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UNITED FIRE GROUP INC - Quarter Report: 2014 March (Form 10-Q)

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
_______________________

 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2014

Commission File Number 001-34257
_____________________________
 UNITED FIRE GROUP, INC.
(Exact name of registrant as specified in its charter)
____________________________
 
 
 
Iowa
 
45-2302834
 
 
 
 
(State of Incorporation)
 
(IRS Employer Identification No.)
 
 

118 Second Avenue, S.E., Cedar Rapids, Iowa 52401
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (319) 399-5700

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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. YES R NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES R NO o

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 definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o 
 
Accelerated filer R 
 
Non-accelerated filer o 
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO R
As of May 2, 2014, 25,399,846 shares of common stock were outstanding.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

United Fire Group, Inc.
Index to Quarterly Report on Form 10-Q
March 31, 2014
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4. Mine Safety Disclosures
 
 
 
 
 
 


Table of Contents

FORWARD-LOOKING INFORMATION
This report may contain forward-looking statements about our operations, anticipated performance and other similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor under the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), for forward-looking statements. The forward-looking statements are not historical facts and involve risks and uncertainties that could cause actual results to differ from those expected and/or projected. Such forward-looking statements are based on current expectations, estimates, forecasts and projections about United Fire Group, Inc. (the "Company", "we", "us", or "our"), the industry in which we operate, and beliefs and assumptions made by management. Words such as "expect(s)," "anticipate(s)," "intend(s)," "plan(s)," "believe(s)," "continue(s)," "seek(s)," "estimate(s)," "goal(s)," "target(s)," "forecast(s)," "project(s)," "predict(s)," "should," "could," "may," "will continue," "might," "hope," "can" and other words and terms of similar meaning or expression in connection with a discussion of future operations, financial performance or financial condition, are intended to identify forward-looking statements. See Part I, Item 1A "Risk Factors" in our 2013 Annual Report on Form 10-K and Part II, Item 1A "Risk Factors" of this report for more information concerning factors that could cause actual results to differ materially from those in the forward-looking statements.
Risks and uncertainties that may affect the actual financial condition and results of the Company include but are not limited to the following:

The frequency and severity of claims, including those related to catastrophe losses and the impact those claims have on our loss reserve adequacy;
Occurrence of catastrophic events, occurrence of significant severe weather conditions, climate change, acts of terrorism, acts of war and pandemics;
Developments in the domestic and global financial markets and "other-than-temporary" impairment losses that could affect our investment portfolio;
The calculation and recovery of deferred policy acquisition costs ("DAC");
The valuation of pension and other postretirement benefit obligations;
Our relationship with our agencies and agents;
Our relationship with our reinsurers;
The financial strength of our reinsurers;
Our exposure to international catastrophes through our assumed reinsurance program;
Lowering of one or more of the financial strength ratings of our operating subsidiaries or our issuer credit ratings and the adverse impact such action may have on our premium writings, policy retention, profitability and liquidity;
Changes in general economic conditions, interest rates, industry trends, increase in competition and significant industry developments;
Competitive, legal, regulatory or tax changes that affect the distribution cost or demand for our products;
Litigation or regulatory actions that could require us to pay significant damages or change the way we do business;
Governmental actions, policies and regulations, including, but not limited to, domestic health care reform, financial services regulatory reform, corporate governance, new laws or regulations or court decisions interpreting existing laws and regulations or policy provisions; and
NASDAQ policies or regulations relating to corporate governance and the cost to comply.

These are representative of the risks, uncertainties, and assumptions that could cause actual outcomes and results to differ materially from what is expressed in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report or as of the date they are made. Except as required under the federal securities laws and the rules and regulations of the Securities and Exchange Commission ("SEC"), we do not have any intention or obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.



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PART I — FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
United Fire Group, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
March 31,
2014
 
December 31,
2013
 
(unaudited)
 
 
ASSETS
 
 
 
Investments
 
 
 
Fixed maturities
 
 
 
Held-to-maturity, at amortized cost (fair value $656 in 2014 and $669 in 2013)
$
644

 
$
656

Available-for-sale, at fair value (amortized cost $2,759,461 in 2014 and $2,733,557 in 2013)
2,805,723

 
2,751,256

Trading securities, at fair value (amortized cost $13,904 in 2014 and $8,049 in 2013)
16,095

 
9,940

Equity securities
 
 
 
Available-for-sale, at fair value (cost $71,021 in 2014 and $70,957 in 2013)
232,377

 
229,368

Trading securities, at fair value (cost $2,704 in 2014 and $2,367 in 2013)
3,037

 
2,487

Mortgage loans
4,368

 
4,423

Policy loans
6,177

 
6,261

Other long-term investments
46,513

 
44,946

Short-term investments
800

 
800

 
3,115,734

 
3,050,137

Cash and cash equivalents
68,663

 
92,193

Accrued investment income
28,686

 
27,923

Premiums receivable (net of allowance for doubtful accounts of $970 in 2014 and $896 in 2013)
236,424

 
218,635

Deferred policy acquisition costs
143,296

 
150,092

Property and equipment (primarily land and buildings, at cost, less accumulated depreciation of $38,058 in 2014 and $36,972 in 2013)
47,974

 
47,218

Reinsurance receivables and recoverables
85,281

 
87,451

Prepaid reinsurance premiums
3,630

 
3,160

Income taxes receivable

 
1,786

Goodwill and intangible assets
26,855

 
27,047

Other assets
12,706

 
15,030

TOTAL ASSETS
$
3,769,249

 
$
3,720,672

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Future policy benefits and losses, claims and loss settlement expenses
 
 
 
Property and casualty insurance
$
974,246

 
$
960,651

Life insurance
1,471,584

 
1,472,132

Unearned premiums
360,782

 
340,464

Accrued expenses and other liabilities
124,124

 
142,677

Income taxes payable
1,948

 

Deferred income taxes
28,458

 
21,915

TOTAL LIABILITIES
$
2,961,142

 
$
2,937,839

Stockholders’ Equity
 
 
 
Common stock, $0.001 par value; authorized 75,000,000 shares; 25,396,845 and 25,360,893 shares issued and outstanding in 2014 and 2013, respectively
$
25

 
$
25

Additional paid-in capital
212,904

 
211,574

Retained earnings
492,848

 
484,084

Accumulated other comprehensive income, net of tax
102,330

 
87,150

TOTAL STOCKHOLDERS’ EQUITY
$
808,107

 
$
782,833

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
3,769,249

 
$
3,720,672

The Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


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United Fire Group, Inc.
Consolidated Statements of Income and Comprehensive Income (Unaudited)
 
Three Months Ended March 31,
(In Thousands, Except Share Data)
2014
 
2013
 
 
 
 
Revenues
 
 
 
Net premiums earned
$
193,341

 
$
176,817

Investment income, net of investment expenses
26,762

 
26,464

Net realized investment gains (includes reclassifications for net unrealized investment gains on available-for-sale securities of $1,482 in 2014; and $1,236 in 2013; previously included in accumulated other comprehensive income)
2,194

 
1,909

Other income
607

 
115

Total revenues
$
222,904

 
$
205,305

Benefits, Losses and Expenses
 
 
 
Losses and loss settlement expenses
$
125,237

 
$
97,470

Increase in liability for future policy benefits
7,821

 
8,236

Amortization of deferred policy acquisition costs
39,534

 
38,081

Other underwriting expenses (includes reclassifications for employee benefit costs of $768 in 2014; and $1,242 in 2013; previously included in accumulated other comprehensive income)
26,428

 
22,348

Interest on policyholders’ accounts
7,987

 
9,320

Total benefits, losses and expenses
$
207,007

 
$
175,455

Income before income taxes
$
15,897

 
$
29,850

Federal income tax expense (includes reclassifications of ($250) in 2014; and $2 in 2013; previously included in accumulated other comprehensive income)
2,566

 
7,457

Net income
$
13,331

 
$
22,393

Other comprehensive income
 
 
 
Change in net unrealized appreciation on investments
$
24,069

 
$
14,488

Change in liability for underfunded employee benefit plans

 

Other comprehensive income, before tax and reclassification adjustments
$
24,069

 
$
14,488

Income tax effect
(8,425
)
 
(5,070
)
Other comprehensive income, after tax, before reclassification adjustments
$
15,644

 
$
9,418

Reclassification adjustment for net realized investment gains included in income
$
(1,482
)
 
$
(1,236
)
Reclassification adjustment for employee benefit costs included in expense
768

 
1,242

Total reclassification adjustments, before tax
$
(714
)
 
$
6

Income tax effect
250

 
(2
)
Total reclassification adjustments, after tax
$
(464
)
 
$
4

Comprehensive income
$
28,511

 
$
31,815

 
 
 
 
Weighted average common shares outstanding
25,372,280

 
25,245,497

Basic earnings per common share
$
0.53

 
$
0.89

Diluted earnings per common share
0.52

 
0.88

The Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


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United Fire Group, Inc.
Consolidated Statement of Stockholders’ Equity (Unaudited)

(In Thousands, Except Share Data)
Three Months Ended March 31, 2014
 
 
Common stock
 
Balance, beginning of year
$
25

Shares issued for stock-based awards (35,952 shares)

Balance, end of period
$
25

 
 
Additional paid-in capital
 
Balance, beginning of year
$
211,574

Compensation expense and related tax benefit for stock-based award grants
507

Shares issued for stock-based awards
823

Balance, end of period
$
212,904

 
 
Retained earnings
 
Balance, beginning of year
$
484,084

Net income
13,331

Dividends on common stock ($0.18 per share)
(4,567
)
Balance, end of period
$
492,848

 
 
Accumulated other comprehensive income, net of tax
 
Balance, beginning of year
$
87,150

Change in net unrealized investment appreciation(1)
14,681

Change in liability for underfunded employee benefit plans(2)
499

Balance, end of period
$
102,330

 
 
Summary of changes
 
Balance, beginning of year
$
782,833

Net income
13,331

All other changes in stockholders’ equity accounts
11,943

Balance, end of period
$
808,107

(1)
The change in net unrealized appreciation is net of reclassification adjustments and income taxes.
(2)
The change in liability for underfunded employee benefit plans is net of reclassification adjustments and income taxes.

The Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.



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United Fire Group, Inc.
Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended March 31,
(In Thousands)
2014
 
2013
Cash Flows From Operating Activities
 
 
 
Net income
$
13,331

 
$
22,393

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Net accretion of bond premium
3,701

 
3,981

Depreciation and amortization
2,295

 
1,785

Stock-based compensation expense
437

 
411

Net realized investment gains
(2,194
)
 
(1,909
)
Net cash flows from trading investments
(5,673
)
 
46

Deferred income tax expense (benefit)
(1,559
)
 
460

Changes in:
 
 
 
Accrued investment income
(763
)
 
296

Premiums receivable
(17,789
)
 
(19,631
)
Deferred policy acquisition costs
(2,124
)
 
(2,917
)
Reinsurance receivables
2,170

 
(5,741
)
Prepaid reinsurance premiums
(470
)
 
(255
)
Income taxes receivable
1,786

 
14,150

Other assets
2,324

 
1,013

Future policy benefits and losses, claims and loss settlement expenses
19,648

 
6,364

Unearned premiums
20,318

 
14,670

Accrued expenses and other liabilities
(17,785
)
 
(5,068
)
Income taxes payable
1,948

 

Deferred income taxes
(72
)
 
1,665

Other, net
(1,038
)
 
31

Total adjustments
$
5,160

 
$
9,351

Net cash provided by operating activities
$
18,491

 
$
31,744

Cash Flows From Investing Activities
 
 
 
Proceeds from sale of available-for-sale investments
$

 
$
2,810

Proceeds from call and maturity of held-to-maturity investments
11

 
19

Proceeds from call and maturity of available-for-sale investments
103,480

 
127,514

Proceeds from short-term and other investments
764

 
407

Purchase of available-for-sale investments
(131,989
)
 
(142,615
)
Purchase of short-term and other investments
(1,152
)
 
(900
)
Net purchases and sales of property and equipment
(2,860
)
 
(386
)
Net cash used in investing activities
$
(31,746
)
 
$
(13,151
)
Cash Flows From Financing Activities
 
 
 
Policyholders’ account balances
 
 
 
Deposits to investment and universal life contracts
$
49,281

 
$
25,369

Withdrawals from investment and universal life contracts
(55,882
)
 
(46,219
)
Payment of cash dividends
(4,567
)
 
(3,786
)
Issuance of common stock
823

 
603

Tax impact from issuance of common stock
70

 
(78
)
Net cash used in financing activities
$
(10,275
)
 
$
(24,111
)
Net Change in Cash and Cash Equivalents
$
(23,530
)
 
$
(5,518
)
Cash and Cash Equivalents at Beginning of Period
92,193

 
107,466

Cash and Cash Equivalents at End of Period
$
68,663

 
$
101,948

The Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


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UNITED FIRE GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, unless otherwise noted)

NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Business
United Fire Group, Inc. ("United Fire", the "Registrant", the "Company", "we", "us", or "our") and its consolidated subsidiaries and affiliates are engaged in the business of writing property and casualty insurance and life insurance and selling annuities through a network of independent agencies. We report our operations in two business segments: property and casualty insurance and life insurance. Our insurance company subsidiaries are licensed as a property and casualty insurer in 43 states and the District of Columbia, and as a life insurer in 37 states.
Basis of Presentation
The unaudited consolidated interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial reporting and with the instructions to Form 10-Q and Regulation S-X promulgated by the SEC. Certain financial information that is included in our Annual Report on Form 10-K, including certain financial statement footnote disclosures, are not required by the rules and regulations of the SEC for interim financial reporting and have been condensed or omitted.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial statement categories that are most dependent on management estimates and assumptions include: investments; deferred policy acquisition costs; reinsurance receivables and recoverables (for net realizable value); future policy benefits and losses, claims and loss settlement expenses; and pension and postretirement benefit obligations.
In the preparation of the accompanying unaudited Consolidated Financial Statements, we have evaluated all material subsequent events or transactions that occurred after the balance sheet date through the date on which the financial statements were issued for potential recognition or disclosure.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Management of United Fire believes the accompanying unaudited Consolidated Financial Statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. All significant intercompany transactions have been eliminated in consolidation. The results reported for the interim periods are not necessarily indicative of the results of operations that may be expected for the year. The unaudited Consolidated Financial Statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013. The review report of Ernst & Young LLP as of March 31, 2014 and for the three-month periods ended March 31, 2014 and 2013 accompanies the unaudited Consolidated Financial Statements included in Part I, Item 1 "Financial Statements."
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash, money market accounts, and non-negotiable certificates of deposit with original maturities of three months or less.
For the three-month periods ended March 31, 2014 and 2013, we made payments for income taxes totaling $1,007 and $5, respectively. We received tax refunds of $615 and $8,744, respectively, during the three-month periods ended March 31, 2014 and 2013.


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For the three-month periods ended March 31, 2014 and 2013, we made no interest payments (excluding interest credited to policyholders’ accounts).
Deferred Policy Acquisition Costs ("DAC")

Certain costs associated with underwriting new business (primarily commissions, premium taxes and variable underwriting and policy issue expenses associated with successful acquisition efforts) are deferred. The following table is a summary of the components of DAC, including the related amortization recognized for the three-month period ended March 31, 2014.
 
 
 
 
 
Property & Casualty
 
Life Insurance
 
Total
Recorded asset at beginning of period
$
67,663

 
$
82,429

 
$
150,092

Underwriting costs deferred
39,822

 
1,836

 
41,658

Amortization of deferred policy acquisition costs
(37,876
)
 
(1,658
)
 
(39,534
)
Ending unamortized deferred policy acquisition costs
$
69,609

 
$
82,607

 
$
152,216

Change in "shadow" deferred policy acquisition costs

 
(8,920
)
 
(8,920
)
Recorded asset at end of period
$
69,609

 
$
73,687

 
$
143,296


Property and casualty policy acquisition costs deferred are amortized as premium revenue is recognized. The method followed in computing DAC limits the amount of such deferred costs to their estimated realizable value. This takes into account the premium to be earned, losses and loss settlement expenses expected to be incurred and certain other costs expected to be incurred as the premium is earned.

For traditional life insurance policies, DAC is amortized to income over the premium-paying period in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue. Expected premium revenue and gross profits are based on the same mortality and withdrawal assumptions used in determining future policy benefits. These assumptions are not revised after policy issuance unless the recorded DAC asset is deemed to be unrecoverable from future expected profits.

For non-traditional life insurance policies, DAC is amortized over the anticipated terms in proportion to the ratio of the expected annual gross profits to the total expected gross profits. Changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on amortization of DAC for revisions to estimated gross profits is reported in earnings in the period the estimated gross profits are revised.

The effect on DAC that results from the assumed realization of unrealized gains (losses) on investments allocated to non-traditional life insurance business is recognized with an offset, or "shadow" DAC, to net unrealized investment appreciation as of the balance sheet date. The "shadow" DAC adjustment decreased the DAC asset by $5,513 at March 31, 2014 and increased the DAC asset by $3,407 at December 31, 2013, respectively.
Income Taxes
Deferred tax assets and liabilities are established based on differences between the financial statement bases of assets and liabilities and the tax bases of those same assets and liabilities, using the currently enacted statutory tax rates. Deferred income tax expense is measured by the year-to-year change in the net deferred tax asset or liability, except for certain changes in deferred tax amounts that affect stockholders’ equity and do not impact federal income tax expense.
We reported a federal income tax expense of $2,566 and $7,457 for the three-month periods ended March 31, 2014 and 2013, respectively. Our effective tax rate is different than the federal statutory rate of 35.0 percent due principally to the effect of tax-exempt municipal bond interest income and non-taxable dividend income.


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We did not recognize any liability for unrecognized tax benefits at March 31, 2014 or December 31, 2013. In addition, we have not accrued for interest and penalties related to unrecognized tax benefits. However, if interest and penalties would need to be accrued related to unrecognized tax benefits, such amounts would be recognized as a component of federal income tax expense.
We file a consolidated federal income tax return. We also file income tax returns in various state jurisdictions. We are no longer subject to federal or state income tax examination for years before 2009. The Internal Revenue Service is conducting a routine examination of our income tax return for the 2011 tax year.
Recently Issued Accounting Standards
Adopted Accounting Standards in 2014

Unrecognized tax benefit
In July 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This new guidance is effective for annual and interim periods beginning after December 15, 2013. The Company currently does not have any liability for unrecognized tax benefits. The Company adopted the new guidance effective January 1, 2014. The adoption of the new guidance had no impact on the Company's financial position or results of operations.
NOTE 2. SUMMARY OF INVESTMENTS
Fair Value of Investments
A reconciliation of the amortized cost (cost for equity securities) to fair value of investments in held-to-maturity and available-for-sale fixed maturity and equity securities as of March 31, 2014 and December 31, 2013, is as follows:


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March 31, 2014
 
Type of Investment
Cost or Amortized Cost
 
Gross Unrealized Appreciation
 
Gross Unrealized Depreciation
 
Fair Value
HELD-TO-MATURITY
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
States, municipalities and political subdivisions
$
249

 
$
4

 
$

 
$
253

Corporate bonds - financial services
200

 

 

 
200

Mortgage-backed securities
195

 
8

 

 
203

Total Held-to-Maturity Fixed Maturities
$
644

 
$
12

 
$

 
$
656

AVAILABLE-FOR-SALE

 

