-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Kw0TahMqerg7ngmoH7xIbGBJgUMI9NaY5Zu0uPNi6+Wr29LDYOAyH/NLkgalBqxw W5VX+n4CMQBHRa3SFeytvg== 0000356130-98-000004.txt : 19980324 0000356130-98-000004.hdr.sgml : 19980324 ACCESSION NUMBER: 0000356130-98-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980323 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMC INSURANCE GROUP INC CENTRAL INDEX KEY: 0000356130 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 426234555 STATE OF INCORPORATION: IA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10956 FILM NUMBER: 98570706 BUSINESS ADDRESS: STREET 1: 717 MULBERRY ST CITY: DES MOINES STATE: IA ZIP: 50309 BUSINESS PHONE: 5152802902 10-K 1 1997 EMC INSURANCE GROUP INC 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the Fiscal Year Ended December 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from to Commission File Number: 0-10956 EMC INSURANCE GROUP INC. (Exact Name of Registrant as Specified in its Charter) Iowa 42-6234555 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 717 Mulberry Street, Des Moines, Iowa 50309 (Address of Principal Executive Office) (Zip Code) Registrant's telephone number, including area code: (515) 280-2902 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $1.00 (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 2, 1998 was $49,857,017. The number of shares outstanding of the registrant's common stock, $1.00 par value, on March 2, 1998, was 11,354,129. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the registrant's annual report to stockholders for the year ended December 31, 1997 are incorporated by reference under Parts II and IV. 2. Portions of the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission on or before April 30, 1998, are incorporated by reference under Part III. This document contains 130 sequentially numbered pages. Index to Exhibits is on page number 42. 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. The term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries. Employers Mutual and all of its subsidiaries and an affiliate (including the Company), are referred to as the "EMC Insurance Companies." The Company conducts its insurance business through 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. These companies are licensed to write insurance in a total of 35 states and are participants in a pooling agreement with Employers Mutual. (See "Property and Casualty Insurance - Pooling Agreement"). The reinsurance subsidiary was formed in 1981 to assume reinsurance business from Employers Mutual. The company assumes a portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts, and is licensed to do business in 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 6 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. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS - --------------------------------------------- For information concerning the Company's revenues, operating income and identifiable assets attributable to each of its industry segments over the past three years, see note 8 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. PROPERTY AND CASUALTY INSURANCE - ------------------------------- POOLING AGREEMENT The three property and casualty insurance subsidiaries of the Company and two subsidiaries and an affiliate of Employers Mutual (Union Insurance Company of Providence, American Liberty Insurance Company and Hamilton Mutual Insurance Company) are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. The aggregate participation of the Company's property and casualty insurance subsidiaries is 22 percent. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment activities and income tax liabilities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all the companies. The pooling agreement produces a more uniform and stable underwriting result from year to year for all companies in the pool than might be experienced individually. In addition, each company benefits from the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own assets, and from the wide range of policy forms, lines of insurance written, rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all seven companies in the pool. Effective January 1, 1997, Hamilton Mutual Insurance Company (Hamilton Mutual) became a participant in the pooling agreement. The addition of Hamilton Mutual did not impact the Company's aggregate participation in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,063 and invested assets increased $5,674,458. The Company reimbursed Employers Mutual $794,074 for commissions incurred to generate this business and Employers Mutual paid the Company $75,469 in interest income as the actual cash transfer did not occur until March 24, 1997. On December 19, 1997, the Company announced that its nonstandard risk automobile insurance subsidiary will become a participant in the pooling agreement effective January 1, 1998. The nonstandard risk automobile insurance subsidiary will receive a 1.5 percent participation in the pool, which will increase the Company's aggregate participation in the pool to 23.5 percent. Revenues of the Company are expected to increase by approximately $2,000,000 due to the increase in the size of the pool. 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, 1997. 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 1997 total 1996 total 1995 total - ---------------- -------- ------ -------- ------ -------- ------ (Dollars in thousands) Commercial Lines: Automobile ............ $118,624 18.4% $107,786 18.9% $ 99,165 17.8% Property .............. 110,637 17.2 92,963 16.3 89,130 16.0 Workers' compensation 115,117 17.9 118,479 20.7 131,415 23.5 Liability ............. 110,647 17.2 105,889 18.5 105,571 18.9 Other ................. 15,139 2.4 13,998 2.5 13,975 2.5 -------- ------ -------- ------ -------- ------ Total commercial lines 470,164 73.1 439,115 76.9 439,256 78.7 Personal Lines: Automobile ............ 109,214 17.0 83,428 14.6 79,121 14.2 Property .............. 61,569 9.6 46,459 8.2 39,840 7.1 Liability ............. 2,026 0.3 1,946 0.3 - - Other ................. 50 - 53 - 54 - -------- ----- -------- ----- -------- ----- Total personal lines 172,859 26.9 131,886 23.1 119,015 21.3 -------- ----- -------- ----- -------- ----- Total ............ $643,023 100.0% $571,001 100.0% $558,271 100.0% ======== ===== ======== ===== ======== ===== MARKETING Marketing of insurance by the parties to the pooling agreement is conducted through 18 offices located throughout the United States and approximately 2,700 independent agencies. 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, 1997. 1997 1996 1995 ---- ---- ---- Alabama ............................ 3.6% 3.7% 3.1% Arizona ............................ 3.8 4.2 3.9 Illinois ........................... 5.4 6.5 6.5 Iowa ............................... 18.7 20.3 21.7 Kansas ............................. 8.2 9.0 8.8 Michigan ........................... 4.1 3.2 3.6 Minnesota .......................... 3.9 4.0 4.7 Nebraska ........................... 7.0 7.7 8.1 North Carolina ..................... 3.4 4.1 4.0 Ohio ............................... 3.2 - - Texas .............................. 4.4 3.9 2.9 Wisconsin .......................... 4.5 4.8 5.5 Other * ............................ 29.8 28.6 27.2 ----- ----- ----- 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' 1996 operating results and financial condition as of December 31, 1996. 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. Each type of reinsurance coverage is purchased in layers, and each layer may have a separate retention level. Retention levels are adjusted according to reinsurance market conditions and the surplus position of 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 benefitting the parties to the pooling agreement is presented below. Retention amounts reflect the accumulated retentions of all layers within a coverage. Type of Coverage Retention Limits ---------------- ----------- -------------------------- Property per risk ........... $ 2,000,000 100 percent of $18,000,000 Property catastrophe ........ $11,550,000 95 percent of $51,000,000 Casualty .................... $ 2,000,000 100 percent of $38,000,000 Workers' Compensation excess $ - $20,000,000 excess of $40,000,000 Umbrella .................... $ 1,400,000* 100 percent of $ 8,600,000 Fidelity and Surety ......... $ 750,000 100 percent of $ 3,250,000 Surety excess .............. $ 400,000 100 percent of $ 6,850,000 Boiler ...................... $ 0 100 percent of $50,000,000 * An annual aggregate deductible of $3,600,000 must be reached before the reinsurers may be petitioned. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer since the primary insurer would only reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreements. The ability to collect reinsurance is subject to the solvency of the reinsurers. The major participants in the pool members' reinsurance programs are presented below. The percentages represent the reinsurers' share of the total reinsurance protection under all coverages. Each type of coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within these coverages. The property per risk, property catastrophe and casualty reinsurance programs are handled by a reinsurance intermediary (broker). The reinsurance of those programs is syndicated to approximately 50 domestic and foreign reinsurers. Percent of total 1997 Property per risk, property catastrophe reinsurance Best's and casualty coverages: protection rating - --------------------------------------- ----------- ------ Underwriters at Lloyd's of London .................... 20.2% A Hannover Ruckversicherung AG ......................... 5.8 (1) Zurich Reinsurance Centre ............................ 5.2 A Hartford Fire Insurance Company ...................... 4.8 A+ AXA Reassurance Company .............................. 4.2 A+ St. Paul Fire and Marine ............................. 3.6 A+ NAC Reinsurance Corporation .......................... 3.6 A+ PMA Reinsurance Corporation .......................... 3.2 A+ Umbrella coverage: - ------------------ General Reinsurance Corporation ...................... 100.0 A++ Fidelity and surety coverages: - ------------------------------ SCOR Reinsurance 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. Premiums ceded by all pool members and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1997 are presented below. Each type of reinsurance coverage is purchased in layers, and an individual reinsurer may participate in more than one coverage and at various layers within the coverages. Since each layer of each coverage is priced separately, with the lower layers being more expensive than the upper layers, a reinsurer's overall participation in a reinsurance program does not necessarily correspond to the amount of premiums it receives. Premiums ceded by ------------------------ Property and casualty All pool insurance Reinsurer members subsidiaries - --------- ----------- ------------ General Reinsurance Corporation...................... $ 3,568,951 $ 785,169 Hartford Steam Boiler Inspection & Insurance Company 1,605,214 353,147 Hartford Fire Insurance Company ..................... 882,352 194,118 SCOR Reinsurance Company ............................ 875,023 192,505 PMA Reinsurance Corporation ......................... 851,558 187,343 Kemper Reinsurance Company .......................... 631,642 138,961 AXA Reassurance Company ............................. 592,297 130,305 American Re-Insurance Company ....................... 494,472 108,784 Spreckley Villers Burnhope & Company ................ 451,669 99,367 PXRE Reinsurance Company ............................ 435,160 95,735 Other Reinsurers .................................... 7,117,222 1,565,789 ----------- ------------ Total ............................................. $17,505,560 $ 3,851,223 =========== ============ The parties to the pooling agreement also cede reinsurance on both a voluntary and a mandatory basis to state and national organizations in connection with various workers' compensation and assigned risk programs and to private organizations established to handle large risks. Premiums ceded by all pool members and by the Company's property and casualty insurance subsidiaries for the year ended December 31, 1997 are presented below. Premiums ceded by ------------------------ Property and casualty All pool insurance Reinsurer members subsidiaries - --------- ----------- ------------ Wisconsin Compensation Rating Bureau ................ $ 4,214,988 $ 927,297 National Workers' Compensation Reinsurance Pool ..... 3,504,567 771,005 North Carolina Reinsurance Facility ................. 1,213,266 266,919 Mutual Reinsurance Bureau ........................... 493,270 108,519 Improved Risk Mutual ................................ 151,884 33,414 Minnesota Workers' Compensation Reinsurance Assn.(1) (1,720,064) (378,414) Other Reinsurers .................................... 162,766 35,809 ----------- ----------- $ 8,020,677 $ 1,764,549 =========== =========== (1) The Minnesota Workers' Compensation Reinsurance Association periodically reviews its financial position and distributes excess funds to its members. Distributions totaling $1,712,074 were received by the parties to the pooling agreement in 1997 and were recorded as a return of ceded premium. 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 amount of insurance a property and casualty insurance company writes under industry standards is a multiple of its surplus calculated in accordance with statutory accounting practices. Generally, a ratio of 3 to 1 or less is considered satisfactory. The ratios of the pool members for the past three years are as follows: Year ended December 31, ------------------------------ 1997 1996 1995 ---- ---- ---- Employers Mutual .................. .80 .95 1.07 EMCASCO ........................... 1.62 1.67 1.91 Illinois EMCASCO .................. 1.68 1.73 1.95 Dakota Fire ....................... 1.59 1.61 1.80 American Liberty .................. 1.08 1.05 1.15 Union ............................. .72 .68 .73 Hamilton Mutual ................... 1.17 - - OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The property and casualty insurance subsidiaries' reserve information is included in the property and casualty loss reserve development for 1997. 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 assumes a quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its quota share portion of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss per event assumed by the reinsurance subsidiary was increased from $1,000,000 to $1,500,000. In connection with the change in the quota share percentage, the Company's liabilities increased $3,173,647 and invested assets increased $3,066,705. The Company reimbursed Employers Mutual $106,942 for commissions incurred to generate this business. PRINCIPAL PRODUCTS The reinsurance subsidiary assumes both pro rata and excess of loss reinsurance from Employers Mutual. The following table sets forth the assumed written premiums of the reinsurance subsidiary for the three years ended December 31, 1997. The amounts for 1997 do not reflect an accounting adjustment of $355 related to the change in quota share percentage. This adjustment was made to offset the income statement effect that resulted from the increase in the reinsurance subsidiary's reserve for unearned premiums on January 1, 1997 in connection with this transaction. Percent Percent Percent of of of Line of Business 1997 total 1996 total 1995 total - ---------------- ------- ----- ------- ----- ------- ----- (Dollars in thousands) Pro rata reinsurance: Property ............... $15,499 45.1% $16,459 45.7% $19,417 53.3% Crop ................... 3,101 9.0 3,704 10.3 3,085 8.5 Casualty ............... 2,911 8.5 2,796 7.7 2,879 7.9 Marine/aviation ........ 1,866 5.4 2,762 7.7 4,168 11.4 Other .................. 2,116 6.2 228 0.6 398 1.1 ------- ----- ------- ----- ------- ----- Total pro rata reinsurance 25,493 74.2 25,949 72.0 29,947 82.2 Excess per risk reinsurance: Property ............... 2,110 6.2 2,258 6.3 1,760 4.8 Casualty ............... 1,595 4.6 1,182 3.3 840 2.3 Marine/aviation ........ - - 9 - 21 0.1 Other .................. 647 1.9 628 1.7 341 0.9 ------- ----- ------- ----- ------- ----- Total excess per risk reinsurance ...... 4,352 12.7 4,077 11.3 2,962 8.1 ------- ----- ------- ----- ------- ----- Excess catastrophe/ aggregate reinsurance: Property ............... 4,293 12.5 5,671 15.7 3,178 8.7 Crop ................... 252 0.8 242 0.7 292 0.8 Marine/aviation ........ 8 - 29 0.1 52 0.2 Other .................. (62) (0.2) 84 0.2 2 - ------- ----- ------- ----- ------- ----- Total excess catastrophe/ aggregate reinsurance 4,491 13.1 6,026 16.7 3,524 9.7 ------- ----- ------- ----- ------- ----- Total excess reinsurance 8,843 25.8 10,103 28.0 6,486 17.8 ------- ----- ------- ----- ------- ----- $34,336 100.0% $36,052 100.0% $36,433 100.0% ======= ===== ======= ===== ======= ===== MARKETING During 1997 and 1996, more emphasis was placed upon writing excess of loss business and on increasing participation on existing contracts that had favorable terms. This movement towards excess of loss business was prompted by the continued deterioration of pro rata rates and greater control over the pricing of excess of loss business. The reinsurance subsidiary strives to be flexible and aggressive with opportunities that arise, while remaining committed to profitability over premium volume. 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. Employers Mutual is addressing this by accepting a larger share of coverage on desirable programs and strengthening its relationships with reinsurance intermediaries. REINSURANCE CEDED Prior to 1997, the reinsurance subsidiary had an aggregate excess of loss reinsurance treaty with Employers Mutual which provided protection from a large accumulation of retentions resulting from multiple catastrophes in any one calendar year. The coverage provided was $2,000,000, excess of $3,000,000 aggregate losses retained, excess of $200,000 per event. Maximum recovery was limited to $2,000,000 per accident year. The reinsurance subsidiary did not have any recoveries under this treaty during 1996 or 1995. Premiums paid to Employers Mutual amounted to $500,000 and $499,950 in 1996 and 1995, respectively. This reinsurance treaty was canceled effective January 1, 1997. 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." BEST'S RATING The most recent Best's Property Casualty Key Rating Guide gives the reinsurance subsidiary a B++ (Very Good) policyholders' rating. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not necessarily directed toward the protection of investors. OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The reinsurance subsidiary's reserve information is included in the property and casualty loss reserve development for 1997. See "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Outstanding Losses and Settlement Expenses." 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 standard automobile insurance market. MARKETING The nonstandard risk automobile insurance subsidiary is licensed in a six state area that includes Iowa, Kansas, Missouri, Nebraska, North Dakota and South Dakota. Personal lines automobile policies are solicited through the American Agency System using approximately 1,100 independent agencies and are written for two, three or six month terms. Limits of liability are offered equal to the various state financial responsibility laws. Physical damage coverages are written at normal insurance deductibles. The nonstandard risk automobile insurance subsidiary experienced an increase in premium volume in 1997 for the first time since 1993. This increase is attributed to a change in marketing philosophy that includes a closer alignment with EMC Insurance Companies and improved marketing and business relationships with its agency force. The following table sets forth the geographic distribution of the direct written premiums of the nonstandard risk automobile insurance subsidiary for the three years ended December 31, 1997. 1997 1996 1995 ----- ----- ----- Iowa ............................... 36.0% 37.2% 39.9% Kansas ............................. 14.1 13.9 11.0 Missouri ........................... 2.1 - - Nebraska ........................... 19.7 22.4 25.0 North Dakota........................ 6.5 4.6 3.8 South Dakota ....................... 21.6 21.9 20.3 ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== ===== COMPETITION The nonstandard risk marketplace is very competitive. Policies are written for relatively short periods of time and insureds continually search for the best rates available. The larger standard insurance companies have developed rate tiers geared toward retaining nonstandard risk customers, rather than passing them into the nonstandard market. In addition, more companies have been willing to write nonstandard coverage. This additional availability in both the standard market and the nonstandard market has resulted in increased competition within the nonstandard market. The nonstandard risk automobile insurance subsidiary has responded with renewed marketing efforts toward new and existing agents and a competitive rate structure. The nonstandard risk automobile insurance subsidiary continues to fine tune territories and classifications in order to maximize profit potential. REINSURANCE CEDED The nonstandard risk automobile insurance subsidiary had a reinsurance treaty on an excess of loss basis with Employers Mutual, which provided reinsurance for 100 percent of each loss in excess of $100,000, up to $1,000,000. There were no recoveries under this treaty during 1997, 1996 or 1995. Premiums paid to Employers Mutual amounted to $36,076 in 1997, $37,942 in 1996 and $45,232 in 1995. This reinsurance treaty was canceled on December 31, 1997 in preparation for the subsidiary's admittance into the pooling agreement on January 1, 1998 and all reinsurance recoverable amounts due from Employers Mutual were commuted. In connection with this commutation, the Company's assets increased $58,921 and liabilities increased $62,487. The Company reported incurred settlement expenses of $3,566 from this transaction. 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." 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. 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 1996. See "Property and Casualty Insurance Subsidiaries, Reinsurance Subsidiary and Nonstandard Risk Automobile Insurance Subsidiary - Outstanding Losses and Settlement Expenses." 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 its subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are allocated to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not allocated to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. STATUTORY COMBINED RATIOS The following table sets forth the Company's insurance subsidiaries' statutory combined ratios and the property and casualty insurance industry averages for the five years ended December 31, 1997. The combined ratios below are the sum of the following: the loss ratio, calculated by dividing losses and settlement expenses incurred by net premiums earned, and the expense ratio, calculated by dividing underwriting expenses incurred by net premiums written and policyholder dividends by net premiums earned. Generally, if the combined ratio is below 100 percent, a company has an underwriting profit; if it is above 100 percent, a company has an underwriting loss. Year ended December 31, -------------------------------------- 1997 1996 1995 1994 1993 ------ ----- ----- ----- ----- Property and casualty insurance Loss ratio ................... 72.8% 69.1% 65.0% 67.2% 72.6% Expense ratio ................ 33.2 34.9 33.1 31.1 30.9 ----- ----- ----- ----- ----- Combined ratio ............. 106.0% 104.0% 98.1% 98.3% 103.5% ===== ===== ===== ===== ===== Reinsurance Loss ratio ................... 68.4% 68.7% 66.3% 82.0% 77.7% Expense ratio ................ 34.1 31.5 32.3 30.4 33.1 ----- ----- ----- ----- ----- Combined ratio ............. 102.5% 100.2% 98.6% 112.4% 110.8% ===== ===== ===== ===== ===== Nonstandard risk automobile insurance Loss ratio ................... 92.8% 88.7% 94.5% 71.5% 94.3% Expense ratio ................ 27.4 26.8 26.1 24.4 23.7 ----- ----- ----- ----- ----- Combined ratio ............. 120.2% 115.5% 120.6% 95.9% 118.0% ===== ===== ===== ===== ===== Total insurance operations Loss ratio ................... 73.1% 70.0% 67.1% 70.9% 75.6% Expense ratio ................ 33.1 33.6 32.5 30.4 30.7 ----- ----- ----- ----- ----- Combined ratio ............. 106.2% 103.6% 99.6% 101.3% 106.3% ===== ===== ===== ===== ===== Property and casualty insurance industry averages (1) Loss ratio ................... 73.7% 78.3% 78.9% 81.1% 79.5% Expense ratio ................ 28.1 27.5 26.1 27.3 27.4 ----- ----- ----- ----- ----- Combined ratio ............. 101.8% 105.8% 105.0% 108.4% 106.9% ===== ===== ===== ===== ===== (1) As reported by A.M. Best Company. The ratio for 1997 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, 1997: 1997 Amount Percent Best's recoverable of total rating ----------- -------- ------ Wisconsin Compensation Rating Bureau .. $ 5,721,614 38.7% (1) American Re-Insurance Company ......... 1,784,051 12.1 A+ National Workers' Compensation Reinsurance Pool .................... 1,678,319 11.3 (1) General Reinsurance Company............ 772,022 5.2 A++ Kemper Reinsurance Company ............ 448,801 3.0 A Minnesota Workers' Compensation Reinsurance Association ............ 388,411 2.6 (2) Mutual Reinsurance Bureau (MRB)........ 361,890 2.5 (3) North Carolina Reinsurance Facility.... 350,290 2.4 (4) Hartford Fire Insurance Company ....... 306,245 2.1 A+ PMA Reinsurance Corporation ........... 287,359 1.9 A+ Other Reinsurers ...................... 2,697,754 18.2 ----------- ----- Total ........................... $14,796,756(5) 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 association by the pool members under a reinsurance contract that provides protection for workers' compensation losses in excess of $1,080,000 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. (3) The amount recoverable reflects the property and casualty insurance subsidiaries' pool participation percentage of amounts ceded to this underwriting organization by Employers Mutual. MRB is composed of Employers Mutual and five other nonaffiliated mutual insurance companies. Each of the six members cede primarily property insurance to MRB and assume equal proportionate shares of this business. Each member benefits from the increased capacity provided by MRB. MRB is backed by the financial strength of the six member companies. All of the members of MRB were assigned an A (Excellent) or better rating by the most recent Best's Property Casualty Key Ratings Guide. (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 total amount at December 31, 1997 represented $571,541 in paid losses and settlement expenses recoverable, $13,030,150 in unpaid losses and settlement expenses recoverable and $1,195,065 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, 1997 is presented below. Year ended December 31, ---------------------------------------- 1997 1996 1995 Premiums written: ------------ ------------ ------------ Direct ........................ $175,350,677 $156,161,030 $152,579,014 Assumed from nonaffiliates .... 1,219,564 1,951,071 3,282,699 Assumed from affiliates ....... 178,624,357 161,671,754 159,253,136 Ceded to nonaffiliates ........ (5,615,772) (7,930,381) (8,365,648) Ceded to affiliates ........... (164,978,055) (147,467,508) (143,259,942) ------------ ------------ ------------ Net premiums written ........ $184,600,771 $164,385,966 $163,489,259 ============ ============ ============ Premiums earned: Direct ........................ $169,304,584 $154,859,778 $151,450,871 Assumed from nonaffiliates .... 1,403,778 2,350,321 3,548,647 Assumed from affiliates ....... 171,514,339 162,326,189 157,897,322 Ceded to nonaffiliates ........ (5,937,679) (8,219,290) (8,680,800) Ceded to affiliates ........... (159,066,776) (146,126,332) (141,949,790) ------------ ------------ ------------ Net premiums earned ......... $177,218,246 $165,190,666 $162,266,250 ============ ============ ============ Losses and settlement expenses incurred: Direct ........................ $126,922,536 $117,368,771 $ 98,651,399 Assumed from nonaffiliates .... 926,403 948,218 608,796 Assumed from affiliates ....... 122,827,934 113,083,014 100,098,436 Ceded to nonaffiliates ........ (3,364,737) (6,817,132) (2,036,962) Ceded to affiliates ........... (117,458,832) (109,215,656) (89,169,391) ------------ ------------ ------------ Net losses and settlement expenses incurred ......... $129,853,304 $115,367,215 $108,152,278 ============ ============ ============ OUTSTANDING LOSSES AND SETTLEMENT EXPENSES The Company maintains reserves for losses and settlement expenses with respect to both reported and unreported claims. The amount of reserves for reported claims is primarily based upon a case-by-case evaluation of the specific type of claim, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of loss. Reserves on assumed business are the amounts reported by the ceding company. The amount of reserves for unreported claims is determined on the basis of statistical information for each line of insurance with respect to the probable number and nature of claims arising from occurrences which have not yet been reported. Established reserves are closely monitored and are frequently recomputed using a variety of formulas and statistical techniques for analyzing actual claim costs, frequency data and other economic and social factors. The Company does not discount reserves. Inflation is implicitly provided for in the reserving function through analysis of cost trends, reviews of historical reserving results and projections of future economic conditions. Large ($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 loss reserves each year, settlement expense reserves are correspondingly revised. 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, 1997 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. Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, beginning of year .......................... $202,502,986 $205,422,109 $203,181,615 Ceded reserves for losses and settlement expenses, beginning of year .......................... 13,796,769 12,226,680 14,146,874 ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year, before adjustments ...... 188,706,217 193,195,429 189,034,741 ------------ ------------ ------------ Adjustment to beginning reserves due to the change in the property and casualty insurance subsidiaries' pooling agreement... 3,795,453 - - Adjustment to beginning reserves due to the change in the reinsurance subsidiary's quota share percentage ................. 2,726,913 - - ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year, after adjustments ....... 195,228,583 193,195,429 189,034,741 Incurred losses and settlement expenses: - ---------------------- Provision for insured events of the current year .......... 137,300,762 131,375,234 123,876,601 Decrease in provision for insured events of prior years (7,447,458) (16,008,019) (15,724,323) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 129,853,304 115,367,215 108,152,278 ------------ ------------ ------------ Payments: - --------- Losses and settlement expenses attributable to insured events of the current year ............ 57,649,830 59,948,110 48,237,715 Losses and settlement expenses attributable to insured events of prior years ................. 62,684,265 59,908,317 55,753,875 ------------ ------------ ------------ Total payments (1) ......... 120,334,095 119,856,427 103,991,590 ------------ ------------ ------------ Net reserves for losses and settlement expenses, end of year 204,747,792 188,706,217 193,195,429 Ceded reserves for losses and settlement expenses, end of year 13,030,150 13,796,769 12,226,680 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, end of year $217,777,942 $202,502,986 $205,422,109 ============ ============ ============ (1) Loss and settlement expense payments reported in the Company's financial statements for the year 1997 totaled $113,811,729. This amount reflects an adjustment of ($3,795,453) related to the change in the property and casualty insurance subsidiaries' pooling agreement and ($2,726,913) related to the change in the reinsurance subsidiary's quota share percentage. These adjustments were made to offset the income statement effect that resulted from the $6,522,366 increase in reserves for losses and settlement expenses on January 1, 1997 related to these transactions. The following table shows the calendar year development of 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, beginning in 1992, (i) a reconciliation of the net loss and settlement expense reserves, to the gross amounts presented in the consolidated financial statements and (ii) disclosure of the gross re-estimated loss and settlement expense reserves and the related re-estimated reinsurance receivables. Reflected in this table is (1) the increase in the reinsurance subsidiary's quota share assumption of Employers Mutual's assumed reinsurance business from 75 percent 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, (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, (7) the increase in the reinsurance subsidiary's quota share assumption of Employers Mutual's assumed reinsurance business from 95 percent to 100 percent in 1997 and (8) the addition of a new participant to the pooling agreement effective January 1, 1997. In evaluating the table, it should be noted that each cumulative redundancy (deficiency) amount includes the effects of all changes in reserves for prior periods. Conditions and trends that have affected development of the liability in the past, such as a time lag in the reporting of assumed reinsurance business, the high rate of inflation associated with medical services and supplies and the reform measures implemented by several states to control administrative costs for workers' compensation insurance, may not necessarily occur in the future. Accordingly, it may not be appropriate to project future development of reserves based on this table. During the last three years the Company has experienced favorable development in the provision for insured events of prior years. The majority of the favorable development has come from the property and casualty insurance subsidiaries, which have benefitted from state reform measures in workers' compensation insurance and various loss control functions implemented by Employers Mutual. Favorable development has also been experienced in the reinsurance subsidiary and the nonstandard risk auto insurance subsidiary, but to a lesser degree. The property and casualty insurance subsidiaries have historically experienced favorable development in their reserves and current reserving practices have not been relaxed; however, the level of redundancies experienced in 1996 and 1995 is not expected to continue.
