successful in 1994 and it is currently unknown whether similar legislation will be introduced in 1995. LIQUIDITY AND INVESTMENTS 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 is invested in securities with maturities that approximate the anticipated liabilities of the insurance issued. Net unrealized holding losses on fixed maturity securities available-for-sale totaled $1,317,000 at December 31, 1994. This compares to net unrealized holding gains of $3,134,000 at December 31, 1993. The decrease in the market value of these investments is primarily due to higher interest rates imposed by the Federal Reserve Board during 1994, which caused bond values to decline. Further declines in the market value of these investments may occur if the Federal Reserve Board again raises interest rates. Since the Company does not actively trade in the bond market, such fluctuations in the market 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. A valuation allowance related to the tax benefits associated with these unrealized holding losses was established in 1994 due to the uncertainty concerning the future realization of these tax benefits. The majority of the Company's assets are invested in fixed maturities. These investments provide a substantial amount of income which offsets underwriting losses and contributes to net earnings. As these investments mature the proceeds will be reinvested at current rates, which may be higher or lower than those now being earned; therefore, more or less investment income may be available to contribute to net earnings depending on the interest rate level. The Company intends to increase its investment in equity securities during 1995. Approximately $13,500,000 of short-term funds will be reinvested in equity securities classified as available-for-sale during the first six months of 1995. The overall liquidity position of the Company will not be affected by this change. The major ongoing sources of the Company's liquidity are insurance premium income, investment income and cash provided from maturing or liquidated investments. The principal outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends and investment purchases. During 1994, the Company generated positive cash flows from operations of $39,006,000, which included $13,148,000 related to the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool, as previously noted. This compares to a negative operating cash flow of $8,794,000 in 1993, which included $24,853,000 paid to Employers Mutual in connection with the change in the property and casualty insurance subsidiaries' pooling agreement relating to the voluntary assumed reinsurance business and the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement. Operating cash flows of $50,826,000 in 1992 included $29,402,000 received from Employers Mutual in connection with the increase in the property and casualty insurance subsidiaries' pool participation. The Company contributed $10,000,000 of the proceeds received from the sale of the life subsidiary to increase the surplus of the property and casualty insurance subsidiaries in 1992 in connection with the increase in pool participation. The Company contributed $3,000,000 to the surplus of the reinsurance subsidiary in 1992 in order to retain its status as an authorized reinsurance company in several states. CAPITAL RESOURCES As of December 31, 1994, the Company had no material commitments for capital expenditures. Insurance company operations require capital to support premium writings. The Company believes that its insurance company subsidiaries have sufficient capital to support their expected near-term writings. The Company's insurance agency operations do not require a large amount of capital. A major source of cash flows for the holding company is dividend payments from its subsidiaries. State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval. See note 7 of Notes to Consolidated Financial Statements for additional information regarding dividend restrictions. The Company collected $3,068,000, $860,000 and $3,288,000 of dividends from its insurance subsidiaries in 1994, 1993 and 1992, respectively. The Company paid cash dividends to stockholders totaling $3,511,000, $3,443,000 and $5,104,000 in 1994, 1993 and 1992, respectively. The decrease from 1992 is due to the fact that Employers Mutual received 50 percent of its dividends in common stock under the Company's dividend reinvestment and common stock purchase plan in 1994 and 1993. IMPACT OF INFLATION Inflation has a widespread effect on the Company's results of operations, primarily through increased losses and settlement expenses. The Company considers inflation, including social inflation which reflects an increasingly litigious society and increasing jury awards, when setting reserve amounts. Premiums are also affected by inflation, although they are often restricted or delayed by competition and the regulatory rate-setting environment. DEVELOPMENTS IN INSURANCE REGULATION The National Association of Insurance Commissioners (NAIC) adopted certain risk-based capital standards in 1994 for property and casualty insurance companies. Risk-based capital requirements attempt to measure minimum statutory capital needs based upon the risks in a company's mix of products and investment portfolio. The formula has been designed to help state regulators assess capital adequacy of insurance companies and identify property/casualty insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based upon the risks applicable to the operations of the individual insurer. The formula takes into consideration industry performance and individual insurer financial characteristics by examining a number of financial criteria to test its perceived levels of risk against assets available to bear such risks. The model act adopted by the NAIC provides a minimum level of capital at which a State Commissioner of Insurance may act to place an insurer under certain restraints or in the worst case, to place an insurer under his or her control. These risk-based capital rules are a quantitative measurement technique which purport to quantify the minimum amount of capital necessary to match the degree of financial risk. It is a method for specifying how much minimum capital an insurer must have, based on the risks it has assumed, to assure that it maintains an acceptably low probability of financial impairment. The risk-based capital requirements measure three major areas of risk facing property and casualty insurers: 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. The Company's insurance subsidiaries' ratio of total adjusted capital to risk-based capital at December 31, 1994 is well in excess of the minimum level required. The NAIC is in the process of developing model legislation to govern insurance company investments. An exposure draft was released in August of 1994 and a model law may be adopted by the NAIC in 1995. This model law is not expected to have a material impact on the operations of the Company's insurance subsidiaries. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ------- -------------------------------------------- Management's Responsibility for Financial Reporting The consolidated financial statements contained in this annual report were prepared by management in conformity with generally accepted accounting principles. In preparing these financial statements, reasonable estimates and judgments have been made when necessary. Management is responsible for establishing and maintaining a system of internal control, designed to provide reasonable assurance as to the integrity and reliability of the financial records. The concept of reasonable assurance recognizes that there are inherent limitations in any control system and that the cost of maintaining a control system should not exceed the expected benefits to be derived therefrom. Management believes its system of internal control effectively meets its objective of reliable financial reporting. The Audit Committee of the Board of Directors, composed solely of outside directors, met during the year with management and the independent accountants to review and discuss audit findings and other financial and accounting matters. The independent accountants have free access to the Audit Committee, with and without management present, to discuss the results of their audit work. The consolidated financial statements are examined by KPMG Peat Marwick LLP, independent certified public accountants. Their report appears elsewhere in this annual report. /s/ E. H. Creese ------------------------------------ E. H. Creese, C.P.A. Senior Vice President, Treasurer and Chief Financial Officer Independent Auditor's Report The Board of Directors and Stockholders EMC Insurance Group Inc.: We have audited the accompanying consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. As discussed in notes 1, 10, 11 and 13 to the consolidated financial statements, the Company changed its method of computing unearned premiums in 1993 and implemented the provisions of the Financial Accounting Standards Board's Statements No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions", No. 109, "Accounting for Income Taxes" and No. 115, "Accounting for Certain Investments in Debt and Equity Securities". /s/ KPMG Peat Marwick LLP Des Moines, Iowa February 20, 1995 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, -------------------------- 1994 1993 ------------ ------------ ASSETS Investments (note 10): Fixed maturities: Securities held-to-maturity, at amortized cost (market value $238,721,488 and $206,305,597) $243,649,720 $191,010,623 Securities available-for-sale, at market value (amortized cost $77,808,992 and $93,218,174) 76,492,396 96,352,190 Equity securities available-for-sale, at market value (cost $0 and $505,000) .................. - 475,000 Short-term investments, at cost ................. 16,029,426 16,729,390 ------------ ------------ Total investments .......................... 336,171,542 304,567,203 Cash .............................................. 1,258,221 675,203 Indebtedness of related party (note 4) ............ - 12,291,512 Accrued investment income ......................... 5,560,633 4,835,451 Accounts receivable ............................... 1,280,550 415,215 Deferred policy acquisition costs ................. 8,393,635 7,698,864 Deferred income taxes (note 11) ................... 14,190,499 13,040,693 Intangible assets, including goodwill, at cost less accumulated amortization of $1,674,643 and $1,540,130 .................................. 1,883,177 2,017,690 Reinsurance receivables (note 3) .................. 14,935,048 18,477,406 Prepaid reinsurance premiums (note 3) ............. 2,121,033 2,832,184 Other assets ...................................... 1,575,540 2,084,102 ------------ ------------ Total assets ............................... $387,369,878 $368,935,523 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, -------------------------- 1994 1993 ------------ ------------ LIABILITIES Losses and settlement expenses (notes 2,3,5 and 6) $203,181,615 $197,121,852 Unearned premiums (notes 2 and 3) ................. 47,672,570 45,941,056 Other policyholders' funds ........................ 3,102,609 2,854,793 Indebtedness to related party (note 4) ............ 937,356 - Income taxes payable .............................. 1,736,000 550,000 Postretirement benefits (note 13).................. 4,086,674 3,537,449 Deferred income (note 2) .......................... 1,283,662 1,717,641 Other liabilities ................................. 8,642,703 7,578,963 ------------ ------------ Total liabilities .......................... 270,643,189 259,301,754 ------------ ------------ STOCKHOLDERS' EQUITY (notes 7,8,10,14 and 15) Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 10,587,629 shares in 1994 and 10,325,329 shares in 1993 ........... 10,587,629 10,325,329 Additional paid-in capital ........................ 57,162,911 55,021,926 Unrealized holding (losses) gains on fixed maturity securities available-for-sale, net of tax ...................................... (1,316,596) 2,068,451 Unrealized holding losses on equity securities available-for-sale, net of tax .................. - (19,800) Retained earnings ................................. 50,402,812 42,319,249 Treasury stock, at cost (10,931 shares in 1994 and 8,090 shares in 1993) ....................... (110,067) (81,386) ------------ ------------ Total stockholders' equity ................. 116,726,689 109,633,769 ------------ ------------ Contingent liabilities (notes 3,11 and 17) Total liabilities and stockholders' equity $387,369,878 $368,935,523 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Income Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ REVENUES: Premiums earned (notes 2 and 3) ... $164,829,379 $156,437,538 $147,410,287 Investment income, net (note 10) .. 20,929,680 20,779,951 21,539,597 Realized investment gains (note 10) 519,567 684,445 384,283 Other income (note 2) ............. 433,979 259,217 - ------------ ------------ ------------ 186,712,605 178,161,151 169,334,167 ------------ ------------ ------------ LOSSES AND EXPENSES: Losses and settlement expenses (notes 2,3 and 5) ...... 116,944,054 120,355,299 122,087,833 Dividends to policyholders ........ 3,103,788 2,494,284 3,382,736 Amortization of deferred policy acquisition costs ........ 31,701,789 30,717,175 29,291,362 Other underwriting expenses ....... 16,286,206 15,575,257 13,597,179 ------------ ------------ ------------ 168,035,837 169,142,015 168,359,110 ------------ ------------ ------------ Income before income taxes and cumulative effect of changes in accounting principles ....... 18,676,768 9,019,136 975,057 ------------ ------------ ------------ INCOME TAXES (note 11): Current ........................... 5,265,482 1,903,128 2,260,795 Deferred .......................... (94,441) (18,027) (1,501,430) ------------ ------------ ------------ 5,171,041 1,885,101 759,365 ------------ ------------ ------------ Income before cumulative effect of changes in accounting principles 13,505,727 7,134,035 215,692 CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES FOR: Income taxes (note 11) .......... - 5,595,177 - Postretirement benefits (note 13) - (2,165,900) - Unearned premiums (note 1) ...... - (807,933) - ------------ ------------ ------------ Net income ................. $ 13,505,727 $ 9,755,379 $ 215,692 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Income, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ EARNINGS PER COMMON SHARE: Income before cumulative effect of changes in accounting principles $ 1.29 $ .70 $ .02 Cumulative effect of changes in accounting principles for: Income taxes ................. - .55 - Postretirement benefits ...... - (.21) - Unearned premiums ............ - (.08) - ------------ ------------ ------------ Total ...................... $ 1.29 $ .96 $ .02 ============ ============ ============ Average number of shares outstanding 10,431,925 10,197,999 10,071,901 ============ ============ ============ Pro forma amounts, assuming retroactive application of new method of calculating unearned premiums: Net income ............................... $ 10,563,312 $ 344,420 ============ ============ Earnings per common share ................ $ 1.04 $ .03 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Common stock, beginning of year ........ $10,325,329 $10,161,760 $10,082,675 Issuance of common stock: Stock option plans ................. 41,694 31,252 79,085 Dividend reinvestment plan ......... 220,606 132,317 - ----------- ----------- ----------- Common stock, end of year .............. 10,587,629 10,325,329 10,161,760 ----------- ----------- ----------- Additional paid-in capital, beginning of year .................... 55,021,926 53,507,459 52,838,624 Additional paid-in capital from issuance of common stock: Stock option plans ................. 349,390 279,234 669,320 Dividend reinvestment plan ......... 1,791,595 1,211,972 - Gain (loss) on sale of treasury stock .. - 23,261 (485) ----------- ----------- ----------- Additional paid-in capital, end of year 57,162,911 55,021,926 53,507,459 ----------- ----------- ----------- Unrealized holding gains on fixed maturity securities available-for- sale, net of tax, beginning of year .. 2,068,451 - - Unrealized holding (losses) gains on revaluation of fixed maturity securities available-for-sale, net of tax (notes 1 and 10) .......... (3,385,047) 2,068,451 - ----------- ----------- ----------- Unrealized holding (losses) gains on fixed maturity securities available- for-sale, net of tax, end of year .... (1,316,596) 2,068,451 - ----------- ----------- ----------- Unrealized holding losses on equity securities available-for-sale, net of tax, beginning of year ........ (19,800) (142,000) (326,375) Unrealized holding gains on revaluation of equity securities available-for-sale, net of tax ....... 19,800 122,200 184,375 ----------- ----------- ----------- Unrealized holding losses on equity securities available-for-sale, net of tax, end of year .............. $ - $ (19,800) $ (142,000) ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity, continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Retained earnings, beginning of year $ 42,319,249 $ 37,866,902 $ 42,891,128 Net income .......................... 13,505,727 9,755,379 215,692 Dividends on common stock ($.52 per share in 1994, 1993 and 1992): Cash dividends .................. (3,510,555) (3,443,465) (5,103,890) Dividends reinvested in shares of common stock .............. (1,911,609) (1,859,567) (136,028) ------------ ------------ ------------ Retained earnings, end of year ...... 50,402,812 42,319,249 37,866,902 ------------ ------------ ------------ Treasury stock at cost, beginning of year ................. (81,386) (483,344) (341,616) Purchase of shares for the treasury (28,681) (126,948) (315,749) Sale of shares from the treasury .... - 528,906 174,021 ------------ ------------ ------------ Treasury stock at cost, end of year (110,067) (81,386) (483,344) ------------ ------------ ------------ Total stockholders' equity ..... $116,726,689 $109,633,769 $100,910,777 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ........................... $13,505,727 $ 9,755,379 $ 215,692 ----------- ----------- ----------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Cumulative effect of changes in accounting principles, net of tax ............................ - (2,621,344) - Losses and settlement expenses ... 5,372,801 8,010,617 33,143,232 Unearned premiums ................ 1,731,514 650,196 4,122,176 Other policyholders' funds ....... 247,816 (840,604) 880,866 Deferred policy acquisition costs (694,771) 413,967 (2,189,375) Indebtedness of related party (note 4) ................. 13,228,868 (8,639,436) 2,261,884 Accrued investment income ........ (725,182) (242,595) (168,511) Accrued income taxes: Current ........................ 1,186,000 (118,000) (2,390,000) Deferred ....................... (94,441) (18,027) (1,501,430) Provision for amortization ....... 4,101 (23,072) 23,660 Realized investment gains ........ (519,567) (684,445) (384,283) Postretirement benefits .......... 549,225 255,782 - Reinsurance receivables .......... 3,542,358 9,389,384 (12,828,945) Prepaid reinsurance premiums ..... 711,151 805,733 (945,813) Amortization of deferred income .. (433,979) (259,217) - Other, net ....................... 706,967 225,040 1,184,844 ----------- ----------- ----------- 24,812,861 6,303,979 21,208,305 Cash (used in) provided by the change in the property and casualty insurance subsidiaries' pooling agreement (note 2) ..... - (4,426,945) 29,402,411 Cash provided by the commutation of outstanding reinsurance balances by the reinsurance subsidiary (note 2) ............ 686,962 - - Cash used in the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement (note 2) - (20,425,955) - ----------- ----------- ----------- Total adjustment ............. 25,499,823 (18,548,921) 50,610,716 ----------- ----------- ----------- Net cash provided by (used in) operating activities $39,005,550 $(8,793,542) $50,826,408 ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued Year ended December 31, ----------------------------------------- 1994 1993 1992 ------------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturity securities held-to-maturity ..... $ (93,131,676) $ - $ - Maturities of fixed maturity securities held-to-maturity ..... 41,099,534 - - Purchases of fixed maturity securities available for sale ... (193,422,946) - - Maturities of fixed maturity securities available-for-sale ... 208,880,152 - - Sales of equity securities available-for-sale .............. 500,000 1,043,068 - Purchases of fixed maturity securities ...................... - (266,682,915)(316,878,492) Maturities of fixed maturity securities ...................... - 274,909,330 270,821,880 Net sales of short-term investments 699,964 1,420,288 797,191 Final settlement on sale of life subsidiary ...................... - - 474,356 ------------- ------------ ------------ Net cash (used in) provided by investing activities .. (35,374,972) 10,689,771 (44,785,065) ------------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock .......... 491,676 331,568 748,405 Dividends paid to stockholders (note 14(c)) ....... (3,510,555) (3,443,465) (5,103,890) Purchase of treasury stock, net ... (28,681) (118,641) (278,241) ------------- ------------ ------------ Net cash used in financing activities ............... (3,047,560) (3,230,538) (4,633,726) ------------- ------------ ------------ NET INCREASE (DECREASE) IN CASH ..... 583,018 (1,334,309) 1,407,617 Cash at beginning of year ........... 675,203 2,009,512 601,895 ------------- ------------ ------------ Cash at end of year ................. $ 1,258,221 $ 675,203 $ 2,009,512 ============= ============ ============ Income taxes paid ................... $ 3,795,381 $ 2,021,128 $ 4,650,795 Interest paid ....................... 33,672 - 387,351 See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation and basis of presentation EMC Insurance Group Inc., an approximately 67 percent owned subsidiary of Employers Mutual Casualty Company (Employers Mutual), is an insurance holding company with operations in property and casualty insurance, reinsurance, nonstandard risk automobile insurance and excess and surplus lines insurance management. EMC Insurance Group Inc. and its subsidiaries are referred to herein as the "Company". The Company's subsidiaries include EMCASCO Insurance Company, Illinois EMCASCO Insurance Company, Dakota Fire Insurance Company, EMC Reinsurance Company, Farm and City Insurance Company and EMC Underwriters, Ltd. The consolidated financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which differ in some respects from those followed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated. Property and Casualty Insurance, Reinsurance and Nonstandard Risk Automobile Insurance Operations Premiums are recognized as revenue ratably over the terms of the respective policies. Effective January 1, 1993, the property and casualty insurance subsidiaries changed their method of calculating unearned premiums from the monthly pro rata method to the daily pro rata method. The property and casualty insurance subsidiaries changed their accounting method because of management's belief that the new method provides for a more accurate matching of revenues and expenses over the terms of the underlying insurance policies. This change resulted in a cumulative increase in unearned premiums of $1,109,799 and a decrease in income of $807,933 ($.08 per share), net of income tax benefits of $301,866. Certain costs of acquiring new business, principally commissions, premium taxes and variable underwriting expenses, have been deferred. Such 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 loss settlement expenses and certain other costs expected to be incurred as the premium is earned. Unpaid losses and settlement expenses are based on estimates of reported and unreported claims and related settlement expenses. Changes in estimates are reflected in current operating results. The provisions for losses and settlement expenses are considered adequate to cover the ultimate net cost of losses and claims incurred to date net of estimated salvage and subrogation recoverable. Since the provisions are necessarily based on estimates, the ultimate liability may be more or less than such provisions. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Excess and Surplus Lines Operations Income is derived from fees and commissions which are realized when earned. Costs of doing business are expensed as incurred. Reinsurance Ceded Ceded reinsurance activities are reported on the basis of Statement of Financial Accounting Standards No. 113 (SFAS 113), "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." SFAS 113 requires a gross (rather than net) balance sheet presentation for ceded reinsurance amounts and addresses the recognition of gain or loss resulting from reinsurance transactions and appropriate financial statement disclosure of reinsurance activities. Investments Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115) "Accounting for Certain Investments in Debt and Equity Securities." SFAS 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the consolidated financial statements. Debt and equity securities that are held for current resale are classified as trading securities and are carried at market value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the above two categories are classified as securities available-for-sale and are carried at market value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of tax. Adoption of this statement had no effect on the income of the Company. Unrealized holding (losses) gains on securities available-for- sale had the effect of (decreasing) increasing stockholders' equity by ($1,316,596) and $2,048,651 at December 31, 1994 and 1993, respectively, net of income taxes of $0 and $1,055,365. At December 31, 1994 and 1993, the Company did not have any investments categorized as trading securities. Prior to December 31, 1993, investments in fixed maturities were carried at amortized cost and equity securities were carried at market value. Changes in unrealized holding gains and losses resulting from the revaluation of equity securities were reported as direct increases and decreases in stockholders' equity. Unrealized holding gains and losses on fixed maturities were not recognized in the consolidated financial statements. Short-term investments represent money market funds and are carried at cost. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The Company's carrying value for investments is reduced to its estimated realizable value if a decline in the market value is deemed other than temporary. Such reductions in carrying value are recognized as realized losses and charged to income. Premiums and discounts on debt securities are amortized over the life of the security as an adjustment to yield using the effective interest method. Realized gains and losses on disposition of investments are included in net income. The cost of investments sold is determined on the first-in, first-out method. Included in investments at December 31, 1994 and 1993 are securities on deposit with various regulatory authorities as required by law amounting to $11,331,550 and $11,329,402, respectively. Effective December 31, 1994, the Company adopted Statement of Financial Accounting Standards No. 119 (SFAS 119), "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." Adoption of this statement had no effect on current disclosures as the Company did not hold or issue any derivative financial instruments at December 31, 1994. Pension Benefits Net periodic pension cost relating to the Company's employee participation in Employers Mutual's Retirement Plan is computed on the basis of Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions." It is the Company'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. Postretirement Benefits other than Pensions Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions." Under SFAS 106, the cost of postretirement benefits other than pensions must be recognized on an accrual basis as employees perform services to earn the benefits. Prior to 1993, the cost of retiree health care and life insurance benefits were recognized as expenses when paid. Postemployment Benefits Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112 (SFAS 112), "Employers Accounting for Postemployment Benefits." SFAS 112 requires that the cost of certain postemployment benefits that vest or accumulate be accrued over the period of an employee's service. Adoption of this standard had no effect on the income of the Company. Income Taxes The Company files a consolidated Federal income tax return with its subsidiaries. Consolidated income tax/benefit is allocated among the entities based upon separate tax liabilities. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Deferred income taxes are provided for temporary differences between financial statement carrying values of assets and liabilities and their respective tax bases. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes." Under SFAS 109, deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and then a valuation allowance is established to reduce that deferred tax asset if it is "more likely than not" that the related tax benefits will not be realized. 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. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. Prior to 1993, the Company computed deferred income taxes in accordance with Statement of Financial Accounting Standards No. 96. Earnings per Share Earnings per common share are computed by dividing earnings by the weighted average number of common shares outstanding during each year. 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 discounted cash flows. 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 three property and casualty insurance subsidiaries of the Company and two subsidiaries 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 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 unaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment programs and income tax liabilities of the pool participants are not subject to the pooling agreement. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Effective January 1, 1992, the aggregate participation of the property and casualty insurance subsidiaries was increased to 22 percent from 17 percent. In connection with this change in pool participation, the Company's liabilities increased $31,427,861 and invested assets increased $29,402,411. The Company reimbursed Employers Mutual $2,025,450 for commissions incurred to generate this business. Employers Mutual voluntarily assumes reinsurance business from nonaffiliated insurance companies and cedes 95 percent of this business to the Company's reinsurance subsidiary, exclusive of certain reinsurance contracts. Prior to 1993, amounts not ceded to the reinsurance subsidiary were retained by Employers Mutual and were subject to cession to the pool members. Effective January 1, 1993, the pooling agreement was amended so that the voluntary assumed reinsurance business written by Employers Mutual is no longer subject to cession to the pool members. As a result, amounts assumed from nonaffiliates have declined from the amount's assumed in 1992. In connection with this change in the pooling agreement, the Company's liabilities decreased $4,470,204 and invested assets decreased $4,426,945. Employers Mutual reimbursed the Company $43,259 for commissions incurred to generate this business. Reinsurance Subsidiary As noted above, the reinsurance subsidiary assumes a 95 percent quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary receives 95 percent of all premiums and assumes 95 percent of all related losses and settlement expenses of this business. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Effective January 1, 1993, the quota share agreement was amended so that losses in excess of $1,000,000 per event are retained by Employers Mutual. The reinsurance subsidiary pays an annual override commission to Employers Mutual for this additional protection, which totaled $2,094,715 in 1994 and $1,808,527 in 1993. The reinsurance subsidiary also pays for 95 percent of the outside reinsurance protection Employers Mutual purchases to protect itself from catastrophic losses on the assumed reinsurance business. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary and amounted to $2,563,041 in 1994 and $2,866,825 in 1993. Employers Mutual retained losses and settlement expenses totaling $7,019,772 in 1994 and $615,000 in 1993 under this agreement. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued In conjunction with this amendment to the quota share agreement, the reinsurance subsidiary terminated its catastrophe reinsurance treaty with Employers Mutual effective January 1, 1993. This treaty paid losses in excess of $1,000,000 resulting from any one catastrophe, subject to a maximum loss of $3,000,000. Maximum recovery was limited to $6,000,000. The reinsurance subsidiary recovered $306,250 and $4,125,000 under this treaty and paid reinstatement premiums of $0 and $1,033,030 in 1993 and 1992, respectively. Total premiums paid to Employers Mutual amounted to $0 and $2,253,579 in 1993 and 1992, respectively. Effective June 30, 1993, Employers Mutual commuted the portion of the quota share agreement that pertained to a casualty pool that is in a run-off position. In connection with this change in the quota share agreement, the Company's liabilities decreased $19,783,037 and invested assets decreased $17,806,179. The reserve discount amount of $1,976,858 was recorded as deferred income and is being amortized into operations over the estimated settlement period of the reserves, which is ten years. The amount recognized as income totaled $433,979 in 1994 and $259,217 in 1993. Effective October 31, 1993, Employers Mutual commuted the portion of the quota share agreement that pertained to a voluntary pool that handles large "highly protected" risks. In connection with this change in the quota share agreement, the Company's liabilities decreased $3,827,201 and invested assets decreased $2,619,776. Employers Mutual reimbursed the Company $1,207,425 for commissions incurred to generate this business. No reserve discount was calculated as this business involved short-tail property coverage. During 1994, the reinsurance subsidiary commuted all outstanding reinsurance balances ceded to Employers Mutual under catastrophe and aggregate excess of loss reinsurance treaties related to accident years 1991 through 1993. In connection with these commutations, the Company's assets and liabilities increased $686,962. There was no income effect from these commutations. Premiums assumed by the reinsurance subsidiary from Employers Mutual amounted to $39,899,335, $34,445,978 and $34,777,710 in 1994, 1993 and 1992, respectively. It is customary in the reinsurance business for the assuming company to compensate the ceding company for the acquisition expenses it incurred in the generation of the business. Commissions paid by the reinsurance subsidiary to Employers Mutual amounted to $11,482,086, $8,979,309 and $10,242,650 in 1994, 1993 and 1992, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The reinsurance subsidiary has an aggregate excess of loss treaty with Employers Mutual which provides protection from a large accumulation of retentions resulting from multiple catastrophes in any one calendar year. The coverage provided is $2,000,000 excess of $2,500,000 aggregate losses retained, excess of $200,000 per event. Maximum recovery is limited to $4,000,000 per accident year. The reinsurance subsidiary recovered $0, $143,501, and $4,221,444 under this treaty and paid reinstatement premiums of $0, $208,470 and $744,561 in 1994, 1993 and 1992, respectively. Total premiums paid to Employers Mutual amounted to $557,842, $708,445 and $1,124,561 in 1994, 1993 and 1992, respectively. Nonstandard Risk Automobile Insurance Subsidiary The nonstandard risk automobile insurance subsidiary has a reinsurance treaty on an excess of loss basis with Employers Mutual which provides reinsurance for 100 percent of each loss in excess of $100,000, up to $1,000,000. Recoveries under this treaty totaled $71,567, $0 and $0 in 1994, 1993 and 1992, respectively. Premiums paid to Employers Mutual amounted to $49,659, $42,065 and $35,377 in 1994, 1993 and 1992, respectively. Services Provided by Employers Mutual Employers Mutual provides various services to all of it's subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are charged to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not charged to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. 3. REINSURANCE CEDED 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. The parties to the pooling agreement also assume insurance from involuntary pools and associations in conjunction with direct business written in various states. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Prior to 1993, the reinsurance subsidiary ceded reinsurance business to Employers Mutual and other nonaffiliated reinsurers in the ordinary course of business for the purpose of limiting its maximum loss exposure. Effective January 1, 1993, the quota share agreement with Employers Mutual was amended so that losses in excess of $1,000,000 per event are retained by Employers Mutual. In conjunction with this amendment to the quota share agreement, the reinsurance subsidiary terminated its catastrophe reinsurance contracts with Employers Mutual and the nonaffiliated reinsurers. Effective January 1, 1993, the reinsurance subsidiary no longer cedes reinsurance to unaffiliated reinsurers and only cedes reinsurance to Employers Mutual under an aggregate "excess of loss" treaty. As a result, reinsurance receivables and prepaid reinsurance premiums for the Company have decreased from 1992 amounts. As of December 31, 1994, deductions for reinsurance ceded to two unaffiliated reinsurers aggregated $10,066,293, which represented 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, 1994 is presented below. Amounts for the years ended December 31, 1994 and 1993 reflect (1) the change in the property and casualty insurance subsidiaries' pooling agreement whereby effective January 1, 1993, the voluntary assumed reinsurance business written by Employers Mutual is no longer subject to cession to the pool members and (2) the amendment to the reinsurance subsidiary's quota share agreement whereby effective January 1, 1993, losses in excess of $1,000,000 per event are retained by Employers Mutual and the reinsurance subsidiary therefore no longer purchases catastrophe protection (see note 2). EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Premiums Written Direct ......................... $143,444,388 $135,277,129 $138,829,576 Assumed from nonaffiliates ..... 5,843,091 6,636,942 16,467,613 Assumed from affiliates ........ 158,646,332 147,620,705 150,070,741 Ceded to nonaffiliates ......... (8,890,119) (10,701,482) (17,721,207) Ceded to affiliates ............ (132,100,537) (120,898,914) (129,826,840) ------------ ------------ ------------ Net premiums written ......... $166,943,155 $157,934,380 $157,819,883 ============ ============ ============ Premiums Earned Direct ......................... $140,012,247 $137,141,457 $142,391,771 Assumed from nonaffiliates ..... 5,988,228 6,758,364 14,980,642 Assumed from affiliates ........ 156,839,482 148,366,487 140,442,245 Ceded to nonaffiliates ......... (9,601,270) (11,507,217) (16,775,394) Ceded to affiliates ............ (128,409,308) (124,321,553) (133,628,977) ------------ ------------ ------------ Net premiums earned .......... $164,829,379 $156,437,538 $147,410,287 ============ ============ ============ Losses and Settlement Expenses Incurred Direct ......................... $113,680,306 $ 97,842,980 $112,579,261 Assumed from nonaffiliates ..... 2,774,689 6,575,099 17,415,319 Assumed from affiliates ........ 108,594,530 107,369,274 114,359,445 Ceded to nonaffiliates ......... (3,077,305) (5,845,414) (16,862,082) Ceded to affiliates ............ (105,028,166) (85,586,640) (105,404,110) ------------ ------------ ------------ Net losses and settlement expenses incurred .......... $116,944,054 $120,355,299 $122,087,833 ============ ============ ============ 4. REINSURANCE ASSUMED Prior to December 31, 1993, the parties to the pooling agreement recorded amounts assumed from the National Workers' Compensation Reinsurance Pool on a net basis. Under this approach, reserves for outstanding losses and unearned premiums were reported as liabilities under "Indebtedness to Related Party" in the Company's consolidated financial statements. Effective December 31, 1993, the parties to the pooling agreement began recording these amounts as outstanding losses and unearned premiums and restated all prior year consolidated financial statements for comparative purposes. There was no income effect from this reclassification. In connection with this gross-up of balances, amounts due from Employers Mutual increased $13,147,831 at December 31, 1993. Under the terms of the pooling agreement, these balances were settled in the first quarter of 1994. 5. 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 in accordance with SFAS 113 (see note 1). EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, beginning of year .......................... $197,121,852 $215,388,865 $158,814,130 Ceded reserves for losses and settlement expenses, beginning of year .......................... 17,454,679 25,253,507 13,951,033 ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year .......................... 179,667,173 190,135,358 144,863,097 ------------ ------------ ------------ Incurred losses and settlement expenses: ------------------------- Provision for insured events of the current year ............ 123,343,829 119,896,526 116,615,951 (Decrease) increase in provision for insured events of prior years .......................... (6,399,775) 458,773 5,471,882 ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 116,944,054 120,355,299 122,087,833 ------------ ------------ ------------ Payments: --------- Losses and settlement expenses attributable to insured events of the current year ............ 48,771,573 47,600,851 46,436,360 Losses and settlement expenses attributable to insured events of prior years ................. 59,491,875 45,508,460 53,810,715 Payment related to the commutation of the reinsurance subsidiary's catastrophe and aggregate excess of loss reinsurance treaties ... (686,962) - - Payment related to the change in the property and casualty insurance subsidiaries' pooling agreement ...................... $ - $ 4,373,629 $(23,431,503) EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Payment related to the commutation of two reinsurance contracts under the reinsurance subsidiary's quota share agreement ...................... $ - $ 21,904,001 $ - Adjustment related to the gross-up of reserve amounts associated with the National Workers' Compensation Reinsurance Pool .. - 11,436,543 - ------------ ------------ ------------ Total payments .............. 107,576,486 130,823,484 76,815,572 ------------ ------------ ------------ Net reserves for losses and settlement expenses, end of year 189,034,741 179,667,173 190,135,358 Ceded reserves for losses and settlement expenses, end of year 14,146,874 17,454,679 25,253,507 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, end of year $203,181,615 $197,121,852 $215,388,865 ============ ============ ============ Underwriting results of the Company are significantly influenced by estimates of loss and settlement expense reserves. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. During 1992, the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary strengthened prior year reserves on certain lines of business and the reinsurance subsidiary experienced a time lag in the reporting of assumed reinsurance business. During 1993, the property and casualty insurance companies continued to strengthen reserves on certain lines of business while the reinsurance subsidiary experienced adverse development on losses associated with Hurricane Andrew. These reserve increases in 1992 and 1993 were partially offset by reserve decreases on other lines of business, resulting in a net increase in the Company's estimate of prior year reserves of $5,471,882 in 1992 and $458,773 in 1993. During 1994, the reinsurance subsidiary experienced adverse development on certain contracts. These reserve increases were offset by significant reserve decreases in the property and casualty insurance subsidiaries and the nonstandard risk automobile insurance subsidiary. As a result, the net decrease in the Company's estimate of prior year reserves in 1994 amounted to $6,399,775. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 6. ENVIRONMENTAL RELATED CLAIMS Estimating loss and settlement reserves for asbestos and environmental related claims is very difficult due to the following uncertainties surrounding these types of claims: the legal definition of asbestos and environmental damage is still evolving, the assignment of responsibility varies widely by state, defense costs are often much greater than the claim costs and claims often emerge long after the policy has expired, making 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. Reserves for asbestos and environmental related claims at December 31, 1994 and 1993 were $749,807 and $550,773, respectively. 7. RETAINED EARNINGS Retained earnings of the Company's insurance subsidiaries available for distribution as dividends to EMC Insurance Group Inc. 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 by Iowa corporations without prior approval of the insurance regulatory authorities is restricted to the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis. Both Illinois and North Dakota impose restrictions which are similar to those of Iowa on the payment of dividends and distributions. At December 31, 1994, $15,513,214 was available for distribution in 1995 to EMC Insurance Group Inc. without prior approval. Statutory surplus of the Company's insurance subsidiaries was $86,820,039 and $78,681,248 at December 31, 1994 and 1993, respectively. Statutory net income (loss) of the Company's insurance subsidiaries was $13,430,353, $8,788,458 and ($3,960,393) for the three years ended December 31, 1994. During 1994, the National Association of Insurance Commissioners implemented the Risk-Based Capital (RBC) model. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk facing property and casualty insurers: 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. The Company's insurance subsidiaries' ratio of total adjusted capital to risk-based capital at December 31, 1994 is well in excess of the minimum level required. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 8. RECONCILIATION OF STATUTORY NET INCOME AND SURPLUS A reconciliation of net income and surplus from that reported on a statutory basis to that reported in the accompanying consolidated financial statements on a GAAP basis is as follows: Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Statutory net income (loss) ........... $13,697,482 $ 8,761,472 $(3,118,589) Change in deferred policy acquisition costs ................... 694,771 (413,967) 2,189,375 Change in salvage and subrogation accrual ............................. 5,851 (232,760) 742,233 Change in other policyholders' funds .. (247,816) 840,604 (880,866) Change in pension accrual ............. (298,021) (103,846) 622,177 GAAP postretirement benefit cost in excess of statutory cost ......... (314,583) (216,091) - Deferred income tax benefit ........... 94,441 18,027 1,501,430 Statutory gain on sale of life subsidiary ..................... - - (474,356) Prior year taxes and related interest (180,770) 817 (387,351) GAAP basis amortization of reserve discount on commutation of reinsurance contract ................ 433,979 259,217 - Statutory reserve discount on commutation of reinsurance contract - (1,976,858) - Other, net ............................ (379,607) 197,420 21,639 ----------- ----------- ----------- Income before cumulative effect of changes in accounting principles, GAAP basis .......................... 13,505,727 7,134,035 215,692 Cumulative effect of changes in accounting principles for: Income taxes ...................... - 5,595,177 - Postretirement benefits ........... - (2,165,900) - Unearned premiums ................. - (807,933) - ----------- ----------- ----------- Net income, GAAP basis ................ $13,505,727 $ 9,755,379 $ 215,692 =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Statutory surplus .................. $ 94,317,215 $ 85,830,140 $ 83,331,013 Deferred policy acquisition costs .. 8,393,635 7,698,864 8,112,831 Accrued salvage and subrogation .... 1,799,443 1,793,592 2,026,352 Other policyholders' funds payable (3,102,609) (2,854,793) (3,695,397) Pension asset ...................... 1,407,714 1,705,735 1,809,581 GAAP postretirement benefit liability in excess of statutory liability ........................ (1,672,780) (1,358,197) - Deferred income tax asset .......... 14,190,499 13,040,693 7,065,221 Goodwill ........................... 1,883,177 2,017,690 2,152,203 Excess statutory reserves over statement reserves .......... 2,044,268 - 8,007 GAAP basis reserve discount on commutation of reinsurance contract in excess of statutory recognition ...................... (1,283,662) (1,717,641) - Unrealized holding (losses) gains on fixed maturity securities available-for-sale ............... (1,316,596) 3,134,016 - Other .............................. 66,385 343,670 100,966 ------------ ------------ ------------ Stockholders' equity, GAAP basis ... $116,726,689 $109,633,769 $100,910,777 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 9. SEGMENT INCOME
The Company's operations include the following major segments: property and casualty insurance, reinsurance, nonstandard risk automobile insurance and excess and surplus lines insurance management. No single source accounted for 10 percent or more of consolidated revenues. Summarized financial information for these segments is as follows: Net Realized Operating Premiums Underwriting Investment Gains Other Income Earned Gain (Loss) Income (Losses) Income (Loss) Assets ------------ ------------ ----------- -------- -------- ----------- ------------ Year Ended December 31, 1994 Property and casualty insurance $115,411,835 $ 933,533 $14,080,206 $334,032 $ - $15,347,771 $273,308,572 Reinsurance ................... 37,256,763 (4,717,242) 5,354,494 115,720 433,979 1,186,951 84,495,802 Nonstandard risk automobile insurance ................... 12,160,781 493,910 1,152,341 74,815 - 1,721,066 20,146,281 Excess and surplus lines insurance management ........ - 399,125 106,120 - - 505,245 4,238,732 Parent company ................ - (315,784) 236,519 (5,000) - (84,265) 116,870,504 Eliminations .................. - - - - - - (111,690,013) ------------ ------------ ----------- -------- -------- ----------- ------------ Consolidated ............. $164,829,379 $ (3,206,458) $20,929,680 $519,567 $433,979 $18,676,768 $387,369,878 ============ ============ =========== ======== ======== =========== ============ Year Ended December 31, 1993 Property and casualty insurance $109,584,986 $ (3,812,671) $13,242,584 $405,193 $ - $ 9,835,106 $266,070,386 Reinsurance ................... 33,324,202 (6,040,296) 6,090,294 200,612 259,217 509,827 76,743,953 Nonstandard risk automobile insurance ................... 13,528,350 (2,542,690) 1,165,684 108,640 - (1,268,366) 20,821,495 Excess and surplus lines insurance management ........ - 36,858 66,564 - - 103,422 2,765,076 Parent company ................ - (345,678) 214,825 (30,000) - (160,853) 109,731,870 Eliminations .................. - - - - - - (107,197,257) ------------ ------------ ----------- -------- -------- ----------- ------------ Consolidated ............. $156,437,538 $(12,704,477) $20,779,951 $684,445 $259,217 $ 9,019,136 $368,935,523 ============ ============ =========== ======== ======== =========== ============ Year Ended December 31, 1992 Property and casualty insurance $109,138,829 $ (7,168,779) $13,047,540 $285,367 $ - $ 6,164,128 $265,598,463 Reinsurance ................... 26,615,180 (11,904,373) 6,763,257 51,649 - (5,089,467) 98,293,214 Nonstandard risk automobile insurance ................... 11,656,278 (1,992,649) 1,178,748 47,267 - (766,634) 18,681,308 Excess and surplus lines insurance management ........ - 429,756 66,266 - - 496,022 2,940,889 Parent company ................ - (312,778) 483,786 - - 171,008 100,995,033 Eliminations .................. - - - - - - (113,701,807) ------------ ------------ ----------- -------- -------- ----------- ------------ Consolidated ............. $147,410,287 $(20,948,823) $21,539,597 $384,283 $ - $ 975,057 $372,807,100 ============ ============ =========== ======== ======== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 10. INVESTMENTS The amortized cost and estimated market value of securities held-to- maturity and available-for-sale as of December 31, 1994 are as follows. The estimated market value is based on quoted market prices, where available, or on values obtained from independent pricing services. Gross Gross Estimated Amortized Unrealized Unrealized Market December 31, 1994 Cost Gains Losses Value ----------------- ------------ ----------- ----------- ------------ Securities held-to-maturity: Fixed maturity securities: U.S. Treasury securities and obligations of U.S. government corporations and agencies ............. $102,480,740 $ 1,239,742 $(1,142,326)$102,578,156 Obligations of states and political subdivisions ......... 78,423,605 876,074 (3,804,723) 75,494,956 Debt securities issued by foreign governments 583,309 7,411 - 590,720 Public utilities ....... 8,622,154 - (370,847) 8,251,307 Corporate securities ... 13,052,550 17,625 (574,197) 12,495,978 Mortgage-backed securities ........... 40,487,362 469,879 (1,646,870) 39,310,371 ------------ ----------- ----------- ------------ Total fixed maturity securities ......... $243,649,720 $ 2,610,731 $(7,538,963)$238,721,488 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: U.S. Treasury securities $ 15,835,019 $ - $ - $ 15,835,019 Obligations of states and political subdivisions ......... 55,274,052 1,275,408 (2,436,572) 54,112,888 Debt securities issued by foreign governments 1,994,980 - (110,260) 1,884,720 Corporate securities ... 4,250,000 - - 4,250,000 Other debt securities .. 454,941 - (45,172) 409,769 ------------ ----------- ----------- ------------ Total fixed maturity securities ......... $ 77,808,992 $ 1,275,408 $(2,592,004)$ 76,492,396 ============ =========== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The amortized cost and estimated market value of securities held-to- maturity and available-for-sale as of December 31, 1993 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Market December 31, 1993 Cost Gains Losses Value ----------------- ------------ ----------- ----------- ------------ Securities held-to-maturity: Fixed maturity securities: U.S. Treasury securities and obligations of U.S. government corporations and agencies ............. $109,895,914 $ 9,931,812 $ (630) $119,827,096 Obligations of states and political subdivisions ......... 18,374,003 1,936,083 (2,129) 20,307,957 Debt securities issued by foreign governments 587,060 70,343 - 657,403 Public utilities ....... 8,813,202 336,199 (910) 9,148,491 Corporate securities ... 17,050,988 819,896 (467) 17,870,417 Mortgage-backed securities ........... 36,289,456 2,204,777 - 38,494,233 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... $191,010,623 $15,299,110 $ (4,136) $206,305,597 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: U.S. Treasury securities $ 26,803,980 $ 166,800 $ - $ 26,970,780 Obligations of states and political subdivisions ......... 58,431,008 3,038,591 (74,084) 61,395,515 Corporate securities ... 7,496,245 - - 7,496,245 Other debt securities .. 486,941 4,779 (2,070) 489,650 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... $ 93,218,174 $ 3,210,170 $ (76,154) $ 96,352,190 ============ =========== =========== ============ Equity securities ........ $ 505,000 $ - $ (30,000) $ 475,000 ============ =========== =========== ============ The amortized cost and estimated market value of fixed maturity securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Estimated Amortized Market Cost Value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 11,767,723 $ 11,920,042 Due after one year through five years ..... 83,119,839 82,556,120 Due after five years through ten years .... 79,969,324 77,390,645 Due after ten years ....................... 28,305,472 27,544,310 Mortgage-backed securities ................ 40,487,362 39,310,371 ------------ ------------ Totals .................................. $243,649,720 $238,721,488 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 20,884,351 $ 20,896,089 Due after one year through five years ..... 16,762,627 16,297,903 Due after five years through ten years .... 25,213,287 25,595,670 Due after ten years ....................... 14,948,727 13,702,734 ------------ ------------ Totals .................................. $ 77,808,992 $ 76,492,396 ============ ============ Proceeds from calls, prepayments and sales of securities held-to-maturity and available-for-sale and realized investment gains and losses were as follows. There were no sales of securities classified as held-to-maturity during 1994; all activity is due to calls, prepayments and maturities. Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Fixed maturity securities held-to-maturity: Proceeds from calls and prepayments $26,469,534 $37,759,956 $18,640,915 Gross realized investment gains ..... 501,628 706,059 388,692 Gross realized investment losses .... 1,027 9,682 4,409 Fixed maturity securities available-for-sale: Proceeds from calls and prepayments $ 842,000 $ - $ - Gross realized investment gains ..... 23,966 - - Equity securities available-for-sale: Proceeds from sales ................. $ 500,000 $ 1,043,068 $ - Gross realized investment gains ..... - 18,068 - Gross realized investment losses .... 5,000 30,000 - EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued A summary of net investment income is as follows: Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Interest on fixed maturities .......... $20,886,029 $20,862,221 $21,361,673 Dividends on equity securities ........ 