 

 

Fixed maturities

 

 

 

Bonds

 

 

 

U.S. Treasury
$
32,539

 
$
346

 
$
130

 
$
32,755

U.S. government agency
319,146

 
1,175

 
11,641

 
308,680

States, municipalities and political subdivisions
699,631

 
33,156

 
5,191

 
727,596

Foreign bonds
157,747

 
6,096

 
104

 
163,739

Public utilities
209,721

 
6,719

 
764

 
215,676

Corporate bonds

 

 

 

Energy
156,177

 
4,667

 
682

 
160,162

Industrials
227,612

 
6,220

 
1,209

 
232,623

Consumer goods and services
171,884

 
4,454

 
597

 
175,741

Health care
82,693

 
3,400

 
552

 
85,541

Technology, media and telecommunications
119,579

 
3,198

 
1,516

 
121,261

Financial services
241,936

 
8,780

 
272

 
250,444

Mortgage-backed securities
20,919

 
401

 
215

 
21,105

Collateralized mortgage obligations
316,736

 
2,224

 
11,941

 
307,019

Asset-backed securities
3,141

 
240

 

 
3,381

Total Available-for-Sale Fixed Maturities
$
2,759,461

 
$
81,076

 
$
34,814

 
$
2,805,723

Equity securities

 

 

 

Common stocks

 

 

 

Public utilities
$
7,231

 
$
10,231

 
$

 
$
17,462

Energy
5,094

 
9,562

 

 
14,656

Industrials
13,286

 
32,197

 
34

 
45,449

Consumer goods and services
10,363

 
10,933

 
3

 
21,293

Health care
7,920

 
17,025

 

 
24,945

Technology, media and telecommunications
6,204

 
7,176

 
58

 
13,322

Financial services
15,939

 
74,451

 
113

 
90,277

Nonredeemable preferred stocks
4,984

 
11

 
22

 
4,973

Total Available-for-Sale Equity Securities
$
71,021

 
$
161,586

 
$
230

 
$
232,377

Total Available-for-Sale Securities
$
2,830,482

 
$
242,662

 
$
35,044

 
$
3,038,100



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December 31, 2013
 
Type of Investment
Cost or Amortized Cost
 
Gross Unrealized Appreciation
 
Gross Unrealized Depreciation
 
Fair Value
HELD-TO-MATURITY
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
States, municipalities and political subdivisions
$
250

 
$
4

 
$

 
$
254

Corporate bonds - financial services
200

 

 

 
200

Mortgage-backed securities
206

 
9

 

 
215

Total Held-to-Maturity Fixed Maturities
$
656

 
$
13

 
$

 
$
669

AVAILABLE-FOR-SALE

 

 

 

Fixed maturities

 

 

 

Bonds

 

 

 

U.S. Treasury
$
33,612

 
$
423

 
$
140

 
$
33,895

U.S. government agency
287,988

 
258

 
18,663

 
269,583

States, municipalities and political subdivisions
690,461

 
34,151

 
10,705

 
713,907

Foreign bonds
167,390

 
5,863

 
397

 
172,856

Public utilities
213,479

 
6,873

 
1,776

 
218,576

Corporate bonds

 


 

 

Energy
157,620

 
4,398

 
1,008

 
161,010

Industrials
234,221

 
5,626

 
2,819

 
237,028

Consumer goods and services
165,565

 
3,770

 
1,421

 
167,914

Health care
91,008

 
3,138

 
1,200

 
92,946

Technology, media and telecommunications
121,746

 
2,541

 
3,321

 
120,966

Financial services
234,739

 
7,735

 
723

 
241,751

Mortgage-backed securities
22,034

 
323

 
291

 
22,066

Collateralized mortgage obligations
309,975

 
1,707

 
16,919

 
294,763

Asset-backed securities
3,719

 
276

 

 
3,995

Total Available-for-Sale Fixed Maturities
$
2,733,557

 
$
77,082

 
$
59,383

 
$
2,751,256

Equity securities

 

 

 

Common stocks

 

 

 

Public utilities
$
7,231

 
$
9,068

 
$
27

 
$
16,272

Energy
5,094

 
9,269

 

 
14,363

Industrials
13,308

 
32,823

 
32

 
46,099

Consumer goods and services
10,363

 
10,895

 

 
21,258

Health care
7,920

 
17,078

 

 
24,998

Technology, media and telecommunications
6,204

 
7,183

 
83

 
13,304

Financial services
15,853

 
72,537

 
128

 
88,262

Nonredeemable preferred stocks
4,984

 
5

 
177

 
4,812

Total Available-for-Sale Equity Securities
$
70,957

 
$
158,858

 
$
447

 
$
229,368

Total Available-for-Sale Securities
$
2,804,514

 
$
235,940

 
$
59,830

 
$
2,980,624




10

Table of Contents

Maturities
The amortized cost and fair value of held-to-maturity, available-for-sale and trading fixed maturity securities at March 31, 2014, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset-backed securities, mortgage-backed securities and collateralized mortgage obligations may be subject to prepayment risk and are therefore not categorized by contractual maturity.
 
Held-To-Maturity
 
Available-For-Sale
 
Trading
March 31, 2014
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less
$
135

 
$
136

 
$
247,860

 
$
251,533

 
$
1,527

 
$
1,527

Due after one year through five years
314

 
317

 
928,808

 
976,157

 
6,926

 
8,174

Due after five years through 10 years

 

 
826,150

 
841,995

 
550

 
684

Due after 10 years

 

 
415,847

 
404,533

 
4,901

 
5,710

Asset-backed securities

 

 
3,141

 
3,381

 

 

Mortgage-backed securities
195

 
203

 
20,919

 
21,105

 

 

Collateralized mortgage obligations

 

 
316,736

 
307,019

 

 

 
$
644

 
$
656

 
$
2,759,461

 
$
2,805,723

 
$
13,904

 
$
16,095

Net Realized Investment Gains and Losses
Net realized gains on disposition of investments are computed using the specific identification method and are included in the computation of net income. A summary of the components of net realized investment gains is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Net realized investment gains
 
 
 
Fixed maturities:
 
 
 
Available-for-sale
$
647

 
$
720

Trading securities
 
 
 
Change in fair value
300

 
560

Sales
235

 

Equity securities
 
 
 
Available-for-sale
835

 
516

Trading securities - change in fair value
177

 
113

Total net realized investment gains
$
2,194

 
$
1,909

The proceeds and gross realized gains on the sale of available-for-sale securities are as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Proceeds from sales
$

 
$
2,810

Gross realized gains

 
142

Gross realized losses

 

There were no sales of held-to-maturity securities during the three-month periods ended March 31, 2014 and 2013.

Our investment portfolio includes trading securities with embedded derivatives. These securities are primarily convertible securities which are recorded at fair value. Income or loss, including the change in the fair value of these trading securities, is recognized currently in earnings as a component of net realized investment gains. Our portfolio of trading securities had a fair value of $19,132 and $12,427 at March 31, 2014 and December 31, 2013, respectively.


11

Table of Contents

Unrealized Appreciation
A summary of the changes in net unrealized investment appreciation during the reporting period is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Change in net unrealized investment appreciation
 
 
 
Available-for-sale fixed maturities
$
28,563

 
$
(9,598
)
Available-for-sale equity securities
2,945

 
17,978

Deferred policy acquisition costs
(8,920
)
 
4,871

Income tax effect
(7,907
)
 
(4,637
)
Total change in net unrealized investment appreciation, net of tax
$
14,681

 
$
8,614

We continually monitor the difference between our cost basis and the estimated fair value of our investments. Our accounting policy for impairment recognition requires other-than-temporary impairment ("OTTI") charges to be recorded when we determine that it is more likely than not that we will be unable to collect all amounts due according to the contractual terms of the fixed maturity security or that the anticipated recovery in fair value of the equity security will not occur in a reasonable amount of time. Impairment charges on investments are recorded based on the fair value of the investments at the measurement date. Factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which fair value has been less than cost; the financial condition and near-term prospects of the issuer; our intention to hold the investment; and the likelihood that we will be required to sell the investment.
The tables on the following pages summarize our fixed maturity and equity securities that were in an unrealized loss position at March 31, 2014 and December 31, 2013. The securities are presented by the length of time they have been continuously in an unrealized loss position. It is possible that we could recognize OTTI charges in future periods on securities held at March 31, 2014, if future events or information cause us to determine that a decline in fair value is other-than-temporary.
We have evaluated the near-term prospects of the issuers of our fixed maturity securities in relation to the severity and duration of the unrealized loss, and unless otherwise noted, these losses do not warrant the recognition of an OTTI charge at March 31, 2014. We believe the unrealized depreciation in value of other securities in our fixed maturity portfolio is primarily attributable to changes in market interest rates and not the credit quality of the issuer. We have no intent to sell and it is more likely than not that we will not be required to sell these securities until the fair value recovers to at least equal to our cost basis or the securities mature.
We have evaluated the near-term prospects of the issuers of our equity securities in relation to the severity and duration of the unrealized loss, and unless otherwise noted, these losses do not warrant the recognition of an OTTI charge at March 31, 2014. Our largest unrealized loss greater than 12 months on an individual equity security at March 31, 2014 was $66. We have no intention to sell any of these securities prior to a recovery in value, but will continue to monitor the fair value reported for these securities as part of our overall process to evaluate investments for OTTI recognition.


