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UFCS > SEC Filings for UFCS > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for UNITED FIRE GROUP INC

Form 10-Q for UNITED FIRE GROUP INC


5-Aug-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 Financial Condition and Results of Operations 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 six-month period ended June 30, 2014, property and casualty insurance business accounted for approximately 93.0 percent of our net premiums earned, of which 90.7 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 65.3 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 six-month period ended June 30, 2014, approximately 48.4 percent of our property and casualty premiums were written in Texas, Iowa, California, New Jersey, and Missouri; approximately 66.0 percent of our life insurance premiums were written in Iowa, Wisconsin, Illinois, Nebraska, 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 June 30,                Six Months Ended June 30,
(In Thousands)             2014            2013           %          2014          2013           %
Revenues
Net premiums earned    $   201,827     $  186,367        8.3  %   $ 395,168     $ 363,184        8.8  %
Investment income, net
of investment expenses      27,603         29,019       (4.9 )       54,365        55,483       (2.0 )
Net realized
investment gains             2,708          4,151      (34.8 )        4,902         6,060      (19.1 )
Other income                   535            182      194.0          1,142           297      284.5
Total revenues         $   232,673     $  219,719        5.9  %   $ 455,577     $ 425,024        7.2  %

Benefits, Losses and
Expenses
Losses and loss
settlement expenses    $   142,716     $  120,435       18.5  %   $ 267,953     $ 217,905       23.0  %
Increase in liability
for future policy
benefits                     8,077          9,869      (18.2 )       15,898        18,105      (12.2 )
Amortization of
deferred policy
acquisition costs           40,196         36,708        9.5         79,730        74,789        6.6
Other underwriting
expenses                    20,776         23,308      (10.9 )       47,204        45,656        3.4
Interest on
policyholders'
accounts                     7,852          9,081      (13.5 )       15,839        18,401      (13.9 )
Total benefits, losses
and expenses           $   219,617     $  199,401       10.1  %   $ 426,624     $ 374,856       13.8  %

Income before income
taxes                  $    13,056     $   20,318      (35.7 )%   $  28,953     $  50,168      (42.3 )%
Federal income tax
expense                      2,371          4,822      (50.8 )        4,937        12,279      (59.8 )%
Net income             $    10,685     $   15,496      (31.0 )%   $  24,016     $  37,889      (36.6 )%

NM=Not meaningful

The following is a summary of our financial performance for the three- and six-month periods ended June 30, 2014:

Consolidated Results of Operations

For the three-month period ended June 30, 2014, net income was $10.7 million compared to $15.5 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 $201.8 million compared to $186.4 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, to a lessor extent, new business writings.

Losses and loss settlement expenses increased by $22.3 million during the three-month period ended June 30, 2014 compared to the same period of 2013. The increase is primarily attributable to an increase in catastrophe loss experience from convective spring storms in regions of the U.S. where we conduct much of our business and a decrease in favorable reserve development. Pre-tax catastrophe losses totaled $20.6 million compared to $14.2 million in the same period of 2013.

For the six-month period ended June 30, 2014, net income was $24.0 million compared to $37.9 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 $395.2 million compared to $363.2 million for the same period of 2013. This increase represents organic growth and is the result of


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a combination of rate increases across most commercial and personal lines and, to a lessor extent, new business writings.

Losses and loss settlement expenses increased by $50.0 million during the six-month period ended June 30, 2014 compared to the same period of 2013. The increase is primarily attributable to an increase in catastrophe loss experience from convective spring storms in regions of the U.S. where we conduct much of our business, 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 U.S. in the first quarter of 2014. Pre-tax catastrophe losses totaled $23.9 million compared to $18.7 million in the same period of 2013.

Consolidated Financial Condition

At June 30, 2014, the book value per share of our common stock was $32.74. We repurchased 201,516 shares of our common stock at a total cost of $5.6 million and an average share price of $27.63 in the six-month period ended June 30, 2014. Under our share repurchase program, which is scheduled to expire on August 31, 2014, we are authorized to repurchase an additional 868,601 shares of our common stock.

Net unrealized investment gains totaled $147.9 million as of June 30, 2014, an increase of $31.3 million, net of tax, or 26.8 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 due to lower interest rates and also, to a lesser extent, an increase in the fair value of our equity investment portfolio.

