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EX-32.2 - EXHIBIT 32.2 - UNITED FIRE GROUP INCexhibit322093016.htm
EX-32.1 - EXHIBIT 32.1 - UNITED FIRE GROUP INCexhibit321093016.htm
EX-31.2 - EXHIBIT 31.2 - UNITED FIRE GROUP INCexhibit312093016.htm
EX-31.1 - EXHIBIT 31.1 - UNITED FIRE GROUP INCexhibit311093016.htm

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-34257
ufglogo2016aa06.jpg
________________________
 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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R 
 
Accelerated filer o 
 
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 October 31, 2016, 25,357,805 shares of common stock were outstanding.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



United Fire Group, Inc.
Index to Quarterly Report on Form 10-Q
September 30, 2016
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4. Mine Safety Disclosures
 
 
 
 
 
 



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 (the "Securities Act") 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. ("UFG," the "Registrant," 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 2015 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; the occurrence of catastrophic events, including international events, significant severe weather conditions, climate change, acts of terrorism, acts of war and pandemics;
The adequacy of our reserves for property and casualty insurance losses and loss settlement expenses and our life insurance reserve for future policy benefits;
Geographic concentration risk in both property and casualty insurance and life insurance segments;
The potential disruption of our operations and reputation due to unauthorized data access, cyber-attacks or cyber-terrorism and other security breaches;
Developments in general economic conditions, domestic and global financial markets, interest rates and other-than-temporary impairment losses that could affect the performance of our investment portfolio;
Our ability to effectively underwrite and adequately price insured risks;
Changes in industry trends, an increase in competition and significant industry developments;
Litigation or regulatory actions that could require us to pay significant damages, fines or penalties or change the way we do business;
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;
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; laws, regulations and stock exchange requirements relating to corporate governance and the cost of compliance;
Our relationship with and the financial strength of our reinsurers; and
Competitive, legal, regulatory or tax changes that affect the distribution cost or demand for our products through our independent agent/agency distribution network.

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.




1


PART I — FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
United Fire Group, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
September 30,
2016
 
December 31,
2015
 
(unaudited)
 
 
ASSETS
 
 
 
Investments
 
 
 
Fixed maturities
 
 
 
Held-to-maturity, at amortized cost (fair value $655 in 2016 and $675 in 2015)
$
652

 
$
672

Available-for-sale, at fair value (amortized cost $2,801,074 in 2016 and $2,793,069 in 2015)
2,916,464

 
2,824,961

Trading securities, at fair value (amortized cost $11,587 in 2016 and $11,475 in 2015)
13,253

 
12,622

Equity securities
 
 
 
Available-for-sale, at fair value (cost $67,909 in 2016 and $68,514 in 2015)
251,101

 
236,247

Trading securities, at fair value (cost $4,410 in 2016 and $4,443 in 2015)
4,645

 
4,353

Mortgage loans
3,772

 
3,961

Policy loans
5,300

 
5,618

Other long-term investments
57,787

 
54,151

Short-term investments
175

 
175

 
3,253,149

 
3,142,760

Cash and cash equivalents
140,944

 
106,449

Accrued investment income
27,007

 
25,136

Premiums receivable (net of allowance for doubtful accounts of $1,248 in 2016 and $867 in 2015)
331,242

 
276,517

Deferred policy acquisition costs
157,238

 
168,264

Property and equipment (primarily land and buildings, at cost, less accumulated depreciation of $50,043 in 2016 and $46,590 in 2015)
54,994

 
53,241

Reinsurance receivables and recoverables
87,159

 
73,527

Prepaid reinsurance premiums
4,002

 
3,790

Income taxes receivable
11,732

 

Goodwill and intangible assets
24,932

 
25,509

Other assets
14,638

 
15,183

TOTAL ASSETS
$
4,107,037

 
$
3,890,376

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Future policy benefits and losses, claims and loss settlement expenses
 
 
 
Property and casualty insurance
$
1,090,167

 
$
1,003,895

Life insurance
1,355,639

 
1,372,358

Unearned premiums
468,745

 
415,057

Accrued expenses and other liabilities
189,519

 
200,599

Income taxes payable

 
4,917

Deferred income taxes
43,787

 
14,653

TOTAL LIABILITIES
$
3,147,857

 
$
3,011,479

Stockholders’ Equity
 
 
 