12

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2014
Less than 12 months
 
12 months or longer
 
Total
Type of Investment
Number
of Issues
 
Fair
Value
 
Gross Unrealized
Depreciation
 
Number
of Issues
 
Fair
Value
 
Gross Unrealized Depreciation
 
Fair
Value
 
Gross Unrealized Depreciation
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
12

 
$
11,663

 
$
130

 

 
$

 
$

 
$
11,663

 
$
130

U.S. government agency
75

 
194,814

 
11,330

 
2

 
4,689

 
311

 
199,503

 
11,641

States, municipalities and political subdivisions
108

 
89,654

 
3,227

 
37

 
32,844

 
1,964

 
122,498

 
5,191

Foreign bonds
3

 
6,231

 
104

 

 

 

 
6,231

 
104

Public utilities
23

 
46,900

 
764

 

 

 

 
46,900

 
764

Corporate bonds
 
 
 
 
 
 
 
 
 
 
 
 


 


Energy
7

 
17,647

 
395

 
1

 
4,053

 
287

 
21,700

 
682

Industrials
14

 
34,997

 
655

 
2

 
7,482

 
554

 
42,479

 
1,209

Consumer goods and services
10

 
28,316

 
363

 
7

 
5,115

 
234

 
33,431

 
597

Health care
5

 
15,026

 
362

 
2

 
4,480

 
190

 
19,506

 
552

Technology, media and telecommunications
7

 
25,434

 
675

 
2

 
7,782

 
841

 
33,216

 
1,516

Financial services
5

 
12,252

 
239

 
1

 
505

 
33

 
12,757

 
272

Mortgage-backed securities
11

 
3,707

 
120

 
7

 
3,086

 
95

 
6,793

 
215

Collateralized mortgage obligations
75

 
143,390

 
6,319

 
34

 
69,064

 
5,622

 
212,454

 
11,941

Total Available-for-Sale Fixed Maturities
355

 
$
630,031

 
$
24,683

 
95

 
$
139,100

 
$
10,131

 
$
769,131

 
$
34,814

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Industrials

 
$

 
$

 
2

 
$
78

 
$
34

 
$
78

 
$
34

Consumer goods and services
1

 
15

 
3

 

 

 

 
15

 
3

Technology, media and telecommunications

 

 

 
6

 
231

 
58

 
231

 
58

Financial services

 

 

 
4

 
230

 
113

 
230

 
113

Nonredeemable preferred stocks

 

 

 
2

 
1,210

 
22

 
1,210

 
22

Total Available-for-Sale Equity Securities
1

 
$
15

 
$
3

 
14

 
$
1,749

 
$
227

 
$
1,764

 
$
230

Total Available-for-Sale Securities
356

 
$
630,046

 
$
24,686

 
109

 
$
140,849

 
$
10,358

 
$
770,895

 
$
35,044



13

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
Less than 12 months
 
12 months or longer
 
Total
Type of Investment
Number
of Issues
 
Fair
Value
 
Gross Unrealized Depreciation
 
Number
of Issues
 
Fair
Value
 
Gross Unrealized Depreciation
 
Fair
Value
 
Gross Unrealized Depreciation
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
10

 
$
9,196

 
$
140

 

 
$

 
$

 
$
9,196

 
$
140

U.S. government agency
101

 
256,203

 
18,019

 
2

 
4,356

 
644

 
260,559

 
18,663

States, municipalities and political subdivisions
136

 
97,950

 
7,423

 
29

 
29,670

 
3,282

 
127,620

 
10,705

Foreign bonds
10

 
20,832

 
397

 

 

 

 
20,832

 
397

Public utilities
31

 
61,582

 
1,776

 

 

 

 
61,582

 
1,776

Corporate bonds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy
9

 
23,735

 
1,008

 

 

 

 
23,735

 
1,008

Industrials
34

 
77,788

 
2,819

 

 

 

 
77,788

 
2,819

Consumer goods and services
31

 
58,833

 
1,276

 
6

 
3,218

 
145

 
62,051

 
1,421

Health care
10

 
25,888

 
942

 
2

 
4,427

 
258

 
30,315

 
1,200

Technology, media and telecommunications
18

 
58,105

 
2,147

 
2

 
7,468

 
1,174

 
65,573

 
3,321

Financial services
7

 
15,191

 
720

 
1

 
1,525

 
3

 
16,716

 
723

Mortgage-backed securities
16

 
4,476

 
177

 
6

 
3,113

 
114

 
7,589

 
291

Collateralized mortgage obligations
111

 
208,855

 
11,062

 
23

 
55,184

 
5,857

 
264,039

 
16,919

Total Available-for-Sale Fixed Maturities
524

 
$
918,634

 
$
47,906

 
71

 
$
108,961

 
$
11,477

 
$
1,027,595

 
$
59,383

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Public utilities

 
$

 
$

 
3

 
$
281

 
$
27

 
$
281

 
$
27

Industrials
1

 
1

 
1

 
2

 
81

 
31

 
82

 
32

Technology, media and telecommunications

 

 

 
6

 
206

 
83

 
206

 
83

Financial services

 

 

 
4

 
215

 
128

 
215

 
128

Nonredeemable preferred stocks
3

 
3,493

 
116

 
2

 
1,170

 
61

 
4,663

 
177

Total Available-for-Sale Equity Securities
4

 
$
3,494

 
$
117

 
17

 
$
1,953

 
$
330

 
$
5,447

 
$
447

Total Available-for-Sale Securities
528

 
$
922,128

 
$
48,023

 
88

 
$
110,914

 
$
11,807

 
$
1,033,042

 
$
59,830



14

Table of Contents

NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS
We estimate the fair value of our financial instruments based on relevant market information or by discounting estimated future cash flows at estimated current market discount rates appropriate to the specific asset or liability.
When possible, we use quoted market prices to determine the fair value of fixed maturities, equity securities, trading securities and short-term investments. When quoted market prices do not exist, we base estimates of fair value on market prices obtained from independent pricing services and brokers or on valuation techniques that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management’s own assumptions about the assumptions a market participant would use in pricing the financial instrument. Our valuation techniques are discussed in more detail later in this section.
The fair value of our mortgage loans is determined by modeling performed by us based on the stated principal and coupon payments provided for in the loan agreement. These cash flows are then discounted using an appropriate risk-adjusted discount rate to determine the security's fair value, which is a Level 3 fair value measurement.
The fair value of our policy loans is equivalent to carrying value, which is a reasonable estimate of fair value. We do not make policy loans for amounts in excess of the cash surrender value of the related policy. In all instances, the policy loans are fully collateralized by the related liability for future policy benefits for traditional insurance policies or by the policyholders' account balance for non-traditional policies.
Our other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. The fair value of the partnerships is obtained from the fund managers, which is based on the fair value of the underlying investments held in the partnerships. In management’s opinion, these values represent a reasonable estimate of fair value. We have not adjusted the net asset value provided by the fund managers.
For cash and cash equivalents and accrued investment income, carrying value is a reasonable estimate of fair value due to the short-term nature of these financial instruments.

Policy reserves are developed and recorded for deferred annuities, which is an interest-sensitive product, and income annuities. The fair value of the reserve liability for these annuity products is based upon an estimate of the discounted pretax cash flows that are forecast for the underlying business, which is a Level 3 fair value measurement. We base the discount rate on the current U.S. Treasury spot yield curve, which is then risk-adjusted for nonperformance risk and, for interest-sensitive business, market risk factors. The risk-adjusted discount rate is developed using interest rates that are available in the market and representative of the risks applicable to the underlying business.





15

Table of Contents

A summary of the carrying value and estimated fair value of our financial instruments at March 31, 2014 and December 31, 2013 is as follows:
 
March 31, 2014
 
December 31, 2013
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Assets
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Held-to-maturity securities
$
656

 
$
644

 
$
669

 
$
656

Available-for-sale securities
2,805,723

 
2,805,723

 
2,751,256

 
2,751,256

Trading securities
16,095

 
16,095

 
9,940

 
9,940

Equity securities:
 
 
 
 
 
 
 
Available-for-sale securities
232,377

 
232,377

 
229,368

 
229,368

Trading securities
3,037

 
3,037

 
2,487

 
2,487

Mortgage loans
4,724

 
4,368

 
4,724

 
4,423

Policy loans
6,177

 
6,177

 
6,261

 
6,261

Other long-term investments
46,513

 
46,513

 
44,946

 
44,946

Short-term investments
800

 
800

 
800

 
800

Cash and cash equivalents
68,663

 
68,663

 
92,193

 
92,193

Liabilities
 
 
 
 
 
 
 
Policy reserves
 
 
 
 
 
 
 
Annuity (accumulations) (1)
$
954,214

 
$
920,038

 
$
941,636

 
$
925,832

Annuity (benefit payments)
142,900

 
94,163

 
140,276

 
94,805

(1) Annuity accumulations represent deferred annuity contracts that are currently earning interest.

Current accounting guidance on fair value measurements includes the application of a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Our financial instruments that are recorded at fair value are categorized into a three-level hierarchy, which is based upon the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets (i.e., Level 1) and the lowest priority to unobservable inputs (i.e., Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the financial instrument.
Financial instruments recorded at fair value are categorized in the fair value hierarchy as follows:
Level 1: Valuations are based on unadjusted quoted prices in active markets for identical financial instruments that we have the ability to access.
Level 2: Valuations are based on quoted prices for similar financial instruments, other than quoted prices included in Level 1, in markets that are not active or on inputs that are observable either directly or indirectly for the full term of the financial instrument.
Level 3: Valuations are based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management’s own assumptions about the assumptions a market participant would use in pricing the financial instrument.
Transfers between levels, if any, are recorded as of the beginning of the reporting period.
To determine the fair value of the majority of our investments, we utilize prices obtained from independent, nationally recognized pricing services. We obtain one price for each security. When the pricing services cannot provide a determination of fair value for a specific security, we obtain non-binding price quotes from broker-dealers with whom we have had several years experience and who have demonstrated knowledge of the subject security. We request and utilize one broker quote per security.


