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EMC Insurance Group 10-K 2009 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
For
the Fiscal Year Ended December 31, 2008
For the
transition period from __________ to ___________
Commission
File Number: 0-10956
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the Act: None
The
aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 30, 2008 was $137,599,068.
The
number of shares outstanding of the registrant’s common stock, $1.00 par value,
on February 27, 2009, was 13,233,554.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the registrant’s definitive proxy statement for the Annual Meeting of
Stockholders to be held on May 19, 2009, and to be filed pursuant to Regulation
14A within 120 days after the registrant’s fiscal year ended December 31, 2008,
are incorporated by reference under Part III.
TABLE OF CONTENTS
PART I
GENERAL
EMC
Insurance Group Inc. is an insurance holding company that was incorporated in
Iowa in 1974 by Employers Mutual Casualty Company (Employers Mutual) and became
a public company in 1982 following the initial public offering of its common
stock. EMC Insurance Group Inc. is 59 percent owned by Employers
Mutual, a multiple-line property and casualty insurance company organized as an
Iowa mutual insurance company in 1911 that is licensed in all 50 states and the
District of Columbia. The term “Company” is used interchangeably to
describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group
Inc. and its subsidiaries. Employers Mutual and all of its
subsidiaries (including the Company) and an affiliate are referred to as the
“EMC Insurance Companies.”
The
Company conducts operations in property and casualty insurance and reinsurance
through its subsidiaries. The Company primarily focuses on the sale
of commercial lines of property and casualty insurance to small and medium-sized
businesses. These products are sold through independent insurance
agents who are supported by a decentralized network of branch
offices. Although the Company actively markets its insurance products
in 41 states, the majority of its business is marketed and generated in the
Midwest.
The
Company conducts its insurance business through two business segments as
follows:
 Illinois
EMCASCO was formed in Illinois in 1976 (and was re-domesticated to Iowa in
2001), Dakota Fire was formed in North Dakota in 1957 and EMCASCO was formed in
Iowa in 1958 for the purpose of writing property and casualty
insurance. EMC Reinsurance Company was formed in 1981 to assume
reinsurance business from Employers Mutual. The Company’s excess and
surplus lines insurance agency, EMC Underwriters, LLC, was formed in Iowa in
1975 and was acquired by the Company in 1985. Effective December 31,
1998, the excess and surplus lines insurance agency was converted to a limited
liability company and the ownership was contributed to EMCASCO.
Property
and casualty insurance is the most significant segment of the Company’s
business, representing approximately 81 percent of consolidated premiums earned
in 2008. The property and casualty insurance operations are
integrated with the property and casualty insurance operations of Employers
Mutual through participation in a reinsurance pooling
agreement. Because the Company conducts its property and casualty
insurance operations together with Employers Mutual through the reinsurance
pooling agreement, the Company shares the same business philosophy, management,
employees and facilities as Employers Mutual and offers the same types of
insurance products. For a discussion of the reinsurance pooling
agreement and its benefits, please see “Organizational Structure – Property and
Casualty Insurance” below.
Reinsurance
operations are conducted through EMC Reinsurance Company, and represented
approximately 19 percent of consolidated premiums earned in 2008. The
principal business activity of EMC Reinsurance Company is to assume, through a
quota share reinsurance agreement, the voluntary reinsurance business written
directly by Employers Mutual with unaffiliated insurance companies (subject to
certain limited exceptions). Effective January 1, 2009, EMC
Reinsurance Company will begin writing Germany-based assumed reinsurance
business on a direct basis as a result of regulatory changes in
Germany. For a discussion of the quota share reinsurance agreement
and its benefits, please see “Organizational Structure – Reinsurance”
below.
The
Company’s insurance agency, EMC Underwriters, LLC, specializes in marketing
excess and surplus lines of insurance. The excess and surplus lines
markets provide insurance coverage at negotiated rates for risks that are not
acceptable to licensed insurance companies. EMC Underwriters accesses
this market by working through independent agents and functions as managing
underwriter for excess and surplus lines insurance for several of the pool
participants. The Company derives income from this business based on
the fees and commissions earned through placement of the business, as opposed to
the underwriting of the risks associated with that business.
Organizational
Structure
Property
and Casualty Insurance
The three
property and casualty insurance subsidiaries of the Company and two subsidiaries
and an affiliate of Employers Mutual (Union Insurance Company of Providence, EMC
Property & Casualty Company and Hamilton Mutual Insurance Company) are
parties to reinsurance pooling agreements with Employers Mutual (collectively
the “pooling agreement”). Under the terms of the pooling agreement,
each company cedes to Employers Mutual all of its insurance business, with the
exception of any voluntary reinsurance business assumed from nonaffiliated
insurance companies, and assumes from Employers Mutual an amount equal to its
participation in the pool. All premiums, 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. Employers Mutual negotiates reinsurance agreements that provide
protection to the pool and each of its participants, including protection
against losses arising from catastrophic events. The aggregate
participation of the Company’s property and casualty insurance subsidiaries is
30 percent.
Operations
of the pool give rise to inter-company balances with Employers Mutual, which are
settled on a quarterly basis. The investment and income tax
activities of the pool participants are not subject to the pooling
agreement. The pooling agreement provides that Employers Mutual will
make up any shortfall or difference resulting from an error in its systems
and/or computation processes that would otherwise result in the required
restatement of the pool participants’ financial statements.