14,167 65,065 119,989 Interest on short-term investments .... 597,896 442,160 566,028 Other interest ........................ 1,552 - - ----------- ----------- ----------- Total investment income ........... 21,499,644 21,369,446 22,047,690 Investment expense .................... 569,964 589,495 508,093 ----------- ----------- ----------- Net investment income ............. $20,929,680 $20,779,951 $21,539,597 =========== =========== =========== A summary of net changes in unrealized holding (losses) gains is as follows: Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ---------- ---------- Fixed maturity securities available-for-sale ................ $ (4,450,612) $ 3,134,016 $ - Equity securities available-for-sale ................ 30,000 112,000 184,375 Applicable income taxes ............. 1,055,365 (1,055,365) - ----------- ---------- ----------- Net changes in unrealized holding (losses) gains ......... $ (3,365,247) $ 2,190,651 $ 184,375 =========== ========== ========== 11. INCOME TAXES As discussed in note 1, Summary of Significant Accounting Policies, the Company adopted SFAS 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes as of January 1, 1993 increased income by $5,595,177 ($.55 per share), net of a valuation allowance of $1,000,000, and is reported separately in the consolidated statement of income for the year ended December 31, 1993. Excluding the amount recognized as the cumulative effect of the change, the effect of applying SFAS 109 on net income for the year ended December 31, 1993 was a decrease of $174,483 ($.02 per share). EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Temporary differences between the consolidated financial statement carrying amount and tax basis of assets and liabilities that give rise to significant portions of the deferred tax asset at December 31, 1994 and 1993 relate to the following: Year ended December 31, ------------------------ 1994 1993 ----------- ----------- Loss reserve discounting .......................... $12,690,876 $12,549,200 Unearned premium reserve limitation ............... 3,075,140 2,953,491 Postretirement benefits ........................... 1,389,469 1,202,733 Policyholder dividends payable .................... 1,054,887 970,630 Prepayment of tax on commutation of loss reserves 436,445 583,998 Net unrealized holding losses ..................... 447,643 - Other, net ........................................ 574,569 617,529 ----------- ----------- Total gross deferred income tax asset ......... 19,669,029 18,877,581 Less valuation allowance .......................... (1,447,643) (1,000,000) ----------- ----------- Total deferred income tax asset ............... 18,221,386 17,877,581 ----------- ----------- Deferred policy acquisition costs ................. (2,853,836) (2,617,614) Net unrealized holding gains ...................... - (1,055,365) Other, net ........................................ (1,177,051) (1,163,909) ----------- ----------- Total gross deferred income tax liability ..... (4,030,887) (4,836,888) ----------- ----------- Net deferred income tax asset ............. $14,190,499 $13,040,693 =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The valuation allowance for the years ended December 31, 1994 and 1993 increased $447,643 and $0, respectively. The valuation allowance at December 31, 1994 consists of $1,000,000 related to the tax benefit of future postretirement deductions that are scheduled to reverse more than fifteen years into the future and $447,643 related to tax benefits associated with unrealized holding losses on fixed maturity securities available-for-sale. A valuation allowance was established for these items due to the uncertainty concerning the future realization of these tax benefits. Based upon anticipated future taxable income and consideration of all other available evidence, management believes that it is "more likely than not" that the Company's net deferred income tax asset will be realized. The Company has had cumulative taxable income in the five-year period of 1990 through 1994 of approximately $44,036,000. The actual income tax expense for the years ended December 31, 1994, 1993 and 1992 differed from the "expected" tax expense for those years (computed by applying the United States federal corporate tax rate of 34 percent to income before income taxes and cumulative effect of changes in accounting principles) as follows: Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Computed "expected" tax expense ...... $ 6,350,101 $ 3,066,506 $ 331,519 Increases (decreases) in taxes resulting from: Tax-exempt interest income ....... (2,034,273) (1,171,612) (1,312,568) Unrecognized future temporary differences .................... - - 1,745,003 Change in accrual of prior year taxes .......................... (209,734) (252,839) - Settlement of tax examinations ... 147,098 117,497 - Proration of tax-exempt interest 223,484 123,342 120,332 Other, net ....................... 694,365 2,207 (124,921) ----------- ----------- ----------- Income taxes ................... $ 5,171,041 $ 1,885,101 $ 759,365 =========== =========== =========== Comprehensive income tax expense (benefit) included in the consolidated financial statements for the years ended December 31, 1994, 1993 and 1992 was as follows: Year ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Income tax expense (benefit) on: Operations .......................... $ 5,171,041 $ 1,885,101 $ 759,365 Accounting changes: Income taxes ...................... - (5,595,177) - Postretirement benefits (note 13) - (1,115,767) - Unearned premiums (note 1)......... - (301,866) - Unrealized holding (losses) gains on revaluation of securities available-for-sale ................ (1,055,365) 1,055,365 - ----------- ----------- ----------- Comprehensive income tax expense (benefit) ............... $ 4,115,676 $(4,072,344) $ 759,365 =========== =========== =========== The Company's 1990 and 1991 tax returns have been examined by the Internal Revenue Service. The Company is currently protesting certain issues arising out of these examinations. The Company does not expect any material assessments related to the final settlement of these issues. 12. EMPLOYEE RETIREMENT PLAN The Company participates in Employers Mutual's defined benefit retirement plan covering substantially all employees. The plan is funded by employer contributions and provides a monthly income for life upon retirement or upon total and permanent disability. The following tables set forth the funded status and the components of the net periodic pension cost (benefit) for the Employers Mutual defined benefit retirement plan, based upon a measurement date of November 1, 1994, 1993 and 1992, respectively: EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1994 1993 1992 ------------ ------------ ------------ Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $52,520,753, $27,245,933 and $23,739,308 .................. $ 53,244,188 $ 29,713,282 $ 24,695,567 ============ ============ ============ Projected benefit obligation for service rendered to date ......... $(69,337,553) $(44,579,398) $(36,103,055) Plan assets at fair value .......... 66,760,033 51,625,386 48,365,122 ------------ ------------ ------------ Plan assets (less) greater than projected benefit obligation ..... (2,577,520) 7,045,988 12,262,067 Unrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions ........... 12,201,810 4,440,487 (754,346) Prior service cost not yet recog- nized in net periodic pension cost 3,955,406 4,374,510 4,941,220 Unrecognized portion of initial net asset ........................ (6,107,252) (7,182,692) (8,072,193) ------------ ------------ ------------ Prepaid pension cost ........ $ 7,472,444 $ 8,678,293 $ 8,376,748 ============ ============ ============ Service cost - benefits earned during the period ................ $ 2,965,867 $ 2,347,984 $ 1,691,648 Interest cost on projected benefit obligation ............... 2,925,086 2,533,587 2,053,584 Actual gain on plan assets ......... (1,606,902) (5,229,721) (4,386,821) Net amortization and deferral ...... (3,078,202) 647,291 (615,762) ------------ ------------ ------------ Net periodic pension cost (benefit) ............ $ 1,205,849 $ 299,141 $ (1,257,351) ============ ============ ============ The unrecognized net asset is being recognized over 12.5 to 15.2 years beginning January 1, 1987. The weighted average discount rate used to measure the projected benefit obligation was 7.25 percent for 1994, 6.75 percent for 1993 and 7.00 percent for 1992. The assumed long-term rate of return on plan assets was 8.00 for 1994, 1993 and 1992. The rate of increase in future compensation levels used in measuring the projected benefit obligation was 5.30 percent in 1994 and 1993 and 5.50 percent in 1992. Pension expense (benefit) for the Company amounted to $298,021, $103,846 and ($622,177) in 1994, 1993 and 1992, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Effective November 1, 1992, the plan was amended to comply with the requirements of the Tax Reform Act of 1986, which placed limits on the benefits for highly compensated employees. The amended plan is referred to as a cash balance plan since the benefits are expressed as a cash value instead of a monthly benefit payment amount. The cash balance plan uses the Pension Benefit Guaranty Corporation (PBGC) interest rate in effect on January 1 of each plan year in calculating the cash value of benefits. Fluctuations in the PBGC rate have a significant impact on the funded status of the plan. The PBGC rate used for plan years ended December 31, 1994, 1993 and 1992 was 4.50 percent, 5.75 percent and 6.50 percent, respectively. The plan amendment described above resulted in a prior service cost of $4,472,778, which is being amortized over 12 to 14 years beginning January 1, 1993. The Company's share of this prior service cost amounted to $1,003,257. The prior service cost amortized for the years ended December 31, 1994 and 1993 was $349,770 and $373,838, respectively, with the Company's share being $78,636 and $83,452, respectively. Effective April 1, 1994, Employers Mutual entered into a new group annuity contract with its pension administrator. Under the old contract, the pension administrator assumed the mortality risk associated with retirees. Accordingly, assets and liabilities of retirees were transferred to the pension administrator and were excluded from the plan. Effective April 1, 1994, Employers Mutual assumed the mortality risk associated with retirees and the related assets and liabilities were transferred back into the plan. As a result, the plan's assets and liabilities increased approximately $19,100,000. This change in contracts had no effect on the funded status of the plan or the benefits payable to participants. 13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company participates in Employers Mutual's postretirement benefit plans which provide certain health care and life insurance benefits for retired employees. Substantially all of the Company's employees may become eligible for those benefits if they reach normal retirement age and have attained the required length of service while working for the Company. 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. Both plans are unfunded and benefits provided are subject to change. As discussed in note 1, Summary of Significant Accounting Policies, the Company adopted SFAS 106 as of January 1, 1993. The Company's transition obligation as of January 1, 1993 amounted to $2,165,900 ($.21 per share), net of income tax benefits of $1,115,767, and was recorded as a cumulative effect adjustment to income. Prior year financial statements have not been restated to apply the provisions of SFAS 106. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The following tables set forth the status and the components of the net periodic postretirement benefit cost of the Employers Mutual postretirement benefit plans based upon a measurement date of November 1, 1994 and 1993, respectively. Year ended December 31, -------------------------- 1994 1993 ------------ ------------ Actuarial present value of benefit obligations: Retirees ....................................... $ 7,404,314 $ 7,874,628 Fully eligible active plan participants ........ 4,859,467 5,681,430 Other active plan participants ................. 6,767,662 7,783,183 ------------ ------------ Total ...................................... 19,031,443 21,339,241 Unrecognized net gain (loss) from past experience different from that assumed and effects of changes in assumptions ............ 3,707,110 (447,778) Prior service cost not yet recognized in net periodic postretirement benefit cost ......... (4,533,871) (5,105,109) ------------ ------------ Postretirement benefit obligation .......... $ 18,204,682 $ 15,786,354 ============ ============ Service cost - benefits earned during the period ....................................... $ 1,027,634 $ 596,498 Interest cost on accumulated postretirement benefit obligation ........................... 1,412,961 999,526 Net amortization and deferral .................. 571,595 - ------------ ------------ Net periodic postretirement benefit cost ... $ 3,012,190 $ 1,596,024 ============ ============ 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) is 12.0 percent for 1995 (compared to 12.5 percent assumed for 1994) and is assumed to decrease gradually to 6 percent in 2007 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, 1994 by $2,669,037 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1994 by $510,634. The weighted average discount rate used in determining the accumulated postretirement benefit obligation at December 31, 1994 and 1993 was 7.25 percent and 6.75 percent, respectively. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Effective January 1, 1993, the health care postretirement plan was amended to provide additional benefits under the prescription drug coverage. The amendment substantially reduced the retired employee's cost sharing provisions for prescription drug coverage. The amendment resulted in a prior service cost of $5,105,109, which is being amortized over 8.9 to 10.0 years. The Company's share of the prior service cost amounted to $1,156,028. The prior service cost amortized for the year ended December 31, 1994 was $571,238, with the Company's share amounting to $129,528. The Company's net periodic postretirement benefit cost for the years ended December 31, 1994 and 1993 was $684,899 and $359,747, respectively. The postretirement benefit cost of $78,807 for the year ended December 31, 1992, which was recorded on a cash basis, has not been restated. 