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UFCS > SEC Filings for UFCS > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for UNITED FIRE GROUP INC

Form 10-Q for UNITED FIRE GROUP INC


6-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Part I, Item 1 "Financial Statements."

CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are representative of significant judgments and uncertainties and that potentially may result in materially different results under different assumptions and conditions. We base our discussion and analysis of our results of operations and financial condition on the amounts reported in our Consolidated Financial Statements, which we have prepared in accordance with GAAP. As we prepare these Consolidated Financial Statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical accounting policies are more fully described in our Management's Discussion and Analysis of Results of Operations and Financial Condition presented in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes in our critical accounting policies from December 31, 2013.

INTRODUCTION

The purpose of this Management's Discussion and Analysis is to provide an understanding of our results of operations and consolidated financial position. Our Management's Discussion and Analysis should be read in conjunction with our consolidated financial statements and related notes, including those in our Annual Report on Form 10-K for the year ended December 31, 2013. When we provide information on a statutory basis, we label it as such, otherwise, all other data is presented in accordance with GAAP.

OUR BUSINESS

Founded in 1946 as United Fire & Casualty Company, United Fire Group, Inc. ("United Fire", the "Registrant", the "Company", "we", "us", or "our") and its consolidated insurance subsidiaries provide insurance protection for individuals and businesses through several regional offices. 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, each with a wide range of products:

property and casualty insurance, which includes commercial lines insurance, personal lines 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 each has different products, pricing, and expense structures.

For the three-month period ended March 31, 2014, property and casualty insurance business accounted for approximately 93.0 percent of our net premiums earned, of which 90.6 percent was generated from commercial


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lines. Life insurance business accounted for approximately 7.0 percent of our net premiums earned, of which 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, which is in runoff, 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 the three-month period ended March 31, 2014, approximately 47.7 percent of our property and casualty premiums were written in Texas, Iowa, California, New Jersey, and Missouri; approximately 64.8 percent of our life insurance premiums were written in Iowa, Illinois, Nebraska, Wisconsin and Minnesota.

Segment 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 this Management's Discussion and Analysis is reported on a pre-tax basis. Additional segment information is presented in Part I, Item 1, Note 6 "Segment Information" to the unaudited 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, effective use of ceded reinsurance and effective and efficient use of technology.


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CONSOLIDATED FINANCIAL HIGHLIGHTS
                                                       Three Months Ended March 31,
(In Thousands)                                         2014            2013         %
Revenues
Net premiums earned                               $   193,341       $ 176,817      9.3  %
Investment income, net of investment expenses          26,762          26,464      1.1
Net realized investment gains                           2,194           1,909     14.9
Other income                                              607             115       NM
Total revenues                                    $   222,904       $ 205,305      8.6  %

Benefits, Losses and Expenses
Losses and loss settlement expenses               $   125,237       $  97,470     28.5  %
Increase in liability for future policy benefits        7,821           8,236     (5.0 )
Amortization of deferred policy acquisition costs      39,534          38,081      3.8
Other underwriting expenses                            26,428          22,348     18.3
Interest on policyholders' accounts                     7,987           9,320    (14.3 )
Total benefits, losses and expenses               $   207,007       $ 175,455     18.0  %

Income before income taxes                        $    15,897       $  29,850    (46.7 )%
Federal income tax expense                              2,566           7,457    (65.6 )
Net income                                        $    13,331       $  22,393    (40.5 )%

NM=Not meaningful

The following is a summary of our financial performance for the three-month period ended March 31, 2014:

Consolidated Results of Operations

For the three-month period ended March 31, 2014, net income was $13.3 million compared to $22.4 million for the same period of 2013, driven primarily by an increase in losses and loss settlement expenses which was partially offset by growth in property and casualty premium revenue. Consolidated net premiums earned increased to $193.3 million, compared to $176.8 million for the same period of 2013. 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.

Losses and loss settlement expenses increased by $27.8 million during the first quarter of 2014 compared to the same period of 2013. The increase is primarily attributable to losses from a single large claim (a large explosion in a suburban townhome community), an increase in our annual aggregate reinsurance deductible, a decrease in favorable reserve development and an increase in the frequency of claims associated with the harsh winter weather experienced in the United States in 2014, partially offset by a decrease in catastrophe loss experience. Pre-tax catastrophe losses totaled $3.3 million compared to $4.5 million in the same period of 2013.

