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EMC Insurance Group 10-Q 2008 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
For
the quarterly period ended SEPTEMBER 30,
2008
OR
For
the transition period from ________________to __________________
Commission
File Number:
0-10956
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
x Yes ¨ No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
¨ Yes x No
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
Total
pages
76
TABLE OF CONTENTS
EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Unaudited)
See
accompanying Notes to Consolidated Financial Statements. EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Unaudited)
See
accompanying Notes to Consolidated Financial Statements. EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
(Unaudited)
All
balances presented below, with the exception of net investment income, realized
investment gains (losses) and income tax expense (benefit), are the result of
related party transactions with Employers Mutual.
See
accompanying Notes to Consolidated Financial Statements. EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
See
accompanying Notes to Consolidated Financial Statements. EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited)
EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS, CONTINUED
(Unaudited)
See
accompanying Notes to Consolidated Financial Statements. EMC
INSURANCE GROUP INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The
accompanying unaudited consolidated financial statements have been prepared on
the basis of U.S. generally accepted accounting principles (GAAP) for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the
information and notes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation of
the interim financial statements have been included. The results of
operations for the interim periods reported are not necessarily indicative of
results to be expected for the year.
The
consolidated balance sheet at December 31, 2007 has been derived from the
audited financial statements at that date, but does not include all of the
information and notes required by GAAP for complete financial
statements.
Certain
amounts previously reported in prior years’ consolidated financial statements
have been reclassified to conform to current year presentation.
In
reading these financial statements, reference should be made to the Company’s
2007 Form 10-K or the 2007 Annual Report to Stockholders for more detailed
footnote information.
In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements,”
which defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. The provisions of
SFAS 157 are effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. The Company adopted the requirements of SFAS 157 effective
January 1, 2008, which resulted in additional disclosures, but no impact on
operating results. In October 2008, the FASB
issued Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial
Asset When the Market For That Asset Is Not Active,” which clarifies the
application of SFAS 157 in a market that is not active. FAS 157-3 was
effective upon issuance, including prior periods for which financial statements
have not been issued. Adoption of FAS 157-3 did not have any effect
on the consolidated financial position or operating results of the
Company.
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans.” SFAS 158 includes a
requirement to measure the defined benefit plan assets and obligations as of the
end of the employer’s fiscal year. This requirement is effective for
fiscal years ending after December 15, 2008. SFAS 158 provides
two approaches to measure the adjustment from a previously reported non-fiscal
year-end measurement date to a fiscal year-end measurement date, both of which
require the adjustment be recorded to beginning retained earnings and
“accumulated other comprehensive income”, as applicable. SFAS 158
does not change the method of calculating the net periodic cost that existed
under previous guidance. Effective January 1, 2008, the Company
elected to apply the approach under which the Company’s previous November 1,
2007 measurement date was used to obtain the adjustment for the two month
transition period. As a result, on January 1, 2008, the Company
recorded a $205,751 decrease to retained earnings and a $46,057 decrease to
“accumulated other comprehensive income” to record the net periodic cost
associated with the two month transition period.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” SFAS 159 permits
reporting entities to choose, at specified election dates, to measure eligible
items at fair value (the “fair value option”). The unrealized gains
and losses on items for which the fair value option has been elected will be
reported in earnings. As it relates to the Company’s financial
reporting, the Company would be permitted to elect fair value recognition of
fixed maturity and equity securities currently classified as either
available-for-sale or held-to-maturity, and report future unrealized gains and
losses from these securities in earnings. Electing the fair value
option for an existing held-to-maturity security will not call into question the
intent of an entity to hold other fixed maturity securities to maturity in the
future. The provisions of this statement are effective beginning with
the first fiscal year that begins after November 15, 2007. The
Company adopted the requirements of SFAS 159 effective January 1, 2008, but did
not elect the fair value option. Therefore, adoption of this
statement had no effect on the operating results of the Company.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations”. This statement replaces SFAS No. 141, “Business
Combinations”; however, it retains the fundamental requirements of SFAS No. 141
in that the acquisition method of accounting (referred to as “purchase method”
in SFAS 141) be used for all business combinations. SFAS 141
(revised) is to be applied prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Adoption of this
statement is not expected to have any effect on the operating results of the
Company.
The
effect of reinsurance on premiums written and earned, and losses and settlement
expenses incurred, for the three months and nine months ended September 30, 2008
and 2007 is presented below.
The
Company’s operations consist of a property and casualty insurance segment and a
reinsurance segment. The property and casualty insurance segment
writes both commercial and personal lines of insurance, with a focus on
medium-sized commercial accounts. The reinsurance segment provides
reinsurance for other insurers and reinsurers. The segments are
managed separately due to differences in the insurance products sold and the
business environments in which they operate.
Summarized
financial information for the Company’s segments is as follows:
The
following table displays the net premiums earned of the property and casualty
insurance segment and the reinsurance segment for the three months and nine
months ended September 30, 2008 and 2007, by line of business.
The
actual income tax expense (benefit) for the three months and nine months ended
September 30, 2008 and 2007 differed from the “expected” income tax expense
(benefit) for those periods (computed by applying the United States federal
corporate tax rate of 35 percent to income (loss) before income tax expense)
primarily due to tax-exempt interest income.