The
purpose of the pooling agreement is to spread the risk of an exposure insured by
any of the pool participants among all of the companies. The
particular benefits that the Company’s property and casualty insurance
subsidiaries realize from participating in the pooling agreement include the
following:
The
amount of insurance a property and casualty insurance company writes under
industry standards is commonly expressed as a multiple of its surplus calculated
in accordance with statutory accounting practices. Generally, a ratio
of 3 or less is considered satisfactory by state insurance
departments. The ratios of the pool participants for the past three
years are as follows:
(1) The
ratios for these companies reflects the issuance of an aggregate $25,000,000 of
surplus notes to Employers Mutual. Surplus notes are considered to be
a component of surplus for statutory reporting purposes; however, under U.S.
generally accepted accounting principles, surplus notes are considered to be
debt and are reported as a liability in the Company’s financial
statements.
Reinsurance
The
Company’s reinsurance subsidiary is a party to a quota share reinsurance
retrocessional agreement with Employers Mutual (the “quota share
agreement”). Under the terms of the quota share agreement, the
reinsurance subsidiary assumes a 100 percent quota share portion of Employers
Mutual’s assumed reinsurance business, exclusive of certain reinsurance
contracts. This includes all premiums and related losses, settlement
expenses and other underwriting and administrative expenses of this business,
subject to a maximum loss of $2,000,000 per event. The cost of the
$2,000,000 cap on losses assumed per event, which is treated as a reduction to
premiums written, is 10.5 percent. The reinsurance subsidiary does
not directly reinsure any of the insurance business written by Employers Mutual
or the other pool participants; however, the reinsurance subsidiary assumes
reinsurance business from the Mutual Reinsurance Bureau (MRB) pool and this pool
provides a small amount of reinsurance protection to the EMC Insurance
Companies. As a result, the reinsurance subsidiary’s assumed
exposures include a small portion of the EMC Insurance Companies’ direct
business, after ceded reinsurance protections purchased by the MRB pool are
applied. In addition, the reinsurance subsidiary does not reinsure
any “involuntary” facility or pool business that Employers Mutual assumes
pursuant to state law. The reinsurance subsidiary assumes all foreign
currency exchange gain/loss associated with contracts incepting on January 1,
2006 and thereafter that are subject to the quota share
agreement. Operations of the quota share agreement give rise to
inter-company balances with Employers Mutual, which are settled on a quarterly
basis. The investment and income tax activities of the reinsurance
subsidiary are not subject to the quota share agreement.
As a
result of regulatory changes in Germany, Employers Mutual ceased being an
approved reinsurer in Germany effective January 1, 2009. To avoid the
loss of approximately $5,000,000 of assumed reinsurance business because of this
regulatory change, management determined that the Company’s reinsurance
subsidiary will begin writing this business on a direct basis (outside the quota
share agreement) effective January 1, 2009. Since this business will
be written outside the quota share agreement, it will not be subject to the
$2,000,000 cap on losses per event. Management has determined that
this business has a low risk of generating losses above $2,000,000 per event and
has therefore elected to not purchase stand-alone reinsurance coverage for these
risks.
Under the
terms of the quota share agreement, the reinsurance subsidiary receives
reinstatement premium income that is collected by Employers Mutual from the
ceding companies when reinsurance coverage is reinstated after a loss event;
however, the cap on losses assumed per event contained in the quota share
agreement is automatically reinstated without cost to the reinsurance
subsidiary. This arrangement can produce unusual underwriting results
for the reinsurance subsidiary when a large event occurs because the
reinstatement premium income received by the reinsurance subsidiary may
approximate, or even exceed, the amount of losses retained.
Property
and Casualty Insurance and Reinsurance
Employers
Mutual provides various services to all of its subsidiaries and
affiliates. Such services include data processing, claims, financial,
actuarial, legal, auditing, marketing and underwriting. Employers
Mutual allocates a portion of the cost of these services to its subsidiaries
that do not participate in the pooling agreement based upon a number of
criteria, including usage of the services and the number of
transactions. The remaining costs are charged to the pooling
agreement and each pool participant shares in the total cost in accordance with
its pool participation percentage.
Investment
expenses are based on actual expenses incurred by the Company plus an allocation
of other investment expenses incurred by Employers Mutual, which is based on a
weighted-average total of invested assets and number of investment
transactions.
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 7 of Notes to Consolidated Financial Statements under Item 8 of this
Form 10-K.
NARRATIVE DESCRIPTION OF
BUSINESS
Principal
Products
Property
and Casualty Insurance
The
Company’s property and casualty insurance subsidiaries and the other parties to
the pooling agreement underwrite both commercial and personal lines of property
and casualty insurance. Those coverages consist of the following
types of insurance:
Commercial
Lines
Personal
Lines
The
following table sets forth the aggregate direct premiums written of all parties
to the pooling agreement for the three years ended December 31, 2008, by line of
business.
Reinsurance
As
previously noted, the reinsurance subsidiary assumes the voluntary reinsurance
business written directly by Employers Mutual with unaffiliated insurance
companies (subject to certain limited exceptions). Employers Mutual
writes both pro rata and excess-of-loss reinsurance for unaffiliated insurance
companies. Pro rata reinsurance is a form of reinsurance in which the
reinsurer assumes a stated percentage of all premiums, losses and related
expenses in a given class of business. In contrast, excess-of-loss
reinsurance provides coverage for a portion of losses incurred by an insurer
which exceed predetermined retention limits. The
following table sets forth the assumed premiums written of the reinsurance
subsidiary for the three years ended December 31, 2008, by line of
business. Effective January 1, 2006, the board of directors of the
MRB pool approved the admission of two new assuming companies to the
pool. This reduced Employers Mutual’s participation in the pool from
a one-third share to an approximate one-fifth share (one company is only
assuming property exposures). The assumed premium written amount for
2006 includes a negative $3,440,000 portfolio adjustment which served as an
offset to the decrease in unearned premiums recognized in connection with this
change in participation.