16

Table of Contents

We validate the prices obtained from independent pricing services and brokers prior to their use for reporting purposes by evaluating their reasonableness on a monthly basis. Our validation process includes a review for unusual fluctuations. In our opinion, the pricing obtained at March 31, 2014 and December 31, 2013 was reasonable.
In order to determine the proper classification in the fair value hierarchy for each security where the price is obtained from an independent pricing service, we obtain and evaluate the vendors' pricing procedures and inputs used to price the security, which include unadjusted quoted market prices for identical securities, such as a New York Stock Exchange closing price, and quoted prices for identical securities in markets that are not active. For fixed maturity securities, an evaluation of interest rates and yield curves observable at commonly quoted intervals, volatility, prepayment speeds, credit risks and default rates may also be performed. We have determined that these processes and inputs result in fair values and classifications consistent with the applicable accounting guidance on fair value measurements.
We review our fair value hierarchy categorizations on a quarterly basis at which time the classification of certain financial instruments may change if the input observations have changed.

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at March 31, 2014 and December 31, 2013:


17

Table of Contents

March 31, 2014
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
32,755

 
$

 
$
32,755

 
$

U.S. government agency
308,680

 

 
308,680

 

States, municipalities and political subdivisions
727,596

 

 
726,898

 
698

Foreign bonds
163,739

 

 
163,739

 

Public utilities
215,676

 

 
215,676

 

Corporate bonds


 


 


 


Energy
160,162

 

 
160,162

 

Industrials
232,623

 

 
232,623

 

Consumer goods and services
175,741

 

 
174,322

 
1,419

Health care
85,541

 

 
85,541

 

Technology, media and telecommunications
121,261

 

 
121,261

 

Financial services
250,444

 

 
238,741

 
11,703

Mortgage-backed securities
21,105

 

 
21,105

 

Collateralized mortgage obligations
307,019

 

 
307,019

 

Asset-backed securities
3,381

 

 
1,468

 
1,913

Total Available-for-Sale Fixed Maturities
$
2,805,723

 
$

 
$
2,789,990

 
$
15,733

Equity securities
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
17,462

 
$
17,462

 
$

 
$

Energy
14,656

 
14,656

 

 

Industrials
45,449

 
45,430

 
19

 

Consumer goods and services
21,293

 
21,293

 

 

Health care
24,945

 
24,945

 

 

Technology, media and telecommunications
13,322

 
13,322

 

 

Financial services
90,277

 
86,322

 
64

 
3,891

Nonredeemable preferred stocks
4,973

 
1,763

 
3,210

 

Total Available-for-Sale Equity Securities
$
232,377

 
$
225,193

 
$
3,293

 
$
3,891

Total Available-for-Sale Securities
$
3,038,100

 
$
225,193

 
$
2,793,283

 
$
19,624

TRADING
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Foreign bonds
$
1,252

 
$

 
$
1,252

 
$

Corporate bonds


 


 


 


Industrials
1,559

 

 
1,559

 

Consumer goods and services
1,096

 

 
1,096

 

Health care
2,172

 

 
2,172

 



18

Table of Contents

Technology, media and telecommunications
2,925

 

 
2,925

 

Financial services
3,493

 

 
3,493

 

Redeemable preferred stocks
3,598

 
3,598

 

 

Equity securities
 
 
 
 
 
 
 
Energy
544

 
544

 

 

Consumer goods and services
30

 
30

 

 

Health care
383

 
383

 

 

Technology, media and telecommunications
379

 
379

 

 

Nonredeemable preferred stocks
1,701

 
1,701

 

 

Total Trading Securities
$
19,132

 
$
6,635

 
$
12,497

 
$

Short-Term Investments
$
800

 
$
800

 
$

 
$

Money Market Accounts
$
16,259

 
$
16,259

 
$

 
$

Total Assets Measured at Fair Value
$
3,074,291

 
$
248,887

 
$
2,805,780

 
$
19,624




19

Table of Contents

December 31, 2013
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
33,895

 
$

 
$
33,895

 
$

U.S. government agency
269,583

 

 
269,583

 

States, municipalities and political subdivisions
713,907

 

 
713,209

 
698

Foreign bonds
172,856

 

 
172,856

 

Public utilities
218,576

 

 
218,576

 

Corporate bonds

 


 


 


Energy
161,010

 

 
161,010

 

Industrials
237,028

 

 
237,028

 

Consumer goods and services
167,914

 

 
166,460

 
1,454

Health care
92,946

 

 
92,946

 

Technology, media and telecommunications
120,966

 

 
120,966

 

Financial services
241,751

 

 
229,725

 
12,026

Mortgage-backed securities
22,066

 

 
22,066

 

Collateralized mortgage obligations
294,763

 

 
294,763

 

Asset-backed securities
3,995

 

 
1,966

 
2,029

Total Available-for-Sale Fixed Maturities
$
2,751,256

 
$

 
$
2,735,049

 
$
16,207

Equity securities
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
16,272

 
$
16,272

 
$

 
$

Energy
14,363

 
14,363

 

 

Industrials
46,099

 
46,083

 
16

 

Consumer goods and services
21,258

 
21,258

 

 

Health care
24,998

 
24,998

 

 

Technology, media and telecommunications
13,304

 
13,304

 

 

Financial services
88,262

 
84,419

 
62

 
3,781

Nonredeemable preferred stocks
4,812

 
1,714

 
3,098

 

Total Available-for-Sale Equity Securities
$
229,368

 
$
222,411

 
$
3,176

 
$
3,781

Total Available-for-Sale Securities
$
2,980,624

 
$
222,411

 
$
2,738,225

 
$
19,988

TRADING
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Foreign bonds
$
1,253

 
$

 
$
1,253

 
$

Corporate bonds

 

 

 

Industrials
1,122

 

 
1,122

 

Consumer goods and services
106

 

 
106

 

Health care
1,154

 

 
1,154

 

Technology, media and telecommunications
2,054

 

 
2,054

 

Financial services
1,866

 

 
1,866

 



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Redeemable preferred stocks
2,385

 
2,385

 

 

Equity securities
 
 
 
 
 
 
 
Energy
563

 
563

 

 

Consumer goods and services
39

 
39

 

 

Health care
332

 
332

 

 

Nonredeemable preferred stocks
1,553

 
1,553

 

 

Total Trading Securities
$
12,427

 
$
4,872

 
$
7,555

 
$

Short-Term Investments
$
800

 
$
800

 
$

 
$

Money Market Accounts
$
37,811

 
$
37,811

 
$

 
$

Total Assets Measured at Fair Value
$
3,031,662

 
$
265,894

 
$
2,745,780

 
$
19,988

The fair value of securities that are categorized as Level 1 is based on quoted market prices that are readily and regularly available.
The fair value of securities that are categorized as Level 2 is determined by management after reviewing market prices obtained from independent pricing services and brokers. Such estimated fair values do not necessarily represent the values for which these securities could have been sold at the reporting date. Our independent pricing services and brokers obtain prices from reputable pricing vendors in the marketplace. They continually monitor and review the external pricing sources, while actively participating to resolve any pricing issues that may arise.
For the three-month period ended March 31, 2014, the change in our available-for-sale securities categorized as Level 1 and Level 2 is the result of investment purchases that were made using funds held in our money market accounts, disposals and the change in unrealized gains on both fixed maturities and equity securities. There were no transfers of securities between Level 1 and Level 2 during the period.
Securities categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities for which an active market does not currently exist.
The fair value of our Level 3 private placement securities is determined by management relying on pricing received from our independent pricing services and brokers consistent with the process to estimate fair value for Level 2 securities. If pricing cannot be obtained from these sources, which occurs on a limited basis, management will perform a cash flow analysis, using an appropriate risk-adjusted discount rate, on the underlying security to estimate fair value.

The following table provides a summary of the changes in fair value of our Level 3 securities for the three-month period ended March 31, 2014:
 
States, municipalities and political subdivisions
 
Corporate bonds
 
Asset-backed securities
 
Equities
 
Total
Balance at January 1, 2014
$
698

 
$
13,480

 
$
2,029

 
$
3,781

 
$
19,988

Unrealized losses(1)

 
(62
)
 
(5
)
 

 
(67
)
Purchases

 

 

 
144

 
144

Disposals

 
(296
)
 
(111
)
 
(34
)
 
(441
)
Balance at March 31, 2014
$
698

 
$
13,122

 
$
1,913

 
$
3,891

 
$
19,624

(1) Unrealized gains (losses) are recorded as a component of comprehensive income.
The fixed maturities reported as disposals relate to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures. The reported transfers are the result of stale pricing due to a lack of current trading activity for the underlying securities.



21

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NOTE 4. EMPLOYEE BENEFITS

Net Periodic Benefit Cost

The components of the net periodic benefit cost for our pension and postretirement benefit plans are as follows:
 
Pension Plan
 
Postretirement Benefit Plan
Three Months Ended March 31,
2014
 
2013
 
2014
 
2013
Net periodic benefit cost
 
 
 
 
 
 
 
Service cost
$
1,303

 
$
1,282

 
$
924

 
$
753

Interest cost
1,468

 
1,262

 
586

 
424

Expected return on plan assets
(1,739
)
 
(1,336
)
 

 

Amortization of net loss
544

 
1,106

 
224

 
136

Net periodic benefit cost
$
1,576

 
$
2,314

 
$
1,734

 
$
1,313


Employer Contributions

We previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013 that we expected to contribute $6,260 to the pension plan in 2014. For the three-month period ended March 31, 2014, we contributed $1,750 to the pension plan. We anticipate that the total contribution in 2014 will not vary significantly from our expected contribution.