Common stock, $0.001 par value; authorized 75,000,000 shares; 25,357,605 and 25,151,428 shares issued and outstanding in 2016 and 2015, respectively
$
25

 
$
25

Additional paid-in capital
213,957

 
207,426

Retained earnings
610,672

 
591,009

Accumulated other comprehensive income, net of tax
134,526

 
80,437

TOTAL STOCKHOLDERS’ EQUITY
$
959,180

 
$
878,897

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
4,107,037

 
$
3,890,376

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


2


United Fire Group, Inc.
Consolidated Statements of Income and Comprehensive Income (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands, Except Share Data)
2016
 
2015
 
2016
 
2015
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
260,069

 
$
239,421

 
$
754,854

 
$
681,817

Investment income, net of investment expenses
26,690

 
24,050

 
73,421

 
74,205

Net realized investment gains (includes reclassifications for net unrealized investment gains on available-for-sale securities of $2,320 and $4,666 in 2016 and $1,825 and $4,715 in 2015; previously included in accumulated other comprehensive income)
2,590


966

 
6,241

 
2,622

Other income
145

 
123

 
436

 
318

Total revenues
$
289,494

 
$
264,560

 
$
834,952

 
$
758,962

Benefits, Losses and Expenses
 
 
 
 
 
 
 
Losses and loss settlement expenses
$
176,555

 
$
144,526

 
$
499,095

 
$
421,297

Increase in liability for future policy benefits
14,091

 
12,784

 
42,645

 
32,503

Amortization of deferred policy acquisition costs
54,116

 
48,697

 
156,932

 
135,526

Other underwriting expenses (includes reclassifications for employee benefit costs of $1,371 and $4,113 in 2016 and $1,867 and $5,601 in 2015; previously included in accumulated other comprehensive income)
24,574

 
26,161

 
76,099

 
73,241

Interest on policyholders’ accounts
4,983

 
5,568

 
15,368

 
18,207

Total benefits, losses and expenses
$
274,319

 
$
237,736

 
$
790,139

 
$
680,774

Income before income taxes
$
15,175

 
$
26,824

 
$
44,813

 
$
78,188

Federal income tax expense (benefit) (includes reclassifications of ($332) and ($194) in 2016 and $15 and $310 in 2015; previously included in accumulated other comprehensive income)
2,807

 
7,290

 
6,904

 
19,957

Net income
$
12,368

 
$
19,534

 
$
37,909

 
$
58,231

Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in net unrealized appreciation on investments
$
(9,440
)
 
$
(2,008
)
 
$
83,768

 
$
(25,131
)
Change in liability for underfunded employee benefit plans

 

 

 

Other comprehensive income (loss), before tax and reclassification adjustments
$
(9,440
)
 
$
(2,008
)
 
$
83,768

 
$
(25,131
)
Income tax effect
3,304

 
703

 
(29,320
)
 
8,795

Other comprehensive income (loss), after tax, before reclassification adjustments
$
(6,136
)
 
$
(1,305
)
 
$
54,448

 
$
(16,336
)
Reclassification adjustment for net realized investment gains included in income
$
(2,320
)
 
$
(1,825
)
 
$
(4,666
)
 
$
(4,715
)
Reclassification adjustment for employee benefit costs included in expense
1,371

 
1,867

 
4,113

 
5,601

Total reclassification adjustments, before tax
$
(949
)
 
$
42

 
$
(553
)
 
$
886

Income tax effect
332

 
(15
)
 
194

 
(310
)
Total reclassification adjustments, after tax
$
(617
)
 
$
27

 
$
(359
)
 
$
576

Comprehensive income
$
5,615

 
$
18,256

 
$
91,998

 
$
42,471

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
25,389,633

 
25,067,080

 
25,322,427

 
25,027,382

Basic earnings per common share
$
0.49

 
$
0.78

 
$
1.50

 
$
2.33

Diluted earnings per common share
0.48

 
0.77

 
1.47

 
2.31

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


3


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

(In Thousands, Except Share Data)
Nine Months Ended September 30, 2016
 
 
Common stock
 
Balance, beginning of year
$
25

Shares repurchased (67,492 shares)