Marketing
and Distribution
Property
and Casualty Insurance
The pool
participants market a wide variety of commercial and personal lines insurance
products through 16 full service branch offices, which actively write business
in 41 states. The pool participants’ products are marketed
exclusively through a network of over 2,100 local independent agencies and
agency groups contracted and serviced by the branch offices. The pool
participants primarily focus on the sale of commercial lines of property and
casualty insurance to small and medium-sized businesses, which are considered to
be policyholders that pay less than $100,000 in annual premiums. The
pool participants also seek to provide more than one policy to a given customer,
because this “account selling” strategy diversifies risks and generally improves
underwriting results.
The pool
participants wrote approximately $1.1 billion in direct premiums in 2008, with
87 percent of this business coming from commercial lines products and 13 percent
coming from personal lines products. Although a majority of the pool
participants’ business is generated by sales in the Midwest, Employers Mutual’s
branch offices are located across the country to take advantage of local market
conditions and opportunities, as well as to spread risk
geographically. Each branch office performs its own underwriting,
claims, marketing and risk management functions according to policies and
procedures established and monitored by the home office. This
decentralized network of branch offices allows the pool participants to develop
marketing strategies, products and pricing that target the needs of individual
marketing territories and take advantage of different opportunities for profit
in each market. This operating structure also enables the pool
participants to develop close relationships with the agents and customers with
whom they do business. Although
each branch office offers a slightly different combination of products, the
branches generally target three customer segments:
The pool
participants write a number of target market and safety dividend group programs
throughout the country, and have developed a strong reputation for these
programs within the marketplace. These programs provide enhanced
insurance protection to businesses or institutions that have similar hazards and
exposures and are willing to implement loss prevention
programs. Underwriting results for these programs are based on the
experience of the group, rather than the individual
participants. These groups include public schools, small
municipalities, petroleum marketers, contractors and mobile home
parks. As an example, the pool participants write coverage for
approximately 1,500 school districts throughout the Midwest. These
programs have been successful because they offer risk management products and
services that are targeted to the needs of the group members through a local
independent agent.
The
following table sets forth the geographic distribution of the aggregate direct
premiums written of all parties to the pooling agreement for the three years
ended December 31, 2008.
*
Includes all other jurisdictions, none of which accounted for more than 3
percent.
On
February 13, 2009, the Company announced that Employers Mutual had recently
began informing its independent agents that EMC Insurance Companies had recently
submitted plans to regulatory authorities in the states of Georgia, Louisiana,
Mississippi, North Carolina, Pennsylvania and Virginia seeking to withdraw from
personal lines programs in those states. This action is being taken
due to management’s conclusion, based on a number of factors, that these states
offer only limited long-term growth and profit
potential. Additionally, personal lines business does not
represent a large part of the marketing plans of the local branch offices
affected. The combination of these factors results in a
disproportionately high cost of conducting personal lines business in these
states.
The
planned exit from personal lines business in these six states should in no way
be construed as a diminished emphasis on personal lines
business. Rather, this action is being taken so that the EMC
Insurance Companies’ resources can be directed toward territories which offer
the greatest potential for long-term growth and profitability.
Reinsurance
The
reinsurance subsidiary obtains 100 percent of its business from Employers Mutual
through the quota share agreement. The reinsurance subsidiary
relies on the financial strength of Employers Mutual to write the reinsurance
business, as well as the competitive advantage that Employers Mutual has by
virtue of being licensed in all 50 states. Reinsurance marketing is
undertaken by Employers Mutual in its role as the direct writer of the
reinsurance business; however, the reinsurance subsidiary is utilized in the
marketing efforts to help differentiate the reinsurance business from the direct
insurance business that is written by Employers Mutual and the other pool
participants.
Employers
Mutual’s reinsurance business is derived from two
sources. Approximately 78 percent of Employers Mutual’s assumed
reinsurance premiums earned in 2008 were generated through the activities of its
Home Office Reinsurance Assumed Department (also known as
“HORAD”). The reinsurance business written by HORAD is brokered
through independent intermediaries. As a result, the risks assumed by
HORAD do not materially overlap with the risks assumed by MRB (discussed
below). The risks which are assumed by Employers Mutual through HORAD
are directly underwritten and priced by Employers Mutual. As such,
Employers Mutual has discretion with respect to the type and size of risks which
it assumes and services through these activities.
The
remaining 22 percent of Employers Mutual’s assumed reinsurance premiums earned
in 2008 were generated through participation in the MRB pool, an unincorporated
association through which Employers Mutual and other unaffiliated insurance
companies participate in a voluntary reinsurance pool to meet the reinsurance
needs of small and medium-sized, unaffiliated mutual insurance
companies. Employers Mutual has participated in the MRB pool since
1957. MRB is controlled by a board of directors composed of the five
members, including one representative designated by Employers
Mutual. As a member of this organization, Employers Mutual assumes
its proportionate share of the risks ceded to MRB by unaffiliated
insurers. Since MRB is structured on a joint liability basis,
Employers Mutual, and therefore the Company’s reinsurance subsidiary, would be
obligated with respect to the proportionate share of risks assumed by the other
participants in the event they were unable to perform. MRB, which is
operated by an independent management team, manages assumed risks through
typical underwriting practices, including loss exposure controls provided
through reinsurance coverage obtained for the benefit of MRB. The
reinsurance risks for MRB arise primarily from the Northeast and Midwest
markets. Underwriting of risks and pricing of coverage is performed
by MRB management under general guidelines established by Employers Mutual and
the other participating insurers. Apart from these procedures,
Employers Mutual has only limited control over the risks assumed by, and the
operating results of, MRB. Because of the joint liability structure,
MRB participating companies must maintain a rating of “A-” (Excellent) or above
from A.M. Best Company and meet certain other standards.