Our stockholders' equity increased to $826.3 million at June 30, 2014, from $782.8 million at December 31, 2013. The increase was primarily attributable to net income of $24.0 million and an increase in net unrealized investment gains of $31.3 million, net of tax, partially offset by shareholder dividends of $9.6 million.


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RESULTS OF OPERATIONS

Property and Casualty Insurance Segment Results
                                  Three Months Ended June 30,           Six Months Ended June 30,
(In Thousands Except Ratios)        2014               2013               2014              2013
Net premiums written          $     222,061       $     198,363     $     421,390       $   375,482
Net premiums earned           $     187,832       $     170,527     $     367,326       $   333,228
Losses and loss settlement
expenses                           (135,493 )          (115,528 )        (254,149 )        (207,621 )
Amortization of deferred
policy acquisition costs            (38,502 )           (34,993 )         (76,378 )         (71,349 )
Other underwriting expenses         (17,104 )           (19,220 )         (39,364 )         (37,635 )
Underwriting gain (loss)      $      (3,267 )     $         786     $      (2,565 )     $    16,623

Investment income, net of
investment expenses                  11,838              12,288            23,001            22,773
Net realized investment gains         2,337               3,560             3,704             4,589
Other income                            315                  72               795                84
Income before income taxes    $      11,223       $      16,706     $      24,935       $    44,069

GAAP Ratios:
Net loss ratio (without
catastrophes)                          61.1 %              59.4 %            62.7 %            56.7 %
Catastrophes - effect on net
loss ratio                             11.0                 8.3               6.5               5.6
Net loss ratio (1)                     72.1 %              67.7 %            69.2 %            62.3 %
Expense ratio (2)                      29.6                31.8              31.5              32.7
Combined ratio (3)                    101.7 %              99.5 %           100.7 %            95.0 %

(1) The GAAP 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 GAAP net loss ratio and the GAAP underwriting expense ratio.

For the three- and six-month periods ended June 30, 2014, our property and casualty segment reported income before taxes of $11.2 million and $24.9 million, respectively, or a decrease of $5.5 million and $19.1 million, respectively, compared to the same periods of 2013. The decrease in the three- and six-month periods ended June 30, 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 10.1 percent to $187.8 million in the three-month period ended June 30, 2014, compared to $170.5 million in the same period of 2013. In the six-month period ended June 30, 2014, net premiums earned also increased 10.2 percent to $367.3 million as compared to $333.2 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, to a lessor extent, new business writings.

The GAAP combined ratio increased 2.2 percentage points to 101.7 percent for the three-month period ended June 30, 2014, compared to 99.5 percent for the same period of 2013. For the six-month period ended June 30, 2014, the GAAP combined ratio was 100.7 percent, compared to 95.0 percent for the same period of 2013. The increase in the GAAP combined ratio in the three- and six-month periods ended June 30, 2014, as compared to the same periods of 2013, is primarily attributable to an increase in catastrophe loss experience from convective spring storms in regions of the U.S. where we conduct much of our business and a decrease in favorable reserve development.


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The net loss ratio, a component of the combined ratio, increased by 4.4 percentage points to 72.1 percentage points in the three-month period ended June 30, 2014, as compared to the same period of 2013. The increase is primarily attributable to convective spring storms in regions of the U.S. where we conduct much of our business and a decrease in favorable reserve development.

For the six-month period ended June 30, 2014, the net loss ratio increased by 6.9 percentage points to 69.2 percentage points as compared to the same period of 2013. The increase is primarily attributable to an increase in catastrophe loss experience from convective spring storms in regions of the U.S. where we conduct much of our business, 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 U.S. in the first quarter of 2014. Pre-tax catastrophe losses totaled $20.6 million and $23.9 million for the three- and six-month periods ended June 30, 2014, respectively, as compared to $14.2 million and $18.7 million, respectively, in the same periods of 2013.

The expense ratio, a component of the combined ratio, of 29.6 percentage points for the quarter ended June 30, 2014 improved by 2.2 percentage points as compared with the same period of 2013. Second quarter underwriting expenses benefited from additional acquisition expenses being deferred due to improved loss experience and continued premium growth.