Shares issued for stock-based awards (292,440 shares)

Balance, end of period
$
25

 
 
Additional paid-in capital
 
Balance, beginning of year
$
207,426

Compensation expense and related tax benefit for stock-based award grants
2,249

Shares repurchased
(2,867
)
Shares issued for stock-based awards
7,149

Balance, end of period
$
213,957

 
 
Retained earnings
 
Balance, beginning of year
$
591,009

Net income
37,909

Dividends on common stock ($0.72 per share)
(18,246
)
Balance, end of period
$
610,672

 
 
Accumulated other comprehensive income, net of tax
 
Balance, beginning of year
$
80,437

Change in net unrealized investment appreciation(1)
51,415

Change in liability for underfunded employee benefit plans(2)
2,674

Balance, end of period
$
134,526

 
 
Summary of changes
 
Balance, beginning of year
$
878,897

Net income
37,909

All other changes in stockholders’ equity accounts
42,374

Balance, end of period
$
959,180

(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.



4


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

Nine Months Ended September 30,
(In Thousands)
2016
 
2015
Cash Flows From Operating Activities
 
 
 
Net income
$
37,909

 
$
58,231

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Net accretion of bond premium
10,883

 
10,534

Depreciation and amortization
4,879

 
7,706

Stock-based compensation expense
2,731

 
1,817

Net realized investment gains
(6,241
)
 
(2,622
)
Net cash flows from trading investments
(36
)
 
2,663

Deferred income tax benefit
(2,187
)
 
(3,854
)
Changes in:
 
 
 
Accrued investment income
(1,871
)
 
(304
)
Premiums receivable
(54,725
)
 
(46,628
)
Deferred policy acquisition costs
(8,831
)
 
(16,884
)
Reinsurance receivables
(13,632
)
 
12,395

Prepaid reinsurance premiums
(212
)
 
(266
)
Income taxes receivable
(11,732
)
 
(1,928
)
Other assets
545

 
(1,561
)
Future policy benefits and losses, claims and loss settlement expenses
128,657

 
60,932

Unearned premiums
53,688

 
50,097

Accrued expenses and other liabilities
(6,966
)
 
811

Income taxes payable
(4,917
)
 
(5,012
)
Deferred income taxes
2,196

 
(499
)
Other, net
(2,069
)
 
(1,221
)
Total adjustments
$
90,160

 
$
66,176

Net cash provided by operating activities
$
128,069

 
$
124,407

Cash Flows From Investing Activities
 
 
 
Proceeds from sale of available-for-sale investments
$
5,049

 
$
8,228

Proceeds from call and maturity of held-to-maturity investments
20

 
108

Proceeds from call and maturity of available-for-sale investments
428,009

 
527,365

Proceeds from short-term and other investments
2,235

 
4,221

Purchase of available-for-sale investments
(446,156
)
 
(502,086
)
Purchase of short-term and other investments
(3,091
)
 
(4,643
)
Net purchases and sales of property and equipment
(6,090
)
 
(10,763
)
Net cash (used in) provided by investing activities
$
(20,024
)
 
$
22,430

Cash Flows From Financing Activities
 
 
 
Policyholders’ account balances
 
 
 
Deposits to investment and universal life contracts
$
63,967

 
$
78,733

Withdrawals from investment and universal life contracts
(123,071
)
 
(175,840
)
Payment of cash dividends
(18,246
)
 
(16,024
)
Repurchase of common stock
(2,867
)
 
(2,423
)
Issuance of common stock
7,149

 
2,679

Tax impact from issuance of common stock
(482
)
 
(475
)
Net cash used in financing activities
$
(73,550
)
 
$
(113,350
)
Net Change in Cash and Cash Equivalents
$
34,495

 
$
33,487

Cash and Cash Equivalents at Beginning of Period
106,449

 
90,574

Cash and Cash Equivalents at End of Period
$
140,944

 
$
124,061

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


5



UNITED FIRE GROUP, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share amounts or as otherwise noted)

NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Business
United Fire Group, Inc. ("UFG," 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 46 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; future policy benefits and losses, claims and loss settlement expenses; and pension and postretirement benefit obligations.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Management of UFG 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, 2015. The review report of Ernst & Young LLP as of September 30, 2016 and for the three- and nine-month periods ended September 30, 2016 and 2015 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 nine-month periods ended September 30, 2016 and 2015, we made payments for income taxes totaling $24,026 and $31,724, respectively. We did not receive a tax refund during the nine-month periods ended September 30, 2016 and 2015.
For the nine-month periods ended September 30, 2016 and 2015, we made no interest payments (excluding interest credited to policyholders’ accounts).


6


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 nine-month period ended September 30, 2016.
 
 
 
 
 
Property & Casualty Insurance
 
Life Insurance
 
Total
Recorded asset at beginning of period
$
90,547

 
$
77,717

 
$
168,264

Underwriting costs deferred
161,484

 
4,279

 
165,763

Amortization of deferred policy acquisition costs
(151,216
)
 
(5,716
)
 
(156,932
)
Ending unamortized deferred policy acquisition costs
$
100,815

 
$
76,280

 
$
177,095

Impact of unrealized gains and losses on available-for-sale securities

 
(19,857
)
 
(19,857
)
Recorded asset at September 30, 2016
$
100,815

 
$
56,423

 
$
157,238


Property and casualty insurance 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 to net unrealized investment appreciation as of the balance sheet date. The impact of unrealized gains and losses on available-for-sale securities decreased the DAC asset by $21,860 and $2,003 at September 30, 2016 and December 31, 2015, 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 $6,904 and $19,957 for the nine-month periods ended September 30, 2016 and 2015, 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.
The Company performs a quarterly review of its tax positions and makes a determination of whether it is more likely than not that the tax position will be sustained upon examination. If based on review, it appears not more likely than


7


not that the positions will be sustained, the Company will calculate any unrecognized tax benefits and, if necessary, calculate and accrue any related interest and penalties. We did not recognize any liability for unrecognized tax benefits at September 30, 2016 or December 31, 2015. 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.

Subsequent Events

In the preparation of the accompanying financial statements, the Company has 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 in the Company's financial statements. The Company concluded there are no material subsequent events or transactions that have occurred after the balance sheet date through the date on which the financial statements were issued.
Recently Issued Accounting Standards
Accounting Standards Adopted in 2016

Short-Duration Contracts

In May 2015, the Financial Accounting Standards Board ("FASB") issued guidance on disclosure requirements for short-duration contracts. The new guidance requires additional disclosures about the liability for unpaid loss and loss adjustment expenses and requires disclosure of any information about significant changes in methodologies and assumptions used to calculate the liability. The new guidance is effective for annual periods beginning after December 15, 2015 and interim periods beginning the following year. The Company will include the new annual disclosures beginning with the December 31, 2016 annual financial statements. The adoption of the new guidance will change disclosures regarding short- duration contracts, but management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.

Other Internal Use Software

In April 2015, the FASB issued guidance which clarifies customers' accounting for fees paid for cloud computing arrangements. The new standard provides guidance to customers about whether a cloud computing arrangement includes a software license or whether the arrangement is considered a service contract. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company adopted the new guidance as of January 1, 2016. The adoption of the new guidance had no impact on the Company's financial position or results of operations.

Debt Issuance Costs

In April 2015, the FASB issued new guidance on the presentation of debt issuance costs. The new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company adopted the new guidance as of January 1, 2016. The adoption of the new guidance had no impact on the Company's financial position or results of operations.

Consolidation

In February 2015, the FASB issued amendments to the consolidation guidance that a reporting entity follows to determine whether it should consolidate certain legal entities. Specifically, the new guidance modifies the evaluation


8


of whether limited partnerships and similar legal entities are variable interest entities ("VIE"), eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that have VIE's, particularly those with fee arrangements and related party relationships. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company adopted the guidance as of January 1, 2016. The adoption of the new guidance had no impact on the Company's financial position or results of operations.