Effective
January 1, 2006, the board of directors of the MRB pool approved the admission
of two new assuming companies to the pool. This reduced Employers
Mutual’s participation in the pool from a one-third share to an approximate
one-fifth share (one company only assumes property exposures). Both
of the new assuming companies carry an A+ (Superior) rating from A.M. Best
Company and their addition enhanced the financial strength of the
pool. During the fourth quarter of 2007, the MRB board of directors
approved Farm Bureau Mutual Insurance Company of Michigan to replace Auto-Owners
Insurance Company as an assuming company in the MRB pool effective January 1,
2008. As a result, Employers Mutual’s participation in the pool
remained at approximately 20 percent in 2008. Over the
past several years Employers Mutual has emphasized writing excess-of-loss
reinsurance business in its HORAD operation and has worked to increase its
participation on existing contracts that had favorable
terms. Employers Mutual strives to be flexible in the types of
reinsurance products it offers, but generally limits its writings to direct
reinsurance business, rather than providing retrocessional covers. In
recent years there has been a trend in the reinsurance marketplace for “across
the board” participation on excess-of-loss reinsurance contracts. As
a result, reinsurance companies must be willing to participate on all layers
offered under a specific contract in order to be considered a viable
reinsurer.
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 for this purpose amounted to $15,767,000 in 2008. During 2008,
Employers Mutual retained 10.5 percent of the gross assumed premiums written
subject to cession to the reinsurance subsidiary as compensation for the
$2,000,000 cap on losses assumed per event, which amounted to
$8,637,000. The reinsurance subsidiary also assumed all foreign
currency exchange gain/loss associated with contracts incepting on January 1,
2006 and thereafter that were subject to the quota share
agreement. The net foreign currency exchange gain assumed by the
reinsurance subsidiary in 2008 was $257,000.
Competition
Property
and Casualty Insurance
The
property and casualty insurance business is very competitive. The
pool participants 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 pool participants are engaged is based on
many factors, including the perceived overall financial strength of the insurer,
premiums charged, contract terms and conditions, services offered, speed of
claim payments, reputation and experience. Because the insurance
products of the pool participants are marketed exclusively through independent
agencies, they face competition to retain qualified agencies, as well as
competition within the agencies. The pool participants also compete
with direct writers, who utilize salaried employees and generally offer their
products at a lower cost, exclusive agencies, who write insurance business for
only one company, and to a lesser extent, internet-based
enterprises. The pool participants utilize a profit-sharing plan as
an incentive for the independent agencies to place high-quality insurance
business with them.
Reinsurance
Employers
Mutual, in writing reinsurance business through its HORAD operation, competes in
the global reinsurance market with numerous reinsurance companies, many of which
have substantially greater financial resources. Competition for
reinsurance business is based on many factors, including financial strength,
industry ratings, stability in products offered and licensing
status. Some ceding companies have tended to favor large,
highly-capitalized reinsurance companies who are able to provide “mega” line
capacity for multiple lines of business. Employers Mutual faces the
risk of ceding companies becoming less interested in diversity and spread of
reinsurance risk in favor of having fewer, highly-capitalized reinsurance
companies on their program.
While
reinsurer competition for national and regional company business is growing, the
Company believes that MRB has a competitive advantage in the smaller mutual
company market that it serves. This segment of the market is not
targeted by the London and Bermuda markets, which tend to deal with larger
insurers at higher margins. MRB understands the needs of the smaller
company market and operates at a very low expense ratio, enabling it to offer
reinsurance coverage (on business that generally presents less risk) to an
under-served market at lower margins. A.M.
Best Company Rating
Property
and Casualty Insurance
A.M. Best
Company (A.M. Best) rates insurance companies based on their relative financial
strength and ability to meet their contractual obligations. The most
recent A.M. Best Property Casualty Key Rating Guide gives the Company’s property
and casualty insurance subsidiaries an “A-” (Excellent) financial strength
rating in their capacity as participants in the pooling
agreement. A.M. Best re-evaluates 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 participants
will maintain their current rating in the future. Management believes
that an A.M. Best 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. A.M. Best’s publications indicate that these
ratings are assigned to companies that have achieved excellent overall
performance and have a strong ability to meet their obligations over a long
period of time. A.M. Best’s ratings are based upon factors of concern
to policyholders and insurance agents, and are not directed toward the
protection of investors.
Reinsurance
The most
recent A.M. Best Property Casualty Key Rating Guide gives the Company’s
reinsurance subsidiary an “A-” (Excellent) financial strength
rating. However, because all of the reinsurance business assumed by
the reinsurance subsidiary is produced by Employers Mutual, the rating of the
reinsurance subsidiary is not critical to the Company’s reinsurance
operations. The rating of Employers Mutual is, however, critical to
the Company’s reinsurance operations, as the unaffiliated insurance companies
that cede business to Employers Mutual view the rating as an indication of
Employers Mutual’s ability to meet its obligations to those insurance
companies. Employers Mutual’s rating of “A-” (Excellent) has resulted
in the loss of some reinsurance business because some insurance companies
require a rating of “A” (Excellent) or higher. A downgrade of
Employers Mutual’s rating would have a material adverse impact on the Company’s
reinsurance subsidiary, as a downgrade would negatively impact Employers
Mutual’s ability to assume reinsurance business and, consequently, to cede that
business to the Company’s reinsurance subsidiary.
