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UFCS > SEC Filings for UFCS > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for UNITED FIRE GROUP INC

Form 10-K for UNITED FIRE GROUP INC


5-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis should be read in conjunction with Part II, Item 6, "Selected Financial Data" and Part II, Item 8, "Financial Statements and Supplementary Data." Amounts (except per share amounts) are presented in thousands, unless otherwise noted.

FORWARD-LOOKING STATEMENTS

It is important to note that our actual results could differ materially from those projected in forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in "Forward-Looking Information" and Part I, Item 1A, "Risk Factors" of this report.

BUSINESS OVERVIEW
Originally founded in 1946 as United Fire & Casualty Company, United Fire Group, Inc. ("United Fire", the "Registrant", the "Company", "we", "us", "our") and its consolidated insurance company subsidiaries provide insurance protection for individuals and businesses through several regional companies. Our property and casualty insurance company subsidiaries are licensed in 43 states plus the District of Columbia and are represented by approximately 1,200 independent agencies. Our life insurance subsidiary is licensed in 37 states and is represented by approximately 1,000 independent agencies. Segments
We operate two business segments that are comprised of a wide range of products:
property and casualty insurance, which includes commercial insurance, personal insurance, surety bonds and assumed reinsurance; and

life insurance, which includes deferred and immediate annuities, universal life products and traditional life (primarily single premium whole life insurance) products.

We manage these business segments separately, as they generally do not share the same customer base, and they each have different products, pricing, and expense structures.
For 2013, property and casualty business accounted for approximately 92.0 percent of our net premiums earned, of which 90.5 percent was generated from commercial insurance. Life insurance business made up approximately 8.0 percent of our net premiums earned, of which over 67.7 percent was generated from traditional life insurance products.
Pooling Arrangement
All of our property and casualty insurance subsidiaries, with the exception of Texas General Indemnity Company, and our affiliate are members of an intercompany reinsurance pooling arrangement. Pooling arrangements permit the participating companies to rely on the capacity of the entire pool's capital and surplus, rather than being limited to policy exposures of a size commensurate with each participant's own surplus level. Geographic Concentration
For 2013, approximately 50.0 percent of our property and casualty direct written premiums were written in Texas, Iowa, California, New Jersey, and Missouri; approximately 75.0 percent of our life insurance premiums were written in Iowa, Illinois, Minnesota, Wisconsin and Nebraska.


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Sources of Revenue and Expense
We evaluate segment profit or loss based upon operating and investment results. Segment profit or loss described in the following sections of Management's Discussion and Analysis is reported on a pre-tax basis. Additional segment information is presented in Part II, Item 8, Note 10 "Segment Information" to the Consolidated Financial Statements.
Our primary sources of revenue are premiums and investment income. Major categories of expenses include losses and loss settlement expenses, future policy benefits, underwriting and other operating expenses and interest on policyholders' accounts.
Profit Factors
Our profitability is influenced by many factors, including price, competition, economic conditions, investment returns, interest rates, catastrophic events and other natural disasters, man-made disasters, state regulations, court decisions, and changes in the law. To manage these risks and uncertainties, we seek to achieve consistent profitability through strong agency relationships, exceptional customer service, fair and prompt claims handling, disciplined underwriting, superior loss control services, prudent management of our investments, appropriate matching of assets and liabilities and effective and efficient use of technology.

MEASUREMENT OF RESULTS
Our consolidated financial statements are prepared on the basis of GAAP. We also prepare financial statements for each of our insurance company subsidiaries based on statutory accounting principles and file them with insurance regulatory authorities in the states where they do business.
Management evaluates our operations by monitoring key measures of growth and profitability. We believe that disclosure of certain non-GAAP financial measures enhances investor understanding of our financial performance. The following provides further explanation of the key measures management uses to evaluate our results:
Catastrophe losses is a commonly used non-GAAP financial measure, which utilizes the designations of the Insurance Services Office (ISO) and are reported with loss and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25.0 million or more in U.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may include U.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance segment, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings.