The
Company had no provision for uncertain tax positions at September 30, 2008 or
December 31, 2007. During the third quarter of 2007, the Company
recognized a $34,736 underpayment penalty related to its December 31, 2006 U.S.
federal tax return. The Company did not recognize any interest or
other penalties related to U.S. federal or state income taxes during the three
months and nine months ended September 30, 2008 or 2007. It is the
Company’s accounting policy to reflect income tax penalties as other expense,
and interest as interest expense.
The
Company files U.S. federal tax returns, along with various state income tax
returns. The Company is no longer subject to U.S. federal and state
income tax examinations by tax authorities for years before 2005.
The
Company’s deferred tax asset increased substantially from December 31, 2007 to
September 30, 2008 primarily due to a decrease in unrealized
gains. The Company’s projections indicate that there will be
sufficient taxable income in future years to fully realize the deferred tax
asset.
The
components of net periodic benefit cost for Employers Mutual’s pension and
postretirement benefit plans is as follows:
The large
decrease in net periodic postretirement benefit cost for the three months and
nine months ended September 30, 2008 is due to a plan amendment that became
effective on January 1, 2008. This plan amendment increased the
minimum retirement age and length of service requirement to receive the full
employer contribution amount in the postretirement health care benefit
plan.
Net
periodic pension benefit cost allocated to the Company amounted to $353,336 and
$378,535 for the three months and $1,060,013 and $1,135,605 for the nine months
ended September 30, 2008 and 2007, respectively. Net periodic
postretirement benefit cost allocated to the Company amounted to $188,076 and
$566,835 for the three months and $564,232 and $1,700,511 for the nine months
ended September 30, 2008 and 2007, respectively.
During
2008, Employers Mutual plans to contribute approximately $2,700,000 to the VEBA
trust and, depending on the performance of the equity markets during the fourth
quarter, approximately $30,000,000 to the pension plan. As of
September 30, 2008, Employers Mutual has not made a contribution to the pension
plan and has contributed $1,200,000 to the postretirement benefit plan’s VEBA
trust.
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. Employers Mutual can provide the common stock required under
its plans by: 1) using shares of common stock that it currently owns; 2)
purchasing common stock on the open market; or 3) directly purchasing common
stock from the Company at the current fair value. Employers Mutual
has historically purchased common stock from the Company for use in its
incentive stock option plans and its non-employee director stock option
plan.
Employers
Mutual maintains two separate incentive stock option plans for the benefit of
officers and key employees of Employers Mutual and its
subsidiaries. A total of 1,000,000 shares of the Company’s common
stock have been reserved for issuance under the 1993 Employers Mutual Casualty
Company Incentive Stock Option Plan (1993 Plan), and a total of 1,500,000 shares
have been reserved for issuance under the 2003 Employers Mutual Casualty Company
Incentive Stock Option Plan (2003 Plan).
Both
plans have a ten year time limit for granting options. Options can no
longer be granted under the 1993 Plan and no additional options will be granted
under the 2003 Plan as Employers Mutual recently implemented a new stock
incentive plan. Options granted under the 1993 Plan and 2003 Plan
have a vesting period of two, three, four or five years with options becoming
exercisable in equal annual cumulative increments. Option prices
cannot be less than the fair value of the common stock on the date of
grant.
On June
1, 2007, the Company registered 2,000,000 shares of the Company’s common stock
for use in the 2007 Employers Mutual Casualty Company Stock Incentive Plan (2007
Plan). The 2007 Plan provides for the awarding of performance shares,
performance units, and other stock-based awards, in addition to qualified
(incentive) and non-qualified stock options, stock appreciation rights,
restricted stock and restricted stock units. The 2007 Plan provides
for a ten-year time limit for granting awards. Officers, key
employees and non-employee directors of Employers Mutual and its subsidiaries
and affiliates, as well as certain agents, may participate in the
plan.
The
Senior Executive Compensation and Stock Option Committee (the “Committee”) of
Employers Mutual’s Board of Directors (the “Board”) grants the awards and is the
administrator of the plans. The Company’s Compensation Committee must
consider and approve all awards granted to the Company’s senior executive
officers.
The
Company recognized compensation expense of $50,027 ($48,957 net of tax) and
$46,243 (gross and net of tax) for the three months and $182,292 ($177,669 net
of tax) and $154,698 (gross and net of tax) for the nine months ended September
30, 2008 and 2007, respectively, related to the 2003 and 2007
Plans. During the first nine months of 2008, 221,875 options were
granted under the 2007 Plan to eligible participants at a price of $23.467, and
87,815 options were exercised under the plans at prices ranging from $9.25 to
$25.455. The Company recognized compensation expense of
$27,090 ($17,609 net of tax) and $6,997 ($4,548 net of tax) during the three
months ended September 30, 2008 and 2007, respectively, related to a stock
appreciation rights agreement that is being accounted for as a
liability-classified award. Compensation expense of $27,090 ($17,609
net of tax) was recognized for this agreement during the nine months ended
September 30, 2008, and negative compensation expense of $89,550 ($58,208 net of
tax) was recognized during the nine months ended September 30,
2007.
The
weighted average fair value of options granted during the nine months ended
September 30, 2008 and 2007 amounted to $2.77 and $3.78,
respectively. The fair value of each option grant was estimated on
the date of grant using the Black-Scholes-Merton option-pricing model and the
following assumptions:
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