NOTE 5. STOCK-BASED COMPENSATION

Non-qualified Employee Stock Award Plan
The United Fire and Casualty Company 2008 Stock Plan (the "Stock Plan") authorizes the issuance of restricted and unrestricted stock awards, stock appreciation rights, incentive stock options, and non-qualified stock options for up to 1,900,000 shares of United Fire common stock to our employees, with 40,861 authorized shares remaining available for future issuance at March 31, 2014. The Stock Plan is administered by the Board of Directors, which determines those employees who will receive awards, when awards will be granted, and the terms and conditions of the awards. The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Stock Plan. Pursuant to the Stock Plan, the Board of Directors may, at its sole discretion, grant awards to our employees who are in positions of substantial responsibility with United Fire.
Options granted pursuant to the Stock Plan are granted to buy shares of United Fire's common stock at the market value of the stock on the date of grant. All outstanding option awards vest and are exercisable in installments of 20.0 percent of the number of shares covered by the option award each year from the grant date, unless the Board of Directors authorizes the acceleration of vesting. To the extent not exercised, vested option awards accumulate and are exercisable by the awardee, in whole or in part, in any subsequent year included in the option period, but not later than 10 years from the grant date. Restricted and unrestricted stock awards granted pursuant to the Stock Plan are granted at the market value of our common stock on the date of the grant. Restricted stock awards fully vest after five years from the date of issuance, unless accelerated upon the approval of the Board of Directors, at which time United Fire common stock will be issued to the awardee. All awards are generally granted free of charge to the eligible employees of United Fire as designated by the Board of Directors.






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Table of Contents

The activity in the Stock Plan is displayed in the following table:
Authorized Shares Available for Future Award Grants
Three Months Ended March 31, 2014
 
From Inception to March 31, 2014
Beginning balance
353,649

 
1,900,000

Number of awards granted
(313,288
)
 
(1,995,784
)
Number of awards forfeited or expired
500

 
136,645

Ending balance
40,861

 
40,861

Number of option awards exercised
26,532

 
408,300

Number of unrestricted stock awards granted

 
4,555

Number of restricted stock awards vested

 
18,576


Non-qualified Non-employee Director Stock Option and Restricted Stock Plan
The United Fire and Casualty Company 2005 Non-Qualified Non-Employee Director Stock Option and Restricted Stock Plan (the "Director Plan") authorizes the issuance of restricted stock awards and non-qualified stock options to purchase shares of United Fire’s common stock to non-employee directors. At March 31, 2014, we had 103,912 authorized shares available for future issuance.
The Board of Directors has the authority to determine which non-employee directors receive awards, when options and restricted stock shall be granted, the option price, the option expiration date, the date of grant, the vesting schedule of options or whether the options shall be immediately vested, the terms and conditions of options and restricted stock (other than those terms and conditions set forth in the plan) and the number of shares of common stock to be issued pursuant to an option agreement or restricted stock agreement. The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Director Plan.

The activity in the Director Plan is displayed in the following table:
Authorized Shares Available for Future Award Grants
Three Months Ended March 31, 2014
 
From Inception to March 31, 2014
Beginning balance
103,912

 
300,000

Number of awards granted

 
(202,091
)
Number of awards forfeited or expired

 
6,003

Ending balance
103,912

 
103,912

Number of option awards exercised

 
3,156

Number of restricted stock awards vested

 
6,402


Stock-Based Compensation Expense

For the three-month periods ended March 31, 2014 and 2013, we recognized stock-based compensation expense of $437 and $411, respectively. Stock-based compensation expense is recognized over the vesting period of the stock options.













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Table of Contents

As of March 31, 2014, we had $6,439 in stock-based compensation expense that has yet to be recognized through our results of operations. We expect this compensation to be recognized over the remainder of 2014 and subsequent years according to the following table, except with respect to awards that are accelerated by the Board of Directors, in which case we will recognize any remaining compensation expense in the period in which the awards are accelerated.
2014
 
$
1,421

2015
 
1,715

2016
 
1,290

2017
 
1,144

2018
 
779

2019
 
90

Total
 
$
6,439


NOTE 6. SEGMENT INFORMATION

We have two reportable business segments in our operations: property and casualty insurance and life insurance. The property and casualty insurance segment has seven domestic locations from which it conducts its business. The life insurance segment operates from our home office. Because all of our insurance is sold domestically, we have no revenues allocable to foreign operations.

We evaluate the two segments on the basis of both statutory accounting practices prescribed or permitted by our states of domicile and GAAP. We analyze results based on profitability (i.e., loss ratios), expenses, and return on equity. The basis we use to determine and analyze segments and to measure segment profit or loss have not changed from that reported in our Annual Report on Form 10-K for the year ended December 31, 2013.
 
We have reconciled the following table for the three-month periods ended March 31, 2014 and 2013 to the amounts reported in our unaudited Consolidated Financial Statements to adjust for intersegment eliminations.
 
Property and Casualty Insurance
 
Life Insurance
 
Total
Three Months Ended March 31, 2014
 
 
 
 
 
Net premiums earned
$
179,494

 
$
13,980

 
$
193,474

Investment income, net of investment expenses
11,113

 
15,599

 
26,712

Net realized investment gains
1,367

 
827

 
2,194

Other income
480

 
127

 
607

Total reportable segment
$
192,454

 
$
30,533

 
$
222,987

Intersegment eliminations
50

 
(133
)
 
(83
)
Total revenues
$
192,504

 
$
30,400

 
$
222,904

Net income
$
11,811

 
$
1,520

 
$
13,331

Assets
$
2,032,501

 
$
1,736,748

 
$
3,769,249

Invested assets
$
1,486,783

 
$
1,628,951

 
$
3,115,734

Three Months Ended March 31, 2013
 
 
 
 
 
Net premiums earned
$
162,701

 
$
14,239

 
$
176,940

Investment income, net of investment expenses
10,421

 
15,979

 
26,400

Net realized investment gains
1,029

 
880

 
1,909

Other income
12

 
103

 
115

Total reportable segment
$
174,163

 
$
31,201

 
$
205,364

Intersegment eliminations
64

 
(123
)
 
(59
)
Total revenues
$
174,227

 
$
31,078

 
$
205,305

Net income
$
20,730

 
$
1,663

 
$
22,393

Assets
$
1,941,227

 
$
1,783,463

 
$
3,724,690

Invested assets
$
1,378,188

 
$
1,685,171

 
$
3,063,359




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NOTE 7. EARNINGS PER COMMON SHARE
Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings per share gives effect to all dilutive common shares outstanding during the reporting period. The dilutive shares we consider in our diluted earnings per share calculation relate to our outstanding stock options and restricted stock awards.
We determine the dilutive effect of our outstanding stock options using the "treasury stock" method. Under this method, we assume the exercise of all of the outstanding stock options whose exercise price is less than the weighted-average market value of our common stock during the reporting period. This method also assumes that the proceeds from the hypothetical stock option exercises are used to repurchase shares of our common stock at the weighted-average market value of the stock during the reporting period. The net of the assumed stock options exercised and assumed common shares repurchased represents the number of dilutive common shares, which we add to the denominator of the earnings per share calculation.
The components of basic and diluted earnings per share were as follows for the three-month periods ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
(In Thousands Except Share Data)
2014
 
2013
 
Basic
 
Diluted
 
Basic
 
Diluted
Net income
$
13,331

 
$
13,331

 
$
22,393

 
$
22,393

Weighted-average common shares outstanding
25,372,280

 
25,372,280

 
25,245,497

 
25,245,497

Add dilutive effect of restricted stock awards

 
102,635

 

 
79,787

Add dilutive effect of stock options

 
115,292

 

 
15,385

Weighted-average common shares
25,372,280

 
25,590,207

 
25,245,497

 
25,340,669

Earnings per common share
$
0.53

 
$
0.52

 
$
0.89

 
$
0.88

Awards excluded from diluted earnings per share calculation(1)

 
908,480

 

 
643,066

(1)
Outstanding awards that are not "in-the-money" are excluded from the diluted earnings per share calculation because the effect of including them would have been anti-dilutive.


NOTE 8. DEBT
In December 2011, United Fire entered into a credit agreement with a syndicate of financial institutions as lenders. KeyBank National Association is the administrative agent, lead arranger, sole book runner, swingline lender, and letter of credit issuer, and Bankers Trust Company is the syndication agent. The four-year credit agreement provides for a $100,000 unsecured revolving credit facility that includes a $20,000 letter of credit subfacility and a swing line subfacility of up to $5,000.
On June 4, 2013, United Fire & Casualty Company, United Fire Group, Inc. and the syndicated lenders entered into an Assignment, Joinder, Assumption, and Release Agreement (the "Joinder Agreement") transferring the obligations under the credit agreement from United Fire & Casualty Company to United Fire Group, Inc. Effective with the execution of the Joinder Agreement, United Fire & Casualty Company was released from any further obligations under the credit agreement.
During the term of this credit agreement, we have the right to increase the total credit facility from $100,000 up to $125,000 if no event of default has occurred and is continuing and certain other conditions are satisfied. The credit facility is available for general corporate purposes, including working capital, acquisitions and liquidity purposes. Any principal outstanding under the credit facility is due in full at maturity, on December 22, 2015. The interest rate is based on our monthly choice of either a base rate or the London Interbank Offered Rate ("LIBOR") plus, in each case, a calculated margin amount. A commitment fee on each lender's unused commitment under the credit facility is also payable quarterly.


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Table of Contents

The credit agreement contains customary representations, covenants and events of default, including certain covenants that limit or restrict our ability to engage in certain activities. Subject to certain exceptions, these activities include restricting our ability to sell or transfer assets or enter into a merger or consolidate with another company, grant certain types of security interests, incur certain types of liens, impose restrictions on subsidiary dividends, enter into leaseback transactions, or incur certain indebtedness. The credit agreement contains certain financial covenants including covenants that require us to maintain a minimum consolidated net worth, a debt to capitalization ratio and minimum shareholders' equity.
There was no outstanding balance on the credit facility at March 31, 2014 and 2013. For the three-month period ended March 31, 2014 and 2013, we did not incur any interest expense related to this credit facility. We were in compliance with all covenants for the credit agreement at March 31, 2014.