Statutory
Combined Trade Ratios
The
following table sets forth the statutory combined trade ratios of the Company’s
insurance subsidiaries and the property and casualty insurance industry averages
for the five years ended December 31, 2008. The combined trade 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 trade ratio is below 100 percent,
a company has an underwriting profit; if it is above 100 percent, a company has
an underwriting loss.
(1) The
2005 expense ratio and combined trade ratio for “property and casualty
insurance” and “total insurance operations” are distorted by $29,631,000 of
additional premiums written and $6,519,000 of commission expense that were
recorded in connection with the increase in the property and casualty insurance
segment’s aggregate pool participation from 23.5 percent to 30.0
percent. Excluding these adjustments, the expense ratios would have
been 34.4 percent and 32.9 percent, respectively, and the combined trade ratios
would have been 96.5 percent and 95.3 percent, respectively.
(2) The
2008, 2007 and 2006 loss ratio, expense ratio, and combined trade ratio for
“reinsurance” and “total insurance operations” reflect the revised terms of the
quota share agreement. The previous terms of the quota share
agreement provided for a 4.5 percent override commission expense payment to
Employers Mutual as compensation for the cap on losses assumed per
event. Effective January 1, 2006, the reinsurance subsidiary no
longer pays this override commission, and instead pays a 10.5 percent premium
charge. In addition, the 2006 expense ratio and combined trade ratio
for “reinsurance” are distorted by $3,440,000 of negative premiums written and
$1,343,000 of commission income that were recorded in connection with the change
in Employers Mutual’s participation in the MRB pool. Excluding these
adjustments, the expense ratio and combined trade ratio for “reinsurance” would
have been 24.7 percent and 93.2 percent, respectively. These
adjustments were not large enough to impact the expense ratio and the combined
trade ratio for “total insurance operations.”
(3) As
reported by A.M. Best Company. The ratio for 2008 is an estimate; the
actual combined trade ratio is not currently available.
Claims
Management
The pool
participants believe that effective claims management is critical to their
success. To this end, the pool participants have adopted a
customer-focused claims management process that is believed to be cost
efficient, and able to deliver an appropriate level of claims service that
produces superior claims results. The claims management process is
focused on controlling claims from their inception, accelerating communication
to insureds and claimants and compressing the cycle time of claims to control
both loss costs and claims-handling costs. The pool participants
believe their process provides quality service and results in the appropriate
handling of claims, allowing them to cost-effectively pay valid claims and
contest fraudulent claims. The
claims management operation includes adjusters, appraisers, special
investigators, attorneys and claims administrative personnel. The
pool participants conduct their claims management operations out of 16 branch
offices and five service offices located throughout the United
States. The home office claims group provides advice and counsel for
branch claims staff in investigating, reserving and settling
claims. The home office claims staff also evaluates branch claims
operations and makes recommendations for improvements in
performance. Additional home office services provided include:
complex claim handling, physical damage and property review, medical case
management, medical bill review, legal coverage analysis, litigation management
and subrogation. The pool participants believe these home office
services assist the branch claims personnel in producing greater efficiencies
than can be achieved at the local level.
Each
branch office is responsible for evaluating and settling claims within the
authority provided by home office claims. Authority levels within the
branch offices are granted based upon an adjuster’s experience and
expertise. The branch office must request input from home office
claims once a case exceeds its authority level. A claims committee
exists within home office and is chaired by the Senior Vice President of
Claims. This committee meets on a weekly basis to assist the branches
in evaluating and settling claims beyond their authority level.
The pool
participants will allow claims to go to litigation in matters such as value
disputes and questionable liability, and will defend appropriate denials of
coverage. The pool participants generally retain outside defense
counsel to litigate such matters; however, internal claims professionals manage
the litigation process, rather than ceding control to an
attorney. The pool participants have implemented a litigation
management system that allows the claims staff to evaluate the quality and cost
effectiveness of outside legal services provided. Cases are
constantly reviewed to adjust the litigation plan if necessary, and all cases
going to trial are carefully reviewed to assess the value of trial or
settlement.
Loss
and Settlement Expense Reserves
Liabilities
for losses and settlement expenses are estimates at a given point in time of
what an insurer expects to pay to claimants and the cost of settling claims,
based on facts and circumstances then known. It can be expected that
the insurer’s ultimate liability for losses and settlement expenses may either
exceed or be less than such estimates. The Company’s estimates of the
liabilities for losses and settlement expenses are based on estimates of future
trends and claims severity, judicial theories of liability and other
factors. However, during the loss adjustment period, which may cover
many years in some cases, the Company may learn additional facts regarding
individual claims, and consequently it often becomes necessary to refine and
adjust its estimates of liability. The Company reflects any
adjustments to its liabilities for losses and settlement expenses in its
operating results in the period in which the changes in estimates are
made.
The
Company maintains reserves for losses and settlement expenses with respect to
both reported and unreported claims. The amount of reserves for
reported claims is primarily based upon a case-by-case evaluation of the
specific type of claim, knowledge of the circumstances surrounding each claim
and the policy provisions relating to the type of loss. Reserves on
assumed reinsurance business are the amounts reported by the ceding
companies.
The
amount of reserves for unreported claims is determined on the basis of
statistical information for each line of insurance with respect to the probable
number and nature of claims arising from occurrences that have not yet been
reported. Established reserves are closely monitored and are
frequently recomputed using a variety of formulas and statistical techniques for
analyzing actual claim costs, frequency data and other economic and social
factors.