                              Years Ended December 31,
(In Thousands)              2013        2012        2011
ISO catastrophes         $  27,222    $ 58,875    $ 57,238
Non-ISO catastrophes (1)     2,994       5,847      23,555
Total catastrophes       $  30,216    $ 64,722    $ 80,793

(1) Includes international assumed losses.


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CONSOLIDATED FINANCIAL HIGHLIGHTS
                                          Years Ended December 31,                  % Change
                                                                                2013         2012
(In Thousands)                        2013          2012         2011(1)      vs. 2012     vs. 2011
Revenues
Net premiums earned                $ 754,846     $ 694,994     $ 586,783         8.6  %      18.4  %
Investment income, net of
investment expenses                  112,799       111,905       109,494         0.8          2.2
Net realized investment gains
(losses)
Other-than-temporary impairment
charges                                 (139 )          (4 )        (395 )        NM         99.0
All other net realized gains           8,834         5,457         6,835        61.9        (20.2 )
Total net realized investment
gains                                  8,695         5,453         6,440        59.5        (15.3 )
Other income                             702           891         2,291       (21.2 )      (61.1 )
Total revenues                     $ 877,042     $ 813,243     $ 705,008         7.8  %      15.4  %

Benefits, losses and expenses
Losses and loss settlement
expenses                           $ 458,814     $ 459,706     $ 430,389        (0.2 )%       6.8  %
Increase in liability for future
policy benefits                       37,625        43,095        32,567       (12.7 )       32.3
Amortization of deferred policy
acquisition costs                    153,677       141,834       153,176         8.3         (7.4 )
Other underwriting expenses           89,861        81,125        58,757        10.8         38.1
Interest on policyholders'
accounts                              35,163        41,409        42,834       (15.1 )       (3.3 )
Total benefits, losses and
expenses                           $ 775,140     $ 767,169     $ 717,723         1.0  %       6.9  %

Income (loss) before income taxes  $ 101,902     $  46,074     $ (12,715 )     121.2  %        NM
Federal income tax expense
(benefit)                             25,762         5,862       (12,726 )        NM        146.1  %
Net income                         $  76,140     $  40,212     $      11        89.3  %        NM

NM = not meaningful
(1) The information presented for 2011 and after includes Mercer Insurance Group's results after the March 28, 2011 acquisition date. Consolidated Results of Operations
During 2013, the increase in net income was driven by growth in property and casualty premium revenue and a reduction in the combined ratio. Net premiums earned increased to $754.8 million compared to $695.0 million in 2012. This increase represents organic growth and is the result of a combination of rate increases across most commercial and personal lines and new business writings. The reduction in the combined ratio resulted from lower catastrophe losses. In 2013, we continued to expand the geographical footprint of our life insurance subsidiary by receiving approval to operate in Nevada, after receiving approval in 2012 to operate in California, Maryland and Delaware and approval in 2011 to operate in New Jersey, North Carolina, Pennsylvania, Virginia and West Virginia, further leveraging the Mercer Insurance Group acquisition. Our life management team continues to improve service to our agents by increasing marketing support and automating life product processes.
During 2012 the increase in net income was driven by growth in property and casualty premium revenue and a reduction in the combined ratio. The reduction in the combined ratio resulted from lower catastrophe losses as well as improvement in non-catastrophe loss experience. In addition, the combined ratio improved due to an improvement in the expense ratio.
Net premiums earned increased to $695.0 million, compared to $586.8 million for the same period of 2011 due in part to the acquisition of Mercer Insurance Group in March 2011, which accounted for $34.9 million of additional earned premium. Our organic growth was $73.3 million over the same period of 2011.