Consolidated Financial Condition

At March 31, 2014, the book value per share of our common stock was $31.82. We did not repurchase any shares of our common stock in the three-month period ended March 31, 2014. Under our share repurchase program, which is scheduled to expire in August 2014, we are authorized to repurchase an additional 1,070,117 shares of our common stock.

Net unrealized investment gains totaled $131.3 million as of March 31, 2014, an increase of $14.7 million, net of tax, or 12.6 percent, since December 31, 2013. The increase in net unrealized investment gains resulted from an increase in the fair value of the fixed maturity investment portfolio and also, to a lesser extent, an increase in the fair value of our equity investment portfolio.


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Our stockholders' equity increased to $808.1 million at March 31, 2014, from $782.8 million at December 31, 2013. The increase was primarily attributable to net income of $13.3 million and an increase in net unrealized investment gains of $14.7 million, net of tax, partially offset by shareholder dividends of $4.6 million.

RESULTS OF OPERATIONS

Property and Casualty Insurance Segment Results
                                                            Three Months Ended March 31,
(In Thousands Except Ratios)                                  2014                 2013
Net premiums written                                    $      199,329       $      177,119
Net premiums earned                                     $      179,494       $      162,701
Losses and loss settlement expenses                           (118,656 )            (92,093 )
Amortization of deferred policy acquisition costs              (37,876 )            (36,355 )
Other underwriting expenses                                    (22,260 )            (18,415 )
Underwriting gain                                       $          702       $       15,838

Investment income, net of investment expenses                   11,163               10,485
Net realized investment gains                                    1,367                1,029
Other income                                                       480                   12
Income before income taxes                              $       13,712       $       27,364

GAAP Ratios:
Net loss ratio (without catastrophes)                             64.3 %               53.8 %
Catastrophes - effect on net loss ratio                            1.8                  2.8
Net loss ratio (1)                                                66.1 %               56.6 %
Expense ratio (2)                                                 33.5                 33.7
Combined ratio (3)                                                99.6 %               90.3 %

(1) 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 unaudited Consolidated Financial Statements.
(2) 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.
(3) The GAAP 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 three-month period ended March 31, 2014, our property and casualty segment reported income before taxes of $13.7 million, or a decrease of $13.7 million, compared to the same period of 2013. The decrease in the three months ended March 31, 2014 is primarily due to an increase in losses and loss settlement expenses partially offset by an increase in net premiums earned.

Net premiums earned increased 10.3 percent to $179.5 million in the three months ended March 31, 2014, compared to $162.7 million in the same period of 2013. 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 GAAP combined ratio increased 9.3 percentage points to 99.6 percent for the three-month period ended March 31, 2014, compared to 90.3 percent for the same period of 2013, primarily due to an increase in non-catastrophe losses.

The net loss ratio, a component of the combined ratio, increased by 9.5 percentage points to 66.1 percentage points in the three-month period ended March 31, 2014, as compared to the same period in 2013. The increase is primarily attributable to losses from a single large claim (a large explosion in a suburban townhome community), an increase in our annual aggregate reinsurance deductible, a decrease in favorable reserve development and an increase in the


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frequency of claims associated with the harsh winter weather experienced in the United States in 2014, partially offset by a decrease in catastrophe loss experience. Pre-tax catastrophe losses totaled $3.3 million for the three-month period ended March 31, 2014, which is $1.2 million or 27.4% lower than the same period of 2013.

The expense ratio, a component of the combined ratio, of 33.5 percentage points for the quarter ended March 31, 2014 improved slightly by 0.2 percentage points as compared with the same period of 2013. Underwriting expenses are elevated due to an increase in non-deferred acquisition costs and continued elevated expenses in pension and post retirement benefits. In 2014, the expense ratio will be impacted by a dual rent obligation associated with the relocation of our Galveston, Texas branch facility and an increase in premium taxes and assessments due to premium growth in specific lines of business.

For a detailed discussion of our consolidated investment results, refer to the "Investment Portfolio" section of this item.