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, if necessary.
Employers
Mutual’s actuaries conduct quarterly reviews of the direct loss and settlement
expense reserves. In addition, they specifically analyze direct case
loss reserves on a quarterly basis and direct incurred but not reported (“IBNR”)
loss reserves on an annual basis. Based on the results of these
regularly-scheduled evaluations, the actuaries make recommendations regarding
adjustments to direct reserve levels, if deemed appropriate.
The
Company does not discount reserves. Inflation is implicitly provided
for in the reserving function through analysis of cost trends, reviews of
historical reserving results and projections of future economic
conditions. Large ($100,000 and over) incurred and reported gross
reserves are reviewed regularly for adequacy. In addition, long-term
and lifetime medical claims are periodically reviewed for cost trends and the
applicable reserves are appropriately revised, if necessary.
Despite
the inherent uncertainties of estimating loss and settlement expense reserves,
the Company believes that its reserves are being calculated in accordance with
sound actuarial practices and, based upon current information, that its reserves
for losses and settlement expenses at December 31, 2008 are
adequate.
The
following table sets forth a reconciliation of beginning and ending reserves for
losses and settlement expenses of the property and casualty insurance
subsidiaries and the reinsurance subsidiary. Amounts presented are on
a net basis, with a reconciliation of beginning and ending reserves to the gross
amounts presented in the consolidated financial statements.
Following
is a detailed analysis of the reserve development the Company has experienced
during the past three years.
Year
ended December 31, 2008
Property
and casualty insurance segment
For the
property and casualty insurance segment, the December 31, 2008 estimate of loss
and settlement expense reserves for accident years 2007 and prior decreased
$21,564,000 from the estimate at December 31, 2007. This decrease
represents approximately 5.3 percent of the December 31, 2007 carried
reserves. No changes were made in the key actuarial assumptions
utilized to estimate loss and settlement expense reserves during
2008. Reserves
on previously reported claims developed favorably in 2008 by approximately
$2,755,000. Favorable development on case and bulk loss reserves
occurred in most major lines of business: other liability
($3,959,000), commercial property ($2,289,000), auto physical damage
($1,356,000), personal auto liability ($1,220,000), bonds ($1,073,000) and
homeowners ($792,000). Partially offsetting this favorable
development was unfavorable development on the workers’ compensation
($1,305,000) and commercial auto ($6,629,000) lines of business. For
all lines combined, the latest five prior accident years were responsible for
over 68 percent of the total favorable development. In aggregate, the
favorable development on previously reported claims is attributable to claims
that closed during 2008.
IBNR
reserves on prior accident years experienced favorable development of
$12,411,000 resulting from better than expected emergence ($11,135,000), the
impact of revised formula IBNR reserves based on an experience review
($1,087,000), and a change in the line of business distribution
($189,000). The emergence of IBNR claims was lower than the change in
prior year IBNR loss reserves and arose from all major lines of
business: other liability ($5,782,000), commercial property
($1,491,000), commercial auto liability ($1,238,000), homeowners ($1,045,000),
auto physical damage ($848,000), workers’ compensation ($495,000), bonds
($148,000), and personal auto liability ($88,000). For all lines
combined, approximately 84 percent of the favorable development is attributable
to accident years 2006 and 2007.
During
2008, underlying exposure increases resulted in premium increases in certain
lines of business, most notably in the other liability and workers’ compensation
lines. Since formula IBNR loss reserves are calculated through the
application of IBNR factors to premiums earned, these exposure increases
resulted in an increase of $932,000 in prior accident year IBNR loss
reserves. Further, reserves for prior years asbestos claims were
increased $942,000 to maintain adequacy targets. These increases
partially offset the favorable case and IBNR reserve development described
above.
Total
settlement expense developed downward in 2008 by
$8,347,000. Approximately 50 percent of the downward development is
related to internal claims department, independent adjuster, and miscellaneous
settlement expenses. Current accident year allocation factors
compared to those at December 31, 2007 generated $380,000 of downward
development. A majority of the remaining development resulted from settlement
expense payments in these categories during 2008 that were lower than
anticipated in the payment patterns used in the accident year allocation of
settlement expense reserves at December 31, 2007. This downward
development occurred primarily in the other liability, workers’ compensation and
commercial auto liability lines of business.
The
defense and cost containment portion of prior year settlement reserves developed
downward in 2008 by $4,187,000. The favorable development resulted
from expense payments in 2008 that were $6,402,000 lower than anticipated in the
2007 year-end reserve levels. The other liability line of business
accounts for approximately 80 percent of this downward
development. Partially offsetting this favorable development,
settlement expense reserves were strengthened $1,800,000, of which $1,147,000
was allocated to prior accident years. This prior year strengthening
occurred primarily in the other liability, commercial auto and workers’
compensation lines of business. This reserving action resulted from
standard actuarial reserve reviews. In addition, asbestos defense and
cost containment reserves were increased $558,000. Finally,
settlement expense reserves for prior years increased approximately $331,000 due
to the exposure increases mentioned above in the discussion of IBNR loss
reserves.
Prior
accident year reserves for non-voluntary assumed business developed adversely by
$305,000, attributable primarily to assigned risk pools.