Going Concern

In August 2014, the FASB issued new guidance on the disclosure of uncertainties about an entity's ability to continue as a going concern. The new guidance requires management to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, to disclose the fact and what the entity's plans are to alleviate that doubt. The guidance is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The Company adopted the guidance as of January 1, 2016. The adoption of the new guidance had no impact on the Company's financial position or results of operations.

Share-Based Payments

In June 2014, the FASB issued new guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The new guidance requires a performance target that affects vesting and that could be achieved after the service period, be treated as a performance condition. The guidance is effective for interim and annual periods beginning after December 15, 2015. The amendments can be applied prospectively or retrospectively and early adoption is permitted. The Company adopted the guidance as of January 1, 2016. The adoption of the new guidance had no impact on the Company's financial position or results of operations.
Pending Adoption of Accounting Standards
Share-Based Payments
In March 2016, the FASB issued new guidance on the accounting for share-based payments. The new guidance was issued to simplify the accounting of share-based payments, specifically in the areas of income taxes, classification on the balance sheets as liabilities or equity and classification in the cash flow statement. The new guidance is effective for annual periods beginning after December 15, 2016 and interim periods within those years. The Company will adopt the new guidance as of January 1, 2017 and is currently evaluating the impact on the Company's financial position and results of operations.
Income Taxes
In December 2015, the FASB issued guidance on the balance sheet classification of deferred taxes. The new guidance eliminates the requirement to split deferred tax liabilities and assets between current and non-current in a classified balance sheet. The new guidance allows deferred tax liabilities and assets to be included in non-current accounts. The Company will adopt the new guidance as of January 1, 2017. The adoption will have no impact on the Company's financial position and results of operations.
Revenue Recognition
In May 2014, the FASB issued comprehensive new guidance on revenue recognition which supersedes nearly all existing revenue recognition guidance under GAAP. The new guidance requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard creates a five-step model that requires companies to exercise judgment when considering the terms of the contract(s) and all relevant facts and circumstances. Insurance contracts are not within the scope of this new guidance. The new guidance is effective for annual and interim periods beginning after December 15, 2017. The Company will adopt the guidance as of January


9


1, 2018 and is currently evaluating the impact on the Company's financial position and results of operations and considering which portions of the guidance, if any, apply to the Company.
Financial Instruments
In January 2016, the FASB issued guidance updating certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in this update supersede the guidance to classify equity securities with readily determinable fair values into different categories (for example, trading or available-for-sale) and require equity securities to be measured at fair value with changes in the fair value recognized through net income. The new guidance also simplifies the impairment process for equity investments without readily determinable fair values. The new guidance is effective for annual periods beginning after December 15, 2017 and interim periods within those years. The Company will adopt the new guidance as of January 1, 2018 and is currently evaluating the impact on the Company's financial position and results of operations.
Statement of Cash Flows - Classification of Certain Cash Receipts and Payments
In August 2016, the FASB issued an update that clarifies the classification of certain cash receipts and payments in the Statement of Cash Flows. The update addresses eight existing cash flow issues by clarifying the correct classification to establish uniformity in practice. The updated guidance is effective for annual periods beginning after December 15, 2017 and interim periods within those years. The Company will adopt the new guidance as of January 1, 2018 and is currently evaluating the impact on the Company's financial position and results of operations.
Leases
In February 2016, the FASB issued guidance on the accounting for leases. The new guidance requires lessees to place most leases on their balance sheets with expenses recognized on the income statement in a similar manner as previous methods. The new guidance is effective for annual periods beginning after December 15, 2018 and interim periods within those years. The Company will adopt the new guidance as of January 1, 2019 and is currently evaluating the impact on the Company's financial position and results of operations.
Financial Instruments - Credit Losses
In June 2016, the FASB issued new guidance on the measurement of credit losses for most financial instruments. The new guidance replaces the current incurred loss model for recognizing credit losses with an expected loss model for instruments measured at amortized cost and requires allowances to be recorded for available-for-sale debt securities rather than reduce the carrying amount. These allowances will be remeasured each reporting period. The new guidance is effective for annual periods beginning after December 15, 2020 and interim periods within those years. The Company will adopt the new guidance as of January 1, 2021 and is currently evaluating the impact on the Company's financial position and results of operations.