Year ended December 31, -------------------------------------------------------------------------------------------------- (Dollars in thousands) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Statutory reserves for losses and settlement expenses ...... $109,088 121,667 127,870 131,623 139,317 180,797 182,072 191,514 196,293 191,892 205,606 Reclassification of reserve amounts associated with the National Workers' Compensation Reinsurance Pool ............. 2,378 2,911 3,855 4,338 6,830 11,364 - - - - - Retroactive restatement of reserves in conjunction with admittance of a new participant into the pooling agreement ... 1,639 1,469 1,777 2,184 2,461 2,621 2,852 3,039 3,515 3,796 - ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Statutory reserves after reclassification ............. 113,105 126,047 133,502 138,145 148,608 194,782 184,924 194,553 199,808 195,688 205,606 GAAP adjustments: Salvage and subrogation ...... (930) (930) (930) (1,203) (1,284) (2,026) (1,804) (1,799) (2,369) (2,400) - Reclass of statutory settlement expense portion of retirement benefit liability - - - - - - (601) (680) (729) (786) (858) ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Reserves for losses and settlement expenses .......... 112,175 125,117 132,572 136,942 147,324 192,756 182,519 192,074 196,710 192,502 204,748 Paid (cumulative) as of: One year later ............... 25,462 36,488 44,341 44,694 32,647 80,171 61,738 59,136 63,613 63,494 - Two years later .............. 46,154 57,836 66,075 59,033 78,792 109,023 88,056 87,480 91,951 - - Three years later ............ 63,144 72,343 77,146 95,435 95,149 125,856 105,173 104,805 - - - Four years later ............. 71,616 79,183 106,557 104,502 104,531 135,099 114,377 - - - - Five years later ............. 77,271 105,572 112,201 109,990 109,662 141,023 - - - - - Six years later .............. 101,726 108,794 115,213 113,479 113,663 - - - - - - Seven years later ............ 103,955 110,746 117,797 116,340 - - - - - - - Eight years later ............ 105,486 112,626 119,674 - - - - - - - - Nine years later ............. 107,001 114,260 - - - - - - - - - Ten years later .............. 108,586 - - - - - - - - - - Reserves reestimated as of: End of year .................. 112,175 125,117 132,572 136,942 147,324 192,756 182,519 192,074 196,710 192,502 204,748 One year later ............... 109,865 124,455 135,523 140,794 151,771 191,986 174,865 175,065 179,240 185,054 - Two years later .............. 111,571 124,404 137,408 141,353 147,993 187,185 165,481 168,254 176,280 - - Three years later ............ 113,724 126,140 137,138 139,774 144,649 181,915 161,805 167,485 - - - Four years later ............. 117,060 128,087 137,656 139,233 144,144 181,783 161,803 - - - - Five years later ............. 119,352 128,491 136,945 139,989 144,449 182,477 - - - - - Six years later .............. 120,165 127,944 138,758 140,679 145,503 - - - - - - Seven years later ............ 120,354 130,086 140,372 141,731 - - - - - - - Eight years later ............ 122,579 131,700 141,746 - - - - - - - - Nine years later ............. 124,121 133,171 - - - - - - - - - Ten years later .............. 125,665 - - - - - - - - - - -------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Cumulative redundancy (Deficiency) ................. $(13,490) (8,054) (9,174) (4,789) 1,821 10,279 20,716 24,589 20,430 7,448 - ======== ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= Gross loss and settlement expense reserves - end of year (A) ........................ $199,974 206,221 208,937 206,298 217,778 Reinsurance receivables .............................................................. 17,455 14,147 12,227 13,797 13,030 -------- ------- ------- ------- ------- Net loss and settlement expense reserves - end of year ............................... $182,519 192,074 196,710 192,501 204,748 ======== ======= ======= ======= ======= Gross re-estimated reserves - latest (B) ............................................. $176,159 180,531 190,073 200,031 217,778 Re-estimated reinsurance receivables - latest ........................................ 14,356 13,046 13,793 14,977 13,030 -------- ------- ------- ------- ------- Net re-estimated reserves - latest ................................................... $161,803 167,485 176,280 185,054 204,748 ======== ======= ======= ======= ======= Gross cumulative redundancy (deficiency) (A-B) ....................................... $ 23,815 25,690 18,864 6,267 - ======== ======= ======= ======= =======
Asbestos and Environmental Claims The Company has exposure to asbestos and environmental related claims associated with the insurance business wriiten by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary. Estimating loss and settlement expense reserves for asbestos and environmental claims is very difficult due to the many uncertainties surrounding these types of claims. Such uncertainties include the fact that the assignment of responsibility varies widely by state and claims often emerge long after the policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult. In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, the social and political conditions and the claim history and trends within the Company and the industry. Based upon current facts, management believes the reserves established for asbestos and environmental related claims at December 31, 1997 are adequate. Although future changes in the legal and political environment may result in adjustments to these reserves, management believes any adjustments will not have a material impact on the financial condition or results of operations of the Company. Asbestos Claims The Company's asbestos claim activity primarily relates to bodily injury claims where a former insured has been named as one of multiple defendants covering exposure over many years. The following table presents selected data on asbestos related losses and settlement expenses incurred and reserves outstanding for the Company: Year ended December 31, ------------------------------- 1997 1996 1995 ---------- ---------- --------- Total losses incurred ....................... $ 394,524 $ 100,090 $ 336,899 Total settlement expenses incurred .......... 25,246 5,847 (31,667) Total losses and settlement expenses ---------- ---------- --------- incurred ................................ $ 419,770 $ 105,937 $ 305,232 ========== ========== ========= Loss reserves ............................... $ 942,822 $ 662,910 $ 581,549 Settlement expense reserves ................. 32,909 28,089 32,117 ---------- ---------- --------- Total loss and settlement expense reserves $ 975,731 $ 690,999 $ 613,666 ========== ========== ========= Number of outstanding claims ................ 92 57 71 ========== ========== ========= The incurred and reserve amounts for 1997, 1996 and 1995 reflect 63, 40 and 25 claims, respectively, by individuals asserting asbestos exposure to products allegedly manufactured by a former insured. Environmental Claims The Company's environmental claims activity is predominately related to pollution from hazardous waste of former insureds. The parties to the pooling agreement have not written primary coverage for the major oil or chemical companies. The greatest exposure arises out of claims from small regional operations or local businesses 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 and gasoline stations. The remaining exposure arises out of commercial general liability and umbrella policies issued during the 1970's and early 1980's which allegedly cover contamination emanating from closed landfills. 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 following table presents selected data on environmental losses and settlement expenses incurred and reserves outstanding for the Company. Year ended December 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Total losses incurred .................... $ 374,822 $ 85,454 $ 892,250 Total settlement expenses incurred ....... 25,615 (27,761) 185,412 ---------- ---------- ---------- Total losses and settlement expenses incurred ............................. $ 400,437 $ 57,693 $1,077,662 ========== ========== ========== Loss reserves ............................ $1,184,569 $1,103,466 $1,109,072 Settlement expense reserves .............. 252,435 308,145 345,897 ---------- ---------- ---------- Total loss and settlement expense reserves ............................. $1,437,004 $1,411,611 $1,454,969 ========== ========== ========== Number of outstanding claims ............. 46 63 58 ========== ========== ========== Included in the above table at December 31, 1997, 1996 and 1995 are two closed landfills which involve three and six policyholders, respectively. Coverage is disputed in all 46 of the claims which were outstanding at December 31, 1997. The coverage disputes relate to claims involving contamination at or from (i) insured property and (ii) closed landfills based on the generation of waste disposed of at these sites. EXCESS AND SURPLUS LINES INSURANCE AGENCY - ----------------------------------------- The excess and surplus lines insurance agency provides access to the excess and surplus lines markets through independent agents and managing general agents and represents several major excess and surplus lines companies, including Lloyd's of London. Lines of insurance handled range from relatively straightforward 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 - ----------- Securities classified as held-to-maturity are purchased with the intent and ability to be held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. All other securities have been classified as securities available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of tax. At December 31, 1997, approximately 90 percent of the Company's bonds were invested in government or government agency issued securities. A variety of maturities are maintained in the Company's portfolio to assure adequate liquidity. The maturity structure of bond investments is also established by the relative attractiveness of yields on short, intermediate and long-term bonds. The Company does not invest in any high-yield debt investments (commonly referred to as junk bonds). The Company's equity investment holdings include common stock mutual funds and preferred stocks. Investments of the Company's insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments 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. In 1996 the National Association of Insurance Commissioners (NAIC) adopted model legislation governing insurance company investments. This model investment law has been adopted by one state (Illinois) and is not expected to have a material impact on the operations of the Company's insurance subsidiaries. The investments of EMC Insurance Group Inc. and its subsidiaries are supervised by investment committees of each entity's respective board of directors. The bond and preferred stock portfolios are managed by an internal staff which is composed of employees of Employers Mutual. The mutual fund equity portfolios are managed by outside fund managers. Investment expenses are based on actual expenses incurred plus an allocation of other investment expenses incurred by Employers Mutual, which is based on a weighted average of total invested assets and number of investment transactions. The following table shows the composition of the Company's investment portfolio (at amortized cost), by type of security, as of December 31, 1997 and 1996. In the Company's consolidated financial statements, securities held-to-maturity are carried at amortized cost; securities available-for-sale are carried at fair value. Year ended December 31, -------------------------------------------- 1997 1996 --------------------- --------------------- Amortized Amortized cost Percent cost Percent ------------ ------- ------------ ------- Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $103,826,052 26.0% $113,288,092 30.3% Obligations of states and political subdivisions ... 41,989,442 10.5 30,975,611 8.3 Mortgage-backed securities 40,013,569 10.0 44,122,018 11.8 ------------ ------- ------------ ------ Total securities held- to-maturity ............ 185,829,063 46.5 188,385,721 50.4 ------------ ------- ------------ ------ Securities available-for-sale: Fixed maturity securities: Obligations of states and political subdivisions ... 130,945,594 32.8 114,538,500 30.6 Foreign governments ........ - - 2,573,101 .7 Public utilities ........... 8,760,899 2.2 8,970,242 2.4 Corporate securities ....... 32,861,713 8.2 20,023,965 5.3 Redeemable preferred stocks 149,000 - 688,350 .2 ------------ ------- ------------ ------ Total fixed maturity securities ............. 172,717,206 43.2 146,794,158 39.2 Equity securities: Common stock mutual funds .. 20,988,146 5.3 15,963,269 4.3 Non-redeemable preferred stocks ................... 5,273,011 1.3 5,273,012 1.4 ------------ ------ ------------ ------ Total equity securities .. 26,261,157 6.6 21,236,281 5.7 ------------ ------ ------------ ------ Total securities available-for-sale ..... 198,978,363 49.8 168,030,439 44.9 ------------ ------ ------------ ------ Short-term investments ......... 14,926,994 3.7 17,553,606 4.7 ------------ ------ ------------ ------ Total investments ........ $399,734,420 100.0% $373,969,766 100.0% ============ ====== ============ ====== 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, 1997. Securities Securities held-to-maturity available-for-sale (at amortized cost) (at fair value) --------------------- --------------------- Amount Percent Amount Percent Rating(1) ------------ ------- ------------ ------- Aaa ..................... $185,829,063 100.0% $ 46,374,134 25.8% Aa ...................... - - 56,387,608 31.4 A ....................... - - 76,037,537 42.3 Baa ..................... - - 352,209 .2 Ba ...................... - - 501,250 .3 ------------ ------ ------------ ------ Total fixed maturities $185,829,063 100.0% $179,652,738 100.0% ============ ====== ============ ====== (1) Ratings for preferred stocks and fixed maturity securities with initial maturities greater than one year are assigned by Moody's Investor's Services, Inc. Moody's rating process seeks to evaluate the quality of a security by examining the factors that affect returns to investors. Moody's ratings are based on quantitative and qualitative factors, as well as the economic, social and political environment in which the issuing entity exists. The quantitative factors include debt coverage, sales and income growth, cash flows and liquidity ratios. Qualitative factors include management quality, access to capital markets and the quality of earnings and balance sheet items. Ratings for securities with initial maturities less than one year are based on an evaluation of the underlying assets or the credit rating of the issuer's parent company. The amortized cost and estimated fair value of fixed maturity securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized fair cost value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 13,989,831 $ 14,142,820 Due after one year through five years ..... 50,088,102 51,876,854 Due after five years through ten years .... 66,752,623 70,871,137 Due after ten years ....................... 14,984,941 15,354,268 Mortgage-backed securities ................ 40,013,566 41,589,934 ------------ ------------ Totals .................................. $185,829,063 $193,835,013 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 13,803,121 $ 13,816,747 Due after one year through five years ..... 56,240,665 57,182,974 Due after five years through ten years .... 42,789,912 45,216,266 Due after ten years ....................... 59,883,508 63,436,751 ------------ ------------ Totals .................................. $172,717,206 $179,652,738 ============ ============ The mortgage-backed securities shown in the above table include $22,523,833 of securities issued by government corporations and agencies and $17,489,733 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, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Average invested assets (1) ........ $386,852,093 $367,276,871 $349,036,057 Investment income (2) .............. 23,759,988 23,907,599 23,173,794 Average yield ...................... 6.14% 6.51% 6.64% Realized investment gains .......... $ 4,100,006 $ 1,890,923 $ 1,043,730 (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 15 employees of Employers Mutual perform administrative duties on a part-time basis. Otherwise, the Company's business activities are conducted by employees of Employers Mutual, the nonstandard risk automobile insurance subsidiary and one of the property and casualty insurance subsidiaries, which have 1,782, 13 and 67 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, 1997, $12,722,219 was available for distribution in 1998 to EMC Insurance Group Inc. without prior approval. See note 6 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. The NAIC utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify property/casualty insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based on the risks applicable to the operations of the individual insurer. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk: asset risk, credit risk and underwriting risk. Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy. At December 31, 1997, each of the Company's insurance subsidiaries has a ratio of total adjusted capital to risk-based capital well in excess of the minimum level required. ITEM 2. PROPERTIES. - ------- ----------- Lease costs of the Company's two office facilities in West Des Moines, Iowa total approximately $71,000 and $31,000 annually. These leases expire on February 28, 1998 and November 30, 1998, at which time the operations will move into facilities owned by Employers Mutual. Lease costs of the Company's office facilities in Oak Brook, Illinois, and Bismarck, North Dakota, which total approximately $288,000 and $128,000 annually, are included as expenses under the pooling agreement. Expenses of office facilities owned and leased by Employers Mutual are borne by the parties to the pooling agreement, less the rent received from the space used and paid for by non-insurance subsidiaries and outside tenants. See "Property and Casualty Insurance - Pooling Agreement" under Item 1 of this Form 10-K. ITEM 3. LEGAL PROCEEDINGS. - ------- ------------------ The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business. The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations. The companies involved have reserves 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 "Market for Common Stock and Related Security Holder Matters" section from the Company's Annual Report to Stockholders for the year ended December 31, 1997, which is included as Exhibit 13(d) to this Form 10-K, is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. - ------- ------------------------ The "Selected Consolidated Financial Data" section from the Company's Annual Report to Stockholders for the year ended December 31, 1997, which is included as Exhibit 13(a) to this Form 10-K, is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS. ---------------------- The "Management's Discussion and Analysis of Financial Condition and Results of Operations" section from the Company's Annual Report to Stockholders for the year ended December 31, 1997, which is included as Exhibit 13(b) to this Form 10-K, is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------- -------------------------------------------- The consolidated financial statements from the Company's Annual Report to Stockholders for the year ended December 31, 1997, which is included as Exhibit 13(c) to this Form 10-K, are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON - ------- ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURE. ------------------------------------ None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- --------------------------------------------------- See the information under the caption "Election of Directors" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 21, 1998, 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 44 President and Chief Executive Officer of the Company and of Employers Mutual since 1992 and Treasurer of both organizations since 1996. He was elected President of the Company and Employers Mutual in 1991. Mr. Kelley was Executive Vice President of the Company and Employers Mutual from 1989 to 1991. He has been employed by Employers Mutual since 1985. Fred A. Schiek 63 Executive Vice President and Chief Operating Officer of the Company and of Employers Mutual since 1992. He was Vice President of Employers Mutual from 1983 until 1992. He has been employed by Employers Mutual since 1959. John D. Isenhart 60 Senior Vice President of the Company since 1997 and of Employers Mutual since 1992. He has been employed by Employers Mutual since 1963. Margaret A. Ball 59 Senior Vice President of the Company since February 1998 and of Employers Mutual since 1997. She has been employed by Employers Mutual since 1971. Ronald W. Jean 49 Senior Vice President of the Company and Employers Mutual since 1997. He has been employed by Employers Mutual since 1979. Raymond W. Davis 52 Vice President of the Company and Employers Mutual since 1985. He has been employed by Employers Mutual since 1979. NAME AGE POSITION Donald D. Klemme 52 Vice President and Secretary of the Company since 1996. Vice President of Employers Mutual since 1987. He has been employed by Employers Mutual since 1972. David O. Narigon 45 Vice President of the Company and of Employers Mutual since 1989. He has been employed by Employers Mutual since 1983. Mark E. Reese 40 Vice President of the Company and Employers Mutual since 1996 and Chief Financial Officer of the Company and Employers Mutual since 1997. He has been employed by Employers Mutual since 1984. Section 16(a) Beneficial Ownership Reporting Compliance On February 28, 1995, Mr. Ronnie D. Hallenbeck was designated as a Section 16 reporting person, however, the Company failed to inform him of this status until February 23, 1998. Due to this lack of notice, Mr. Hallenbeck was not aware of his obligation to file appropriate reports required by Section 16(a) of the Securities Exchange Act of 1934. Since being advised of this designation, Mr. Hallenbeck has filed two late reports identifying his status as a reporting person and nine events which were not reported on a timely basis. All of Mr. Hallenbeck's activities during this period of non- reporting involved purchases of Company stock resulting in his current holdings of 610 shares and periodic awards of options under Employers Mutual's Incentive Stock Option Plan. ITEM 11. EXECUTIVE COMPENSATION. - -------- ----------------------- See the information under the caption "Compensation of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 21, 1998, which information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - -------- --------------------------------------------------------------- See the information under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 21, 1998, which information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------- ----------------------------------------------- See the information under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 21, 1998, which information is incorporated herein by reference. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. - -------- ----------------------------------------------------------------- (a) List of Financial Statements and Schedules. Page ---- 1. Financial Statements Independent Auditors' Report ................................ 8* Consolidated Balance Sheets, December 31, 1997 and 1996 ..... 21-22* Consolidated Statements of Income for the Years ended December 31, 1997, 1996 and 1995 ......................... 23* Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1997, 1996 and 1995 ............. 24* Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996 and 1995 ......................... 25-26* Notes to Consolidated Financial Statements .................. 27-48* Form 10-K 2. Schedules Page ------- Independent Auditors' Report on Schedules ................... 33 Schedule I - Summary of Investments ....................... 34 Schedule II - Condensed Financial Information of Registrant 35 Schedule III - Supplementary Insurance Information .......... 38 Schedule IV - Reinsurance .................................. 39 Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations ..... 40 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. * Refers to the respective page of EMC Insurance Group Inc.'s 1997 Annual Report to Stockholders. The Consolidated Financial Statements and Independent Auditors' Report, which are included as Exhibit 13(c), are incorporated by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and Items 5, 6, 7 and 8, such Annual Report shall not be deemed filed as part of this Form 10-K or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934. 3. Management contracts and compensatory plan arrangements Exhibit 10(b). 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. Exhibit 10(n). Employers Mutual Casualty Company Supplemental Executive Retirement Plan. (b) Reports on Form 8-K. None. (c) Exhibits. 3. Articles of incorporation and bylaws: (a) Articles of Incorporation of the Company, as amended. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 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. (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. (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, 1995.) (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 Nos. 33-49337 and 333-45279.) (m) Employers Mutual Casualty Company Non-Employee Director Stock Option Plan. (Incorporated by reference to Registration No. 33-49339.) (n) Employers Mutual Casualty Company Supplemental Executive Retirement Plan. (Incorporated by reference to the Company's Form 10-K for the calendar year ended December 31, 1995.) 13. Annual Report to Security Holders. (a) Selected Financial Data from the Company's 1997 Annual Report to Stockholders. (b) Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's 1997 Annual Report to Stockholders. (c) Consolidated Financial Statements from the Company's 1997 Annual Report to Stockholders. (d) Market for Common Stock and Related Security Holder Matters from the Company's 1997 Annual Report to Stockholders. 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, 33-49339 and 333-45279) and Form S-3 (Registration No. 33-34499). 