NOTE 9. ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table shows the changes in the components of our accumulated other comprehensive income (loss), net of tax, for the three-month period ended March 31, 2014:

 
 
 
Liability for
 
 
 
Net unrealized
 
underfunded
 
 
 
appreciation
 
employee
 
 
 
on investments
 
benefit costs
 
Total
Balance as of January 1, 2014
$
116,601

 
$
(29,451
)
 
$
87,150

Change in accumulated other comprehensive income before reclassifications
15,644

 

 
15,644

Reclassification adjustments from accumulated other comprehensive income
(963
)
 
499

 
(464
)
Balance as of March 31, 2014
$
131,282

 
$
(28,952
)
 
$
102,330






26

Table of Contents

Review Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
United Fire Group, Inc.

We have reviewed the consolidated balance sheet of United Fire Group, Inc. as of March 31, 2014, and the related consolidated statements of income and comprehensive income for the three-month periods ended March 31, 2014 and 2013, the consolidated statements of cash flows for the three-month periods ended March 31, 2014 and 2013, and the consolidated statement of stockholders' equity for the three-month period ended March 31, 2014. These financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of United Fire Group, Inc. as of December 31, 2013, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for the year then ended (not presented herein) and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 5, 2014. In our opinion, the accompanying consolidated balance sheet of United Fire Group, Inc. as of December 31, 2013 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 
/s/ Ernst & Young LLP  
 
 
Ernst & Young LLP 
 

Des Moines, Iowa
May 6, 2014



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Table of Contents

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


28

Table of Contents

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.






















29

Table of Contents

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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Table of Contents

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

Our invested assets totaled $3,115.7 million at March 31, 2014, compared to $3,050.1 million at December 31, 2013, an increase of $65.6 million. At March 31, 2014, fixed maturity securities and equity securities made up 90.6 percent and 7.6 percent of the value of our investment portfolio, respectively. Because the primary purpose of our investment portfolio is to fund future claims payments, we use a conservative investment philosophy, investing in a diversified portfolio of high-quality, intermediate-term taxable corporate bonds, taxable U.S. government bonds and tax-exempt U.S. municipal bonds. Our overall investment strategy is to keep our cash on hand low in the current interest rate environment. If additional cash is needed, we can borrow funds available under our revolving credit facility.

Composition
We develop our investment strategies based on a number of factors, including estimated duration of reserve liabilities, short- and long-term liquidity needs, projected tax status, general economic conditions, expected rates of inflation, regulatory requirements, interest rates and credit quality of assets. We administer our investment portfolio based on investment guidelines approved by management and the investment committee of our Board of Directors that comply with applicable statutory regulations.


















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The composition of our investment portfolio at March 31, 2014 is presented at carrying value in the following table:
 
Property & Casualty Insurance Segment
 
Life Insurance Segment
 
Total
 
 
 
Percent

 
 
 
Percent

 
 
 
Percent

(In Thousands)
 
 
of Total

 
 
 
of Total

 
 
 
of Total

Fixed maturities (1)
 
 
 
 
 
 


 


 


Held-to-maturity
$
315

 
%
 
$
329

 
%
 
$
644

 
%
Available-for-sale
1,227,797

 
82.6

 
1,577,926

 
96.8

 
2,805,723

 
90.1

Trading securities
16,095

 
1.1

 

 

 
16,095

 
0.5

Equity securities
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale
205,086

 
13.7

 
27,291

 
1.7

 
232,377

 
7.5

Trading securities
3,037

 
0.2

 

 

 
3,037

 
0.1

Mortgage loans

 

 
4,368

 
0.3

 
4,368

 
0.1

Policy loans

 

 
6,177

 
0.4

 
6,177

 
0.2

Other long-term investments
33,653

 
2.3

 
12,860

 
0.8

 
46,513

 
1.5

Short-term investments
800

 
0.1

 

 

 
800

 

Total
$
1,486,783

 
100.0
%
 
$
1,628,951

 
100.0
%
 
$
3,115,734

 
100.0
%
(1) Available-for-sale securities and trading fixed maturities are carried at fair value. Held-to-maturity fixed maturities are carried at amortized cost.

At March 31, 2014, we classified $2,805.7 million, or 99.4 percent, of our fixed maturities portfolio as available-for-sale, compared to $2,751.3 million, or 99.6 percent, at December 31, 2013. We classify our remaining fixed maturities as held-to-maturity or trading. We record held-to-maturity securities at amortized cost. We record available-for-sale securities at fair value, with any changes in fair value recognized in accumulated other comprehensive income. We record trading securities, primarily convertible redeemable preferred debt securities, at fair value, with any changes in fair value recognized in earnings.

As of March 31, 2014 and December 31, 2013, we did not have direct exposure to investments in subprime mortgages or other credit enhancement vehicles.

Credit Quality

The following table shows the composition of fixed maturity securities held in our available-for-sale, held-to-maturity and trading security portfolios, by credit rating at March 31, 2014 and December 31, 2013. Information contained in the table is generally based upon the issue credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain it from Standard & Poor's.
(In Thousands)
March 31, 2014
 
December 31, 2013
Rating
Carrying Value
 
% of Total
 
Carrying Value
 
% of Total
AAA
$
826,839

 
29.3
%
 
$
761,017

 
27.6
%
AA
564,250

 
20.0

 
537,527

 
19.5

A
574,667

 
20.3

 
564,396

 
20.4

Baa/BBB
789,611

 
28.0

 
830,735

 
30.1

Other/Not Rated
67,095

 
2.4

 
68,177

 
2.5

 
$
2,822,462

 
100.0
%
 
$
2,761,852

 
100.0
%

Duration
Our investment portfolio is invested primarily in fixed maturity securities whose fair value is susceptible to market risk, specifically interest rate changes. Duration is a measurement used to quantify our inherent interest rate risk and analyze our ability to match our invested assets to our reserve liabilities. If our invested assets and reserve liabilities have similar durations, then any change in interest rates will have an equal effect on these accounts. The primary purpose for matching invested assets and reserve liabilities is liquidity. With appropriate matching, our investments


36

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will mature when cash is needed, preventing the need to liquidate other assets prematurely. Mismatches in the duration of assets and liabilities can cause significant fluctuations in our results of operations.

Group

The weighted average effective duration of our portfolio of fixed maturity securities, at March 31, 2014, is 4.8 years compared to 5.0 years at December 31, 2013.

Property and Casualty Insurance Segment

The weighted average effective duration of our portfolio of fixed maturity securities, at March 31, 2014, is 4.8 years compared to 4.9 years at December 31, 2013.

Life Insurance Segment

The weighted average effective duration of our portfolio of fixed maturity securities, at March 31, 2014, is 4.9 years compared to 5.0 years at December 31, 2013.

Investment Results
We invest the premiums received from our policyholders and annuitants in order to generate investment income, which is an important component of our revenues and profitability. The amount of investment income that we are able to generate is affected by many factors, some of which are beyond our control. Some of these factors are volatility in the financial markets, economic growth, inflation, interest rates, world political conditions, terrorist attacks or threats of terrorism, adverse events affecting other companies in our industry or the industries in which we invest and other unpredictable national or world events. Our net investment income increased by 1.1 percent in the three-month period ended March 31, 2014, compared with the same period of 2013. We are maintaining our investment philosophy of purchasing investments rated investment grade or better.
Our net realized investment gains were $2.2 million during the three-month period ended March 31, 2014, as compared with $1.9 million in the same period of 2013.
We hold certain investments in limited liability partnerships that are recorded on the equity method of accounting, with changes in the value of these investments recorded in investment income. The increase in the value of these investments contributed to the increase of 1.1 percent in net investment income during the three-month period ended March 31, 2014, compared with the same period of 2013. The increases were somewhat offset by the impact of low investment yields.
We regularly monitor the difference between our cost basis and the estimated fair value of our investments. Our accounting policy for impairment recognition requires other-than-temporary impairment charges to be recorded when we determine that it is more likely than not that we will be unable to collect all amounts due according to the contractual terms of the fixed maturity security or that the anticipated recovery in fair value of the equity security will not occur in a reasonable amount of time. Impairment charges on investments are recorded based on the fair value of the investments at the measurement date. Factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which fair value has been less than cost; the financial condition and near-term prospects of the issuer; our intention to hold the investment; and the likelihood that we will be required to sell the investment.
Changes in unrealized gains and losses on available-for-sale securities do not affect net income and earnings per share but do impact comprehensive income, stockholders’ equity and book value per share. We believe that any unrealized losses on our available-for-sale securities at March 31, 2014 are temporary based upon our current analysis of the issuers of the securities that we hold and current market events. It is possible that we could recognize impairment charges in future periods on securities that we own at March 31, 2014 if future events and information cause us to determine that a decline in value is other-than-temporary. However, we endeavor to invest in high quality


37

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assets to provide protection from future credit quality issues and corresponding other-than-temporary impairment write-downs.  