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Effective January 1, 2012, we prospectively adopted the change in accounting guidance that limits the amount of underwriting expenses eligible for deferral. The adoption of the updated accounting guidance resulted in the recognition of approximately $10.3 million ($8.7 million for our property and casualty insurance segment; $1.6 million for our life insurance segment) of additional expense during 2012 that we would not have recognized had the accounting guidance remained unchanged. This represents a reduction to net income of $0.26 per share. Refer to the "Deferred Policy Acquisition Costs" section of Part II, Item 8, Note 1 "Summary of Significant Accounting Policies" for further discussion of the impact of the updated accounting guidance on our reported results.
The year 2011 will be remembered for its devastating catastrophes, both domestic and abroad. According to various reports, 2011 was the costliest catastrophe year on record for the property and casualty insurance industry globally. We experienced losses in our direct and assumed books of business that negatively impacted our full-year results. However, premium rates increased across all lines of business, and there were some positive signs in the overall economy. Additionally, we took steps to improve and strengthen our underwriting guidelines in response to our catastrophe experiences. Internal analyses of our catastrophe exposures, utilizing various approaches including the results of the updated RMS Model Version 11, supported the underwriting changes.
We also focused on our capital management strategy through our stock repurchase program and by entering into a new banking relationship with KeyBank National Association that established a $100.0 million syndicated line of credit, allowing us to reduce our cash position.
During 2011, we began the process of integrating Mercer Insurance Group into our operations. The integration of the West Coast business of Mercer Insurance Group's policy renewals into our processing systems was completed in 2012. We began the integration of the East Coast policy renewals into our processing systems which are on schedule to be completed at the end of 2015. In addition, effective January 1, 2012, we consolidated Mercer Insurance Group's core and catastrophe reinsurance programs into our programs, resulting in increased coverage and reduction in Mercer Insurance Group's historical costs. At a special meeting held on January 24, 2012, our shareholders approved our reorganization into a new holding company structure. United Fire Group, Inc. has replaced United Fire & Casualty Company as the publicly held corporation, and United Fire & Casualty Company is now a wholly owned subsidiary of United Fire Group, Inc. In addition to creating a more streamlined corporate structure, the new holding company's organizational documents enhanced our shareholders' rights by reducing the percentage of shareholders required to amend our Articles of Incorporation, approve the merger or sale of substantially all Company assets, and call a special meeting. This new structure will potentially provide us with more flexibility to operate and finance our businesses, particularly if we should need to raise capital in the future.


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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Property and Casualty Insurance Segment
                                         Years Ended December 31,                  % Change
                                                                               2013         2012
(In Thousands)                       2013          2012         2011(1)      vs. 2012     vs. 2011
Net premiums written              $ 722,821     $ 655,331     $ 551,923        10.3  %      18.7  %
Net premiums earned               $ 694,192     $ 629,411     $ 533,771        10.3         17.9
Losses and loss settlement
expenses                           (437,353 )    (439,137 )    (407,831 )      (0.4 )        7.7
Amortization of deferred policy
acquisition costs                  (147,175 )    (134,444 )    (143,952 )       9.5         (6.6 )
Other underwriting expenses         (73,626 )     (63,620 )     (46,404 )      15.7         37.1
Underwriting gain (loss)          $  36,038     $  (7,790 )   $ (64,416 )        NM        (87.9 )%

Investment income, net of
investment expenses                  46,332        41,879        35,513        10.6  %      17.9  %
Net realized investment gains
(losses)
Other-than-temporary impairment
charges                                (139 )           -             -           -  %         -  %
All other net realized gains          6,400         1,676         3,081       281.9        (45.6 )
Total net realized investment
gains                                 6,261         1,676         3,081       273.6  %     (45.6 )%
Other income                             88           316         1,592       (72.2 )      (80.2 )%
Income (loss) before income taxes $  88,719     $  36,081     $ (24,230 )     145.9  %        NM

GAAP Ratios:
Net loss ratio (without
catastrophes)                          58.6 %        59.5 %        61.3 %      (1.5 )%      (2.9 )%
Catastrophes - effect on net loss
ratio                                   4.4          10.3          15.1       (57.3 )      (31.8 )
Net loss ratio(2)                      63.0 %        69.8 %        76.4 %      (9.7 )%      (8.6 )%
Expense ratio (3)                      31.8          31.4          35.7         1.3        (12.0 )
Combined ratio(4)                      94.8 %       101.2 %       112.1 %      (6.3 )%      (9.7 )%