Reserve Development

For many liability claims, significant periods of time, ranging up to several years and for certain construction defect claims more than a decade, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement or other disposition of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability. Reserves for these long-tail coverages represent a significant portion of our overall carried reserves.

When establishing reserves and monitoring reserve adequacy, we analyze historical data and consider the potential impact of various loss development factors and trends including historical loss experience, legislative enactments, judicial decisions, legal developments in imposition of damages, experience with alternative dispute resolution, results of our medical bill review process, the potential impact of salvage and subrogation and changes and trends in general economic conditions, including the effects of inflation. All of these factors influence our estimates of required reserves and for long-tail lines these factors can change over the course of the settlement of the claim. However there is no precise method for evaluating the specific dollar impact of any individual factor on the development of reserves.

Our reserving philosophy is to reserve claims to their ultimate expected loss amount as soon as practicable after information about a claim becomes available. This approach tends to produce, on average, prudently conservative case reserves, which we expect to result in some level of favorable development over the course of settlement.

2014 Development

The property and casualty insurance segment experienced $14.5 million of favorable development in our net reserves for prior accident years for the three-month period ended March 31, 2014. The significant driver of the favorable reserve development in 2014 was our commercial auto liability line which contributed $8.8 million of the total, primarily due to favorable results from loss control and re-underwriting initiatives over the past several months. Also contributing to the favorable development during the three-month period ended March 31, 2014, only to a lesser extent than commercial auto liability were, personal auto liability and auto physical damage which combined for $2.9 million of favorable development. Long-tail liability lines contributed an additional $3.1 million of favorable development. No other line of business contributed a significant portion of the total development.


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2013 Development

The property and casualty insurance segment experienced $23.7 million of favorable development in our net reserves for prior accident years for the three-month period ended March 31, 2013. The favorable reserve development on prior year reserves was primarily related to our long-tail commercial other liability line of business, though auto liability (both commercial and personal), reinsurance assumed, and surety also developed favorably. The significant driver of the favorable reserve development in 2013 was the other liability line which contributed $18.4 million of the total, primarily due to additional recognition of relatively recent changes in reserve development patterns which have shown increased redundancies in reserves for reported claims along with relatively less need for IBNR claim reserves. Also contributing to the favorable development during the three-month period ended March 31, 2013, only to a lesser extent than the other liability line of business, were auto liability, reinsurance assumed, and surety lines of business, which contributed $2.9 million, $2.3 million and $1.0 million, respectively, to the favorable reserve development.

Development amounts can vary significantly from quarter-to-quarter and year-to-year depending on a number of factors, including the number of claims settled and the settlement terms, and are subject to reallocation between accident years and lines of business. At March 31, 2014, our total reserves remained relatively flat compared to December 31, 2013.

The following tables display our net premiums earned, net losses and loss settlement expenses and net loss ratio by line of business:

Three Months Ended
March 31,                                2014                                       2013
                                      Net Losses                                 Net Losses
                                       and Loss                                   and Loss
                           Net        Settlement        Net           Net        Settlement         Net
(In Thousands)          Premiums       Expenses        Loss        Premiums       Expenses         Loss
Unaudited                Earned        Incurred        Ratio        Earned        Incurred         Ratio
Commercial lines
Other liability        $  53,153     $   30,670         57.7  %   $  45,329     $    20,697         45.7  %
Fire and allied lines     42,887         34,658         80.8         40,974          18,601         45.4
Automobile                38,450         22,248         57.9         34,958          26,173         74.9
Workers' compensation     21,030         18,209         86.6         19,108          16,363         85.6
Fidelity and surety        4,460           (313 )       (7.0 )        4,759             294          6.2
Miscellaneous                664             11          1.7             45             614           NM
Total commercial lines $ 160,644     $  105,483         65.7  %   $ 145,173     $    82,742         57.0  %

Personal lines
Fire and allied lines  $  11,032     $    6,855         62.1  %   $  10,436     $     6,201         59.4  %
Automobile                 5,681          4,294         75.6          5,346           3,195         59.8
Miscellaneous                244            105         43.0             53             234           NM
Total personal lines   $  16,957     $   11,254         66.4  %   $  15,835     $     9,630         60.8  %
Reinsurance assumed    $   1,893     $    1,919        101.4  %   $   1,693     $      (279 )      (16.5 )%
Total                  $ 179,494     $  118,656         66.1  %   $ 162,701     $    92,093         56.6  %

NM=Not meaningful

Commercial other liability - The net loss ratio deteriorated 12.0 percentage points in the three-month period ended March 31, 2014, compared to the same period of 2013. The deterioration of this line was due to an increase in loss severity in the three-month period ended March 31, 2014.