The above
results reflect reserve development on a direct and assumed
basis. During 2008, ceded losses and settlement expenses for prior
accident years increased $503,000. The impact of the increase in
reinsurance recoverable was to improve the favorable development on the direct
and assumed business described above. Reinsurance
segment
For the
reinsurance segment, the December 31, 2008 estimate of loss and settlement
expense reserves for accident years 2007 and prior decreased $13,744,000 from
the estimate at December 31, 2007. This represents 9.7 percent of the
December 31, 2007 carried reserves and is primarily attributable to the HORAD
book of business for accident year 2007. Much of this development can
be attributed to reported losses that were below December 2007 implicit
projections for policy years 2005 through 2007 in the property, casualty and
multi-line classes.
For the
HORAD and MRB books of business combined, the favorable development can be
attributed to the property pro rata, property excess, and casualty excess lines
of business.
No
changes were made in the key actuarial assumptions utilized to estimate loss and
settlement expenses reserves during 2008.
Year
ended December 31, 2007
Property
and casualty insurance segment
For the
property and casualty insurance segment, the December 31, 2007 estimate of loss
and settlement expense reserves for accident years 2006 and prior decreased
$27,977,000 from the estimate at December 31, 2006. This decrease, a
majority of which was attributable to favorable development on case loss
reserves, represented approximately 6.8 percent of the December 31, 2006 gross
carried reserves. No changes were made in the key actuarial
assumptions utilized to estimate loss and settlement expense reserves during
2007.
Reserves
on previously reported claims developed favorably in 2007 by approximately
$17,154,000. Favorable development on case and bulk loss reserves
occurred in most major lines of business: other liability ($7,126,000), workers’
compensation ($6,005,000), commercial property ($3,083,000), auto physical
damage ($1,327,000), bonds ($1,020,000), homeowners ($947,000) and personal auto
liability ($764,000). For all lines combined, the latest three prior
accident years were responsible for over 77 percent of the total favorable
development, and the latest five prior accident years contributed over 99
percent. In aggregate, all of the favorable development on previously
reported claims was attributable to claims that closed during 2007.
The
emergence of IBNR claims was lower than the change in prior year IBNR loss
reserves, resulting in approximately $11,750,000 of favorable development in
2007. This development arose from all major lines of business: other
liability ($4,607,000), commercial property ($1,814,000), commercial auto
liability ($1,599,000), homeowners ($1,214,000), auto physical damage
($1,060,000), workers’ compensation ($847,000), bonds ($490,000) and personal
auto liability ($119,000). For all lines combined, the favorable
development on prior year IBNR loss reserves was attributable to accident year
2006.
During
2007, underlying exposure increases resulted in premium increases in certain
lines of business, most notably in the other liability and workers’ compensation
lines. Since formula IBNR loss reserves are calculated through the
application of IBNR factors to premiums earned, these exposure increases
resulted in an increase of $2,226,000 in prior accident year IBNR loss reserves,
which partially offset the favorable case and IBNR loss reserve development
described above.
Total
settlement expense reserves developed downward in 2007 by
$6,760,000. Approximately 51 percent of the downward development was
related to internal claims department, independent adjuster, and miscellaneous
settlement expenses. Settlement expense payments in these categories
during 2007 were lower than anticipated in the payment patterns used in the
accident year allocation of settlement expense reserves at December 31,
2006. This downward development occurred primarily in the workers’
compensation, other liability and commercial auto liability lines of
business. The
defense and cost containment portion of prior accident year settlement expense
reserves developed downward in 2007 by $3,320,000. The favorable
development resulted from expense payments in 2007 that were $5,763,000 lower
than anticipated in the 2006 year-end reserve levels. The other
liability line of business accounted for approximately three fourths of this
downward development. Partially offsetting this favorable
development, settlement expense reserves were strengthened $2,700,000, of which
approximately $1,752,000 was allocated to prior accident years. This
prior year strengthening occurred primarily in the other liability, commercial
auto and workers’ compensation lines of business. This reserving
action resulted from standard actuarial reserve reviews. In addition,
$824,000 of settlement expense reserves were reallocated to defense and cost
containment, of which $590,000 was allocated to prior accident
years. Finally, settlement expense reserves for prior accident years
increased approximately $244,000 due to the exposure increases mentioned above
in the discussion of IBNR loss reserves.
Prior
accident year reserves for non-voluntary assumed business developed adversely by
$127,000, attributable primarily to auto assigned risk pools.
The above
results reflected reserve development on a direct and assumed basis. During
2007, ceded losses for prior accident years decreased $5,587,000, which was
largely attributable to a reduction in prior accident year losses ceded for the
workers’ compensation, umbrella, bonds and commercial property lines of
business. The impact of the decrease in reinsurance recoverables was
to reduce the favorable development on the direct and assumed business described
above.
Reinsurance
segment
For the
reinsurance segment, the December 31, 2007 estimate of loss and settlement
expense reserves for accident years 2006 and prior decreased $10,761,000 from
the estimate at December 31, 2006. This represented 7.8 percent of
the December 31, 2006 carried gross reserves and was attributable to the HORAD
book of business for accident years 2004 - 2006. Much of this development could
be attributed to reported losses for policy years 2004 - 2006 for property,
casualty and multi-line classes that were below December 31, 2006 implicit
projections.
For the
HORAD and MRB books of business combined, the favorable development could be
attributed to the property pro rata and property excess lines of
business.
No
changes were made in the key actuarial assumptions utilized to estimate loss and
settlement expense reserves during 2007.
Year
ended December 31, 2006
Property
and casualty insurance segment
For the
property and casualty insurance segment, the December 31, 2006 estimate of loss
and settlement expense reserves for accident years 2005 and prior decreased
$32,255,000 from the estimate at December 31, 2005. This decrease
represented approximately 7.9 percent of the December 31, 2005 gross carried
reserves and was attributed primarily to favorable development on case loss
reserves of previously reported claims. No changes were made in the
key actuarial assumptions utilized to estimate loss and settlement expense
reserves during 2006.