14. COMMON STOCK (a) Employee Stock Purchase Plans 1993 Employee Stock Purchase Plan On February 12, 1993, the Company filed a registration statement with the Securities and Exchange Commission authorizing the issuance of up to 500,000 shares of the Company's common stock for use in the Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. The plan provides for two option periods each calendar year; from January 1 until the last business day of June, and from July 1 until the last business day of December, with the last business day in each option period being the option exercise date. 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. Eligible employees may elect to participate in the plan either through payroll deduction or by lump sum contributions, but in no case can the participation level exceed 10 percent of the employee's base annual compensation amount. The option price is 85 percent of the fair market value of the stock on the exercise date. Upon exercise of an option, the Company shall issue a stock certificate evidencing the ownership of the participant in the shares of stock so purchased. The certificate, however, will be held in custody by the stock transfer agent for a period of one year from the exercise date. During such one year period, the participant shall have the rights and privileges of a shareholder, including the right to vote, to receive dividends, and to have such shares participate in the dividend reinvestment and common stock purchase plan. However, the participant shall not be able to sell, transfer, assign, pledge or otherwise encumber or dispose of such shares during such one year period. Upon expiration of the one year period or upon any earlier termination of employment of the participant for any reason, including death, such participant shall, within thirty days of such expiration or termination, receive the stock certificate(s) evidencing his or her shares of stock. The plan is administered by the Board of Directors 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 1994, 126 employees participated in the plan and exercised a total of 22,606 options at prices of $7.65 and $8.08. Activity under the plan was as follows: EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ----------------------- 1994 1993 ---------- ---------- Shares available for purchase, beginning of year 486,546 - Shares registered for use in plan ............. - 500,000 Shares purchased under plan ................... (22,606) (13,454) ---------- ---------- Shares available for purchase, end of year ...... 463,940 486,546 ========== ========== 1987 Employee Stock Purchase Plan Under the Employers Mutual 1987 Employee Stock Purchase Plan, Employers Mutual could purchase up to 200,000 shares of EMC Insurance Group Inc. common stock for resale to eligible employees. The plan was similar to the 1993 employee stock purchase plan explained above, except that there was not a holding period before the participant received the shares purchased. The plan was terminated in August of 1993 and the remaining shares were deregistered. Activity under the plan was as follows: Year ended December 31, ----------------------- 1993 1992 ---------- ---------- Shares available for purchase, beginning of year 55,720 85,765 Shares purchased under plan .................... (10,706) (30,045) Shares deregistered ............................ (45,014) - ---------- ---------- Shares available for purchase, end of year ....... - 55,720 ========== ========== (b) 1993 Non-Employee Director Stock Purchase Plan On February 12, 1993, the Company filed a registration statement with the Securities and Exchange Commission authorizing the issuance of up to 200,000 shares of the Company's common stock for use in the 1993 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 Employers Mutual's Board of Directors (the "Board") as of the beginning of the option period are eligible for participation in the plan. The option period is from the date of each eligible director's respective Annual Meeting to the day immediately prior to the next and subsequent Annual Meeting. Each eligible director is granted an option at the beginning of the option period to purchase stock at an option price equal to 75 percent of the fair market value of the stock on the option exercise date. The option may be exercised anytime during the option period. An eligible director can purchase shares of common stock in an amount equal to a minimum of 25 percent to a maximum of 100 percent of their annual cash retainer. Eligible directors may not have sold any of the Company's common stock in the six month period preceding the exercise date and may not sell any shares of the Company's common stock in the six month period following the exercise of an option. 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. The plan will continue through the option period for options granted at the 2002 Annual Meeting. During 1994, five directors participated in the plan and exercised a total of 5,949 options at prices ranging from $6.47 to $6.94. Activity under the plan was as follows: EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, -------------------------- 1994 1993 ------------ ------------ Shares available for purchase, beginning of year 194,048 - Shares registered for use in plan ............. - 200,000 Shares purchased under plan ................... (5,949) (5,952) ------------ ------------ Shares available for purchase, end of year ...... 188,099 194,048 ============ ============ (c) 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. Any holder of shares of common stock is eligible to participate in the plan. During 1994 and 1993, Employers Mutual elected to participate in the Dividend Reinvestment Plan by reinvesting 50 percent of its dividends in additional shares of the Company's common stock. Activity under the plan was as follows: Year ended December 31, ------------------------- 1994 1993 1992 ------- ------- ------- Shares available for purchase, beginning of year 758,266 944,453 963,285 Shares purchased under plan ................... (220,606)(186,187) (18,832) ------- ------- ------- Shares available for purchase, end of year ...... 537,660 758,266 944,453 ======= ======= ======= Range of purchase prices ........................ $ 8.75 $10.00 $ 8.00 to to to $ 9.50 $10.25 $10.25 (d) Treasury Stock The Company from time to time repurchases shares of its outstanding common stock in the open market or through negotiated purchases for the purpose of providing shares for use in the Company's Dividend Reinvestment and Common Stock Purchase Plan. The Company repurchased 7,000 shares for this purpose during 1992 at an average cost of $10.47. The Company also repurchases shares of its outstanding common stock in connection with the issuance of new shares under Employers Mutual's stock option plans. Treasury stock activity was as follows: Year ended December 31, ------------------------- 1994 1993 1992 ------- ------- ------- Treasury shares, beginning of year ............... 8,090 49,392 36,685 Repurchased shares ............................ 2,841 12,568 31,539 Reissued shares ............................... - (53,870) (18,832) ------- ------- ------- Treasury shares, end of year ..................... 10,931 8,090 49,392 ======= ======= ======= Average cost ..................................... $ 10.07 $ 10.06 $ 9.79 ======= ======= ======= Gain (loss) on sale .............................. $ - $23,261 $ (485) ======= ======= ======= EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 15. STOCK OPTIONS During 1994, Employers Mutual maintained three separate stock option plans which utilize the common stock of the Company. The Company receives the current fair market value for any shares issued under the plans and all costs of the plans are borne by Employers Mutual or the company employing the individual optionees. (a) 1993 Incentive Stock Option Plan On February 12, 1993, the Company filed a registration statement with the Securities and Exchange Commission authorizing the issuance of up to 500,000 shares of the Company's common stock for use in the 1993 Employers Mutual Casualty Company Incentive Stock Option Plan. Options granted under the plan can be for a term of two to ten years. Each option shall have a vesting period of two, three, four or five years, with options becoming exercisable in equal annual cumulative increments. The vesting period shall commence one year from the date of grant, with the exception of an option with a two year vesting period for which the vesting period shall commence on the date of grant. The time limit for granting options under the plan is December 31, 2002. The Senior Executive Compensation and Stock Option Committee of Employers Mutual's Board of Directors is the administrator of the plan. Options have been granted to 64 individuals under the plan. For the 60 remaining eligible participants at February 21, 1995, the option price is the fair market value at dates of grant ranging from $8.81 to $9.56 per share. Option prices are determined by the Committee but can not be less than the fair market value of the stock on the date of grant. During 1994, 64,600 options were granted to eligible participants at a price of $8.81. During 1994, 800 options were exercised under the plan at a price of $8.81. Stock options under the plan were as follows: Year ended December 31, ------------------------- 1994 1993 ------------ ------------ Outstanding, beginning of year ............... 161,150 - Granted .................................... 64,600 163,650 Exercised .................................. (800) - Expired .................................... (7,800) (2,500) ------------ ------------ Outstanding, end of year ..................... 217,150 161,150 ============ ============ Shares exercisable, end of year .............. 34,410 - ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (b) 1982 Incentive Stock Option Plan Under the terms of Employers Mutual's 1982 Incentive Stock Option Plan, 600,000 shares of the Company's common stock were reserved for issuance to officers and key employees of Employers Mutual and its subsidiaries. The Board of Directors of Employers Mutual is the administrator of the plan. Options were granted to 57 individuals. For the 33 remaining eligible participants at February 21, 1995, the option price is the fair market value at dates of grant ranging from $7.81 to $10.25 per share. Options granted under the plan were for a term of two to ten years. Each option granted had a vesting period of two, three, four or five years, with such vesting commencing one year from the date of grant, except in the event of termination of employment when all such granted options are exercisable within three, six or twelve months depending upon the circumstances of such termination. The period for granting options under the plan expired on August 30, 1992. The period for exercising the options can not exceed ten years from date of grant. The option price was determined by the Board of Directors but could not be less than the fair market value of the stock on the date of grant. During 1994, 7,946 options were exercised at prices ranging from $7.81 to $8.75. Stock options under the plan were as follows: Year ended December 31, ---------------------------- 1994 1993 1992 -------- -------- -------- Outstanding, beginning of year ............ 352,073 387,093 447,393 Granted ................................ - - 82,900 Exercised .............................. (7,946) (24,820) (58,540) Expired ................................ (5,000) (10,200) (84,660) -------- -------- ------- Outstanding, end of year .................. 339,127 352,073 387,093 ======== ======== ======= Shares exercisable, end of year ........... 264,797 214,680 168,082 ======== ======== ======= (c) 1979 Stock Option Plan Under Employers Mutual's 1979 Stock Option Plan, 480,000 shares of the Company's common stock were reserved for issuance to certain officers and key management employees of Employers Mutual and its subsidiaries as determined by its Board of Directors. Options were granted to 37 individuals. The period for granting options under the plan expired on March 31, 1984. Options granted vested at an annual rate of 10 percent on a cumulative basis. Upon death, retirement, or permanent disability, all options granted became exercisable. During 1994, 4,800 options were exercised at a price of $6.38. Stock options under the plan were as follows: Year ended December 31, ---------------------------- 1994 1993 1992 -------- -------- -------- Outstanding, beginning of year ............ 4,800 5,760 44,440 Exercised .............................. (4,800) (960) (38,200) Expired ................................ - - (480) -------- -------- -------- Outstanding, end of year .................. - 4,800 5,760 ======== ======== ======== Shares exercisable, end of year ........... - 4,800 3,840 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 16. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of (1) cash, (2) indebtedness to/from related party, (3) accounts receivable, (4) accounts payable and (5) accrued expenses approximate fair value because of the short maturity of these instruments. The estimated fair value of the Company's investments at December 31, 1994 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 10). Carrying Estimated Amount Fair Value ------------ ------------ Fixed maturity securities: Held-to-maturity .............................. $243,649,720 $238,721,488 Available-for-sale ............................ 76,492,396 76,492,396 Short-term investments .......................... 16,029,426 16,029,426 17. 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. Employers Mutual has entered into unsecured financing arrangements with several large commercial policyholders. The Company, under terms of the pooling agreement, is a 22 percent participant in these policies (note 2). At December 31, 1994, the Company is contingently liable for $2,156,000 of unsecured receivables held by Employers Mutual. Employers Mutual has purchased annuities to fund future payments that are fixed pursuant to specific claim settlement provisions. The Company, under terms of the pooling agreement, is a 22 percent participant in these annuities (note 2). The Company is contingently liable to various claimants in the amount of $1,262,412 in the event that the issuing company would be unable to fulfill its obligations. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 18. UNAUDITED INTERIM FINANCIAL INFORMATION Three months ended, ------------------------------------------------------ March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ 1994 ---- Total revenues ........ $ 45,660,377 $ 44,748,377 $ 47,061,359 $ 49,242,492 ============ ============ ============ ============ Income before income taxes ............... $ 3,059,771 $ 5,107,880 $ 4,830,735 $ 5,678,382 Income taxes .......... 757,227 1,288,137 1,543,917 1,581,760 ------------ ------------ ------------ ------------ Net income ....... $ 2,302,544 $ 3,819,743 $ 3,286,818 $ 4,096,622 ============ ============ ============ ============ Earnings per share*.... $ .22 $ .37 $ .31 $ .39 ============ ============ ============ ============ 1993 ---- Total revenues ........ $ 42,369,391 $ 45,480,653 $ 45,519,261 $ 44,791,846 ============ ============ ============ ============ Income before income taxes (benefit) ..... $ 3,375,144 $ 476,062 $ 627,295 $ 4,540,635 Income taxes (benefit) 1,262,205 (963,626) 392,546 1,193,976 ------------ ------------ ------------ ------------ Income from operations 2,112,939 1,439,688 234,749 3,346,659 Income from accounting changes ............. 2,621,344 - - - ------------ ------------ ------------ ------------ Net income ....... $ 4,734,283 $ 1,439,688 $ 234,749 $ 3,346,659 ============ ============ ============ ============ Earnings per share:* Income from operations ........ $ .21 $ .14 $ .02 $ .33 Income from accounting changes .26 - - - ------------ ------------ ------------ ------------ Total ............ $ .47 $ .14 $ .02 $ .33 ============ ============ ============ ============ 1992 ---- Total revenues ........ $ 40,592,007 $ 41,298,060 $ 42,664,483 $ 44,779,617 ============ ============ ============ ============ Income (loss) before income taxes (benefit) ........... $ 2,315,687 $ 1,015,692 $ (2,472,573) $ 116,251 Income taxes (benefit) 299,983 516,923 (879,335) 821,794 ------------ ------------ ------------ ------------ Net income (loss) $ 2,015,704 $ 498,769 $ (1,593,238) $ (705,543) ============ ============ ============ ============ Earnings (loss) per share* .............. $ .20 $ .05 $ (.16) $ (.07) ============ ============ ============ ============ * Since the weighted average shares for the quarters are calculated independent of the weighted average shares for the year, quarterly earnings per share may not total to annual earnings per share. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ------- ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURE. ------------------------------------ None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. -------- --------------------------------------------------- See the information under the caption "Election of Directors" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 1995, which information is incorporated herein by reference. The following sets forth information regarding all executive officers of the Company. NAME AGE POSITION Bruce G. Kelley 41 President and Chief Executive Officer of the Company and of Employers Mutual since 1992. He was elected President of the Company and Employers Mutual in 1991. Mr. Kelley was Executive Vice President of the Company and Employers Mutual from 1989 to 1991. He has been employed with Employers Mutual since 1985. Fred A. Schiek 60 Executive Vice President and Chief Operating Officer of the Company and of Employers Mutual since 1992. He was Vice President of Employers Mutual from 1983 until 1992. He has been employed by Employers Mutual since 1959. E. H. Creese 63 Senior Vice President and Treasurer of the Company since 1993 and of Employers Mutual since 1992. He was Vice President and Treasurer of the Company from 1983 until 1993 and of Employers Mutual from 1985 until 1992. He has been employed by Employers Mutual since 1984. Philip T. Van Ekeren 64 Senior Vice President and Secretary of the Company since 1993 and of Employers Mutual since 1992. He was Vice President and Secretary of the Company from 1978 until 1993 and of Employers Mutual from 1978 until 1992. He has been employed by Employers Mutual since 1961. David O. Narigon 42 Vice President of the Company and of Employers Mutual since 1989. He has been employed by Employers Mutual since 1983. Raymond W. Davis 49 Vice President of the Company and Employers Mutual since 1985. He has been employed by Employers Mutual since 1979. ITEM 11. EXECUTIVE COMPENSATION. -------- ----------------------- See the information under the caption "Compensation of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 1995, which information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. -------- --------------------------------------------------------------- See the information under the captions "Voting Securities and Principal Stockholder" and "Security Ownership of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 1995, which information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -------- ----------------------------------------------- See the information under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 25, 1995, which information is incorporated herein by reference. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. -------- ----------------------------------------------------------------- (a) List of Financial Statements and Schedules. Form 10-K Page ------ 1. Financial Statements Independent Auditor's Report ................................ 51 Consolidated Balance Sheets, December 31, 1994 and 1993 ..... 52 Consolidated Statements of Income for the Years ended December 31, 1994, 1993 and 1992 ......................... 54 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1994, 1993 and 1992 ............. 56 Consolidated Statements of Cash Flows for the Years ended December 31, 1994, 1993 and 1992 ......................... 58 Notes to Consolidated Financial Statements .................. 60 2. Schedules Independent Auditor's Report on Schedules ................... 97 Schedule I - Summary of Investments ....................... 98 Schedule III - Condensed Financial Information of Registrant 99 Schedule V - Supplementary Insurance Information .......... 102 Schedule VI - Reinsurance .................................. 103 Schedule X - Supplemental Information Concerning Property-Casualty Insurance Operations ..... 104 All other schedules have been omitted for the reason that the items required by such schedules are not present in the consolidated financial statements, are covered in notes to consolidated financial statements or are not significant in amount. 3. Management contracts and compensatory plan arrangements Exhibit 10(b). Management Incentive Compensation Plan. Exhibit 10(d). Employers Mutual Casualty Company 1982 Incentive Stock Option Plan, as amended. Exhibit 10(f). Deferred Bonus Compensation Plans. Exhibit 10(g). EMC Reinsurance Company Executive Bonus Program. Exhibit 10(i). Employers Mutual Casualty Company Excess Retirement Benefit Agreement. Exhibit 10(k). Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. Exhibit 10(l). 1993 Employers Mutual Casualty Company Incentive Stock Option Plan. Exhibit 10(m). Employers Mutual Casualty Company Non-Employee Director Stock Option Plan. (b) Reports on Form 8-K. None. (c) Exhibits. 3. Articles of incorporation and bylaws: (a) Articles of Incorporation of the Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1988.) (b) Bylaws of the Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1992.) 10. Material contracts. (a) Quota Share Reinsurance Contract between Employers Mutual Casualty Company and EMC Reinsurance Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1993.) (b) Management Incentive Compensation Plan. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1983.) (c) EMC Insurance Companies reinsurance pooling agreements between Employers Mutual Casualty Company and certain of its affiliated companies, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1993.) (d) Employers Mutual Casualty Company 1982 Incentive Stock Option Plan, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1986.) (e) Excess of loss reinsurance contract between Employers Mutual Casualty Company and Farm and City Insurance Company. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1985.) (f) Deferred Bonus Compensation Plans. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1986.) (g) EMC Reinsurance Company Executive Bonus Program. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1989.) (h) EMC Insurance Group Inc. Amended and Restated Dividend Reinvestment and Common Stock Purchase Plan. (Incorporated by reference to Registration No. 33-34499.) (i) Employers Mutual Casualty Company Excess Retirement Benefit Agreement. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1989.) (j) Aggregate Catastrophe Excess of Loss Retrocession Agreement between EMC Reinsurance Company and Employers Mutual Casualty Company. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1991.) (k) Employers Mutual Casualty Company 1993 Employee Stock Purchase Plan. (Incorporated by reference to Registration No. 33-49335.) (l) 1993 Employers Mutual Casualty Company Incentive Stock Option Plan. (Incorporated by reference to Registration No. 33-49337.) (m) Employers Mutual Casualty Company Non-Employee Director Stock Option Plan. (Incorporated by reference to Registration No. 33-49339.) 13. 1994 Annual Report to Stockholders. (All information called for by Parts I and II of this Form 10-K has been included in this document under the respective item numbers (Items 1 through 9). 21. Subsidiaries of the Registrant. 23. Consent of KPMG Peat Marwick LLP with respect to Forms S-8 (Registration Nos. 2-93738, 33-49335, 33-49337 and 33-49339) and Form S-3 (Registration No. 33-34499). 24. Power of Attorney. 28. Consolidated Schedule P of Annual Statements provided to state regulatory authorities. (d) Financial statements required by Regulation S-X which are excluded from the Annual Report to Stockholders by Rule 14a-3(b)(1). None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 27, 1995. EMC INSURANCE GROUP INC. /s/ E. H. Creese ------------------------------------ E. H. Creese Senior Vice President, Treasurer & Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 27, 1995. /s/ E. H. Creese -------------------------------------- George C. Carpenter III* Director /s/ E. H. Creese -------------------------------------- E. H. Creese Director /s/ E. H. Creese -------------------------------------- David J. Fisher* Director /s/ E. H. Creese -------------------------------------- Bruce G. Kelley* President and Director (Chief Executive Officer) /s/ E. H. Creese -------------------------------------- George W. Kochheiser* Chairman of the Board and Director /s/ E. H. Creese -------------------------------------- Raymond A. Michel* Director /s/ E. H. Creese -------------------------------------- Fredrick A. Schiek* Director * by power of attorney INDEPENDENT AUDITORS' REPORT ON SCHEDULES The Board of Directors and Stockholders EMC Insurance Group Inc.: Under date of February 20, 1995, we reported on the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in Part II, Item 8 of the Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related supplementary financial statement schedules listed in Part IV, Item 14(a)2. These supplementary financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these supplementary financial statement schedules based on our audits. In our opinion, such supplementary financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in notes 1, 10, 11 and 13 to the consolidated financial statements, the Company changed its method of computing unearned premiums in 1993 and implemented the provisions of the Financial Accounting Standards Board's Statements No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions", No. 109, "Accounting for Income Taxes" and No. 115, "Accounting for Certain Investments in Debt and Equity Securities." /s/ KPMG Peat Marwick LLP Des Moines, Iowa February 20, 1995 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule I - Summary of Investments - Other Than Investments in Related Parties December 31, 1994 Amount at which shown Market in the Type of investment Cost value balance sheet ------------------ ------------ ------------ ------------- Securities held-to-maturity: Fixed maturities: United States Government and government agencies and authorities ............... $142,968,102 $141,888,527 $142,968,102 States, municipalities and political subdivisions ........ 78,423,605 75,494,956 78,423,605 Foreign governments ............. 583,309 590,720 583,309 Public utilities ................ 8,622,154 8,251,307 8,622,154 All other corporate bonds ....... 13,052,550 12,495,978 13,052,550 ------------ ------------ ------------ Total fixed maturity securities 243,649,720 238,721,488 243,649,720 ------------ ------------ ------------ Securities available-for-sale: Fixed maturities: United States Government and government agencies and authorities ............... 15,835,019 15,835,019 15,835,019 States, municipalities and political subdivisions ........ 55,274,052 54,112,888 54,112,888 Foreign governments ............. 1,994,980 1,884,720 1,884,720 All other corporate bonds ....... 4,250,000 4,250,000 4,250,000 Redeemable preferred stocks ..... 454,941 409,769 409,769 ------------ ------------ ------------ Total fixed maturity securities 77,808,992 76,492,396 76,492,396 ------------ ------------ ------------ Short-term investments ............ 16,029,426 16,029,426 16,029,426 ------------ ------------ ------------ Total investments ....... $337,488,138 $331,243,310 $336,171,542 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule III - Condensed Financial Information of Registrant Condensed Balance Sheets December 31, -------------------------- 1994 1993 ------------ ------------ ASSETS ------ Investment in common stock of subsidiaries (equity method) .................. $111,420,069 $104,350,390 Fixed maturity securities held-to-maturity, at amortized cost ............................. 2,002,494 - Equity securities available-for-sale, at market value .................................. - 475,000 Short-term investments .......................... 3,172,259 4,785,692 Cash ............................................ 61,389 35,414 Accrued investment income ....................... 57,768 13,750 Accounts receivable ............................. 37,502 - Income taxes recoverable ........................ 32,000 67,000 Indebtedness of related party ................... 87,023 4,624 ------------ ------------ Total assets ............................... $116,870,504 $109,731,870 ============ ============ LIABILITIES ----------- Accounts payable ................................ $ 143,815 $ 98,101 ------------ ------------ Total liabilities .......................... 143,815 98,101 ------------ ------------ STOCKHOLDERS' EQUITY -------------------- Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 10,587,629 shares in 1994 and 10,325,329 shares in 1993 ......... 10,587,629 10,325,329 Additional paid-in capital ...................... 57,162,911 55,021,926 Unrealized holding losses on equity securities available-for-sale, net of tax ................ - (19,800) Retained earnings ............................... 49,086,216 44,387,700 Treasury stock, at cost (10,931 shares in 1994 and 8,090 shares in 1993) ..................... (110,067) (81,386) ------------ ------------ Total stockholders' equity ................. 116,726,689 109,633,769 ------------ ------------ Total liabilities and stockholders' equity $116,870,504 $109,731,870 ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Income Years ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Equity in undistributed earnings (loss) $10,464,926 $ 6,370,743 $(3,142,782) Dividends received from consolidated subsidiaries ........... 3,068,019 860,000 3,288,010 Investment income ..................... 236,519 214,825 483,786 Loss on sale of stock ................. (5,000) (30,000) - ----------- ----------- ----------- 13,764,464 7,415,568 629,014 Operating expenses .................... 315,784 345,678 312,778 ----------- ----------- ----------- Income from operations before income taxes (benefit) ........... 13,448,680 7,069,890 316,236 Income taxes (benefit) ................ (57,047) (64,145) 100,544 ----------- ----------- ----------- Income from operations ............. 13,505,727 7,134,035 215,692 Income from accounting changes ........ - 2,621,344 - ----------- ----------- ----------- Net income .............. $13,505,727 $ 9,755,379 $ 215,692 =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Cash Flows Years ended December 31, ------------------------------------- 1994 1993 1992 ----------- ----------- ----------- Net cash provided by operating activities ................ $ 2,962,596 $ 761,673 $ 3,370,212 ----------- ----------- ----------- Cash flows from investing activities: Fixed maturities .................... (2,002,494) - - Short-term investments .............. 1,613,433 1,937,409 13,815,080 Sale of life subsidiary ............. - - 474,356 Sale of stock ....................... 500,000 500,000 - ----------- ----------- ----------- Net cash provided by investing activities ........... 110,939 2,437,409 14,289,436 ----------- ----------- ----------- Cash flows from financing activities: Issuance of common stock ............ 491,676 331,568 748,405 Dividends paid to stockholders ...... (3,510,555) (3,443,465) (5,103,890) Capital contribution to subsidiaries - - (13,000,000) Purchase of treasury stock, net ..... (28,681) (118,641) (278,241) ----------- ----------- ----------- Net cash used in financing activities ....................... (3,047,560) (3,230,538) (17,633,726) ----------- ----------- ----------- Net increase (decrease) in cash ....... 25,975 (31,456) 25,922 Cash at beginning of year ............. 35,414 66,870 40,948 ----------- ----------- ----------- Cash at end of year ................... $ 61,389 $ 35,414 $ 66,870 =========== =========== =========== Income taxes paid ..................... $ 62,433 $ 14,000 $ 86,544 Interest paid ......................... - - -
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule V - Supplementary Insurance Information For Years Ended December 31, 1994, 1993 and 1992 Deferred Losses and Net acquisition settlement Unearned Premium Investment Segment costs expenses premiums revenue income ------- ---------- ------------ ----------- ------------ ----------- Year ended December 31, 1994: Property and casualty insurance $6,448,141 $148,541,352 $38,804,128 $115,411,835 $14,080,206 Reinsurance ................... 1,706,245 46,925,895 7,755,657 37,256,763 5,354,494 Nonstandard risk automobile insurance ................... 239,249 7,714,368 1,112,785 12,160,781 1,152,341 Excess and surplus lines insurance management ........ - - - - 106,120 Parent company ................ - - - - 236,519 ---------- ------------ ----------- ------------ ----------- Consolidated .............. $8,393,635 $203,181,615 $47,672,570 $164,829,379 $20,929,680 ========== ============ =========== ============ =========== Year ended December 31, 1993: Property and casualty insurance $6,275,214 $146,305,725 $38,898,256 $109,584,986 $13,242,584 Reinsurance ................... 1,134,185 42,063,802 5,670,927 33,324,202 6,090,294 Nonstandard risk automobile insurance ................... 289,465 8,752,325 1,371,873 13,528,350 1,165,684 Excess and surplus lines insurance management ........ - - - - 66,564 Parent company ................ - - - - 214,825 ---------- ------------ ----------- ------------ ----------- Consolidated .............. $7,698,864 $197,121,852 $45,941,056 $156,437,538 $20,779,951 ========== ============ =========== ============ =========== Year ended December 31, 1992: Property and casualty insurance $5,824,597 $156,531,043 $39,252,263 $109,138,829 $13,047,540 Reinsurance ................... 2,006,408 68,136,494 6,918,647 26,615,180 6,763,257 Nonstandard risk automobile insurance ................... 281,826 6,731,101 1,335,666 11,656,278 1,178,748 Excess and surplus lines insurance management ........ - - - - 66,266 Parent company................. - - - - 483,786 Eliminations................... - (16,009,773) (1,522,102) - - ---------- ------------ ----------- ------------ ----------- Consolidated .............. $8,112,831 $215,388,865 $45,984,474 $147,410,287 $21,539,597 ========== ============ =========== ============ ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule V - Supplementary Insurance Information For Years Ended December 31, 1994, 1993 and 1992 Losses and policy Other settlement acquisition underwriting Premiums Segment expenses costs expenses written ------- ------------ ----------- ----------- ------------ Year ended December 31, 1994: Property and casualty insurance $ 77,872,039 $20,338,769 $13,163,706 $115,699,969 Reinsurance ................... 30,564,830 8,754,885 2,654,290 $ 39,341,493 Nonstandard risk automobile insurance ................... 8,507,185 2,608,135 551,551 $ 11,901,693 Excess and surplus lines insurance management ........ - - (399,125) Parent company ................ - - 315,784 ------------ ----------- ----------- Consolidated .............. $116,944,054 $31,701,789 $16,286,206 ============ =========== =========== Year ended December 31, 1993: Property and casualty insurance $ 79,777,312 $19,528,117 $11,597,944 $112,293,341 Reinsurance ................... 27,871,896 8,331,595 3,161,007 $ 32,076,482 Nonstandard risk automobile insurance ................... 12,706,091 2,857,463 507,486 $ 13,564,557 Excess and surplus lines insurance management ........ - - (36,858) Parent company ................ - - 345,678 ------------ ------------ ----------- Consolidated .............. $120,355,299 $30,717,175 $15,575,257 ============ ============ =========== Year ended December 31, 1992: Property and casualty insurance $ 82,313,897 $18,050,053 $12,560,922 $117,716,175 Reinsurance ................... 29,046,587 8,784,715 688,251 $ 28,207,488 Nonstandard risk automobile insurance ................... 10,727,349 2,456,594 464,984 $ 11,896,220 Excess and surplus lines insurance management ........ - - (429,756) Parent company................. - - 312,778 Eliminations................... - - - ----------- ----------- ----------- Consolidated .............. $122,087,833 $29,291,362 $13,597,179 ============ =========== ===========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule VI - Reinsurance For years ended December 31, 1994, 1993 and 1992 Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------------ ------------ ------------ ------------ ------ Year ended December 31, 1994: Earned premiums: Consolidated property and casualty insurance .......................... $140,012,247 $138,010,578 $162,827,710 $164,829,379 98.8% ============ ============ ============ ============ ====== Year ended December 31, 1993: Earned premiums: Consolidated property and casualty insurance .......................... $137,141,457 $135,828,770 $155,124,851 $156,437,538 99.2% ============ ============ ============ ============ ====== Year ended December 31, 1992: Earned premiums: Consolidated property and casualty insurance .......................... $142,391,771 $150,404,371 $155,422,887 $147,410,287 105.4% ============ ============ ============ ============ ======
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule X - Supplemental Insurance Information Concerning Property-Casualty Insurance Operations For Years Ended December 31, 1994, 1993 and 1992 Discount, Deferred Reserves for if any, policy losses and deducted Net Consolidated property- acquisition settlement from Unearned Earned investment casualty entities costs expenses reserves premiums premiums income ---------------------- ---------- ------------ -------- ----------- ------------ ----------- Year ended December 31, 1994: $8,393,635 $203,181,615 $ -0- $47,672,570 $164,829,379 $20,587,041 ========== ============ ======== =========== ============ =========== Year ended December 31, 1993: $7,698,864 $197,121,852 $ -0- $45,941,056 $156,437,538 $20,498,562 ========== ============ ======== =========== ============ ========== Year ended December 31, 1992: $8,112,831 $215,388,865 $ -0- $45,984,474 $147,410,287 $20,989,545 ========== ============ ======== =========== ============ ===========
Losses and settlement expenses Amortization incurred related to of deferred Paid (1) (2) policy losses and Consolidated property- Current Prior acquisition settlement Premiums casualty entities Year Years costs expenses Written ---------------------- ------------ ---------- ----------- ------------ ------------ Year ended December 31, 1994: $123,343,829 ($6,399,775) $31,701,789 $107,576,486 $166,943,155 ============ ========== =========== ============ ============ Year ended December 31, 1993: $119,896,526 $ 458,773 $30,717,175 $130,823,484 $157,934,380 ============ ========== =========== ============ ============ Year ended December 31, 1992: $116,615,951 $5,471,882 $29,291,362 $ 76,815,572 $157,819,883 ============ ========== =========== ============ ============
Differences between Electronic and Circulated 10-K's ---------------------------------------------------- 1) The index to exhibits in the electronic format indicates if the exhibits are included in the direct transmission or are filed under Form SE. The circulated document contains the page numbers of the exhibits. 2) Exhibit 28 was filed in hard copy under Form SE and is not included in the filed under EDGAR. EX-99 2 INDEX TO EXHIBITS EMC Insurance Group Inc. and Subsidiaries Index to Exhibits Exhibit Number Item ------ ---- 21 Subsidiaries of the Registrant Included in direct transmission 23 Consent of KPMG Peat Marwick LLP with Included in respect to Forms S-8 and Form S-3. direct transmission 24 Power of Attorney. Included in direct transmission 27 Financial Data Schedule Included in direct transmission 28 Consolidated Schedule P of Annual Filed under cover Statements provided to state regulatory of Form SE authorities. EX-21 3 SUBSIDIARIES OF THE REGISTRANT Exhibit 21 EMC INSURANCE GROUP INC. ORGANIZATIONAL CHART ............................... : : : EMC INSURANCE GROUP INC. : :.............................: : : : : : .........................:.................................... : : : : : : : : EMCASCO Insurance EMC Farm and City EMC Company Reinsurance Insurance Underwriters, Illinois EMCASCO Company Company Ltd. Insurance Company Dakota Fire Insurance Company EX-23 4 KPMG PEAT MARKWICK,LLP CONSENT Exhibit 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders EMC Insurance Group Inc.: We consent to incorporation by reference in Registration Statement Nos. 2-93738, 33-49335, 33-49337 and 33-49339 on Forms S-8 and No. 33-34499 on Form S-3 of EMC Insurance Group Inc. of our reports dated February 20, 1995, relating to the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows and related schedules for each of the years in the three-year period ended December 31, 1994, which reports appear in the December 31, 1994 annual report on Form 10-K of EMC Insurance Group Inc. As discussed in notes 1, 10, 11 and 13 to the consolidated financial statements, the Company changed its method of computing unearned premiums in 1993 and implemented the provisions of the Financial Accounting Standards Board's Statements No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions", No. 109, "Accounting for Income Taxes", and No. 115, "Accounting for Certain Investments in Debt and Equity Securities." /s/ KPMG Peat Marwick LLP Des Moines, Iowa March 24, 1995 EX-24 5 POWER OF ATTORNEY Exhibit 24 POWER OF ATTORNEY KNOW EVERYONE BY THESE PRESENTS, that each director whose signature appears below constitutes and appoints E. H. Creese and B. G. Kelley, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities related to entering his personal identification number onto the EDGAR online reporting system and transmitting the 1994 Form 10-K (annual report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934) and all other required filings, until the 1995 annual meeting of shareholders, to the Securities and Exchange Commission, and hereby ratifies and confirms all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. SIGNATURE TITLE --------- ----- /s/ George C. Carpenter III --------------------------- George C. Carpenter III Director /s/ E. H. Creese --------------------------- E. H. Creese Director /s/ David J. Fisher --------------------------- David J. Fisher Director /s/ Bruce G. Kelley --------------------------- Bruce G. Kelley Director /s/ George W. Kochheiser --------------------------- Chairman of the Board of George W. Kochheiser Directors and Director /s/ Raymond A. Michel --------------------------- Raymond A. Michel Director /s/ Fredrick A. Schiek --------------------------- Fredrick A. Schiek Director February 28, 1995 EX-27 6 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 12/31/94 BALANCE SHEET AND INCOME STATEMENT AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1994 DEC-31-1994 76,492,396 243,649,720 238,721,488 0 0 0 336,171,542 1,258,221 14,935,048 8,393,635 387,369,878 203,181,615 47,672,570 0 3,102,609 0 10,587,629 0 0 106,139,060 387,369,878 164,829,379 20,929,680 519,567 433,979 116,944,054 31,701,789 19,389,994 18,676,768 5,171,041 13,505,727 0 0 0 13,505,727 1.29 1.29 197,121,852 123,343,829 (6,399,775) 48,771,573 59,491,875 203,181,615 (6,399,775)