10


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 September 30, 2016 and December 31, 2015, is as follows:
September 30, 2016
 
Type of Investment
Cost or Amortized Cost
 
Gross Unrealized Appreciation
 
Gross Unrealized Depreciation
 
Fair Value
HELD-TO-MATURITY
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Corporate bonds
 
 
 
 
 
 
 
Technology, media and telecommunications
$
450

 
$
2

 
$

 
$
452

Financial services
150

 

 

 
150

Mortgage-backed securities
52

 
1

 

 
53

Total Held-to-Maturity Fixed Maturities
$
652

 
$
3

 
$

 
$
655

AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
21,966

 
$
281

 
$
1

 
$
22,246

U.S. government agency
71,717

 
2,893

 
3

 
74,607

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations:
 
 
 
 
 
 
 
Midwest
153,150

 
5,302

 
90

 
158,362

Northeast
58,373

 
2,836

 

 
61,209

South
132,843

 
4,444

 
314

 
136,973

West
123,845

 
4,631

 
180

 
128,296

Special revenue:
 
 
 
 
 
 
 
Midwest
161,368

 
6,799

 
56

 
168,111

Northeast
54,109

 
1,863

 
98

 
55,874

South
208,747

 
7,399

 
542

 
215,604

West
100,225

 
4,069

 
184

 
104,110

Foreign bonds
71,011

 
3,484

 
894

 
73,601

Public utilities
217,670

 
10,539

 
83

 
228,126

Corporate bonds

 

 

 

Energy
110,345

 
3,747

 
187

 
113,905

Industrials
232,088

 
12,192

 
668

 
243,612

Consumer goods and services
179,502

 
9,422

 

 
188,924

Health care
82,497

 
4,928

 

 
87,425

Technology, media and telecommunications
141,598

 
6,225

 
168

 
147,655

Financial services
266,576

 
12,262

 
20

 
278,818

Mortgage-backed securities
18,422

 
465

 
8

 
18,879



11


Collateralized mortgage obligations
 
 
 
 
 
 
 
Government national mortgage association
131,200

 
4,635

 
289

 
135,546

Federal home loan mortgage corporation
153,379

 
5,626

 
262

 
158,743

Federal national mortgage association
105,952

 
5,439

 
131

 
111,260

Asset-backed securities
4,491

 
318

 
231

 
4,578

Total Available-for-Sale Fixed Maturities
$
2,801,074

 
$
119,799

 
$
4,409

 
$
2,916,464

Equity securities:

 

 

 

Common stocks

 

 

 

Public utilities
$
6,394

 
$
13,718

 
$
198

 
$
19,914

Energy
6,514

 
7,988

 
39

 
14,463

Industrials
13,252

 
34,387

 
215

 
47,424

Consumer goods and services
10,324

 
15,059

 
43

 
25,340

Health care
7,763

 
21,100

 

 
28,863

Technology, media and telecommunications
5,931

 
9,214

 
37

 
15,108

Financial services
17,288

 
82,294

 
65

 
99,517

Nonredeemable preferred stocks
443

 
29

 

 
472

Total Available-for-Sale Equity Securities
$
67,909

 
$
183,789

 
$
597

 
$
251,101

Total Available-for-Sale Securities
$
2,868,983

 
$
303,588

 
$
5,006

 
$
3,167,565



































12


December 31, 2015
 
Type of Investment
Cost or Amortized Cost
 
Gross Unrealized Appreciation
 
Gross Unrealized Depreciation
 
Fair Value
HELD-TO-MATURITY
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Corporate bonds
 
 
 
 
 
 
 
Technology, media and telecommunications
$
450

 
$
1

 
$

 
$
451

Financial services
150

 

 

 
150

Mortgage-backed securities
72

 
2

 

 
74

Total Held-to-Maturity Fixed Maturities
$
672

 
$
3

 
$

 
$
675

AVAILABLE-FOR-SALE

 