24. Power of Attorney. (d) Financial statements required by Regulation S-X which are excluded from the Annual Report to Stockholders by Rule 14a-3(b)(1). None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 20, 1998. EMC INSURANCE GROUP INC. /s/ Bruce G. Kelley ------------------------ Bruce G. Kelley President, Treasurer and Chief Executive Officer /s/ Mark E. Reese ------------------------ Mark E. Reese Vice President - Chief Financial Officer (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 20, 1998. /s/ Mark E. Reese ------------------------ George C. Carpenter III* Director /s/ Mark E. Reese ------------------------ E. H. Creese* Director /s/ Mark E. Reese ------------------------ David J. Fisher* Director /s/ Bruce G. Kelley ------------------------ Bruce G. Kelley Director /s/ Mark E. Reese ------------------------ George W. Kochheiser* Chairman of the Board /s/ Mark E. Reese ------------------------ Raymond A. Michel* Director /s/ Mark E. Reese ------------------------ Fredrick A. Schiek* Director * by power of attorney INDEPENDENT AUDITORS' REPORT ON SCHEDULES The Board of Directors and Stockholders EMC Insurance Group Inc.: Under date of February 26, 1998, we reported on the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1997 and 1996, 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, 1997, 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. /s/ KPMG Peat Marwick LLP Des Moines, Iowa February 26, 1998 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule I - Summary of Investments - Other Than Investments in Related Parties December 31, 1997 Amount at which shown Fair in the Type of investment Cost value balance sheet ------------------ ------------ ------------ ------------- Securities held-to-maturity: Fixed maturities: United States Government and government agencies and authorities .............. $103,826,052 $109,820,127 $103,826,052 States, municipalities and political subdivisions ....... 41,989,442 42,424,949 41,989,442 Mortgage - backed securities ... 40,013,569 41,589,937 40,013,569 ------------ ------------ ------------ Total fixed maturity securities 185,829,063 193,835,013 185,829,063 ------------ ------------ ------------ Securities available-for-sale: Fixed maturities: States, municipalities and political subdivisions ....... 130,945,594 137,218,479 137,218,479 Public utilities ............... 8,760,899 8,832,942 8,832,942 Corporate securities ........... 32,861,713 33,446,729 33,446,729 Redeemable preferred stocks .... 149,000 154,588 154,588 ------------ ------------ ------------ Total fixed maturity securities 172,717,206 179,652,738 179,652,738 Equity securities: Common stock mutual funds ...... 20,988,146 25,075,965 25,075,965 Non-redeemable preferred stocks 5,273,011 5,896,767 5,896,767 ------------ ------------ ------------ Total equity securities ...... 26,261,157 30,972,732 30,972,732 Short-term investments ............. 14,926,994 14,926,994 14,926,994 ------------ ------------ ------------ Total investments ...... $399,734,420 $419,387,477 $411,381,527 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule II - Condensed Financial Information of Registrant Condensed Balance Sheets December 31, -------------------------- 1997 1996 ASSETS ------------ ------------ - ------ Investment in common stock of subsidiaries (equity method) .................. $154,839,418 $141,767,346 Fixed maturity securities held-to-maturity, at amortized cost ............................. 6,494,491 4,488,040 Short-term investments .......................... 909,698 2,323,602 Cash ............................................ 3,884 180,917 Accrued investment income ....................... 108,945 74,259 Accounts receivable ............................. 166,488 30,234 Indebtedness of related party ................... - 14,375 ------------ ------------ Total assets ............................... $162,522,924 $148,878,773 ============ ============ LIABILITIES - ----------- Accounts payable ................................ $ 127,846 $ 112,169 Income taxes payable ............................ 37,000 37,000 Indebtedness to related party ................... 8,490 - Deferred tax liability .......................... 3,132 576 ------------ ------------ Total liabilities .......................... 176,468 149,745 ------------ ------------ STOCKHOLDERS' EQUITY - -------------------- Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,351,119 shares in 1997 and 11,084,461 shares in 1996 ......... 11,351,119 11,084,461 Additional paid-in capital ...................... 65,916,681 62,762,613 Retained earnings ............................... 85,078,656 74,881,954 ------------ ------------ Total stockholders' equity ................. 162,346,456 148,729,028 ------------ ------------ Total liabilities and stockholders' equity $162,522,924 $148,878,773 ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Income Years ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Equity in undistributed earnings ...... $ 9,377,037 $11,914,842 $13,123,772 Dividends received from consolidated subsidiaries ........... 3,750,032 3,060,026 4,200,019 Investment income ..................... 445,816 406,952 357,408 ----------- ----------- ----------- 13,572,885 15,381,820 17,681,199 Operating expenses .................... 313,762 313,087 307,713 ----------- ----------- ----------- Income from operations before income taxes ..................... 13,259,123 15,068,733 17,373,486 Income taxes .......................... 42,556 34,569 24,658 ----------- ----------- ----------- Net income............... $13,216,567 $15,034,164 $17,348,828 =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Condensed Statements of Cash Flows Years ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Net cash provided by operating activities ................ $ 3,702,567 $ 3,178,773 $ 4,269,852 ----------- ----------- ----------- Cash flows from investing activities: Purchases of fixed maturity securities held-to-maturity ....... (3,999,340) (2,485,938) (2,002,500) Disposals of fixed maturity securities held-to-maturity ....... 2,000,000 2,000,000 - Disposals of fixed maturity securities available-for-sale ..... - - 1,000,000 Net sales (purchases) of short-term investments ...................... 1,413,904 364,526 (515,869) ----------- ----------- ----------- Net cash used in investing activities ........... (585,436) (121,412) (1,518,369) ----------- ----------- ----------- Cash flows from financing activities: Issuance of common stock ........... 1,019,919 1,251,119 850,317 Dividends paid to stockholders ..... (4,314,083) (4,017,222) (3,653,299) (Purchases) sales of treasury stock, net ....................... - (129,877) 9,646 ----------- ----------- ----------- Net cash used in financing activities ..................... (3,294,164) (2,895,980) (2,793,336) ------------ ----------- ----------- Net (decrease) increase in cash ....... (177,033) 161,381 (41,853) Cash at beginning of year ............. 180,917 19,536 61,389 ----------- ----------- ----------- Cash at end of year ................... $ 3,884 $ 180,917 $ 19,536 =========== =========== =========== Income taxes paid ..................... $ 40,000 $ 20,993 $ 31,342
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule III - Supplementary Insurance Information For Years Ended December 31, 1997, 1996 and 1995 Amortization Deferred of deferred policy Losses and Net Losses and policy acquisition settlement Unearned Premium investment settlement acquisition Segment costs expenses premiums revenue income expenses costs ------- ----------- ------------ ----------- ------------ ----------- ------------ ------------ Year ended December 31, 1997: Property and casualty insurance $ 8,711,171 $151,738,249 $46,506,654 $132,874,752 $15,528,726 $ 97,083,777 $ 25,328,393 Reinsurance ................... 1,611,531 58,374,665 7,325,143 34,105,686 6,615,029 23,305,824 8,253,329 Nonstandard risk automobile insurance ................... 237,955 7,665,028 1,025,666 10,237,808 1,011,799 9,463,703 2,360,370 Excess and surplus lines insurance agency ............ - - - - 158,618 - - Parent company ................ - - - - 445,816 - - ----------- ------------ ----------- ------------ ----------- ------------ ------------ Consolidated ............. $10,560,657 $217,777,942 $54,857,463 $177,218,246 $23,759,988 $129,853,304 $ 35,942,092 =========== ============ =========== ============ =========== ============ ============ Year ended December 31, 1996: Property and casualty insurance $ 7,335,953 $142,948,679 $40,278,119 $119,282,389 $15,828,102 $ 82,034,078 $ 22,505,659 Reinsurance ................... 1,482,796 51,816,998 6,739,983 36,674,831 6,436,095 25,180,022 7,951,458 Nonstandard risk automobile insurance ................... 203,114 7,737,309 890,852 9,233,446 1,111,896 8,153,115 2,097,616 Excess and surplus lines insurance agency ............ - - - - 124,554 - - Parent company ................ - - - - 406,952 - - ----------- ------------ ----------- ------------ ----------- ------------ ------------ Consolidated ............. $ 9,021,863 $202,502,986 $47,908,954 $165,190,666 $23,907,599 $115,367,215 $ 32,554,733 =========== ============ =========== ============ =========== ============ ============ Year ended December 31, 1995: Property and casualty insurance $ 6,777,303 $146,575,010 $39,973,174 $116,439,266 $15,428,401 $ 74,926,023 $ 21,742,128 Reinsurance ................... 1,729,903 50,748,972 7,863,197 35,825,953 6,067,678 23,744,247 8,191,751 Nonstandard risk automobile insurance ................... 207,563 8,098,127 930,776 10,001,031 1,175,392 9,482,008 2,218,737 Excess and surplus lines insurance agency ............ - - - - 144,915 - - Parent company ................ - - - - 357,408 - - ----------- ------------ ----------- ------------ ----------- ------------ ------------ Consolidated ............. $ 8,714,769 $205,422,109 $48,767,147 $162,266,250 $23,173,794 $108,152,278 $ 32,152,616 =========== ============ =========== ============ =========== ============ ============
Other underwriting Premiums Segment expenses written ------- ----------- ------------ Year ended December 31, 1997 Property and casualty insurance $16,168,332 $139,537,302 Reinsurance ................... 3,498,497 34,690,846 Nonstandard risk automobile insurance ................... 604,897 10,372,622 Excess and surplus lines insurance agency ............ (417,252) - Parent company ................ 313,762 - ----------- ------------ Consolidated ............. $20,168,236 $184,600,771 =========== ============ Year ended December 31, 1996 Property and casualty insurance $15,399,752 $119,640,828 Reinsurance ................... 3,506,366 35,551,617 Nonstandard risk automobile insurance ................... 541,985 9,193,521 Excess and surplus lines insurance agency ............ (333,880) - Parent company ................ 313,087 - ----------- ------------ Consolidated ............. $19,427,310 $164,385,966 =========== ============ Year ended December 31, 1995 Property and casualty insurance $14,548,773 $117,736,744 Reinsurance ................... 3,391,578 35,933,493 Nonstandard risk automobile insurance ................... 557,028 9,819,022 Excess and surplus lines insurance agency ............ (338,001) - Parent company ................ 307,713 - ----------- ------------ Consolidated ............. $18,467,091 $163,489,259 =========== ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule IV - Reinsurance For years ended December 31, 1997, 1996 and 1995 Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------------ ------------ ------------ ------------ ---------- Year ended December 31, 1997: Earned premiums: Consolidated property and casualty insurance .......................... $169,304,584 $165,004,455 $172,918,117 $177,218,246 97.6% ============ ============ ============ ============ ========== Year ended December 31, 1996: Earned premiums: Consolidated property and casualty insurance .......................... $154,859,778 $154,345,622 $164,676,510 $165,190,666 99.7% ============ ============ ============ ============ ========== Year ended December 31, 1995: Earned premiums: Consolidated property and casualty insurance .......................... $151,450,871 $150,630,590 $161,445,969 $162,266,250 99.5% ============ ============ ============ ============ ==========
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Schedule VI - Supplemental Insurance Information Concerning Property-Casualty Insurance Operations For Years Ended December 31, 1997, 1996 and 1995 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, 1997: $10,560,657 $217,777,942 $ -0- $54,857,463 $177,218,246 $23,155,554 =========== ============ ======== =========== ============ =========== Year ended December 31, 1996: $ 9,021,863 $202,502,986 $ -0- $47,908,954 $165,190,666 $23,376,093 =========== ============ ======== =========== ============ =========== Year ended December 31, 1995: $ 8,714,769 $205,422,109 $ -0- $48,767,147 $162,266,250 $22,671,471 =========== ============ ======== =========== ============ ===========
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, 1997: $137,300,762 ($ 7,447,458) $ 35,942,092 $113,811,729 $184,600,771 ============ =========== ============ ============ ============ Year ended December 31, 1996: $131,375,234 ($16,008,019) $ 32,554,733 $119,856,427 $164,385,966 ============ =========== ============ ============ ============ Year ended December 31, 1995: $123,876,601 ($15,724,323) $ 32,152,616 $103,991,590 $163,489,259 ============ =========== ============ ============ ============
Difference between Electronic and Circulated 10-k - -------------------------------------------------- The index to exhibits in the electronic format indicates the exhibits are included in the direct transmission. The circulated document contains the page numbers of the exhibits. EMC Insurance Group Inc. and Subsidiaries Index to Exhibits Exhibit number Item - ------- ---- 10(a) Quota Share Reinsurance Contract Included in between Employers Mutual Casualty direct transmission Company and EMC Reinsurance Company. 10(c) EMC Insurance Companies reinsurance Included in pooling agreements between Employers direct transmission Mutual Casualty Company and certain of its affiliated companies. 13(a) Selected Financial Data. Included in direct transmission 13(b) Management's Discussion and Analysis Included in of Financial Condition and Results direct transmission of Operations. 13(c) Financial Statements and Supplementary Included in Data. direct transmission 13(d) Market for Registrant's Common Equity Included in and Related Stockholder Matters. direct transmission 21 Subsidiaries of the Registrant. Included in direct transmissin 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 EX-10 2 MANAGEMENT CONTRACTS Exhibit 10(a) QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY This agreement made by and between Employers Mutual Casualty Company ("Employers") and EMC Reinsurance Company ("EMC Re"). ARTICLE I EMC Re is an affiliate of Employers and was formed by Employers for the sole purpose of engaging in the business of reinsurance. It is the intention of the parties hereto that EMC Re will solicit, underwrite, and assume reinsurance risks in a mode of operation similar to that heretofore conducted by Employers, and that consistent therewith, EMC Re will gradually assume by means of this Quota Share Agreement, the major portion of the reinsurance assumed business of Employers as is in force or as may be placed in force by Employers. ARTICLE II Excluded from this Quota Share Agreement at its inception are: (1) all direct insurance business written by Employers and its affiliated companies; (2) all involuntary insurance or reinsurance business written by Employers and classed by Employers as "facilities business"; (3) facultative reinsurance assumed contracts; (4) intercompany reinsurance contracts between Employers and its affiliated companies; (5) reinsurance assumed contracts that have been terminated or are in the process of termination. ARTICLE III Pursuant to and subject to the foregoing, Employers hereby cedes and transfers to EMC Re, and EMC Re hereby accepts, a quota share portion of the reinsurance contracts on which Employers is subject to liability which were outstanding and in force as of 12:01 a.m. January 1, 1981, or which were issued thereafter, or as shall be issued hereafter, in accordance with the Assumption Addendum attached hereto. Such liability shall include reserves for unearned premiums, outstanding loss and loss expenses (including unreported losses) and all other underwriting and administrative expenses, but shall not include liabilities incurred in connection with investment transactions. Employers hereby assigns and transfers to EMC Re amounts equal to the aggregate of the liabilities quota shared as above, less a commission for the prepaid expenses of Employers. ARTICLE IV Employers shall not be prejudiced in any way by any error or omission through accident or oversight resulting in a failure to accurately or fully cede, report, or recover with respect to this Quota Share Agreement, but any such error or omission shall be corrected immediately upon discovery. ARTICLE V This agreement is a continuing one and is unlimited as to duration, but may be terminated as of the end of any calendar year upon ninety days prior written notice; or may be otherwise terminated by agreement of the parties. ARTICLE VI Each of the parties hereto agrees that the reinsurance business quota shared hereunder shall be payable by EMC Re on the basis of the liability of Employers under the contracts reinsured without diminution because of the insolvency of Employers; provided that such reinsurance shall be payable directly to Employers or its liquidator, receiver or such other statutory successor, except as provided by Section 315 of new York Insurance Law, or except (a) where the contract specifically provides another payee for such reinsurance in the event of the insolvency of the ceding insurer and (b) where EMC Re, with the consent of the direct reinsured company, has assumed such contract obligations of Employers as direct obligations of EMC Re to the payees under wich reinsurance contracts and in substitution for the obligations of Employers to such payees; and further provided that the liquidator, receiver or statutory successor of Employers shall give written notice of the pendency of any claim against Employers on such contracts with any reasonable time after such claim; and EMC Re may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be ajudicated in the defense or defenses which it may deem available to Employers or its liquidator, receiver or statutory successor, the expense thus incurred by EMC Re to be chargable, subject to court approval, against Employers as part of the expense of liquidation to the extent of a proportionate share of the benefit which may accrue to Employers solely as a result of the defense undertaken by EMC Re. Executed by the parties hereto the day and year as reflected in the Assumption Addendum attached hereto. ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY This agreement shall incept as 12:01 a.m. on the date executed by the parties hereto. The parties to this agreement mutually agree that as of its inception, the quota share portion of the net liabilities of Employers as 12:01 a.m. January 1, 1981 ceded to and assumed by EMC Re shall be five percent. Executed by the parties hereto this 10th day of June, 1981. Employers Mutual Casualty Company By:/s/ Robb B. Kelley -------------------------------------- Robb B. Kelley, President EMC Reinsurance Company By:/s/ Richard E. Haskins -------------------------------------- Richard E. Haskins, President AMENDMENT #1 TO ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY The parties to this agreement mutually agree that the quota share portion of the net liabilities of Employers at 12:01 a.m. January 1, 1982 ceded to and assumed by EMC Re shall be twenty-five percent. Executed by the parties hereto this 3rd day of January, 1982. Employers Mutual Casualty Company By:/s/ Robb B. Kelley ------------------------------ Robb B. Kelley, President EMC Reinsurance Company By:/s/ Richard E. Haskins ------------------------------ Richard E. Haskins, President AMENDMENT #2 TO ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY The parties to this agreement mutually agree that the quota share portion of the net liabilities of Employers at 12:01 a.m. January 1, 1983 ceded to and assumed by EMC Re shall be fifty percent. Executed by the parties hereto this 18th day of March, 1983. Employers Mutual Casualty Company By:/s/ George W. Kochheiser ------------------------------ George W. Kochheiser, President EMC Reinsurance Company By:/s/ Richard E. Haskins ------------------------------ Richard E. Haskins, President AMENDMENT #3 TO ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY The parties to this agreement mutually agree that the quota share portion of the net liabilities of Employers at 12:01 a.m. January 1, 1984 ceded to and assumed by EMC Re shall be seventy- five percent. Executed by the parties hereto this 3rd day of January, 1984. Employers Mutual Casualty Company By:/s/ Robb B. Kelley ------------------------------- Robb B. Kelley, Chairman & CEO EMC Reinsurance Company By:/s/ Richard E. Haskins ------------------------------- Richard E. Haskins, President AMENDMENT #4 TO ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY The parties to this agreement mutually agree that the quota share portion of the net liabilities of Employers at 12:01 a.m. January 1, 1988 ceded to and assumed by EMC Re shall be ninety- five percent. Executed by the parties hereto this 9th day of March, 1988. Employers Mutual Casualty Company By:/s/ Robb B. Kelley ------------------------------ Robb B. Kelley, Chairman & CEO EMC Reinsurance Company By:/s/ Richard E. Haskins ------------------------------ Richard E. Haskins, President ENDORSEMENT #1 TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY It is understood and agreed by and between the parties as follows: 1. Certain business subject to this agreement and ceded hereunder was protected by pro-rata and excess of loss reinsurances; such reinsurances to enure to the benefit of the parites as their interests appear herein. 2. Such reinsurances were represented to be collectable; there was no intent to transfer to the reinsurer the credit risk of non-collectable reinsurances other than as would be deemed incidental; and there was no consideration contemplated nor given for the assumption of such credit risk. 3. At various times during the pendency of this agreement the parties have come to perceive that recoverables from on such reinsurer, Transit Casualty Company, were becoming of doubtful collectability, and the parties began a scheduled "write down" of receivables from that source as their interests appeared in order to recognize the degree of doubt perceived. 4. The parties have now determined that no part of such receivables from Transit Casualty Company are collectable, and that the entire account should be written off as a bad debt. 5. The parties further recognize that the combination of a) increases in the percentages of business ceded hereunder, and b) the more than 200 percent growth in the loss amounts now recognized as non-recoverable from Transit, have exacerbated the adverse affects upon EMC Re hereunder to the point of severely reducing EMC Re's surplus, and to the frustration of the purpose of this contract and to the goals of the parties when it was drafted. Now therefore, in consideration of the foregoing, the parties agree as follows: 1. EMC Re will pay Employers in full the outstanding portion of its 95% pro-rata part of the Transit Casualty Company scheduled write off as booked through September 30, 1988, in the amount of 95% of $2,650,000. 