Reserves
on previously reported claims developed favorably in 2006 by approximately
$28,187,000. Favorable case loss reserve development occurred in all
major lines of business: workers’ compensation ($11,366,000), other liability
($8,503,000), commercial property ($2,369,000), personal auto liability
($1,436,000), homeowners ($1,412,000), auto physical damage ($1,304,000), bonds
($1,248,000) and commercial auto liability ($549,000). For all lines
combined, the latest three prior accident years were responsible for over 80
percent of the total favorable development, and the latest five prior accident
years contributed over 95 percent. In aggregate, all of the favorable
development was attributable to claims that closed during 2006. During
2006, direct IBNR loss reserves other than asbestos were strengthened
$1,800,000, of which approximately $970,000 was allocated to prior accident
years. This reserving action resulted from standard actuarial reserve
reviews and reflected somewhat higher ratios of IBNR emergence to premiums
earned for several lines of business. In addition, asbestos IBNR loss
reserves were strengthened $170,000, reflecting the results of an outside
consultant’s analysis of the Company’s asbestos liabilities.
The
emergence of IBNR claims was lower than the change in prior year IBNR loss
reserves, resulting in approximately $5,195,000 of favorable development in
2006. This favorable development arose from five lines of business:
other liability ($2,755,000), commercial auto liability ($2,018,000), homeowners
($1,401,000), auto physical damage ($859,000) and commercial property
($102,000). Partially offsetting this favorable development was
adverse development totaling ($1,940,000) on the remaining lines of
business. For all lines combined, the favorable development of prior
year IBNR loss reserves was attributable to accident year 2005.
During
2006, underlying exposure increases resulted in premium increases in certain
lines of business, most notably in the other liability line. Since
formula IBNR loss reserves are calculated through the application of IBNR
factors to premiums earned, these exposure increases resulted in an increase of
$1,554,000 in prior accident year IBNR loss reserves.
Total
settlement expense reserves developed downward in 2006 by
$3,915,000. Approximately 57 percent of the downward development was
related to internal claims department, independent adjuster and miscellaneous
settlement expenses. Settlement expense payments in these categories
during 2006 were lower than anticipated in the payment patterns used in the
accident year allocation of settlement expense reserves at December 31,
2005. This downward development occurred primarily in the workers’
compensation, other liability and commercial auto liability lines of
business.
The
defense and cost containment portion of prior accident year settlement expense
reserves developed downward in 2006 by $1,690,000. The favorable
development resulted from expense payments in 2006 that were $3,681,000 lower
than anticipated in the 2005 year-end reserve levels. The other
liability line of business accounted for approximately 80 percent of this
downward development. During 2006, the settlement expense formula
case loss reserve for involuntary auto business was eliminated, resulting in
$206,000 of additional downward development. Partially offsetting
this favorable development was $511,000 of strengthening in asbestos settlement
expense reserves, which resulted from an outside consultant’s analysis of the
Company’s asbestos liabilities. Settlement expense reserves other
than asbestos were strengthened $1,800,000, of which approximately $1,183,000
was allocated to prior accident years. About 80 percent of this prior
accident year strengthening occurred in the other liability and workers’
compensation lines of business. This reserving action resulted from
standard actuarial reserve reviews, which indicated generally higher ultimate
expense to loss ratios in these lines of business. In addition,
settlement expense reserves for prior accident years increased approximately
$421,000 due to the exposure increases mentioned above in the discussion of IBNR
loss reserves.
The above
results reflect reserve development on a direct and assumed
basis. During 2006, ceded losses for prior accident years decreased
$2,378,000, which was attributed to a reduction in prior year losses ceded to
workers’ compensation assigned risk pools. The impact of the decrease
in reinsurance recoverables was to reduce the favorable development on the
direct and assumed business described above.
Reinsurance
segment
For the
reinsurance segment, the December 31, 2006 estimate of loss and settlement
expense reserves for accident years 2005 and prior decreased $9,661,000 from the
estimate at December 31, 2005. This represented 7.2 percent of the
December 31, 2005 gross carried reserves and was attributed primarily to the
HORAD book of business, which developed downward by
$7,896,000. Approximately 95 percent of the HORAD favorable
development arose from accident years 2004 and 2005. Much of this
development could be attributed to reported policy year 2004 and 2005 losses for
property, casualty, ocean marine and multi-line classes that were below December
31, 2005 implicit projections.
MRB
reserves developed favorably by $1,765,000, which was less than 20 percent of
the total favorable development in the reinsurance segment. This
development was attributed to accident years 2004 and 2005, which experienced
$2,037,000 of favorable development. During 2006, system changes were
implemented to split reported settlement expense reserves from reported loss
reserves. Simultaneously, the Company eliminated the formula case
loss reserve for settlement expenses that had been carried in previous
years. This action accounted for approximately two-thirds of the
total MRB favorable development.
For the
HORAD and MRB books of business combined, the property excess and casualty
excess classes accounted for about 90 percent of the total favorable
development.
No
changes were made in the key actuarial assumptions utilized to estimate loss and
settlement expense reserves during 2006.
Calendar
year development table
The
following table shows the calendar year development of the loss and settlement
expense reserves of the property and casualty insurance subsidiaries and the
reinsurance subsidiary. Amounts presented are on a net basis with (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.
The table
has been restated to reflect the increase in the property and casualty insurance
subsidiaries’ aggregate participation in the pooling agreement to 30.0 percent
effective January 1, 2005.
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.
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