Commercial fire and allied lines - The net loss ratio deteriorated 35.4 percentage points in the three-month period ended March 31, 2014, compared to the same period of 2013. The change is primarily attributable to losses from a single large claim (a large explosion in a suburban townhome community), an increase in our


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annual aggregate reinsurance deductible, and an increase in the frequency of claims associated with the harsh winter weather experienced in the United States in 2014.

Commercial automobile - The net loss ratio improved 17.0 percentage points in the three-month period ended March 31, 2014, compared to the same period of 2013. The change was primarily due to favorable results from loss control and re-underwriting initiatives over the past several months that focused on under-performing accounts and agents.

Workers' compensation- The net loss ratio was up slightly for the three-month period ended March 31, 2014, compared to the same period of 2013. The net loss ratio is above our expectations, but we are actively working on a plan to re-underwrite hazardous risks and higher premium accounts, focus on cost control programs, and more appropriately align our underwriting staff.

Personal automobile - The net loss ratio deteriorated 15.8 percentage points in the three-month period ended March 31, 2014, compared to the same period of 2013. The change in the three-month period ended March 31, 2014 was primarily due to increased claim frequency and severity due to the harsh winter weather experienced in the United States in 2014.

Life Insurance Segment Results
                                                          Three Months Ended March 31,
(In Thousands)                                               2014               2013
Revenues
Net premiums earned                                    $        13,847     $     14,116
Investment income, net                                          15,599           15,979
Net realized investment gains                                      827              880
Other income                                                       127              103
Total revenues                                         $        30,400     $     31,078

Benefits, Losses and Expenses
Losses and loss settlement expenses                    $         6,581     $      5,377
Increase in liability for future policy benefits                 7,821            8,236
Amortization of deferred policy acquisition costs                1,658            1,726
Other underwriting expenses                                      4,168            3,933
Interest on policyholders' accounts                              7,987            9,320
Total benefits, losses and expenses                    $        28,215     $     28,592

Income before income taxes                             $         2,185     $      2,486

Income before income taxes decreased $0.3 million in the three-month period ended March 31, 2014, as compared to the same period of 2013 due to a decrease in net investment income and net premiums earned along with an increase in losses and loss settlement expense partially offset by a decrease in interest on policyholders' accounts which is due to continued negative cash flows on annuity products, and also by a decrease in the increase in the liability for future policy benefits.

Net premiums earned decreased 1.9 percent to $13.8 million for the three-month period ended March 31, 2014, compared to $14.1 million in the same period of 2013. The decrease in net premiums earned in the three-month period ended March 31, 2014 was primarily due to a decrease in sales of single premium whole life policies as we have chosen to maintain price diligence to achieve adequate rate spreads.


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Net investment income decreased 2.4 percent to $15.6 million for the three-month period ended March 31, 2014, compared to $16.0 million for the same period of 2013, due to the decrease in the reinvestment interest rates from the continued low interest rate environment.

Losses and loss settlement expenses increased $1.2 million for the three-month period ended March 31, 2014 compared to the same period of 2013 due to an increase in policy claims.

The increase in the liability for future policy benefits improved in the three-month period ended March 31, 2014 compared to the same period of 2013, due to net withdrawals of annuity products and the decline in sales of our single premium whole life product.

Deferred annuity deposits increased 204.1 percent for the three-month period ended March 31, 2014, compared with the same period of 2013. The increase in guaranteed interest rates had a favorable effect in the three-month period ended March 31, 2014.

Net cash outflow related to our annuity business was $11.1 million in the three-month period ended March 31, 2014, compared to a net cash outflow of $25.9 million in the same period of 2013. We attribute this to the activity described above.

For a detailed discussion of our consolidated investment results, refer to the "Investment Portfolio" section of this item.

Investment Portfolio

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