For the six-month period ended June 30, 2014, the expense ratio of 31.5 percentage points for the quarter ended June 30, 2014 improved by 1.2 percentage point as compared with the same period of 2013. 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. Our expectation is a gradual return to a more favorable expense ratio consistent with our history as we continue to reap the benefit of economies of scale and the ultimate completion of the Mercer Insurance integration.

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 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. Historically, this approach has tended to produce, on average, some level of favorable development over the course of settlement.


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2014 Development

The property and casualty insurance segment experienced $11.3 million and $25.8 million of favorable development in our net reserves for prior accident years for the three- and six-month periods ended June 30, 2014, respectively. The significant driver of the favorable reserve development in 2014 was our long-tail liability of commercial business including other liability, workers' compensation and auto liability, which have contributed $9.6 million and$12.7 million, respectively, of the three- and six-month reserve development totals. Commercial auto liability, with $7.6 million of favorable year-to-date reserve development, continues to benefit from loss control and re-underwriting initiatives over the past several years. Also contributing to the favorable development during the six-month period ended June 30, 2014, only to a lesser extent than the long-tail liability lines and commercial auto liability, were workers' compensation and auto physical damage lines which combined for $8.1 million of favorable year-to-date development. Development from all other lines combined provided a partial offset to the favorable development noted above, though no single line of business contributed a significant portion of the total additional development.

2013 Development

The property and casualty insurance segment experienced $16.4 million and $40.5 million of favorable development in our net reserves for prior accident years for the three- and six-month periods ended June 30, 2013, respectively. The favorable development in 2013 was primarily related to our long-tail lines of commercial business including other liability, workers' compensation and auto liability. The favorable development is generally caused by changes in loss development patterns due to many factors discussed previously. Specifically, we observed a continuation of a trend, started in 2011, reducing the overall number of reported new construction defect claims and lower than expected emergence on known claims. In addition, in 2009 management began an initiative to control legal defense costs. As these costs are a significant component of the carried reserves for the other liability line, management believes this initiative is also contributing to the favorable development trends.

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. During second quarter, the decrease in favorable reserve development is attributable to the timing of paid claims; however, year-to-date the decline in favorable reserve development also reflects adverse development of large claims from prior accident years, primarily relevant to fourth quarter 2013 large losses that further developed in first quarter 2014. At June 30, 2014, our total reserves remained relatively flat compared to December 31, 2013 and within our actuarial estimates.


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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 June 30,                   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             $  55,891     $   24,192         43.3  %   $  49,175     $   28,618         58.2  %
Fire and allied lines          44,467         42,840         96.3         39,416         26,093         66.2
Automobile                     40,391         29,353         72.7         36,025         28,777         79.9
Workers' compensation          20,996         16,129         76.8         20,159         14,477         71.8
Fidelity and surety             4,099          1,308         31.9          4,048           (974 )      (24.1 )
Miscellaneous                     683             (1 )       (0.1 )          517             45          8.7
Total commercial lines      $ 166,527     $  113,821         68.3  %   $ 149,340     $   97,036         65.0  %

Personal lines
Fire and allied lines       $  11,070     $   13,530        122.2  %   $  10,689     $   10,765        100.7  %
Automobile                      5,791          6,672        115.2          5,515          4,367         79.2
Miscellaneous                     247            (17 )       (6.9 )          235            667           NM
Total personal lines        $  17,108     $   20,185        118.0  %   $  16,439     $   15,799         96.1  %
Reinsurance assumed         $   4,197     $    1,487         35.4  %   $   4,748     $    2,693         56.7  %
Total                       $ 187,832     $  135,493         72.1  %   $ 170,527     $  115,528         67.7  %

NM=Not meaningful

Six Months Ended June 30,                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           $ 109,044    $     54,862    50.3 %   $  94,504    $   49,315      52.2  %
Fire and allied lines        87,354          77,498    88.7        80,390        44,694      55.6
Automobile                   78,841          51,601    65.4        70,983        54,950      77.4
Workers' compensation        42,026          34,338    81.7        39,267        30,840      78.5
Fidelity and surety           8,559             995    11.6         8,807          (680 )    (7.7 )
Miscellaneous                 1,347              10     0.7           562           659     117.3
Total commercial lines    $ 327,171    $    219,304    67.0 %   $ 294,513    $  179,778      61.0  %

Personal lines
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