2. Employers Mutual Casualty Company will retain (in addition to its 5% quota share portion), and hereby releases EMC Re from liability therefore, any additional non-recoverable sums now due or in the future recognized as necessary to be written off, applicable not only to Transit but to any other non-collectable reinsurance protections on business subject to this quota share agreement, from its inception. Executed by the parties hereto this 6th day of December, 1988. Employers Mutual Casualty Company By: /s/ Robb B. Kelley ------------------------------ Robb B. Kelley, Chairman & CEO EMC Reinsurance Company By: /s/ Richard E. Haskins ------------------------------ Richard E. Haskins, President COMMUTATION AGREEMENT AND RELEASE This Agreement entered into by and between Employers Mutual Casualty Company (the "Company") and EMC Reinsurance Company (the "Reinsurer") and shall be effective as of September 30, 1989 (the "commutation date"). WHEREAS, the parties have entered into a certain quota share reinsurance contract effective from January 1, 1981, and remaining in full force and effect, and WHEREAS, the Company and the Reinsurer desire to settle, adjust and determine the liabilities of the Reinsurer thereunder for losses occurring during all years prior to 12:01 A.M., January 1, 1981, and WHEREAS, by reason of which settlement agreement there is due and owing to the Company from the Reinsurer the sum of $2,982,882.00, NOW, THEREFORE, in consideration of the payment to the Company by the Reinsurer of $2,982,882.00, the Company has released and discharged, and by these presents does for itself, its successors and assigns, release and discharge the Reinsurer with respect to any contractual obligations under the aforesaid quota share reinsurance contract as respects, and only as respects, losses occurring during any and all years prior to 12:01 A.M., January 1, 1981. IN WITNESS WHEREOF, the parties have caused these presents to be executed in duplicate this 5th day of December, 1989. EMPLOYERS MUTUAL CASUALTY COMPANY By /s/ George W. Kochheiser ----------------------------- George W. Kochheiser President EMC REINSURANCE COMPANY By /s/ Richard E. Haskins ----------------------------- Richard E. Haskins President ENDORSEMENT #2 TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY It is understood and agreed by and between the parties as follows: Effective January 1, 1993 Article III of the Quota Share is amended by adding the follosing additional paragraph: Notwithstanding the foregoing terms, it is agreed that the maximum liability transferred to EMC Re for loss resulting from any one occurrence, including reinstatement premium costs resulting from such occurrence, is limited to $1,000,000. As consideration to Employers for this per occurrence limitation, it is agreed that EMC Re shall allow Employers an additional ceding commission of 5.25% Executed by the parties this 2nd day of December, 1992. Employers Mutual Casualty Company by /s/ Bruce G. Kelley --------------------------------- EMC Reinsurance Company by /s/ Dean P. McClaflin --------------------------------- COMMUTATION AGREEMENT AND RELEASE This Agreement entered into by and between Employers Mutual Casualty Company (the "Company") and EMC Reinsurance Company (the "Reinsurer") and shall be effective as of June 30, 1993 (the "commutation date"). WHEREAS, the parties have entered into a certain quota share reinsurance contract effective from January 1, 1981, and remaining in full force and effect, and WHEREAS, the Company and the Reinsurer desire to settle, adjust and determine final liabilities of the Reinsurer thereunder for losses originating from the business written by Russell Reinsurace Services, Inc., and WHEREAS, by reason of such settlement agreement there is due and owing to the Company from the Reinsurer the sum $17,806,179. NOW, THEREFORE, in consideration of the payment to the Company by the Reinsurer of $17,806,179, the Company has released and discharged, and by these presents does for itself, its successors and assigns, release and discharge the Reinsurer with respect to any contractual obligations under the aforesaid quota share reinsurance contract as respects, all business originating through Russell Reinsurance Services, Inc. IN WITNESS WHEREOF, the parties have caused these presents to be executed in duplicate this 29th day of July, 1993. EMPLOYERS MUTUAL CASUALTY COMPANY By /s/ Bruce G. Kelley ----------------------------- Bruce G. Kelley President EMC REINSURANCE COMPANY By /s/ Dean P. McClaflin ----------------------------- Dean P. McClaflin President COMMUTATION AGREEMENT AND RELEASE This Agreement entered into by and between Employers Mutual Casualty Company (the "Company") and EMC Reinsurance Company (the "Reinsurer") and shall be effective as of October 31, 1993 (the "commutation date"). WHEREAS, the parties have entered into a certain quota share reinsurance contract effective from January 1, 1981, and remaining in full force and effect, and WHEREAS, the Company and the Reinsurer desire to settle, adjust and determine final liabilities of the Reinsurer thereunder for losses originating from the business written by Improved Risk Mutual, and WHEREAS, by reason of such settlement agreement there is due and owing to the Company from the Reinsurer the sum of $2,619,776. NOW, THEREFORE, in consideration of the payment to the Company by the Reinsurer of $2,619,776, the Company has released and discharged, and by these presents does for itself, its successors and assigns, release and discharge the Reinsurer with respect to any contractual obligations under the aforesaid quota share reinsurance contract as respects, all business originating through Improved Risk Mutual. IN WITNESS WHEREOF, the parties have caused these presents to be executed in duplicate this 1st day of December, 1993. EMPLOYERS MUTUAL CASUALTY COMPANY By /s/ Bruce G. Kelley ----------------------------- Bruce G. Kelley President EMC REINSURANCE COMPANY By /s/ Dean P. McClaflin ----------------------------- Dean P. McClaflin President ENDORSEMENT #3 TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY It is understood and agreed by and between the parties as follows: Effective January 1, 1997, the last paragraph of Article III of the Quota Share found in Endorsement #2 is changed to read as follows: Notwithstanding the foregoing terms, it is agreed that the maximum liability transferred to EMC Re for loss resulting from any one occurrence, including reinstatement premium costs resulting from such occurrence, is limited to $1,500,000. As consideration to Employers for this per occurrence limitation, it is agreed that EMC Re shall allow Employers an override commission of 5.00% plus .25% (fronting fee) equaling 5.25%. Executed by the parties this 7th day of January, 1997. Employers Mutual Casualty Company By:/s/Bruce G. Kelley ------------------------------ EMC Reinsurance Company By:/s/Ronnie D. Hallenbeck ------------------------------ AMENDMENT #5 TO ASSUMPTION ADDENDUM TO QUOTA SHARE REINSURANCE RETROCESSIONAL AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND EMC REINSURANCE COMPANY The parties to this agreement mutually agree that the quota share portion of the net liabilities of Employers at 12:01 a.m. January 1, 1997 ceded to and assumed by EMC Re shall be one hundred percent. Executed by the parties hereto this 7th day of January, 1997. Employers Mutual Casualty Company By:/s/Bruce G. Kelley ------------------------------ EMC Reinsurance Company By:/s/Ronnie D. Hallenbeck ----------------------------- Exhibit 10 (c) EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND CERTAIN OF ITS AFFILIATED COMPANIES REWRITTEN EFFECTIVE JANUARY 1, 1987 REINSURANCE POOLING AGREEMENT This Agreement made by and between Employers Mutual Casualty Company and certain of its affiliated or subsidiary companies such as are signatory hereto by means of exhibits setting forth the interests and liabilities of the parties, attached hereto and made a part of this Agreement. Employers Mutual Casualty Company is hereinafter referred to as "EMC", and the other companies signatory hereto are hereinafter referred to as the "Affiliated Companies" or as the "Affiliated Company", as the context requires. EMC and each Affiliated Company signatory to the Pooling Agreement agree to honor the terms set forth herein as if this Agreement were solely between EMC and each such Affiliated Company. Balances payable to or recoverable from EMC and any such Affiliated Company shall not serve to offset any balances payable to or recoverable from any other Affiliated Company signatory to this Agreement. Reports and remittances between EMC and each Affiliated Company shall be in sufficient detail to identify the individual premium and loss obligation of each party to the other. ARTICLE I The Companies are engaged in the insurance business and maintain a mutual business relationship having certain incidents of common management, and desire to bring about for each other added economies of operation, uniform underwriting results, diversification as respects the classes of insurance business written, and maximization of capacity. To accomplish the aforesaid, the Companies do by means of this Agreement, pool all of their insurance business then in force as of 12:01 A.M. of the date signatory hereto, and thereafter to share in the fortunes of their pooled insurance business. ARTICLE II EMC hereby reinsures and the Affiliated Company hereby cedes and transfers to EMC all liabilities incurred under or in connections with all contracts and policies of insurance issued by the Affiliated Company outstanding and in force as of 12:01 A.M. of the date signatory hereto, or thereafter issued by it. Such liabilities shall include the Affiliated Company's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other underwriting and administrative expenses as evidenced by the Affiliated Company's books and records, but shall not include inter-company balances, liabilities for Corporate Taxes including Federal or State Income Taxes, or liabilities incurred in connection with their respective investment transactions. ARTICLE III The Affiliated Company hereby assigns and transfers to EMC all right, title and interest in and to reinsurance outstanding and in force with respect to the liabilities reinsured by EMC under Article II hereof. ARTICLE IV The Affiliated Company assigns and transfers to EMC amounts equal to the aggregate of all of its liabilities reinsured by EMC under Article II hereof, less a commission allowance equal to the prepaid expenses of the Affiliated Company but not in excess of 40 percent of the Affiliated Company's combined ratio on a trade basis. Prepaid expenses is defined as those expenses records in column 2, part 4, of the Underwriting and Expense Exhibit of the Affiliated Company's convention statement. The trade combined ratio is the ratio of loss and loss adjustment expense to earned premium, plus the ratio of underwriting expenses to premiums written. ARTICLE V The Affiliated Company hereby reinsures, and EMC hereby cedes and transfers to the Affiliated Company a portion of its net liabilities under all contracts and policies of insurance (including those reinsured by EMC under Article II hereof) on which EMC is subject to liability and which are outstanding and in force as of 12:01 A.M. of the date signatory hereto, or are issued thereafter, in accordance with the exhibit attached hereto to which the Affiliated Company is a signatory party. Such liabilities shall include reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other underwriting and administrative expenses, but shall not include inter-company balances, liabilities for Corporate Taxes including Federal or State Income Taxes, or liabilities in connection with investment transactions. ARTICLE VI EMC hereby assigns and transfers to the Affiliated Company amounts equal to the aggregate of all liabilities of EMC reinsured by the Affiliated Company under contracts and policies of insurance which are outstanding and in force as of 12:01 A.M. of the date signatory hereto under Article V hereof, less a commission allowance equal to the prepaid expenses of EMC but not in excess of 40 percent of EMC's combined ratio on a trade basis. Prepaid expenses is defined as those expenses recorded in column 2, part 4, of the Underwriting and Expense Exhibit of EMC's convention statement. The trade combined ratio is the ratio of loss and loss adjustment expense to earned premium, plus the ratio of underwriting expenses to premiums written. ARTICLE VII EMC agrees to pay to the Affiliated Company it respective participation of all premiums written by the companies after first deducting premiums on all reinsurance ceded to reinsurers (other than the parties hereto). Similarly, it is further agreed that all losses, loss expense and other underwriting and administrative expenses (with the exceptions noted in Articles II and V hereof) of the companies, less all losses and expense recovered and recoverable under reinsurance ceded to reinsurers (other than the parties hereto), shall be pro-rated between the parties on the basis of their respective participations as reflected in the aforesaid exhibit. ARTICLE VIII The obligation of the companies under this Agreement to exchange reinsurance between themselves may be offset by reciprocal obligation so that the net amount only shall be required to be transferred, except no offset shall be valid under circumstances prohibited by Section 7472, New York Insurance Laws. An accounting on all transactions shall be rendered quarterly, and the settling of balances shall be made within 30 days after the rendering of the quarterly reports. Except as otherwise required by the context of this Agreement, the amount of all payments between the companies under this Agreement shall be determined on the basis of the convention form of annual statements of the companies. Notwithstanding anything herein contained, this Agreement shall not apply to the investment operations of the companies. ARTICLE IX The conditions of reinsurance hereunder shall in all cases be identical with the conditions of the original insurance or as changed during the term of insurance. ARTICLE X This Agreement is a continuing one and is unlimited as to duration but may be terminated upon mutual consent or by 30 day prior written notice by either party. ARTICLE XI Each of the companies hereto, as the assuming insurer, hereby agrees that all reinsurance made, ceded, renewed or otherwise becoming effective under this Agreement shall be payable by the assuming insurer on the basis of the liability of the ceding insurer under the policy or contract reinsured without diminution because of insolvency of the ceding insurer; provided that such reinsurance shall be payable directly to the ceding insurer or to its liquidator, receiver or other statutory successor, except as provided by Section 4118 of New York Insurance Law or except (a) where the contract specifically provides another payee for such reinsurance in the event of the insolvency of the ceding insurer and (b) where the assuming insurer, with consent of the direct insured or insureds, has assumed such policy obligations of the ceding insurer as direct obligations of the assuming insurer to the payees under such policies and in substitution for the obligations of the ceding insurer to such payee; and further provided that the liquidator, receiver or statutory successor of the ceding insurer shall give written notice of the pendency of any claim against the insolvent ceding insurer on the policy or contract reinsured within a reasonable time after such claim; and the assuming insurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense or defenses which it may deem available to the ceding insurer or it liquidator, receiver or statutory successor, the expense thus incurred by the assuming insurer to be chargeable, subject to court approval against the insolvent ceding insurer as part of the expense of liquidation to the extent of proportionate share of the benefit which may accrue to the ceding insurer solely as a result of the defense undertaken by the assuming insurer. ARTICLE XII Each party shall allow the other party to inspect, at reasonable times, the records of the Company relevant to the business reinsured under this Agreement, including files concerning claims, losses, or legal proceedings which involve or are likely to involve the other party. ARTICLE XIII A. As a condition precedent to any right of action hereunder, any dispute arising out of this Agreement shall be submitted to the decision of a board of arbitration composed of two arbitrators and an umpire, meeting in Des Moines, Iowa, unless otherwise agreed. B. The members of the board of arbitration shall be active or retired disinterested officials of insurance or reinsurance companies. Each party shall appoint its arbitrator and the two arbitrators shall choose an umpire before instituting the hearing. If the respondent fails to appoint its arbitrator within four weeks after being requested to do so by the claimant, the latter shall also appoint the second arbitrator. If the two arbitrators fail to agree upon the appointment of an umpire within four weeks after their nominations, each of them shall name three, of whom the other shall decline two and the decision shall be made by drawing lots. C. The claimant shall submit its initial brief within 20 days from appointment of the umpire. The respondent shall submit its brief within 20 days after receipt of the claimant's brief and the claimant may submit a reply brief within 10 days after receipt of the respondent's brief. D. The board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The board shall issue its decision in writing based upon a hearing in which evidence may be introduced without following strict rules of evidence but in which cross examination and rebuttal shall be allowed. The board shall make its decision within 60 days following the termination of the hearings unless the parties consent to an extension. The majority decision of the board shall be final and binding upon all parties to the proceeding. Judgment may be entered upon the award of the board in any court having jurisdiction thereof. E. Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the expense of the umpire. The remaining costs of the arbitration proceedings shall be allocated by the board. ARTICLE XIV By execution of this Agreement, the parties hereto simultaneously terminate any and all reinsurance agreements by and between them heretofore existing, upon the understanding that this Agreement shall supersede and exist in substitution for any such prior agreements. Executed by the parties hereto the day and year as reflected in the exhibit attached hereto. ADDENDUM #I TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT BETWEEN EMPLOYERS MUTUAL CASUALTY COMPANY AND CERTAIN OF ITS AFFILIATED COMPANIES This Pooling Agreement is amended by adding Article XV thereto, with effect from January 1, 1993, as follows: ARTICLE XV Notwithstanding the wording of this Agreement as contained in Articles II through VIII, it is agreed and understood that the voluntary reinsurance assumed business written by EMC and heretofore ceded to the Affiliated Companies under this Pooling Agreement, is hereafter not "contracts and policies of insurance" as used in this agreement, and is not business subject to cession and transfer by EMC to the Affiliated Companies. On January 1, 1993, EMC and the Affiliated Companies shall make such asset and reserve transfers as are required to give effect to the provisions of this Article XV. This Pooling Agreement is further amended by substituting "EMC Insurance Companies" for "Employers Mutual Companies" wherever it appears, consistent with and pursuant to action of the Board of Directors effecting this name change. INTEREST AND LIABILITIES EXHIBIT # II TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfers to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 3% of EMC's net liabilities, pursuant to Article V, effective January 1, 1987. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the date of this Addendum, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 3 % EMCASCO Insurance Company 8 % Illinois EMCASCO Insurance Company 6 % Union Mutual Insurance Company of Providence 2.5% ----- 24.5% EMC's Net Retained Portions of its Net Liabilities is 75.5% ----- 100.0% Executed by the parties hereto this 25th day of November, 1986. Employers Mutual Casualty Company By:/s/Richard E. Haskins -------------------------- Dakota Fire Insurance Company By:/s/Robb B. Kelley -------------------------- AMENDMENT # I TO INTEREST AND LIABILITIES EXHIBIT # II TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfers to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 5% of EMC's net liabilities, pursuant to Article V, effective January 1, 1992. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Illinois EMCASCO Insurance Company 8 % Union Mutual Insurance Company of Providence 2.5% 29.5% ----- EMC's Net Retained Portions of its Net Liabilities is 70.5% ----- 100.0% Executed by the parties hereto this 20th day of December, 1991. Employers Mutual Casualty Company By:/s/Richard E. Haskins ------------------------------ Dakota Fire Insurance Company By:/s/Bruce G. Kelley ------------------------------ ENDORSEMENT NO. I TO REINSURANCE POOLING AGREEMENT BETWEEN DAKOTA FIRE INSURANCE CO. AND EMPLOYERS MUTUAL CASUALTY COMPANY Whereby Dakota Fire Insurance Company does not desire to become licensed in the State of Iowa which disallows credits taken by Employers Mutual Casualty Company in their financial statements for unearned premium reserve and loss reserve for reinsurance ceded to Dakota Fire Insurance Company. In consideration of continuing with a reinsurance program between the companies, Dakota Fire Insurance Company does place the Bond and Corporate Note portion of their Custodial Account Number 1929009 at the Bankers Trust Company, Des Moines, Iowa, under the control of Employers Mutual Casualty Company. The market value of the account exceeds $9,000,000 and that amount or a greater amount will be maintained there during the life of this Agreement. It is further agreed that there will be no bonds cashed by Employers Mutual casualty Company for their benefit unless Dakota Fire Insurance Company defaults on the reinsurance contract. This contract may be terminated by either party at such a time as may be mutually agreeable. Executed by the parties hereto 25th Day of November 1986. DAKOTA FIRE INSURANCE COMPANY By:/s/Robb B. Kelley ------------------------------ EMPLOYERS MUTUAL CASUALTY COMPANY By:/s/Richard E. Haskins ------------------------------ ENDORSEMENT NO. II TO REINSURANCE POOLING AGREEMENT BETWEEN DAKOTA FIRE AND EMPLOYERS MUTUAL CASUALTY COMPANY Endorsement No. I is hereby deleted from this Agreement. Executed by the Parties this 4th day of March, 1993. Employers Mutual Casualty Company By:/s/Fred A. Schiek ------------------------------ Dakota Fire Insurance Company By:/s/Bruce G. Kelley ------------------------------ AMENDMENT #II TO INTERESTS AND LIABILITY EXHIBIT II TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in Addendum #I to the Reinsurance Pooling Agreement to which this Exhibit is attached, EMC and the affiliated company which is signatory to this Exhibit each do hereby ratify Addendum #I as a part of the Pooling Agreement effective from January 1, 1993. Executed by the parties this 23rd day of December, 1992. Employers Mutual Casualty Company By:/s/Bruce G. Kelley ------------------------------ Dakota Fire Insurance Company By:/s/Fred A. Schiek ------------------------------ AMENDMENT #III TO INTEREST AND LIABILITIES EXHIBIT #II TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT This Amendment is effective January 1, 1997. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Hamilton Mutual Insurance Company of Cincinnati, Ohio 5 % Illinois EMCASCO Insurance Company 8 % Union Insurance Company of Providence 2.5% ----- 34.5% EMC's Net Retained Portion of its Net Liabilities is 65.5% ----- 100.0% Executed by the parties hereto this 26th day of March, 1997. Employers Mutual Casualty Company By: /s/Bruce G. Kelley ----------------------------- Dakota Fire Insurance Company By: /s/Fred A. Schiek ----------------------------- INTEREST AND LIABILITIES EXHIBIT #III TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfer to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 6% of EMC's net liabilities, pursuant to Article V, effective January 1, 1987. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the date of this Addendum, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 3 % EMCASCO Insurance Company 8 % Illinois EMCASCO Insurance Company 6 % Union Mutual Insurance Company of Providence 2.5% ----- 24.5% EMC's Net Retained Portions of its Net Liabilities is 75.5% ----- 100.0% Executed by the parties hereto this 25th day of November, 1986. EMPLOYERS MUTUAL CASUALTY COMPANY By:/s/Richard E. Haskins ------------------------------- ILLINOIS EMCASCO INSURANCE COMPANY By:/s/Robb B. Kelley ------------------------------- AMENDMENT # I TO INTEREST AND LIABILITIES EXHIBIT # III TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfers to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 8% of EMC's net liabilities, pursuant to Article V, effective January 1, 1992. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Illinois EMCASCO Insurance Company 8 % Union Mutual Insurance Company of Providence 2.5% ----- 29.5% EMC's Net Retained Portions of its Net Liabilities is 70.5% ----- 100.0% Executed by the parties hereto this 20th day of December, 1991. Employers Mutual Casualty Company By:/s/Richard E. Haskins ------------------------------- Illinois EMCASCO Insurance Company By:/s/Bruce G. Kelley ------------------------------- AMENDMENT #II TO INTERESTS AND LIABILITY EXHIBIT III TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in Addendum #I to the Reinsurance Pooling Agreement to which this Exhibit is attached, EMC and the affiliated company which is signatory to this Exhibit each do hereby ratify Addendum #I as a part of the Pooling Agreement effective from January 1, 1993. Executed by the parties this 23rd day of December, 1992. Employers Mutual Casualty Company By:/s/Bruce G. Kelley ------------------------------- Illinois EMCASCO Insurance Company By:/s/Fred A. Schiek ------------------------------- AMENDMENT #III TO INTEREST AND LIABILITIES EXHIBIT #III TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT This Amendment is effective January 1, 1997. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Hamilton Mutual Insurance Company of Cincinnati, Ohio 5 % Illinois EMCASCO Insurance Company 8 % Union Insurance Company of Providence 2.5% ----- 34.5% EMC's Net Retained Portion of its Net Liabilities is 65.5% ----- 100.0% Executed by the parties hereto this 26th day of March, 1997. Employers Mutual Casualty Company By: /s/Bruce G. Kelley ------------------------------ Illinois EMCASCO Insurance Company By: /s/Fred A. Schiek ------------------------------ INTEREST AND LIABILITIES EXHIBIT #IV TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfers to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 8% of EMC's net liabilities, pursuant to Article V, effective January 1, 1987. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the date of this Addendum, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 3 % EMCASCO Insurance Company 8 % Illinois EMCASCO Insurance Company 6 % Union Mutual Insurance Company of Providence 2.5% ----- 24.5% EMC's Net Retained Portions of its Net Liabilities is 75.5% ----- 100.0% Executed by the parties hereto this 25th day of November, 1986. Employers Mutual Casualty Company By:/s/Richard E. Haskins ------------------------------ EMCASCO Insurance Company By:/s/Robb B. Kelley ------------------------------ AMENDMENT # I TO INTEREST AND LIABILITIES EXHIBIT # IV TO EMPLOYERS MUTUAL COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in the Reinsurance Pooling Agreement to which this exhibit is attached, by and between EMC and the Affiliated Company which is signatory to this exhibit, EMC hereby cedes and transfers to the Affiliated Company, and the Affiliated Company hereby accepts reinsurance thereon, 9% of EMC's net liabilities, pursuant to Article V, effective January 1, 1992. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Illinois EMCASCO Insurance Company 8 % Union Mutual Insurance Company of Providence 2.5% ----- 29.5% EMC's Net Retained Portions of its Net Liabilities is 70.5% ----- 100.0% Executed by the parties hereto this 20th day of December, 1991. Employers Mutual Casualty Company By:/s/Richard E. Haskins ------------------------------ EMCASCO Insurance Company By:/s/Bruce G. Kelley ------------------------------ AMENDMENT #II TO INTERESTS AND LIABILITY EXHIBIT IV TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT In consideration of the covenants and agreements as reflected in Addendum #I to the Reinsurance Pooling Agreement to which this Exhibit is attached, EMC and the affiliated company which is signatory to this Exhibit each do hereby ratify Addendum #I as a part of the Pooling Agreement effective from January 1, 1993. Executed by the parties this 23rd day of December, 1992. Employers Mutual Casualty Company By:/s/Bruce G. Kelley ------------------------------ EMCASCO Insurance Company By:/s/Fred A. Schiek ------------------------------ AMENDMENT #III TO INTEREST AND LIABILITIES EXHIBIT #IV TO EMC INSURANCE COMPANIES REINSURANCE POOLING AGREEMENT This Amendment is effective January 1, 1997. The Affiliated Companies signatory to this Agreement and their assumed portions of the net liabilities of EMC are, as of the effective date of this Amendment, as follows: American Liberty Insurance Company 5 % Dakota Fire Insurance Company 5 % EMCASCO Insurance Company 9 % Hamilton Mutual Insurance Company of Cincinnati, Ohio 5 % Illinois EMCASCO Insurance Company 8 % Union Insurance Company of Providence 2.5% ----- 34.5% EMC's Net Retained Portion of its Net Liabilities is 65.5% ----- 100.0% Executed by the parties hereto this 26th day of March, 1997. Employers Mutual Casualty Company By: /s/Bruce G. Kelley ----------------------------- EMCASCO Insurance Company By: /s/Fred A. Schiek ----------------------------- EX-13.A 3 SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA. EXHIBIT 13(a) - ------------------------ ------------- Year ended December 31, -------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- (In thousands, except per share amounts) Income Statement Data Insurance premiums earned ... $177,218 $165,191 $162,266 $164,829 $156,438 $147,410 $113,419 $101,323 $ 91,728 $ 88,598 $95,531 Investment income, net ...... 23,760 23,907 23,174 20,930 20,780 21,540 20,202 19,884 19,309 16,623 13,632 Realized investment gains ... 4,100 1,891 1,043 520 684 384 65 48 257 36 177 Other income ................ 219 274 344 434 259 - - - - - - -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Total revenues ......... 205,297 191,263 186,827 186,713 178,161 169,334 133,686 121,255 111,294 105,257 109,340 Losses and expenses ......... 188,494 170,594 162,511 168,036 169,142 168,359 123,254 110,415 102,517 89,795 96,612 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Income before income taxes .. 16,803 20,669 24,316 18,677 9,019 975 10,432 10,840 8,777 15,462 12,728 Income taxes ................ 3,586 5,635 6,967 5,171 1,885 759 3,124 2,894 2,055 3,920 2,271 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Income from: Continuing operations .... 13,217 15,034 17,349 13,506 7,134 216 7,308 7,946 6,722 11,542 10,457 Discontinued operations .. - - - - - - 1,853 319 274 263 225 Accounting changes ....... - - - - 2,621 - - - - - - -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Net income ............ $ 13,217 $ 15,034 $ 17,349 $ 13,506 $ 9,755 $ 216 $ 9,161 $ 8,265 $ 6,996 $ 11,805 $10,682 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======= Earnings per common share: Income from: Continuing operations .. $ 1.18 $ 1.37 $ 1.62 $ 1.29 $ .70 $ .02 $ .73 $ .80 $ .71 $ 1.29 $ 1.23 Discontinued operations - - - - - - .18 .03 .03 .03 .03 Accounting changes ..... - - - - .26 - - - - - - -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Total ................. $ 1.18 $ 1.37 $ 1.62 $ 1.29 $ .96 $ .02 $ .91 $ .83 $ .74 $ 1.32 $ 1.26 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======= Premiums earned by segment: Property and casualty ..... $132,875 $119,282 $116,439 $115,412 $109,585 $109,139 $ 78,413 $ 70,597 $ 62,517 $ 54,178 $51,534 Reinsurance ............... 34,105 36,675 35,826 37,256 33,324 26,615 25,009 20,696 18,621 21,417 29,808 Nonstandard risk automobile 10,238 9,234 10,001 12,161 13,529 11,656 9,997 10,030 10,590 13,003 14,189 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ------- Total ..................$177,218 $165,191 $162,266 $164,829 $156,438 $147,410 $113,419 $101,323 $ 91,728 $ 88,598 $95,531 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======= Balance Sheet Data Total assets ................ $459,110 $430,328 $412,881 $387,370 $368,936 $372,807 $311,001 $296,126 $284,396 $266,812 $235,435 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Stockholders' equity ........ $162,346 $148,729 $136,889 $116,727 $109,634 $100,911 $105,144 $100,615 $ 95,911 $ 89,604 $ 78,240 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