Statutory Ratios:
Net loss ratio (without
catastrophes)                          58.9 %        60.2 %        61.3 %      (2.2 )%      (1.8 )%
Catastrophes - effect on net loss
ratio                                   4.4          10.3          15.1       (57.3 )      (31.8 )
Net loss ratio(2)                      63.3 %        70.5 %        76.4 %     (10.2 )%      (7.7 )%
Expense ratio (3)                      32.0          31.3          32.2         2.2         (2.8 )
Combined ratio(4)                      95.3 %       101.8 %       108.6 %      (6.4 )%      (6.3 )%

NM = not meaningful
(1) The information presented for 2011 and after includes Mercer Insurance Group's results after the March 28, 2011 acquisition date.
(2) The net loss ratio is calculated by dividing the sum of losses and loss settlement expenses by net premiums earned. We use the net loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio is meaningful in evaluating our financial results as reported in our Consolidated Financial Statements.
(3) The GAAP expense ratio is calculated by dividing nondeferred underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company's operational efficiency in producing, underwriting and administering its insurance business. The statutory expense ratio is calculated in a similar fashion as GAAP but uses net premium written instead of net premium earned.
(4) The combined ratio is a commonly used financial measure of property and casualty underwriting performance. A combined ratio below 100.0 percent generally indicates a profitable book of business. The combined ratio is the sum of the net loss ratio and the underwriting expense ratio.

For the year ended December 31, 2013, our property and casualty insurance segment reported income before income taxes of $88.7 million compared to income before income taxes of $36.1 million in the same period in 2012. The increase in income before income taxes during 2013 as compared to 2012 is primarily a result of a 10.3 percent increase in net premiums earned and a decrease in catastrophe losses discussed in more detail throughout this section.

For the year ended December 31, 2012, our property and casualty insurance segment reported income before income taxes of $36.1 million compared to losses before income taxes of $24.2 million in the same period in 2011. The increase in income before income taxes during 2012 as compared to 2011 is primarily a result of a 17.9 percent


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increase in net premiums earned, a decrease in catastrophe losses, and a decrease in amortization of deferred policy acquisition costs, partially offset by an increase in underwriting expenses, and an increase in loss and loss settlement expenses.

Amortization of deferred policy acquisition costs decreased during 2012 as compared to 2011 due to a change in accounting guidance that limits the amount of underwriting expenses eligible for deferral. We prospectively adopted the new accounting guidance effective January 1, 2012. As a result, the amount of underwriting expenses eligible for deferral has decreased, which resulted in the recognition of $8.7 million of additional expense in 2012 in our property and casualty insurance segment than would have been recognized had the guidance remained the same.
Premiums
The following table shows our premiums written and earned for 2013, 2012 and 2011:

                                                                         % Change
(In Thousands)                                                       2013        2012
Years ended December 31,    2013          2012        2011 (1)     vs. 2012    vs. 2011
Direct premiums written  $ 754,594     $ 682,390     $ 580,890        10.6 %      17.5 %
Assumed premiums written    18,938        17,181        14,954        10.2        14.9
Ceded premiums written     (50,711 )     (44,240 )     (43,921 )      14.6         0.7
Net premiums written     $ 722,821     $ 655,331     $ 551,923        10.3 %      18.7 %
Net premiums earned        694,192       629,411       533,771        10.3        17.9

(1) The information presented for 2011 and after includes Mercer Insurance Group's results after the March 28, 2011 acquisition date.