LIQUIDITY AND CAPITAL RESOURCES
Liquidity measures our ability to generate sufficient cash flows to meet our short- and long-term cash obligations. Our cash inflows are primarily a result of the receipt of premiums, annuity deposits, reinsurance recoveries, sales or maturities of investments, and investment income. Cash provided from these sources is used to fund the payment of losses and loss settlement expenses, policyholder benefits under life insurance contracts, annuity withdrawals, the purchase of investments, operating expenses, dividends, pension plan contributions, and in recent years, common stock repurchases.
We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by various rating agencies, at a level considered necessary by management to enable our insurance company subsidiaries to compete and (2) sufficient capital to enable our insurance company subsidiaries to meet the capital adequacy tests performed by regulatory agencies in the United States.
Cash outflows may be variable because of the uncertainty regarding settlement dates for losses. In addition, the timing and amount of individual catastrophe losses are inherently unpredictable and could increase our liquidity requirements. The timing and amount of reinsurance recoveries may be affected by reinsurer solvency and reinsurance coverage disputes.
Historically, we have generated substantial cash inflows from operations. It is our policy to invest the cash generated from operations in securities with maturities that, in the aggregate, correlate to the anticipated timing of payments for losses and loss settlement expenses and future policyholder benefits of the underlying insurance policies, and annuity withdrawals. The majority of our assets are invested in available-for-sale fixed maturity securities.
The following table displays a summary of cash sources and uses in 2014 and 2013.
Cash Flow Summary
Three Months Ended March 31,
(In Thousands)
2014
 
2013
Cash provided by (used in)
 
 
 
Operating activities
$
18,491

 
$
31,744

Investing activities
(31,746
)
 
(13,151
)
Financing activities
(10,275
)
 
(24,111
)
Net decrease in cash and cash equivalents
$
(23,530
)
 
$
(5,518
)
Operating Activities
Net cash flows provided by operating activities totaled $18.5 million and $31.7 million for the three-month periods ended March 31, 2014 and 2013, respectively. Operating cash flows in the three-month period ended March 31, 2014 reflect a higher level of property and casualty loss payments, slightly offset by a lower level of net withdrawals of annuity products. Our cash flows from operations were sufficient to meet our liquidity needs for the three-month periods ended March 31, 2014 and 2013.
Investing Activities
Cash in excess of operating requirements is generally invested in fixed maturity securities and equity securities. Fixed maturities provide regular interest payments and allow us to match the duration of our liabilities. Equity securities provide dividend income, potential dividend income growth and potential appreciation. For further discussion of our investments, including our philosophy and our strategy for our portfolio, see the "Investment Portfolio" section contained in this item.


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In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years, $1.1 billion, or 39.6 percent of our fixed maturity portfolio will mature.
We invest funds required for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. At March 31, 2014, our cash and cash equivalents included $16.3 million related to these money market accounts, compared to $37.8 million at December 31, 2013.
Net cash flows used in investing activities totaled $31.7 million and $13.2 million for the three-month periods ended March 31, 2014 and 2013, respectively. For the three-month period ended March 31, 2014, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments of $104.3 million, compared to $130.8 million for the same period of 2013.
Our cash outflows for investment purchases were $133.1 million for the three-month period ended March 31, 2014, compared to $143.5 million for the same period of 2013. In 2014, we continued to purchase a higher level of fixed maturity securities, which are more profitable than other categories of investments when market interest rates are low.
Financing Activities
Net cash flows used in financing activities were $10.3 million for the three-month period ended March 31, 2014 compared to net cash flows used in financing activities of $24.1 million for the three-month period ended March 31, 2013. The decrease reflects a lower level of net annuity withdrawals in the three-month period ended March 31, 2014, compared to the same period of 2013.
Credit Facilities
In December 2011, United Fire entered into a credit agreement with a syndicate of financial institutions as lenders, KeyBank National Association as administrative agent, lead arranger, sole book runner, swingline lender, and letter of credit issuer, and Bankers Trust Company as syndication agent.
On June 4, 2013, United Fire & Casualty Company, United Fire Group, Inc. and the syndicated lenders entered into an Assignment, Joinder, Assumption, and Release Agreement (the "Joinder Agreement") transferring the obligations under the credit agreement from United Fire & Casualty Company to United Fire Group, Inc. Effective with the execution of the Joinder Agreement, United Fire & Casualty Company was released from any further obligations under the credit agreement. As of March 31, 2014, there were no balances outstanding under this credit agreement. For further discussion of our credit agreement, refer to Part I, Item 1, Note 8 "Debt" to the unaudited Consolidated Financial Statements.
Dividends
Dividends paid to shareholders totaled $4.6 million and $3.8 million in the three-month periods ended March 31, 2014 and 2013, respectively. Our practice has been to pay quarterly cash dividends, which we have paid every quarter since March 1968.
Payments of any future dividends and the amounts of such dividends, however, will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors out of legally available funds.
As a holding company with no independent operations of its own, United Fire Group, Inc. relies on dividends received from its insurance company subsidiaries in order to pay dividends to its common shareholders. Dividends payable by our insurance subsidiaries are governed by the laws in the states in which they are domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, under Iowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the preceding December 31, or net income of the preceding calendar year on a statutory basis,


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not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, at March 31, 2014, our insurance company subsidiary, United Fire & Casualty, is able to make a maximum of $46.9 million in dividend payments without prior regulatory approval. These restrictions will not have a material impact in meeting our cash obligations.
Stockholders' Equity
Stockholders' equity increased 3.2 percent 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, during the first three months of 2014, partially offset by shareholder dividends of $4.6 million. At March 31, 2014, the book value per share of our common stock was $31.82 compared to $30.87 at December 31, 2013.


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 section provides further explanation of the key measures management uses to evaluate our results.

Catastrophe losses is a commonly used non-GAAP financial measure that uses 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.
 
Three Months Ended March 31,
(In Thousands)
2014
 
2013
ISO catastrophes
$
3,275

 
$
4,511

Non-ISO catastrophes (1)

 

Total catastrophes
$
3,275

 
$
4,511

(1) This number includes international assumed losses.


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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have exposure to market risk arising from potential losses in our investment portfolio due to adverse changes in interest rates and market prices. However, we have the ability to hold fixed maturity investments to maturity. Our investment guidelines define the overall framework for managing our market and other investment risks including accountability and controls. In addition, each of our subsidiaries has specific investment policies that delineate the investment limits and strategies that are appropriate given each entity's liquidity, surplus, product, and regulatory requirements. We respond to market risk by managing the character of investment purchases.

It is our philosophy that we do not utilize financial hedges or derivative financial instruments to manage risks, nor do we enter into any swap, forward or option contracts, but attempt to mitigate our exposure through active portfolio management. In addition, we place the majority of our investments in high-quality, liquid securities and limit the amount of credit exposure to any one issuer. At March 31, 2014, we did not have direct exposure to investments in sub-prime mortgages or other credit-enhancement exposures.

While our primary market risk exposure is to changes in interest rates, we do have limited exposure to changes in equity prices and limited exposure to foreign currency exchange rates.

There have been no material changes in our market risk or market risk factors from what we reported in our Annual Report on Form 10-K for the year ended December 31, 2013.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were designed and functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

Changes in Internal Control Over Financial Reporting

Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated our internal control over financial reporting to determine whether any changes occurred during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on this evaluation, no such change in our internal control over financial reporting occurred during the fiscal quarter to which this report relates.



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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
We consider all our litigation pending as of March 31, 2014 to be ordinary, routine, and incidental to our business.
ITEM 1A. RISK FACTORS

Our business is subject to a number of risks, including those identified in Part I, Item 1A "Risk Factors" in our 2013 Annual Report on Form 10-K filed with the SEC on March 5, 2014, that could have a material effect on our business, results of operations, financial condition, and/or liquidity and that could cause our operating results to vary significantly from period to period. The risks described in the above mentioned report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial could also have a material effect on our business, results of operations, financial condition and/or liquidity.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Under our share repurchase program, first announced in August 2007, we may purchase United Fire common stock from time to time on the open market or through privately negotiated transactions. The amount and timing of any purchases will be at our discretion and will depend upon a number of factors, including the share price, general economic and market conditions, and corporate and regulatory requirements.

We are authorized to purchase 1,070,117 shares of common stock at March 31, 2014. Our share repurchase program is scheduled to end in August 2014.

The following table provides information with respect to purchases of shares of common stock made by or on our behalf or by any "affiliated purchaser," as defined in Rule 10b-18(a)(3) under the Exchange Act, during the three-month period ended March 31, 2014.
 
 
 
 
 
Total Number of Shares
 
Maximum Number of
 
Total
 
 
 
Purchased as a Part of
 
Shares that may be
 
Number of
 
Average Price
 
Publicly Announced
 
Purchased Under the
Period
Shares Purchased
 
Paid per Share
 
Plans or Programs
 
Plans or Programs
1/1/2014 - 1/31/2014

 
$

 

 
1,070,117

2/1/2014 - 2/28/2014

 

 

 
1,070,117

3/1/2014 - 3/31/2014

 

 

 
1,070,117


ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.


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ITEM 6. EXHIBITS
Exhibit number
 
Exhibit description
 
Filed herewith
11
 
Statement Re Computation of Per Share Earnings. All information required by Exhibit 11 is presented within Note 7 of the Notes to Unaudited Consolidated Financial Statements, in accordance with the FASB guidance on Earnings per Share.
 
X
31.1
 
Certification of Randy A. Ramlo pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
X
31.2
 
Certification of Dianne M. Lyons pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
X
32.1
 
Certification of Randy A. Ramlo pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
X
32.2
 
Certification of Dianne M. Lyons pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
X
101.1
 
The following financial information from United Fire Group, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 formatted in XBRL: (i) Consolidated Balance Sheets at March 31, 2014 (unaudited) and December 31, 2013; (ii) Consolidated Statements of Income and Comprehensive Income (unaudited) for the three months ended March 31, 2014 and 2013; (iii) Consolidated Statement of Stockholders’ Equity (unaudited) for the three months ended March 31, 2014; (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2014 and 2013; and (v) Notes to Unaudited Consolidated Financial Statements, tagged as a block of text.

 
X



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

UNITED FIRE GROUP, INC.
 
 
(Registrant)
 
 
 
 
 
/s/ Randy A. Ramlo
 
/s/ Dianne M. Lyons
Randy A. Ramlo
 
Dianne M. Lyons
President, Chief Executive Officer,
 
Vice President, Chief Financial Officer and
Director and Principal Executive Officer
 
Principal Accounting Officer
 
 
 
May 6, 2014
 
May 6, 2014
(Date)
 
(Date)
 



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