SELECTED FINANCIAL DATA.(continued) EXHIBIT 13(a) - ----------------------------------- ------------- Year ended December 31, -------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (In thousands, except per share amounts) Other Data Average return on equity .... 8.5% 10.5% 13.7% 11.9% 9.3% .2% 8.9% 8.4% 7.5% 14.1% 14.4% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Book value per share ........ $ 14.30 $ 13.42 $ 12.66 $ 11.03 $ 10.63 $ 9.98 $ 10.47 $ 10.04 $ 9.82 $ 9.65 $ 9.01 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Dividends paid per share .... $ .60 $ .57 $ .53 $ .52 $ .52 $ .52 $ .52 $ .52 $ .52 $ .49 $ .48 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Property and casualty segment pool percentage ........... 22% 22% 22% 22% 22% 22% 17% 17% 17% 17% 17% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Reinsurance subsidiary quota share percentage .......... 100% 95% 95% 95% 95% 95% 95% 95% 95% 95% 75% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Closing stock price ......... $ 13 1/4 $ 12 $ 13 3/4 $ 9 1/2 $ 9 1/2 $ 8 1/2 $ 9 1/2 $ 6 7/8 $ 8 $ 7 3/4 $ 7 1/2 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Net investment yield (pretax) 6.14% 6.51% 6.64% 6.55% 6.78% 7.47% 7.99% 8.49% 8.75% 8.28% 8.03% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Cash dividends to closing stock price........ 4.5% 4.8% 3.9% 5.5% 5.5% 6.1% 5.5% 7.6% 6.5% 6.3% 6.4% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Common shares outstanding ... 11,351 11,084 10,814 10,577 10,317 10,112 10,046 10,015 9,762 9,287 8,684 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Statutory combined ratio .... 106.2% 103.6% 99.6% 101.3% 106.3% 113.9% 109.2% 109.5% 112.7% 98.7% 99.8% ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
EX-13.B 4 MANAGEMENT DISCUSSION AND ANALYSIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL EXHIBIT 13(b) ------------------------------------------------- ------------- CONDITION AND RESULTS OF OPERATIONS. ------------------------------------ The following discussion and analysis of EMC Insurance Group Inc. and its subsidiaries' financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere herein. OVERVIEW EMC Insurance Group Inc., 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 an excess and surplus lines insurance agency. Property and casualty insurance is the most significant segment, representing 75.0 percent of consolidated premiums earned. For purposes of this discussion, the term "Company" is used interchangeably to describe EMC Insurance Group Inc. (Parent company only) and EMC Insurance Group Inc. and its subsidiaries. The three property and casualty insurance subsidiaries of the Company and two subsidiaries and an affiliate of Employers Mutual are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. The aggregate participation of the Company's property and casualty insurance subsidiaries is 22 percent. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment activities and income tax liabilities of the pool participants are not subject to the pooling agreement. The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all the companies. The pooling agreement produces a more uniform and stable underwriting result from year to year for all companies in the pool than might be experienced individually. In addition, each company benefits from the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own assets, and from the wide range of policy forms, lines of insurance written, rate filings and commission plans offered by each of the companies. A single set of reinsurance treaties is maintained for the protection of all seven companies in the pool. Effective January 1, 1997, Hamilton Mutual Insurance Company (Hamilton Mutual), a new affiliate of Employers Mutual, became a participant in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,000 and invested assets increased $5,674,000. The Company reimbursed Employers Mutual $794,000 for commissions incurred to generate this business and Employers Mutual paid the Company $75,000 in interest income as the actual cash transfer did not occur until March 24, 1997. On December 19, 1997, the Company announced that its nonstandard risk automobile insurance subsidiary (Farm and City Insurance Company) will become a participant in the pooling agreement effective January 1, 1998. The nonstandard risk automobile insurance subsidiary will receive a 1.5 percent participation in the pool, which will increase the Company's aggregate participation to 23.5 percent. Revenues of the Company are expected to increase by approximately $2,000,000 due to the increase in the size of the pool. The Company's reinsurance subsidiary assumes a quota share portion of Employers Mutual's assumed reinsurance business, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its quota share portion of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss assumed per event was increased from $1,000,000 to $1,500,000. In connection with the change in the quota share percentage, the Company's liabilities increased $3,174,000 and invested assets increased $3,067,000. The Company reimbursed Employers Mutual $107,000 for commissions incurred to generate this business. The Company's nonstandard risk automobile insurance subsidiary specializes in insuring private passenger automobile risks that are found to be unacceptable in the standard automobile insurance market. The excess and surplus lines insurance agency provides insurance agents access to the excess and surplus lines markets and also functions as managing underwriter for such lines for Employers Mutual and several of the pool members. CONSOLIDATED RESULTS OF OPERATIONS Operating results for the three years ended December 31, 1997 are as follows: ($ in thousands) 1997 1996 1995 -------- -------- -------- Premiums earned .......................... $177,218 $165,191 $162,266 Losses and settlement expenses ........... 129,853 115,367 108,152 Acquisition and other expenses ........... 58,641 55,227 54,359 -------- -------- -------- Underwriting loss ........................ (11,276) (5,403) (245) Net investment income .................... 23,760 23,907 23,174 Realized investment gains ................ 4,100 1,891 1,043 Other income ............................. 219 274 344 -------- -------- -------- Operating income before income taxes ..... $ 16,803 $ 20,669 $ 24,316 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $137,300 $131,375 $123,877 Decrease in provision for insured events of prior years ................ (7,447) (16,008) (15,725) -------- -------- -------- Total losses and settlement expenses $129,853 $115,367 $108,152 ======== ======== ======== Catastrophe and storm losses ............. $ 5,846 $ 9,192 $ 6,603 ======== ======== ======== Operating income before income taxes declined in 1997 and 1996 after increasing substantially in 1995. The decline in 1997 operating results is primarily attributable to the property and casualty insurance subsidiaries, although all segments contributed to the decline. The major factor influencing this decline was a substantial decrease in the amount of favorable development experienced in the actual settlement of claims and changes in reserves associated with prior year losses. The decline in 1996 operating results was also attributable to the property and casualty insurance subsidiaries, which experienced an unusually large number of commercial property losses. Results for 1995 reflect a substantial improvement in the operations of the reinsurance subsidiary and a solid increase in the performance of the property and casualty insurance subsidiaries. Premium income increased substantially in 1997 after rising moderately in 1996. The majority of this increase came from the property and casualty insurance subsidiaries, which benefitted from the addition of Hamilton Mutual to the pooling agreement. The nonstandard risk automobile insurance subsidiary also reported an increase in premium income while the reinsurance subsidiary experienced a decline. For the year 1996, the property and casualty insurance subsidiaries and the reinsurance subsidiary had increases in premium income while the nonstandard risk automobile insurance subsidiary reported a decline. Losses and settlement expenses increased significantly in 1997, reflecting a substantial decrease in the amount of favorable development experienced in the actual settlement of claims and changes in reserves associated with prior year losses. This decrease in favorable development was partially offset by lower catastrophe and storm losses reported by the reinsurance subsidiary and the property and casualty insurance subsidiaries. For the year 1996, losses and settlement expenses increased despite the benefit of an elevated level of favorable development in the actual settlement of claims and changes in reserves associated with prior year losses. This was primarily due to an unusually large number of commercial property losses experienced by the property and casualty insurance subsidiaries and a substantial increase in catastrophe losses in the reinsurance subsidiary. Acquisition and other expenses have increased steadily over the last three years. These increases are primarily attributable to higher commission rates associated with the property business written by the property and casualty insurance subsidiaries, increased contingent commission expense on the reinsurance subsidiary's assumed business and various loss control functions that have been implemented. The increase for 1997 also reflects commission expense incurred by the property and casualty insurance subsidiaries in connection with the addition of Hamilton Mutual to the pooling agreement and the reinsurance subsidiary in connection with the increase in the quota share percentage. Investment income declined in 1997 after increasing in 1996 and 1995. This decline was attributable to a reduction in the average rate of return earned on fixed maturity investments, which more than offset an increase in the Company's average invested asset balance. Realized gains on investments increased significantly in 1997 and more moderately in 1996 as a result of capital gain distributions from the Company's investment in common stock mutual funds. Proceeds from these distributions were reinvested in the mutual funds. SEGMENT RESULTS Property and Casualty Insurance Operating results for the three years ended December 31, 1997 are as follows: ($ in thousands) 1997 1996 1995 -------- -------- -------- Premiums earned .......................... $132,874 $119,282 $116,439 Losses and settlement expenses ........... 97,083 82,034 74,926 Acquisition and other expenses ........... 44,027 41,150 40,030 -------- -------- -------- Underwriting (loss) gain ................. (8,236) (3,902) 1,483 Net investment income .................... 15,529 15,828 15,428 Realized investment gains ................ 4,071 1,790 1,027 -------- -------- -------- Operating income before income taxes ..... $ 11,364 $ 13,716 $ 17,938 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ..... $102,557 $ 93,965 $ 87,411 Decrease in provision for insured events of prior years ................ (5,474) (11,931) (12,485) -------- -------- -------- Total losses and settlement expenses $ 97,083 $ 82,034 $ 74,926 ======== ======== ======== Catastrophe and storm losses ............. $ 4,570 $ 4,935 $ 5,671 ======== ======== ======== Premium income increased substantially in 1997 after rising moderately in 1996 and 1995. The large increase for 1997 was due in part to the addition of Hamilton Mutual to the pooling agreement, which added $8,634,000 to premium income. The remaining increase was generated from the existing branch structure, where competitive rates and a strong working relationship with local agents played a critical role in this very competitive environment. Marketing programs emphasizing property insurance targeted at commercial insureds contributed to this increase in production, as did an increased marketing emphasis in the South. Premium income from mandatory assigned risk business continued to decline in 1997; however, this decline is looked at favorably as losses associated with this type of business are generally higher than losses associated with controlled business. Premium growth in the workers' compensation line of business continued to be hampered by rate decreases in 1997, although not to the extent experienced in 1996 when the states of Iowa, Illinois, Kansas and Nebraska implemented large rate decreases. Losses and settlement expenses increased substantially in 1997 and 1996 after declining in 1995. The large increase for 1997 was attributable to a significant decrease in the amount of favorable development experienced in the actual settlement of claims and changes in reserves associated with prior year losses as well as the increase in the size of the pool with the addition of Hamilton Mutual. The decline in favorable development was not unexpected and has been discussed in previous comments published by the Company. The large increase for 1996 was primarily due to an unusually large number of severe commercial property losses. Acquisition and other expenses increased in 1997 as a result of the increase in the size of the pool and the payment of $794,000 of commission expense related to the transfer of unearned premiums to the Company in connection with the pool change. Additional items affecting the growth in expenses include higher commission rates on the growing book of property business as well as expenses associated with various loss control functions that have been implemented. The decline in 1997 underwriting results is primarily related to the large decrease in the amount of favorable development experienced in the actual settlement of claims and changes in reserves associated with prior year losses. As previously noted, this decline in favorable development was not unexpected; however, the impact of the decline was compounded by a second consecutive year of an elevated loss and settlement expense ratio associated with current accident year losses. Unlike 1996, when the elevated loss and settlement expense ratio was attributable to an increase in loss frequency and severity, the elevated loss and settlement expense ratio for 1997 is more closely associated with the highly competitive marketplace for commercial lines of insurance. Rates for commercial lines of insurance continue to decline due to excess capitalization in the insurance industry. As a result, increases in premium income are not keeping pace with increases in loss costs. Management is aware of the narrowing profit margin on commercial lines of insurance and continues to emphasize the use of strict underwriting guidelines. Reinsurance Operating results for the three years ended December 31, 1997 are as follows: ($ in thousands) 1997 1996 1995 -------- -------- -------- Premiums earned ............................ $ 34,106 $ 36,675 $ 35,826 Losses and settlement expenses ............. 23,306 25,180 23,744 Acquisition and other expenses ............. 11,752 11,457 11,584 -------- -------- -------- Underwriting (loss) gain ................... (952) 38 498 Net investment income ...................... 6,615 6,436 6,068 Realized investment gains .................. 23 73 13 Other income ............................... 219 274 344 -------- -------- -------- Operating income before income taxes ....... $ 5,905 $ 6,821 $ 6,923 ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ....... $ 25,109 $ 28,877 $ 26,668 Decrease in provision for insured events of prior years .................. (1,803) (3,697) (2,924) -------- -------- -------- Total losses and settlement expenses $ 23,306 $ 25,180 $ 23,744 ======== ======== ======== Catastrophe losses ......................... $ 1,276 $ 4,257 $ 932 ======== ======== ======== Premium income decreased in 1997 despite an increase in the quota share percentage from 95 percent to 100 percent and the cancellation of an aggregate reinsurance treaty with Employers Mutual. This decrease is primarily due to rate reductions caused by the competitive reinsurance marketplace and the absence of run-off premium recognized in 1996 related to the cancellation of several large pro rata treaties in 1995. For the year 1996, premium income increased slightly despite a decline in production. This increase was primarily attributable to a change in the mix of business from pro rata reinsurance to excess of loss reinsurance, which generally earns premiums more rapidly. Losses and settlement expenses have fluctuated over the last three years in connection with the changes experienced in premium volume. Results for 1997 benefitted from a substantial decrease in catastrophe losses; however, this decline was partially offset by a reduction in the amount of benefit realized from the actual settlement of claims and changes in reserves associated with prior year losses. Results for 1996 were negatively impacted by a large increase in catastrophe losses. Acquisition and other expenses increased slightly in 1997, despite the decline in premium income. This increase is primarily due to an increase in the reserve for contingent commissions, which is associated with the favorable loss results experienced on the reinsurance book of business. Underwriting results have declined during the last two years from the exceptionally good results achieved in 1995, but are still considered very favorable. Excluding the effect of catastrophe losses, which vary greatly from year to year, the loss and settlement expense ratio associated with insured events of the current year deteriorated in 1997. This decline is primarily due to the rate reductions noted above, which are the result of excess capacity in the reinsurance marketplace. The reinsurance subsidiary is working to address this issue by accepting a larger share of coverage on desirable programs and strengthening its relationships with reinsurance intermediaries. Management is aware of the narrowing profit margin on reinsurance business and continues to emphasize profitability over premium volume. Nonstandard Risk Automobile Insurance Operating results for the three years ended December 31, 1997 are as follows: ($ in thousands) 1997 1996 1995 -------- -------- -------- Premiums earned ............................ $ 10,238 $ 9,234 $ 10,001 Losses and settlement expenses ............. 9,464 8,153 9,482 Acquisition and other expenses ............. 2,965 2,640 2,775 -------- -------- -------- Underwriting loss .......................... (2,191) (1,559) (2,256) Net investment income ...................... 1,011 1,111 1,175 Realized investment gains .................. 6 28 3 -------- -------- -------- Operating loss before income taxes ......... $ (1,174) $ (420) $ (1,078) ======== ======== ======== Incurred losses and settlement expenses: Insured events of the current year ....... $ 9,634 $ 8,533 $ 9,798 Decrease in provision for insured events of prior years .................. (170) (380) (316) -------- -------- -------- Total losses and settlement expenses $ 9,464 $ 8,153 $ 9,482 ======== ======== ======== Premium income increased in 1997 for the first time since 1993. This increase was the result of renewed marketing efforts toward new and existing agents and a competitive rate structure. The nonstandard marketplace remains highly competitive. Standard carriers in search of premium income continue to actively pursue marginal risks that previously would have stayed in the nonstandard market. As a result, nonstandard carriers are competing for a smaller pool of potential insureds, which has led to intense rate competition. Losses and settlement expenses have fluctuated over the last three years in connection with the change in premium volume; however, the amounts for 1997 and 1995 also reflect a higher level of losses associated with poor winter driving conditions. Results for 1997 also include a change to a more conservative reserving methodology. Acquisition and other expenses increased slightly in 1997 after declining in 1996 and 1995. This increase primarily reflects costs associated with the company's renewed marketing efforts. Underwriting results remained unprofitable for the third consecutive year, the result of conflicting market forces at work in the nonstandard marketplace. As previously noted, the nonstandard market has been faced with a smaller pool of potential insureds due to the relaxed underwriting standards being utilized by the standard carriers. This reduction in potential insureds has led to increased rate competition, even though the pool of potential insureds contains a higher percentage of high risk drivers. The combination of reduced rates and increased loss costs has resulted in very poor underwriting results. Management is working to improve both rate adequacy and the overall quality of the book of business in 1998. As previously noted, the nonstandard risk automobile insurance subsidiary will become a participant in the pooling agreement effective January 1, 1998. As a result of this change, future operating results for the nonstandard risk automobile insurance subsidiary will be included in the amounts reported for the property and casualty insurance subsidiaries and will no longer be presented as a separate segment of business. Excess and Surplus Lines Insurance Agency Operating income before income taxes increased to $576,000 in 1997, up from $458,000 in 1996 and $483,000 in 1995. The increase for 1997 reflects increased commission income resulting from the introduction of a new long-haul trucking program. Prior to 1997, operating income before income taxes had decreased three consecutive years. These declines were primarily due to a reduction in commission income caused by increased competition for excess and surplus lines business. Competition for excess and surplus lines business remains intense as a number of insurance carriers continue to pursue opportunities in the excess and surplus lines market. Parent Company Operating income before income taxes increased to $132,000 in 1997 from $94,000 in 1996 and $50,000 in 1995. The improvement in 1997 and 1996 is primarily due to additional investment income that resulted from an increase in the invested asset balance. LOSS AND SETTLEMENT EXPENSE RESERVES Loss and settlement expense reserves are the Company's largest liability. Management continually reviews these reserves using a variety of statistical and actuarial techniques to analyze claim costs, frequency and severity data, and social and economic factors. Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of the loss. During the loss settlement period, additional facts regarding individual claims become known, and accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. Estimating loss and settlement expense reserves for asbestos and environmental claims is very difficult due to the many uncertainties surrounding these types of claims. Such uncertainties include the fact that the assignment of responsibility varies widely by state and claims often emerge long after the policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult. In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, the social and political conditions and the claim history and trends within the Company and the industry. The Company's financial results have not been materially affected by losses associated with asbestos and environmental exposures. The Company's environmental claims activity is predominately related to pollution from hazardous waste of former insureds. The parties to the pooling agreement have not written primary coverage for the major oil or chemical companies. The greatest exposure arises out of claims from small regional operations or local businesses 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, and gasoline stations. The remaining 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 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. 