Net Premiums Written
Net premiums written comprise direct and assumed premiums written, less ceded premiums written. Direct premiums written are the total policy premiums, net of cancellations, associated with policies issued and underwritten by our property and casualty insurance segment. Assumed premiums written are the total premiums associated with the insurance risk transferred to us by other insurance and reinsurance companies pursuant to reinsurance contracts. Ceded premiums written is the portion of direct premiums written that we cede to our reinsurers under our reinsurance contracts. Net premiums earned are recognized over the life of a policy and differ from net premiums written, which are recognized on the effective date of the policy.
Direct Premiums Written
Direct premiums written increased $72.2 million in 2013 as compared to 2012 primarily due to organic growth and is the result of a combination of rate increases across most commercial and personal lines and new business writings. Direct premiums written increased $101.5 million in 2012 as compared to 2011, of which $37.2 million resulted from our acquisition of Mercer Insurance Group. The remaining $64.3 million is due to organic growth, primarily the result of rate increases and an increase in audit premiums. Assumed Premiums Written
Assumed premiums written increased $1.8 million in 2013 as compared to 2012 due to pricing increases in recent years, the addition of two new assumed programs and the renewal of our participation levels in all but one of our active assumed programs. We added two new programs to replace the lost premium from the program not renewed and to take advantage of areas where we had exposure capacity. One of the new programs has worldwide exposure and the other has exposure in the United Kingdom and Japan.
Assumed premiums written increased $2.2 million in 2012 as compared to 2011 due to pricing increases in recent years and our renewal of our participation levels in all of our active assumed programs, with the exception of one contract for which we decreased our participation level after a review of the results of our catastrophe experience.


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Ceded Premiums Written
Direct and assumed premiums written are reduced by the ceded premiums that we pay to reinsurers. For 2013, ceded premiums written increased slightly compared to 2012 due to premium rate increases.
We consolidated Mercer Insurance Group's non-catastrophe reinsurance programs into our programs, effective August 1, 2011 and their catastrophe reinsurance program into our programs, effective January 1, 2012, resulting in increased coverage and retentions for Mercer Insurance Group. The change in programs increased Mercer Insurance Group's catastrophe protection from $55.0 million to $200.0 million and increased their catastrophe retention from $5.0 million to $20.0 million. Mercer Insurance Group's non-catastrophe retention was increased from $1.0 million to $2.0 million and the surety retention was increased from $0.5 million to $1.5 million. We had no other significant changes to coverage, limits, or retentions for our catastrophe or non-catastrophe programs. Losses and Loss Settlement Expenses
Catastrophe Exposures
Catastrophe losses are inherent risks of the property and casualty insurance business. Catastrophic events include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds, winter storms and other natural disasters, along with man-made exposures to losses resulting from, without limitation, acts of war, acts of terrorism and political instability. Such events result in insured losses that can be, and may continue to be, a material factor in our results of operations and financial position, as the extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. Because the level of insured losses that may occur in any one year cannot be accurately predicted, these losses contribute to fluctuations in our year-to-year results of operations and financial position. Some types of catastrophes are more likely to occur at certain times within the year than others, which adds an element of seasonality to our property and casualty insurance claims. The frequency and severity of catastrophic events are difficult to accurately predict in any year. However, some geographic locations are more susceptible to these events than others.
We control our direct insurance exposures in regions that are prone to naturally occurring catastrophic events through a combination of geographic diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. We regularly assess our concentration of risk exposures in natural catastrophe exposed areas. We have strategies and underwriting standards to manage these exposures through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance coverage. We use catastrophe modeling and a risk concentration management tool to monitor and control our accumulations of potential losses in natural catastrophe exposed areas of the United States, such as the Gulf and East Coasts, as well as in areas of exposure in other countries where we are exposed to a portion of an insurer's underwriting risk under our assumed reinsurance contracts.
A new version of a third-party catastrophe modeling tool that we and others in the insurance industry utilize for estimating potential losses from natural catastrophes was released in 2011. Overall, the model increased risk estimates for our exposure to hurricanes in the United States, but the impact of the new model on our book of business varies significantly among the regions that we model for hurricanes. Based on our analysis, and the indications of other catastrophe models, we have begun to implement more targeted underwriting and rate initiatives in some regions. We will continue to take underwriting actions and/or purchase additional reinsurance as necessary to reduce our exposure. Catastrophe modeling generally relies on multiple inputs based on experience, science, engineering and history, and the selection of those inputs requires a significant amount of judgment. The modeling results may also fail to account for risks that are outside the range of normal probability or are otherwise unforeseen. Because of this, actual results may differ materially from those . . .

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