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. Unrealized holding gains on fixed maturity securities available-for-sale, net of tax, totaled $4,577,000 at December 31, 1997 compared to $2,141,000 and $3,472,000 at December 31, 1996 and 1995, respectively. Since the Company does not actively trade in the bond market, such fluctuations in the fair value of these investments are not expected to have a material impact on the operations of the Company, as forced liquidations of investments are not anticipated. The Company closely monitors the bond market and makes appropriate adjustments in investment policy as changing conditions warrant. The majority of the Company's assets are invested in fixed maturities. These investments provide a substantial amount of income which supplements underwriting results and contributes to net earnings. As these investments mature the proceeds will be reinvested at current rates, which may be higher or lower than those now being earned; therefore, more or less investment income may be available to contribute to net earnings depending on the interest rate level. 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 1997, the Company generated positive cash flows from operations of $22,564,000 compared to $17,097,000 in 1996 and $24,651,000 in 1995. The amount for 1997 includes $8,741,000 received from Employers Mutual in connection with the change in the pooling agreement and the increase in the quota share percentage. CAPITAL RESOURCES As of December 31, 1997, 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 operation does not require a large amount of capital. The National Association of Insurance Commissioners (NAIC) maintains certain risk-based capital standards for property and casualty insurance companies. Risk-based capital requirements attempt to measure minimum statutory capital needs based upon the risks in a company's mix of products and investment portfolio. At December 31, 1997, each of the Company's insurance subsidiaries has a ratio of total adjusted capital to risk-based capital well in excess of the minimum level required. A major source of cash flows for the Company is dividend payments from its subsidiaries. State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval. See note 6 of Notes to Consolidated Financial Statements for additional information regarding dividend restrictions. The Company received $3,750,000, $3,060,000 and $3,200,000 of dividends from its insurance subsidiaries in 1997, 1996 and 1995, respectively, and $1,000,000 from its insurance agency in 1995. The Company paid cash dividends to its stockholders totaling $4,314,000, $4,017,000 and $3,653,000 in 1997, 1996 and 1995, respectively. Total dividends, including amounts reinvested in shares of the Company's common stock, amounted to $6,715,000, $6,234,000 and $5,662,000 in 1997, 1996 and 1995, respectively. For the last three years, Employers Mutual has elected to receive 50 percent of its dividends in common stock under the Company's dividend reinvestment and common stock purchase plan. 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. IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS Employers Mutual owns and maintains the computer systems utilized in the operation of the Company's businesses. Employers Mutual is currently in the process of finalizing changes to these systems in order to be Year 2000 compliant. Most systems have been updated and all remaining work is scheduled for completion and testing in 1998. The Company, under the terms of the pooling agreement, will be a 23.5 percent participant in the remaining costs associated with this project. These costs are not expected to be material to the Company's financial position or its results of operations. Employers Mutual is also aware of and monitoring Year 2000 compliance on systems from outside third parties with which it interacts. By verifying Year 2000 compliance with these parties, management is further minimizing the risks of Year 2000 noncompliance. NEW ACCOUNTING PRONOUNCEMENTS The Company adopted Statement of Financial Accounting Standards (SFAS) 128, "Earnings Per Share" in the fourth quarter of 1997. SFAS 128 simplifies the computation of net income per share and specifies the disclosure requirement of basic and diluted net income per share. Adoption of this statement did not change the income or the number of shares used to compute the Company's net income per share. The Company will adopt the disclosure requirements of SFAS 130, "Reporting Comprehensive Income" in the first quarter of 1998. Adoption of this statement will have no effect on the income of the Company. The Company will adopt the presentation requirements of SFAS 131, "Disclosures about Segments of an Enterprise and Related Information" in the fourth quarter of 1998. Management is currently in the process of evaluating the segment reporting disclosure requirements. Adoption of this statement will have no effect on the income of the Company. The Company will adopt the disclosure requirements of SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" in the first quarter of 1998. Adoption of this statement will have no effect on the income of the Company. DEVELOPMENTS IN INSURANCE REGULATION In 1996 the NAIC adopted model legislation governing insurance company investments. This model investment law has been adopted by one state (Illinois) and is not expected to have a material impact on the operations of the Company's insurance subsidiaries. The NAIC is in the final stages of a project to codify statutory accounting principles. The goal of this project is to establish a uniform set of accounting rules and regulations that will be utilized by all insurance companies when preparing financial reports submitted to regulatory authorities. Nearly all issue papers documenting this new comprehensive basis of accounting have been finalized; however, the approval process is not yet complete. The Company has begun a study to determine the impact of adopting the proposed accounting and reporting requirements in the codification of statutory accounting principles, but is unable to determine what impact, if any, this project will have on the statutory surplus of its insurance subsidiaries when enacted. CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS The 1995 Private Securities Litigation Reform Act provides issuers the opportunity to make cautionary statements regarding forward-looking statements. Accordingly, any forward-looking statement contained herein or in any other oral or written statement by the Company or any of its officers, directors or employees is qualified by the fact that actual results of the Company may differ materially from such statement due to the following important factors, among other risks and uncertainties inherent in the Company's business: catastrophic events, state insurance regulations, rate competition, adverse changes in interest rates, unforeseen losses with respect to loss and settlement expense reserves for unreported and reported claims, including asbestos and environmental claims. EX-13.C 5 FINANCIAL STATEMENTS AND FOOTNOTES FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. EXHIBIT 13(c) - -------------------------------------------- ------------- Management's Responsibility for Financial Reporting The management of EMC Insurance Group Inc. and Subsidiaries is responsible for the preparation and for the integrity and objectivity of the accompanying financial statements and other financial information in this report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based on management's estimates and judgments where necessary. The Company's financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. Management has made available to KPMG Peat Marwick LLP all of the Company's financial records and related data, as well as the minutes of the shareholders' and directors' meetings. Furthermore, management believes that all representations made to KPMG Peat Marwick LLP during its audit were valid and appropriate. Their report appears elsewhere in this annual report. Management of the Company has established and maintains a system of internal controls that are designed to provide assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal controls provides for appropriate division of responsibility. Certain aspects of these systems and controls are tested periodically by the Company's internal auditors. Management considers the recommendations of its internal auditors and independent public accountants concerning the Company's internal controls and takes the necessary actions that are cost-effective in the circumstances to respond appropriately to the recommendations presented. Management believes that as of December 31, 1997, the Company's system of internal controls was adequate to accomplish the above objectives. The Audit Committee of the Board of Directors, composed solely of outside directors, met during the year with management and the independent accountants to review and discuss audit findings and other financial and accounting matters. The independent accountants and the internal auditors have free access to the Audit Committee, with and without management present, to discuss the results of their audit work. /s/ Bruce G. Kelley /s/ Mark E. Reese - ------------------------------------ ------------------------------------- Bruce G. Kelley Mark E. Reese President, Treasurer and Chief Vice President Executive Officer Chief Financial Officer Independent Auditors' Report The Board of Directors and Stockholders EMC Insurance Group Inc.: We have audited the accompanying consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Des Moines, Iowa February 26, 1998 EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, -------------------------- 1997 1996 ------------ ------------ ASSETS Investments (note 9): Fixed maturities: Securities held-to-maturity, at amortized cost (fair value $193,835,013 and $194,655,256) $185,829,063 $188,385,721 Securities available-for-sale, at fair value (amortized cost $172,717,206 and $146,794,158) 179,652,738 150,038,644 Equity securities available-for-sale, at fair value (cost $26,261,157 and $21,236,281) ...... 30,972,732 24,040,381 Short-term investments, at cost ................. 14,926,994 17,553,606 ------------ ------------ Total investments .......................... 411,381,527 380,018,352 Cash .............................................. 1,200,300 3,500,629 Indebtedness of related party (note 2) ........... 822,403 - Accrued investment income ......................... 5,752,295 6,567,186 Accounts receivable ............................... 1,457,312 740,736 Deferred policy acquisition costs ................. 10,560,657 9,021,863 Deferred income taxes (note 10) ................... 9,751,721 10,974,425 Intangible assets, including goodwill, at cost less accumulated amortization of $2,078,182 and $1,943,669 .................................. 1,479,638 1,614,151 Reinsurance receivables (note 3) .................. 13,601,691 14,735,786 Prepaid reinsurance premiums (note 3) ............. 1,195,065 1,516,972 Other assets ...................................... 1,907,187 1,637,473 ------------ ------------ Total assets ............................... $459,109,796 $430,327,573 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, -------------------------- 1997 1996 ------------ ------------ LIABILITIES Losses and settlement expenses (notes 2,4 and 5) $217,777,942 $202,502,986 Unearned premiums (note 2) ....................... 54,857,463 47,908,954 Other policyholders' funds ....................... 2,781,544 3,467,449 Indebtedness to related party (note 2) ........... - 7,000,482 Income taxes payable ............................. 3,548,000 2,942,000 Postretirement benefits (note 12) ................ 5,428,913 4,932,834 Deferred income .................................. 446,678 665,550 Other liabilities ................................ 11,922,800 12,178,290 ------------ ------------ Total liabilities ......................... 296,763,340 281,598,545 ------------ ------------ STOCKHOLDERS' EQUITY (notes 6,7,9 and 13) Common stock, $1 par value, authorized 20,000,000 shares; issued and outstanding, 11,351,119 shares in 1997 and 11,084,461 shares in 1996 .......... 11,351,119 11,084,461 Additional paid-in capital ....................... 65,916,681 62,762,613 Unrealized holding gains on fixed maturity securities available-for-sale, net of tax ..................................... 4,577,452 2,141,361 Unrealized holding gains on equity securities available-for-sale, net of tax ................. 3,109,640 1,850,706 Retained earnings ................................ 77,391,564 70,889,887 ------------ ------------ Total stockholders' equity ................ 162,346,456 148,729,028 ------------ ------------ Contingent liabilities (notes 3 and 15) Total liabilities and stockholders' equity $459,109,796 $430,327,573 ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Income Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ REVENUES: Premiums earned (notes 2 and 3) .... $177,218,246 $165,190,666 $162,266,250 Investment income, net (note 9) .... 23,759,988 23,907,599 23,173,794 Realized investment gains (note 9) 4,100,006 1,890,923 1,043,730 Other income ....................... 218,872 274,459 343,653 ------------ ------------ ------------ 205,297,112 191,263,647 186,827,427 ------------ ------------ ------------ LOSSES AND EXPENSES (note 2): Losses and settlement expenses (notes 3,4 and 5) ....... 129,853,304 115,367,215 108,152,278 Dividends to policyholders ......... 2,530,747 3,245,036 3,739,533 Amortization of deferred policy acquisition costs ......... 35,942,092 32,554,733 32,152,616 Other underwriting expenses ........ 20,168,236 19,427,310 18,467,091 ------------ ------------ ------------ 188,494,379 170,594,294 162,511,518 ------------ ------------ ------------ Income before income taxes ... 16,802,733 20,669,353 24,315,909 ------------ ------------ ------------ INCOME TAXES (note 10): Current .......................... 4,266,959 4,534,961 6,907,754 Deferred ......................... (680,793) 1,100,228 59,327 ------------ ------------ ------------ 3,586,166 5,635,189 6,967,081 ------------ ------------ ------------ Net income ................... $ 13,216,567 $ 15,034,164 $ 17,348,828 ============ ============ ============ Net income per common share - basic and diluted .............. $ 1.18 $ 1.37 $ 1.62 ============ ============ ============ Average number of shares outstanding - basic and diluted .............. 11,193,243 10,936,897 10,685,344 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Common stock: Beginning of year ................... $11,084,461 $10,821,978 $10,587,629 Issuance of common stock: Stock option plans ................ 71,073 91,062 102,797 Dividend reinvestment plan (note 13(d)) ............... 195,585 188,072 131,552 Retirement of treasury stock ........ - (16,651) - ----------- ----------- ----------- End of year ......................... 11,351,119 11,084,461 10,821,978 ----------- ----------- ----------- Additional paid-in capital: Beginning of year ................... 62,762,613 59,787,926 57,162,911 From issuance of common stock: Stock option plans ................ 854,641 1,105,155 1,092,041 Dividend reinvestment plan ........ 2,299,427 2,099,436 1,417,808 (Losses) gains on sale of treasury stock ............................. - (16,257) 115,166 Retirement of treasury stock ........ - (213,647) - ----------- ----------- ----------- End of year ......................... 65,916,681 62,762,613 59,787,926 ----------- ----------- ----------- Unrealized holding gains (losses) on fixed maturity securities available- for-sale, net of tax: Beginning of year ................. 2,141,361 3,472,016 (1,316,596) Gains (losses) on revaluation of fixed maturity securities available-for-sale, net of tax (notes 1 and 9) ............. 2,436,091 (1,330,655) 4,788,612 ----------- ----------- ----------- End of year ....................... 4,577,452 2,141,361 3,472,016 ----------- ----------- ----------- Unrealized holding gains on equity securities available-for-sale, net of tax: Beginning of year ................. 1,850,706 817,965 - Gains on revaluation of equity securities available-for-sale, net of tax (note 9) ............. 1,258,934 1,032,741 817,965 ----------- ----------- ----------- End of year ....................... $ 3,109,640 $ 1,850,706 $ 817,965 ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity, Continued Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Retained earnings: Beginning of year ................ $ 70,889,887 $ 62,089,294 $ 50,402,812 Net income ....................... 13,216,567 15,034,164 17,348,828 Dividends on common stock ($.60 per share in 1997, $.57 in 1996 and $.53 in 1995): Cash dividends ............... (4,314,083) (4,017,222) (3,653,299) Dividends reinvested in shares of common stock ............ (2,400,807) (2,216,349) (2,009,047) ------------ ------------ ------------ End of year ...................... 77,391,564 70,889,887 62,089,294 ------------ ------------ ------------ Treasury stock, at cost: Beginning of year ................ - (100,421) (110,067) Purchase of stock for the treasury - (265,499) (653,967) Sale of stock from the treasury .. - 135,622 663,613 Retirement of treasury stock ..... - 230,298 - ------------ ------------ ------------ End of year ...................... - - (100,421) ------------ ------------ ------------ Total stockholders' equity ..... $162,346,456 $148,729,028 $136,888,758 ============ ============ ============ See accompanying Notes to Consolidated Financial Statements. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income .......................... $13,216,567 $15,034,164 $17,348,828 ----------- ----------- ----------- Adjustments to reconcile net income to net cash provided by operating activities: Losses and settlement expenses .. 9,356,859 (2,919,123) 2,240,494 Unearned premiums ............... 4,125,443 (858,193) 1,094,577 Other policyholders' funds ...... (685,905) (125,879) 490,719 Deferred policy acquisition costs (1,538,794) (307,094) (321,134) Indebtedness of related party ... (7,822,885) 6,572,019 (508,893) Accrued investment income ....... 814,891 (263,435) (188,986) Accrued income taxes: Current ....................... 606,000 403,331 802,669 Deferred ...................... (680,793) 1,100,228 59,327 Realized investment gains ....... (4,100,006) (1,890,923) (1,043,730) Postretirement benefits ......... 496,079 443,022 403,138 Reinsurance receivables ......... 1,134,095 (1,818,843) 2,018,105 Prepaid reinsurance premiums .... 321,907 288,909 315,152 Amortization of deferred income (218,872) (274,459) (343,653) Other, net ...................... (1,201,299) 1,712,868 2,284,450 ----------- ----------- ----------- 606,720 2,062,428 7,302,235 Cash provided by the change in the property and casualty insurance subsidiaries' pooling agreement (note 2)....................... 5,674,458 - - Cash provided by the change in the reinsurance subsidiary's quota share agreement (note 2)....... 3,066,705 - - ----------- ----------- ----------- Total adjustment ............ 9,347,883 2,062,428 7,302,235 ----------- ----------- ----------- Net cash provided by operating activities .... $22,564,450 $17,096,592 $24,651,063 ----------- ----------- ----------- EMC INSURANCE GROUP INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturity securities held-to-maturity .... $(35,504,382) $(30,412,885) $(46,384,530) Disposals of fixed maturity securities held-to-maturity .... 38,138,196 33,576,694 18,257,425 Purchases of fixed maturity securities available-for-sale .. (46,586,660) (30,619,591) (27,866,616) Disposals of fixed maturity securities available-for-sale .. 20,769,810 21,202,597 49,104,032 Purchases of equity securities available-for-sale ............. (1,014,193) (5,363,426) (13,785,451) Net sales (purchases) of short-term investments ......... 2,626,614 (281,808) (1,242,372) ------------ ------------ ----------- Net cash used in investing activities .............. (21,570,615) (11,898,419) (21,917,512) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock ......... 1,019,919 1,251,119 850,317 Dividends paid to stockholders (note 13(d)) ...... (4,314,083) (4,017,222) (3,653,299) (Purchases) sales of treasury stock, net ..................... - (129,877) 9,646 ------------ ------------ ------------ Net cash used in financing activities .............. (3,294,164) (2,895,980) (2,793,336) ------------ ------------ ------------ NET (DECREASE) INCREASE IN CASH .... (2,300,329) 2,302,193 (59,785) Cash at beginning of year .......... 3,500,629 1,198,436 1,258,221 ------------ ------------ ------------ Cash at end of year ................ $ 1,200,300 $ 3,500,629 $ 1,198,436 ============ ============ ============ Income taxes paid .................. $ 3,660,959 $ 4,131,630 $ 6,242,085 Interest paid ...................... 88,922 57,938 177,156 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 an excess and surplus lines insurance agency. Both commercial and personal lines of insurance are written, with the focus on medium-sized commercial accounts. About two-thirds of the premiums written are in Iowa and contiguous states. The term "Company" is used interchangeably to describe EMC Insurance Group Inc.(Parent company only) and EMC Insurance Group Inc. and its subsidiaries. The Company's subsidiaries include EMCASCO Insurance Company, Illinois EMCASCO Insurance Company, Dakota Fire Insurance Company, 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. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. PROPERTY AND CASUALTY INSURANCE, REINSURANCE AND NONSTANDARD RISK AUTOMOBILE INSURANCE OPERATIONS Premiums are recognized as revenue ratably over the terms of the respective policies. Unearned premiums are calculated on the daily pro rata method. Amounts paid for ceded reinsurance premiums are reported as prepaid reinsurance premiums and amortized over the remaining contract period in proportion to the amount of insurance protection provided. Certain costs of acquiring new business, principally commissions, premium taxes and other underwriting expenses that vary with and are directly related to the production of business have been deferred. Such deferred costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Liabilities for losses are based upon case-basis estimates of reported losses, estimates of unreported losses based upon prior experience adjusted for current trends, and estimates of losses expected to be paid under assumed reinsurance contracts. Liabilities for loss adjusting expenses are provided by estimating expenses expected to be incurred in settling the claims provided for in the loss reserve. Changes in estimates are reflected in current operating results (see note 4). EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Ceded reinsurance amounts with nonaffiliated reinsurers relating to reinsurance receivables for paid and unpaid losses and loss adjusting expenses and prepaid reinsurance are reported on the balance sheets on a gross basis. Amounts ceded to Employers Mutual relating to the affiliated reinsurance pooling agreement have not been grossed up because the contracts provide that receivables and payables may be offset upon settlement. The liabilities for losses and settlement expenses are considered adequate to cover the ultimate net cost of losses and claims incurred to date 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. 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. INVESTMENTS Securities classified as held-to-maturity are purchased with the intent and ability to be held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. All other securities have been classified as securities available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of deferred income taxes. Short-term investments represent money market funds and are carried at cost. The Company's carrying value for investments is reduced to its estimated realizable value if a decline in the fair value is deemed other than temporary. Such reductions in carrying value are recognized as realized losses and charged to income. Premiums and discounts on debt securities are amortized over the life of the security as an adjustment to yield using the effective interest method. Realized gains and losses on disposition of investments are included in net income. The cost of investments sold is determined on the specific identification method using the highest cost basis first. Included in investments at December 31, 1997 and 1996 are securities on deposit with various regulatory authorities as required by law amounting to $12,178,402 and $11,971,889, respectively. In November of 1995 the Financial Accounting Standards Board issued a special report titled "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." This report contained a provision that allowed entities a one-time option to reassess the appropriateness of the classifications of all securities held and to reclassify securities from the held-to-maturity category without calling into question the intent of that enterprise to hold other debt securities to maturity in the future. The Company elected to take advantage of this option and reclassified $80,534,719 of municipal and corporate bonds from the held- to-maturity category to the available-for-sale category in the fourth quarter of 1995 in order to achieve more flexibility in its investment portfolio. BENEFIT PLANS The Company participates in Employers Mutual's defined benefit retirement plan covering substantially all employees. The plan is funded by employer contributions and provides benefits based on the employee's years of service and compensation level. Benefits generally vest after five years of service. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued It is Employers Mutual's policy to fund pension costs according to regulations provided under the Internal Revenue Code. Assets held in the plan are a mix of equity, debt and guaranteed interest securities and real estate funds. The Company participates in Employers Mutual's postretirement benefit plans which provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for those benefits if they reach normal retirement age and have attained the required length of service while working for Employers Mutual or its subsidiaries. The health care postretirement plan requires contributions from participants and contains certain cost sharing provisions such as coinsurance and deductibles. The life insurance plan is noncontributory. Both plans are unfunded and benefits provided are subject to change. INCOME TAXES The Company files a consolidated Federal income tax return with its subsidiaries. Consolidated income taxes/benefit are allocated among the entities based upon separate tax liabilities. Deferred income taxes are provided for temporary differences between the tax basis of assets and liabilities and the reported amounts of those assets and liabilities for financial reporting purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted. A valuation allowance is established to reduce deferred tax assets to their net realizable value if it is "more likely than not" that a tax benefit will not be realized. NET INCOME PER SHARE - BASIC AND DILUTED The Company adopted SFAS 128 "Earnings Per Share" in the fourth quarter of 1997. SFAS 128 simplifies the computation of net income per share and specifies the disclosure requirements of basic and diluted net income per share. Adoption of this statement did not change the income or the number of shares used to compute the Company's net income per share. The Company's basic and diluted net income per share are computed by dividing net income by the weighted average number of common shares outstanding during each year. TREASURY STOCK Prior to 1996, repurchased shares of the Company's common stock were included in treasury stock at cost. Shares issued from treasury stock in connection with Employers Mutual's employee stock purchase plan and the Company's dividend reinvestment plan were at original cost on a first-in, first-out basis. Effective June 30, 1996, the use of treasury stock was discontinued and all treasury shares held at that time were retired. All shares of the Company's common stock repurchased after June 30, 1996 have been retired. INTANGIBLE ASSETS Goodwill, which represents the excess of cost over the fair value of net assets of acquired subsidiaries, is being amortized on a straight-line basis over 25 years. The Company reviews the recoverability of the unamortized balance of goodwill on a periodic basis using projected cash flows. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 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 and an affiliate of Employers Mutual are parties to reinsurance pooling agreements with Employers Mutual (collectively the "pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, with the exception of any voluntary reinsurance business assumed from nonaffiliated insurance companies, and assumes from Employers Mutual an amount equal to its participation in the pool. All losses, settlement expenses and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. The aggregate participation of the Company's property and casualty insurance subsidiaries is 22 percent. Operations of the pool give rise to intercompany balances with Employers Mutual, which are settled on a quarterly basis. The investment activities and income tax liabilities of the pool participants are not subject to the pooling agreement. Effective January 1, 1997, a new affiliate of Employers Mutual became a participant in the pooling agreement. In connection with this change in the pooling agreement, the Company's liabilities increased $6,393,063 and invested assets increased $5,674,458. The Company reimbursed Employers Mutual $794,074 for commissions incurred to generate this business and Employers Mutual paid the Company $75,469 in interest income as the actual cash transfer did not occur until March 24, 1997. On December 19, 1997, the Company announced that its nonstandard risk automobile insurance subsidiary will become a participant in the pooling agreement effective January 1, 1998. The nonstandard risk automobile insurance subsidiary will receive a 1.5 percent participation in the pool, which will increase the Company's aggregate participation in the pool to 23.5 percent. Revenues of the Company are expected to increase by approximately $2,000,000 due to the increase in the size of the pool. REINSURANCE SUBSIDIARY Employers Mutual voluntarily assumes reinsurance business from nonaffiliated insurance companies and cedes a portion of this business to the Company's reinsurance subsidiary, exclusive of certain reinsurance contracts. The reinsurance subsidiary assumes its share of all premiums and related losses and settlement expenses of this business, subject to a maximum loss per event. The reinsurance subsidiary does not reinsure any of Employers Mutual's direct insurance business, nor any "involuntary" facility or pool business that Employers Mutual assumes pursuant to state law. In addition, the reinsurance subsidiary is not liable for credit risk in connection with the insolvency of any reinsurers of Employers Mutual. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Effective January 1, 1997, the reinsurance subsidiary's quota share participation was increased from 95 percent to 100 percent and the maximum loss per event assumed by the reinsurance subsidiary was increased from $1,000,000 to $1,500,000. In connection with the change in the quota share percentage, the Company's liabilities increased $3,173,647 and invested assets increased $3,066,705. The Company reimbursed Employers Mutual $106,942 for commissions incurred to generate this business. Premiums assumed by the reinsurance subsidiary from Employers Mutual amounted to $34,690,846, $36,051,617 and $36,433,443 in 1997, 1996 and 1995, respectively. It is customary in the reinsurance business for the assuming company to compensate the ceding company for the acquisition expenses incurred in the generation of the business. Commissions paid by the reinsurance subsidiary to Employers Mutual amounted to $8,134,202, $8,200,072 and $8,224,060 in 1997, 1996 and 1995, respectively. The reinsurance subsidiary pays an annual override commission to Employers Mutual in connection with the $1,500,000 ($1,000,000 in 1996 and 1995) cap on losses assumed per event, which totaled $1,821,270, $1,892,710 and $1,912,756 in 1997, 1996 and 1995, respectively. Employers Mutual retained losses and settlement expenses totaling ($93,621) in 1997, $166,573 in 1996 and $1,103,442 in 1995 under this agreement. The reinsurance subsidiary also pays for 100 percent (95 percent in 1996 and 1995) of the outside reinsurance protection Employers Mutual purchases to protect itself from catastrophic losses on the assumed reinsurance business. This cost is recorded as a reduction to the premiums received by the reinsurance subsidiary and amounted to $1,841,000, $1,315,750 and $1,983,579 in 1997, 1996 and 1995, respectively. Prior to 1997, the reinsurance subsidiary had an aggregate excess of loss reinsurance treaty with Employers Mutual which provided protection from a large accumulation of retentions resulting from multiple catastrophes in any one calendar year. The coverage provided was $2,000,000, excess of $3,000,000 aggregate losses retained, excess of $200,000 per event. Maximum recovery was limited to $2,000,000 per accident year. The reinsurance subsidiary did not have any recoveries under this treaty during 1996 or 1995. Premiums paid to Employers Mutual amounted to $500,000 and $499,950 in 1996 and 1995, respectively. This reinsurance treaty was canceled effective January 1, 1997. NONSTANDARD RISK AUTOMOBILE INSURANCE SUBSIDIARY The nonstandard risk automobile insurance subsidiary had a reinsurance treaty on an excess of loss basis with Employers Mutual which provided reinsurance for 100 percent of each loss in excess of $100,000, up to $1,000,000. There were no recoveries under this treaty during 1997, 1996 or 1995. Premiums paid to Employers Mutual amounted to $36,076 in 1997, $37,942 in 1996 and $45,232 in 1995. The reinsurance treaty was canceled on December 31, 1997 in preparation for the subsidiary's admittance into the pooling agreement on January 1, 1998 and all reinsurance recoverable amounts due from Employers Mutual were commuted. In connection with this commutation, the Company's assets increased $58,921 and liabilities increased $62,487. The Company reported incurred settlement expenses of $3,566 from this transaction. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued SERVICES PROVIDED BY EMPLOYERS MUTUAL Employers Mutual provides various services to all of its subsidiaries. Such services include data processing, claims, financial, actuarial, auditing, marketing and underwriting. Costs of these services are allocated to the subsidiaries outside the pooling agreement based upon a number of criteria, including usage and number of transactions. Costs not allocated to these subsidiaries are charged to the pool and each pool participant shares in the total cost in proportion to its participation percentage. 3. REINSURANCE 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. As of December 31, 1997, reinsurance ceded to two nonaffiliated reinsurers aggregated $7,399,933, 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. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The effect of reinsurance on premiums written and earned, and losses and settlement expenses incurred for the three years ended December 31, 1997 is presented below. Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ PREMIUMS WRITTEN Direct ......................... $175,350,677 $156,161,030 $152,579,014 Assumed from nonaffiliates ..... 1,219,564 1,951,071 3,282,699 Assumed from affiliates ........ 178,624,357 161,671,754 159,253,136 Ceded to nonaffiliates ......... (5,615,772) (7,930,381) (8,365,648) Ceded to affiliates ............ (164,978,055) (147,467,508) (143,259,942) ------------ ------------ ------------ Net premiums written ......... $184,600,771 $164,385,966 $163,489,259 ============ ============ ============ PREMIUMS EARNED Direct ......................... $169,304,584 $154,859,778 $151,450,871 Assumed from nonaffiliates ..... 1,403,778 2,350,321 3,548,647 Assumed from affiliates ........ 171,514,339 162,326,189 157,897,322 Ceded to nonaffiliates ......... (5,937,679) (8,219,290) (8,680,800) Ceded to affiliates ............ (159,066,776) (146,126,332) (141,949,790) ------------ ------------ ------------ Net premiums earned .......... $177,218,246 $165,190,666 $162,266,250 ============ ============ ============ LOSSES AND SETTLEMENT EXPENSES INCURRED Direct ......................... $126,922,536 $117,368,771 $ 98,651,399 Assumed from nonaffiliates ..... 926,403 948,218 608,796 Assumed from affiliates ........ 122,827,934 113,083,014 100,098,436 Ceded to nonaffiliates ......... (3,364,737) (6,817,132) (2,036,962) Ceded to affiliates ............ (117,458,832) (109,215,656) (89,169,391) ------------ ----------- ------------ Net losses and settlement expenses incurred .......... $129,853,304 $115,367,215 $108,152,278 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 4. LIABILITY FOR LOSSES AND SETTLEMENT EXPENSES The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the Company. Amounts presented are on a net basis, with a reconciliation of beginning and ending reserves to the gross amounts presented in the consolidated financial statements. Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, beginning of year .......................... $202,502,986 $205,422,109 $203,181,615 Ceded reserves for losses and settlement expenses, beginning of year .......................... 13,796,769 12,226,680 14,146,874 ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year, before adjustments ...... 188,706,217 193,195,429 189,034,741 Adjustment to beginning reserves due to the change in the property and casualty insurance subsidiaries' pooling agreement (note 2) ......................... 3,795,453 - - Adjustment to beginning reserves due to the change in the reinsurance subsidiary's quota share percentage (note 2)......... 2,726,913 - - ------------ ------------ ------------ Net reserves for losses and settlement expenses, beginning of year, after adjustments ....... 195,228,583 193,195,429 189,034,741 ------------ ------------ ------------ Incurred losses and settlement expenses: - ---------------------- Provision for insured events of the current year .......... 137,300,762 131,375,234 123,876,601 Decrease in provision for insured events of prior years (7,447,458) (16,008,019) (15,724,323) ------------ ------------ ------------ Total incurred losses and settlement expenses ...... 129,853,304 115,367,215 108,152,278 ------------ ------------ ------------ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Payments: - --------- Losses and settlement expenses attributable to insured events of the current year ............ 57,649,830 59,948,110 48,237,715 Losses and settlement expenses attributable to insured events of prior years ................. 62,684,265 59,908,317 55,753,875 ------------ ------------ ------------ Total payments (1) ......... $120,334,095 $119,856,427 $103,991,590 ------------ ------------ ------------ Net reserves for losses and settlement expenses, end of year $204,747,792 $188,706,217 $193,195,429 Ceded reserves for losses and settlement expenses, end of year 13,030,150 13,796,769 12,226,680 ------------ ------------ ------------ Gross reserves for losses and settlement expenses, end of year $217,777,942 $202,502,986 $205,422,109 ============ ============ ============ (1) Loss and settlement expense payments reported in the Company's financial statements for the year 1997 totaled $113,811,729. This amount reflects an adjustment of ($3,795,453) related to the change in the property and casualty insurance subsidiaries' pooling agreement and ($2,726,913) related to the change in the reinsurance subsidiary's quota share percentage. These adjustments were made to offset the income statement effect that resulted from the $6,522,366 increase in reserves for losses and settlement expenses on January 1, 1997 related to these transactions. Underwriting results of the Company are significantly influenced by estimates of loss and settlement expense reserves. Changes in reserve estimates are reflected in operating results in the year such changes are recorded. During the last three years the Company has experienced favorable development in the provision for insured events of prior years. The majority of the favorable development has come from the property and casualty insurance subsidiaries, which have benefitted from state reform measures in workers' compensation insurance and various loss control functions implemented by Employers Mutual. Favorable development has also been experienced in the reinsurance subsidiary and the nonstandard risk automobile insurance subsidiary, but to a lesser degree. The property and casualty insurance subsidiaries have historically experienced favorable development in their reserves and current reserving practices have not been relaxed; however, the level of redundancies experienced in 1996 and 1995 is not expected to continue. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 5. ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS The Company has exposure to asbestos and environmental related claims associated with the insurance business written by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary. Reserves for asbestos and environmental related claims totaled $2,412,735 and $2,102,610 at December 31, 1997 and 1996, respectively. Estimating loss and settlement expense reserves for asbestos and environmental claims is very difficult due to the many uncertainties surrounding these types of claims. Such uncertainties include the fact that the assignment of responsibility varies widely by state and claims often emerge long after the policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult. In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, the social and political conditions and the claim history and trends within the Company and the industry. 6. RETAINED EARNINGS Retained earnings of the Company's insurance subsidiaries available for distribution as dividends are limited by law to the statutory unassigned surplus of each of the subsidiaries as of the previous December 31, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the state of domicile of each subsidiary. Subject to this limitation, the maximum dividend that may be paid 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, 1997, $12,722,219 was available for distribution in 1998 without prior approval. The National Association of Insurance Commissioners utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify property/casualty insurers that are in (or are perceived as approaching) financial difficulty by establishing minimum capital needs based on the risks applicable to the operations of the individual insurer. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk: asset risk, credit risk and underwriting risk. Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy. At December 31, 1997, each of the Company's insurance subsidiaries' ratio of total adjusted capital to risk-based capital is well in excess of the minimum level required. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 7. RECONCILIATION OF STATUTORY NET INCOME AND SURPLUS A reconciliation of net income and surplus from that reported on a statutory basis to that reported in the accompanying consolidated financial statements on a GAAP basis is as follows: Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Net income from insurance subsidiaries, statutory basis .... $ 10,067,951 $ 14,876,685 $ 17,411,599 Change in deferred policy acquisition costs ................ 1,538,794 307,094 321,134 Change in salvage and subrogation accrual .......................... (419,578) 290,917 568,919 Change in other policyholders' funds 685,905 125,879 (490,719) Change in pension accrual .......... 476,705 251,042 (572,062) GAAP postretirement benefit cost in excess of statutory cost ...... (235,916) (256,119) (235,592) Deferred income tax benefit (expense) ........................ 680,793 (1,100,228) (59,327) Prior year income taxes and related interest ................. (117,948) 24,002 (231,001) GAAP basis amortization of reserve discount on commutation of reinsurance contract ............. 218,872 274,459 343,653 Other, net ......................... (92,713) (69,162) (3,020) ------------ ------------ ------------ Net income from insurance subsidiaries, GAAP basis ......... 12,802,865 14,724,569 17,053,584 Net income from non-insurance companies ........................ 413,702 309,595 295,244 ------------ ------------ ------------ Net income, GAAP basis ............. $ 13,216,567 $ 15,034,164 $ 17,348,828 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Surplus from insurance subsidiaries, statutory basis .................. $127,222,191 $111,069,880 $ 97,385,213 Deferred policy acquisition costs .. 10,560,657 9,021,863 8,714,769 Accrued salvage and subrogation .... - 2,399,578 2,368,362 Other policyholders' funds payable . (2,781,544) (3,467,449) (3,593,328) Pension asset ...................... 1,563,399 1,086,694 835,652 GAAP postretirement benefit liability in excess of statutory liability ........................ (2,400,407) (2,164,491) (1,908,372) Deferred income tax asset .......... 9,751,721 10,974,425 11,921,182 Goodwill ........................... 1,479,638 1,614,151 1,748,664 Excess of statutory reserves over statement reserves .......... 677,975 6,667,612 6,685,303 GAAP basis reserve discount on commutation of reinsurance contract in excess of statutory recognition ...................... (446,678) (665,550) (940,009) Unrealized holding gains on available-for-sale securities .... 6,940,501 3,248,859 5,260,630 Other .............................. 238,570 271,823 212,057 ------------ ------------ ------------ Equity from insurance subsidiaries, GAAP basis ......... 152,806,023 140,057,395 128,690,123 Equity from non-insurance companies 9,540,433 8,671,633 8,198,635 ----------- ----------- ----------- Stockholders' equity, GAAP basis ... $162,346,456 $148,729,028 $136,888,758 ============ ============ ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 8. SEGMENT INCOME The Company's operations include the following major segments: property and casualty insurance, reinsurance, nonstandard risk automobile insurance and an excess and surplus lines insurance agency. No single source accounted for 10 percent or more of consolidated revenues. Summarized financial information for these segments is as follows: Net Operating Premiums Underwriting investment Realized Other income earned gain (loss) income gains income (loss) Assets ------------ ------------ ----------- ---------- -------- ----------- ------------ Year ended December 31, 1997 Property and casualty insurance $132,874,752 $ (8,236,497) $15,528,726 $4,071,250 $ - $11,363,479 $318,339,019 Reinsurance ................... 34,105,686 (951,964) 6,615,029 22,923 218,872 5,904,860 111,568,145 Nonstandard risk automobile insurance ................... 10,237,808 (2,191,162) 1,011,799 5,833 - (1,173,530) 18,438,160 Excess and surplus lines insurance agency ............ - 417,252 158,618 - - 575,870 3,775,807 Parent company ................ - (313,762) 445,816 - - 132,054 162,519,792 Eliminations .................. - - - - - - (155,531,127) ------------ ------------ ----------- ---------- -------- ----------- ------------ Consolidated ............ $177,218,246 $(11,276,133) $23,759,988 $4,100,006 $218,872 $16,802,733 $459,109,796 ============ ============ =========== ========== ======== =========== ============ Year ended December 31, 1996 Property and casualty insurance $119,282,389 $ (3,902,136) $15,828,102 $1,789,890 $ - $13,715,856 $296,036,605 Reinsurance ................... 36,674,831 36,985 6,436,095 73,308 274,459 6,820,847 98,603,338 Nonstandard risk automobile insurance ................... 9,233,446 (1,559,270) 1,111,896 27,725 - (419,649) 18,759,584 Excess and surplus lines insurance agency ............ - 333,880 124,554 - - 458,434 3,191,718 Parent company ................ - (313,087) 406,952 - - 93,865 148,878,197 Eliminations .................. - - - - - - (135,141,869) ------------ ------------ ----------- ---------- -------- ----------- ------------ Consolidated ............ $165,190,666 $ (5,403,628) $23,907,599 $1,890,923 $274,459 $20,669,353 $430,327,573 ============ ============ =========== ========== ======== =========== ============ Year ended December 31, 1995 Property and casualty insurance $116,439,266 $ 1,482,804 $15,428,401 $1,026,770 $ - $17,937,975 $290,494,396 Reinsurance ................... 35,825,953 498,377 6,067,678 13,626 343,653 6,923,334 94,412,625 Nonstandard risk automobile insurance ................... 10,001,031 (2,256,737) 1,175,392 3,334 - (1,078,011) 19,679,620 Excess and surplus lines insurance agency ............ - 338,001 144,915 - - 482,916 2,642,707 Parent company ................ - (307,713) 357,408 - - 49,695 137,033,527 Eliminations .................. - - - - - - (131,381,902) ------------ ------------ ----------- ---------- -------- ----------- ------------ Consolidated ............. $162,266,250 $ (245,268) $23,173,794 $1,043,730 $343,653 $24,315,909 $412,880,973 ============ ============ =========== ========== ======== =========== ============
EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 9. INVESTMENTS The amortized cost and estimated fair value of securities held-to- maturity and available-for-sale as of December 31, 1997 and 1996 are as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services. Gross Gross Estimated Amortized unrealized unrealized fair December 31, 1997 cost gains losses value ----------------- ------------ ----------- ----------- ------------ Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $103,826,052 $ 6,008,149 $ (14,074)$109,820,127 Obligations of states and political subdivisions ......... 41,989,442 481,671 (46,164) 42,424,949 Mortgage-backed securities ........... 40,013,569 1,577,841 (1,473) 41,589,937 ------------ ----------- ----------- ------------ Total securities held-to-maturity $185,829,063 $ 8,067,661 $ (61,711)$193,835,013 ============ =========== =========== ============ Securities available-for- sale: Fixed maturity securities: Obligations of states and political subdivisions ......... $130,945,594 $ 6,272,885 $ - $137,218,479 Public utilities ....... 8,760,899 82,678 (10,635) 8,832,942 Corporate securities ... 32,861,713 598,805 (13,789) 33,446,729 Redeemable preferred stocks ............... 149,000 5,588 - 154,588 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... 172,717,206 6,959,956 (24,424) 179,652,738 ------------ ----------- ----------- ------------ Equity securities: Common stock mutual funds ................ 20,988,146 4,228,650 (140,831) 25,075,965 Non-redeemable preferred stocks ..... 5,273,011 628,916 (5,160) 5,896,767 ------------ ----------- ----------- ------------ Total equity securities ....... 26,261,157 4,857,566 (145,991) 30,972,732 ------------ ----------- ----------- ------------ Total securities available-for-sale $198,978,363 $11,817,522 $ (170,415)$210,625,470 ============ =========== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Gross Gross Estimated Amortized unrealized unrealized fair December 31, 1996 cost gains losses value ----------------- ------------ ----------- ----------- ------------ Securities held-to-maturity: Fixed maturity securities: U.S. treasury securities and obligations of U.S. government corporations and agencies ............. $113,288,092 $ 5,300,274 $ (409)$118,587,957 Obligations of states and political subdivisions ......... 30,975,611 131,398 (282,008) 30,825,001 Mortgage-backed securities ........... 44,122,018 1,313,204 (192,924) 45,242,298 ------------ ----------- ----------- ------------ Total securities held-to-maturity $188,385,721 $ 6,744,876 $ (475,341)$194,655,256 ============ =========== =========== ============ Securities available-for sale: Fixed maturity securities: Obligations of states and political subdivisions ......... $114,538,500 $ 3,089,141 $ (101,722)$117,525,919 Debt securities issued by foreign governments 2,573,101 15,498 - 2,588,599 Public utilities ....... 8,970,242 26,525 (51,184) 8,945,583 Corporate securities ... 20,023,965 306,841 (42,874) 20,287,932 Redeemable preferred stocks ............... 688,350 5,387 (3,126) 690,611 ------------ ----------- ----------- ------------ Total fixed maturity securities ....... 146,794,158 3,443,392 (198,906) 150,038,644 ------------ ----------- ----------- ------------ Equity securities: Common stock mutual funds ................ 15,963,269 2,659,897 - 18,623,166 Non-redeemable preferred stocks ..... 5,273,012 147,953 (3,750) 5,417,215 ------------ ----------- ----------- ------------ Total equity securities ....... 21,236,281 2,807,850 (3,750) 24,040,381 ------------ ----------- ----------- ------------ Total securities available-for-sale $168,030,439 $ 6,251,242 $ (202,656)$174,079,025 ============ =========== =========== ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The amortized cost and estimated fair value of fixed maturity securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized fair cost value ------------ ------------ Securities held-to-maturity: Due in one year or less ................... $ 13,989,831 $ 14,142,820 Due after one year through five years ..... 50,088,102 51,876,854 Due after five years through ten years .... 66,752,623 70,871,137 Due after ten years ....................... 14,984,941 15,354,268 Mortgage-backed securities ................ 40,013,566 41,589,934 ------------ ------------ Totals .................................... $185,829,063 $193,835,013 ============ ============ Securities available-for-sale: Due in one year or less ................... $ 13,803,121 $ 13,816,747 Due after one year through five years ..... 56,240,665 57,182,974 Due after five years through ten years .... 42,789,912 45,216,266 Due after ten years ....................... 59,883,508 63,436,751 ------------ ------------ Totals .................................. $172,717,206 $179,652,738 ============ ============ Realized investment gains and losses from calls and prepayments of securities held-to-maturity and available-for-sale are presented below. Realized investment gains reported in the financial statements include capital gain distributions of $4,010,683, $1,655,566, and $985,971 in 1997, 1996 and 1995, respectively, from common stock mutual funds included in equity securities available-for-sale. There were no sales of securities classified as held-to-maturity or available-for-sale during 1997, 1996 and 1995. Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Fixed maturity securities held-to-maturity: Gross realized investment gains ... 1,927 36,155 32,733 Gross realized investment losses .. - 7,957 2,388 Fixed maturity securities available-for-sale: Gross realized investment gains ... 110,304 207,161 27,414 Gross realized investment losses .. 22,908 - - 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, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Interest on fixed maturities .......... $22,876,491 $22,921,309 $22,895,745 Dividends on equity securities ........ 599,043 481,025 235,451 Interest on short-term investments .... 1,250,492 1,178,435 821,560 ----------- ----------- ----------- Total investment income ........... 24,726,026 24,580,769 23,952,756 Investment expense .................... 966,038 673,170 778,962 ----------- ----------- ----------- Net investment income ............. $23,759,988 $23,907,599 $23,173,794 =========== =========== =========== A summary of net changes in unrealized holding gains (losses) on securities available-for-sale is as follows: Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Fixed maturity securities ........... $ 3,691,046 $(2,016,144) $ 6,577,226 Applicable income taxes ............. (1,254,955) 685,489 (1,788,614) ----------- ----------- ----------- Total fixed maturity securities ... 2,436,091 (1,330,655) 4,788,612 ----------- ----------- ----------- Equity securities ................... 1,907,475 1,564,759 1,239,341 Applicable income taxes ............. (648,541) (532,018) (421,376) ----------- ----------- ----------- Total equity securities ........... 1,258,934 1,032,741 817,965 ----------- ----------- ----------- Total available-for-sale securities $ 3,695,025 $ (297,914) $ 5,606,577 =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 10. INCOME TAXES Temporary differences between the consolidated financial statement carrying amount and tax basis of assets and liabilities that give rise to significant portions of the deferred tax asset at December 31, 1997 and 1996 relate to the following: Year ended December 31, ------------------------ 1997 1996 ----------- ----------- Loss reserve discounting ........................... $12,470,142 $11,912,949 Unearned premium reserve limitation ................ 3,605,597 3,103,585 Postretirement benefits ............................ 1,554,085 1,613,764 Other policyholders' funds payable ................. 945,725 1,178,933 Prepayment of tax on commutation of loss reserves .. 151,871 226,287 Other, net ......................................... 562,653 496,498 ----------- ----------- Total gross deferred income tax asset ........ 19,290,073 18,532,016 Less valuation allowance ........................... (1,200,000) (1,200,000) ----------- ----------- Total deferred income tax asset .............. 18,090,073 17,332,016 ----------- ----------- Deferred policy acquisition costs .................. (3,590,623) (3,067,433) Net unrealized holding gains ....................... (3,960,017) (2,056,518) Other, net ......................................... (787,712) (1,233,640) ----------- ----------- Total gross deferred income tax liability .... (8,338,352) (6,357,591) ----------- ----------- Net deferred income tax asset .............. $ 9,751,721 $10,974,425 =========== =========== The valuation allowance at December 31, 1997 and 1996 relates to the tax benefits associated with postretirement benefit deductions that are scheduled to reverse more than fifteen years into the future. The valuation allowance was established 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 1993 through 1997 of approximately $62,578,000. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The actual income tax expense for the years ended December 31, 1997, 1996 and 1995 differed from the "expected" tax expense for those years (computed by applying the United States federal corporate tax rate of 34 percent (35 percent in 1995) to income before income taxes) as follows: Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Computed "expected" tax expense ...... $ 5,712,929 $ 7,027,580 $ 8,510,568 Increases (decreases) in tax resulting from: Tax-exempt interest income ....... (2,330,842) (1,980,599) (2,190,686) Change in accrual of prior year taxes .......................... (424,161) - - Settlement of tax examinations ... 29,026 (46,949) 182,309 Proration of tax-exempt interest and dividends received deduction 226,175 289,705 235,330 Other, net ....................... 373,039 345,452 229,560 ----------- ----------- ----------- Income taxes ................... $ 3,586,166 $ 5,635,189 $ 6,967,081 =========== =========== =========== Comprehensive income tax expense included in the consolidated financial statements for the years ended December 31, 1997, 1996 and 1995 was as follows: Year ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Income tax expense (benefit) on: Operations .......................... $ 3,586,166 $ 5,635,189 $ 6,967,081 Unrealized holding gains (losses) on revaluation of securities available-for-sale ................ 1,903,496 (153,472) 2,209,990 ----------- ----------- ----------- Comprehensive income tax expense ....................... $ 5,489,662 $ 5,481,717 $ 9,177,071 =========== =========== =========== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 11. EMPLOYEE RETIREMENT PLAN The following tables set forth the funded status and the components of the net periodic pension cost for the Employers Mutual defined benefit retirement plan, based upon a measurement date of November 1, 1997, 1996 and 1995, respectively: Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $51,311,323, $50,211,301 and $51,185,830 .................. $ 52,198,952 $ 51,043,973 $ 52,190,610 ============ ============ ============ Projected benefit obligation for service rendered to date ..... $ 68,560,979 $ 66,414,419 $ 66,544,344 Plan assets at fair value .......... 85,475,793 76,056,949 72,048,850 ------------ ------------ ------------ Plan assets greater than projected benefit obligation ..... 16,914,814 9,642,530 5,504,506 Unrecognized net (gain) loss from past experience different from that assumed and effects of changes in assumptions ........... (8,522,657) (3,080,096) 625,332 Prior service cost not yet recognized in net periodic pension cost ..................... 2,889,260 3,327,217 3,765,174 Unrecognized portion of initial net asset ........................ (2,880,932) (3,956,372) (5,031,812) ------------ ------------ ------------ Prepaid pension cost ........ $ 8,400,485 $ 5,933,279 $ 4,863,200 ============ ============ ============ Service cost - benefits earned during the period ................ $ 3,174,041 $ 3,029,857 $ 3,124,494 Interest cost on projected benefit obligation ............... 4,673,368 4,477,060 4,827,694 Actual gain on plan assets ......... (12,575,950) (9,237,498) (10,414,728) Net amortization and deferral ...... 5,770,244 3,043,014 5,071,784 ------------ ------------ ------------ Net periodic pension cost ... $ 1,041,703 $ 1,312,433 $ 2,609,244 ============ ============ ============ The unrecognized net asset is being recognized over 12.5 to 15.2 years beginning January 1, 1987. Prior service costs are being amortized over 12 to 14 years beginning January 1, 1993. The weighted average discount rate used to measure the projected benefit obligation was 7.25 percent for 1997 and 1996 and 7.00 percent for 1995. The assumed long-term rate of return on plan EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued assets was 8.00 percent for 1997, 1996 and 1995. The rate of increase in future compensation levels used in measuring the projected benefit obligation was 5.26 percent in 1997 and 5.30 percent in 1996 and 1995. Pension expense for the Company amounted to $257,812, $289,055 and $572,062 in 1997, 1996 and 1995, respectively. 12. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS 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, 1997, 1996 and 1995, respectively. Year ended December 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Actuarial present value of postretirement benefit obligations: Retirees ....................... $ 11,376,687 $ 8,878,520 $ 8,319,946 Fully eligible active plan participants ................. 5,909,934 4,624,846 4,775,324 Other active plan participants 8,955,244 7,777,499 6,705,681 ------------ ------------ ------------ Total ........................ 26,241,865 21,280,865 19,800,951 Unrecognized net gain from past experience different from that assumed and effects of changes in assumptions ........... 594,992 3,973,690 4,110,579 Prior service cost not yet recognized in net periodic postretirement benefit cost ...... (2,820,157) (3,391,395) (3,962,633) ------------ ------------ ------------ Liability for postretirement benefits ................... $ 24,016,700 $ 21,863,160 $ 19,948,897 ============ ============ ============ Service cost - benefits earned during the period ................ $ 1,039,710 $ 917,917 $ 907,297 Interest cost on accumulated postretirement benefit obligation ....................... 1,518,680 1,365,150 1,361,790 Net amortization and deferral ...... 423,899 336,117 409,556 ------------ ------------ ------------ Net periodic postretirement benefit cost ............... $ 2,982,289 $ 2,619,184 $ 2,678,643 ============ ============ ============ EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Prior service costs are being amortized over 8.9 to 10 years beginning January 1, 1994. The assumed weighted average annual rate of increase in the per capita cost of covered health care benefits (i.e. the health care cost trend rate) for 1997 is 9.00 percent, and is assumed to decrease gradually to 5.00 percent in 2001 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, 1997 by $3,685,672 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1997 by $467,132. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25 percent for 1997 and 1996, and 7.00 percent for 1995. The Company's net periodic postretirement benefit cost for the years ended December 31, 1997, 1996 and 1995 was $677,336, $596,102 and $608,832, respectively. 13. COMMON STOCK The Company has no stock based compensation plans of its own; however, Employers Mutual has several stock plans which utilize the common stock of the Company. The Company receives the current fair market value for any shares issued under the plans and all expenses (the excess of current fair market value over the participant's price) of the plans are borne by Employers Mutual or the company employing the individual optionees. As a result of this arrangement, the Company is not subject to accounting requirements of Accounting Principles Board Opinion No. 25 or SFAS 123, "Accounting for Stock- Based Compensation." Under the terms of the pooling agreement (note 2), the Company's property and casualty insurance subsidiaries incur 22 percent of the expenses recognized by Employers Mutual relating to these plans. The Company also incurs 100 percent of any expense of these plans that is associated with optionees working for its other subsidiaries. Total expenses incurred by the Company relating to the Employers Mutual stock plans amounted to $81,653, $47,395 and $79,703 for 1997, 1996 and 1995, respectively. (a) INCENTIVE STOCK OPTION PLANS During 1997, Employers Mutual maintained two separate stock option plans for the benefit of officers and key employees of Employers Mutual and its subsidiaries. A total of 500,000 shares were reserved for issuance under the 1993 Employers Mutual Incentive Stock Option Plan (1993 Plan) and a total of 600,000 shares were reserved for the 1982 Employers Mutual Incentive Stock Option Plan (1982 Plan). There is a ten year time limit for granting options under the plans. Options can no longer be granted under the 1982 Plan and the time period for granting options under the 1993 Plan expires on December 31, 2002. Options granted under the plans have a vesting period of two, three, four or five years with options becoming exercisable in equal annual cumulative increments. Options have been granted to 57 individuals under the 1982 Plan and 87 individuals under the 1993 Plan. At February 26, 1998, 24 eligible participants remained in the 1982 Plan and 70 eligible participants remained in the 1993 Plan. EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The Senior Executive Compensation and Stock Option Committee (the "Committee") of Employers Mutual's Board of Directors (the "Board") is the administrator of the plans. Option prices are determined by the Committee but can not be less than the fair market value of the stock on the date of grant. During 1997, 88,050 options were granted under the 1993 plan to eligible participants at a price of $12.25 and 71,068 options were exercised under the plans at prices ranging from $11.75 to $14.25. A summary of Employers Mutual's incentive stock option plans is as follows: Year ended December 31, ----------------------------- 1997 1996 1995 -------- -------- -------- Options outstanding, beginning of year .. 538,012 565,882 556,277 Granted ................................. 88,050 54,800 119,550 Exercised ............................... (71,068) (79,270) (88,645) Expired ................................. (4,550) (3,400) (21,300) -------- -------- -------- Options outstanding, end of year ........ 550,444 538,012 565,882 ======== ======== ======== Options exercisable, end of year ........ 308,354 296,552 284,112 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (b) EMPLOYEE STOCK PURCHASE PLAN A total of 500,000 shares of the Company's common stock were reserved for issuance under the Employers Mutual 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, a stock certificate is issued evidencing the ownership of the participant in the shares of stock so purchased. The certificate, however, is 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 has 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 plan. However, the participant is not 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 will, 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 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 1997, 149 employees participated in the plan and exercised a total of 21,940 options at prices of $12.81 and $13.13. Activity under the plan was as follows: Year ended December 31, ---------------------------- 1997 1996 1995 -------- -------- -------- Shares available for purchase, beginning of year ...................... 424,922 446,045 463,940 Shares purchased under plan .............. (21,940) (21,123) (17,895) -------- -------- -------- Shares available for purchase, end of year 402,982 424,922 446,045 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (c) NON-EMPLOYEE DIRECTOR STOCK PURCHASE PLAN A total of 200,000 shares of the Company's common stock were reserved for issuance under Employers Mutual's Non-Employee Director Stock Purchase Plan. All non-employee directors of Employers Mutual and its subsidiaries who are not serving on the "Disinterested Director Committee" of the Board as of the beginning of the option period are eligible for participation in the plan. 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 1997, six directors participated in the plan and exercised a total of 5,884 options at prices ranging from $10.88 to $13.75. Activity under the plan was as follows: Year ended December 31, ---------------------------- 1997 1996 1995 -------- -------- -------- Shares available for purchase, beginning of year ...................... 176,252 185,568 188,099 Shares purchased under plan .............. (5,884) (9,316) (2,531) -------- -------- -------- Shares available for purchase, end of year 170,368 176,252 185,568 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (d) 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. On December 17, 1997, an additional 1,000,000 shares of stock were registered for issuance in the Dividend Reinvestment Plan. During 1997, 1996 and 1995, 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, ----------------------------- 1997 1996 1995 --------- -------- -------- Shares available for purchase, beginning of year ...................... 176,489 364,561 537,660 Additional shares registered ............. 1,000,000 - - Shares purchased under plan .............. (195,585) (188,072) (173,099) --------- -------- -------- Shares available for purchase, end of year 980,904 176,489 364,561 ========= ======== ======== Range of purchase prices .................. $11.88 $11.00 $10.00 to to to $13.50 $13.75 $14.75 (e) TREASURY STOCK The Company repurchases shares of its outstanding common stock in connection with the issuance of new shares under Employers Mutual's stock option plans. These repurchased shares have historically been used to fulfill the stock requirements of the Company's dividend reinvestment plan and Employers Mutual's employee stock purchase plan. Effective June 30, 1996, the use of treasury stock was discontinued and all treasury shares held at that time were retired. All shares of the Company's common stock repurchased after June 30, 1996 have been retired. Treasury stock activity was as follows: Year ended December 31, ---------------------------- 1997 1996 1995 -------- -------- -------- Treasury shares, beginning of year ....... - 7,585 10,931 Shares repurchased ....................... - 19,328 56,096 Shares reissued .......................... - (10,262) (59,442) Shares retired ........................... - (16,651) - -------- -------- -------- Treasury shares, end of year ............. - - 7,585 ======== ======== ======== Average cost ............................. $ - $ - $ 11.66 ======== ======== ======== (Loss) gain on reissue of treasury shares $ - $(16,257) $115,166 ======== ======== ======== EMC INSURANCE GROUP INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 14. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of (1) cash, (2) indebtedness of/to 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 are summarized as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services (see note 9). Carrying Estimated December 31, 1997 amount fair value ------------ ------------ Fixed maturity securities: Held-to-maturity ......................... $185,829,063 $193,835,013 Available-for-sale ....................... 179,652,738 179,652,738 Equity securities available-for-sale ....... 30,972,732 30,972,732 Short-term investments ..................... 14,926,994 14,926,994 December 31, 1996 Fixed maturity securities: Held-to-maturity ......................... $188,385,721 $194,655,256 Available-for-sale ....................... 150,038,644 150,038,644 Equity securities available-for-sale ....... 24,040,381 24,040,381 Short-term investments ..................... 17,553,606 17,553,606 15. CONTINGENT LIABILITIES The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business. The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations. The companies involved have reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings. 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 $808,776 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 16. UNAUDITED INTERIM FINANCIAL INFORMATION Three months ended, ------------------------------------------------------ March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ 1997 - ---- Total revenues ........ $ 48,320,069 $ 50,104,278 $ 52,301,840 $ 54,570,925 ============ ============ ============ ============ Income before income taxes ............... $ 2,070,552 $ 1,922,904 $ 3,064,442 $ 9,744,835 Income taxes .......... 322,653 231,301 399,790 2,632,422 ------------ ------------ ------------ ------------ Net income ....... $ 1,747,899 $ 1,691,603 $ 2,664,652 $ 7,112,413 ============ ============ ============ ============ Net income per share basic and diluted* $ .16 $ .15 $ .24 $ .63 ============ ============ ============ ============ 1996 - ---- Total revenues ........ $ 46,337,861 $ 46,456,275 $ 48,302,736 $ 50,166,775 ============ ============ ============ ============ Income before income taxes ............... $ 4,373,874 $ 1,482,899 $ 5,587,906 $ 9,224,674 Income taxes .......... 1,041,409 11,696 1,409,696 3,172,388 ------------ ------------ ------------ ------------ Net income ....... $ 3,332,465 $ 1,471,203 $ 4,178,210 $ 6,052,286 ============ ============ ============ ============ Net income per share basic and diluted* $ .31 $ .13 $ .38 $ .55 ============ ============ ============ ============ 1995 - ---- Total revenues ........ $ 45,941,694 $ 43,549,373 $ 47,358,200 $ 49,978,160 ============ ============ ============ ============ Income before income taxes ............... $ 5,528,309 $ 7,393,160 $ 3,706,098 $ 7,688,342 Income taxes .......... 1,528,206 2,273,383 715,805 2,449,687 ------------ ------------ ------------ ------------ Net income ....... $ 4,000,103 $ 5,119,777 $ 2,990,293 $ 5,238,655 ============ ============ ============ ============ Net income per share basic and diluted* $ .38 $ .48 $ .28 $ .48 ============ ============ ============ ============ * Since the weighted average shares for the quarters are calculated independent of the weighted average shares for the year, quarterly net income per share may not total to annual net income per share. EX-13.D 6 MARKET FOR REGISTRANT'S COMMON EQUITY & RELATED ST MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED EXHIBIT 13(d) ------------------------------------------------- ------------- STOCKHOLDER MATTERS. -------------------- The Company's common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol EMCI. The following table shows the high and low sales prices, as reported by by Nasdaq, and the dividends paid for each quarter within the two most recent years. 1997 1996 ---------------------------- ---------------------------- High Low Dividends High Low Dividends ------- ------- --------- ------- ------- --------- 1st Quarter $12 3/4 $11 1/4 $.15 $14 1/4 $11 3/4 $ .14 2nd Quarter 13 1/2 10 3/4 .15 14 1/2 10 1/8 .14 3rd Quarter 15 12 1/2 .15 13 1/2 10 1/2 .14 4th Quarter 14 1/4 12 3/4 .15 12 1/4 10 1/2 .15 At December 31 13 1/4 12 On February 27, 1998, there were approximately 1,387 registered shareholders of the Company's common stock. There are certain regulatory restrictions relating to the payment of dividends by the Company's insurance subsidiaries (see note 6 of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K). It is the present intention of the Company's Board of Directors to declare quarterly cash dividends, but the amount and timing thereof, if any, is to be determined by the Board of Directors at its discretion. A dividend reinvestment and common stock purchase plan provides stockholders with the option of receiving additional shares of common stock instead of cash dividends. Participants may also purchase additional shares of common stock without incurring broker commissions by making optional cash contributions to the Plan. See note 13(d) of Notes to Consolidated Financial Statements under Item 8 of this Form 10-K. During 1997 and 1996, Employers Mutual elected to receive 50 percent of its dividends in common stock under this plan. EX-21 7 ORGANIZATIONAL CHART 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 8 CPA 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, 33-49339 and 333-45279 on Forms S-8 and No. 33-34499 on Form S-3 of EMC Insurance Group Inc. of our reports dated February 26, 1998, relating to the consolidated balance sheets of EMC Insurance Group Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows and related financial statement schedules for each of the years in the three-year period ended December 31, 1997, which reports appear in the December 31, 1997 annual report on Form 10-K of EMC Insurance Group Inc. /s/ KPMG Peat Marwick LLP Des Moines, Iowa March 20, 1998 EX-24 9 POWER OF ATTORNEY Exhibit 24 POWER OF ATTORNEY KNOW EVERYONE BY THESE PRESENTS, that each director whose signature appears below constitutes and appoints Mark E. Reese and 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 signing and filing the 1997 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 1998 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 /s/ Raymond A. Michel - --------------------------- Raymond A. Michel Director /s/ Fredrick A. Schiek - --------------------------- Fredrick A. Schiek Director May 20, 1997 EX-27 10 FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the 12/31/97 balance sheet and income statement and is qualified in its entirety by reference to such financial statements. YEAR DEC-31-1997 DEC-31-1997 179,652,738 185,829,063 193,835,013 30,972,732 0 0 411,381,527 1,200,300 13,601,691 10,560,657 459,109,796 217,777,942 54,857,463 0 2,781,544 0 0 0 11,351,119 150,995,337 459,109,796 177,218,246 23,759,988 4,100,006 218,872 129,853,304 35,942,092 20,168,236 16,802,733 3,586,166 13,216,567 0 0 0 13,216,567 1.18 1.18 195,228,583 137,300,762 (7,447,458) 57,649,830 62,684,265 217,777,942 (7,447,458)
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