 

 

Fixed maturities:

 

 

 

Bonds

 

 

 

U.S. Treasury
$
21,587

 
$
100

 
$
38

 
$
21,649

U.S. government agency
232,808

 
2,622

 
2,400

 
233,030

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations:
 
 
 
 
 
 
 
Midwest
160,484

 
4,990

 
18

 
165,456

Northeast
56,449

 
1,996

 

 
58,445

South
125,565

 
3,358

 
134

 
128,789

West
103,721

 
3,160

 
67

 
106,814

Special revenue:
 
 
 
 
 
 
 
Midwest
152,780

 
4,956

 
30

 
157,706

Northeast
23,892

 
919

 
212

 
24,599

South
144,183

 
4,281

 
27

 
148,437

West
78,935

 
3,150

 
44

 
82,041

Foreign bonds
82,580

 
2,405

 
2,457

 
82,528

Public utilities
213,233

 
3,701

 
1,251

 
215,683

Corporate bonds

 


 

 

Energy
116,800

 
1,032

 
4,713

 
113,119

Industrials
227,589

 
3,329

 
6,663

 
224,255

Consumer goods and services
172,529

 
2,844

 
776

 
174,597

Health care
92,132

 
2,168

 
791

 
93,509

Technology, media and telecommunications
142,431

 
1,972

 
2,003

 
142,400

Financial services
259,382

 
5,246

 
1,143

 
263,485

Mortgage-backed securities
16,413

 
376

 
51

 
16,738

Collateralized mortgage obligations
 
 
 
 
 
 
 
Government national mortgage association
120,220

 
1,391

 
1,985

 
119,626

Federal home loan mortgage corporation
137,874

 
2,377

 
1,342

 
138,909

Federal national mortgage association
106,021

 
2,400

 
941

 
107,480

Asset-backed securities
5,461

 
221

 
16

 
5,666



13


Total Available-for-Sale Fixed Maturities
$
2,793,069

 
$
58,994

 
$
27,102

 
$
2,824,961

Equity securities:

 

 

 

Common stocks

 

 

 

Public utilities
$
7,231

 
$
12,022

 
$
193

 
$
19,060

Energy
6,103

 
5,374

 
266

 
11,211

Industrials
13,251

 
31,872

 
313

 
44,810

Consumer goods and services
10,301

 
13,017

 
3

 
23,315

Health care
7,763

 
20,454

 

 
28,217

Technology, media and telecommunications
5,931

 
7,538

 
105

 
13,364

Financial services
17,392

 
78,411

 
109

 
95,694

Nonredeemable preferred stocks
542

 
34

 

 
576

Total Available-for-Sale Equity Securities
$
68,514

 
$
168,722

 
$
989

 
$
236,247

Total Available-for-Sale Securities
$
2,861,583

 
$
227,716

 
$
28,091

 
$
3,061,208

Maturities
The amortized cost and fair value of held-to-maturity, available-for-sale and trading fixed maturity securities at September 30, 2016, 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
September 30, 2016
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less
$
150

 
$
150

 
$
99,301

 
$
100,197

 
$
2,430

 
$
2,919

Due after one year through five years
450

 
452

 
820,503

 
851,672

 
6,036

 
6,905

Due after five years through 10 years

 

 
879,226

 
926,253

 
961

 
1,133

Due after 10 years

 

 
588,600

 
609,336

 
2,160

 
2,296

Asset-backed securities

 

 
4,491

 
4,578

 

 

Mortgage-backed securities
52

 
53

 
18,422

 
18,879

 

 

Collateralized mortgage obligations

 

 
390,531

 
405,549

 

 

 
$
652

 
$
655

 
$
2,801,074

 
$
2,916,464

 
$
11,587

 
$
13,253













14


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 (losses) is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net realized investment gains (losses)
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Available-for-sale
$
945

 
$
407

 
$
2,307

 
$
2,363

Trading securities
 
 
 
 
 
 
 
Change in fair value
148

 
(999
)
 
519

 
(1,461
)
Sales
107

 
531

 
568

 
1,230

Equity securities:
 
 
 
 
 
 
 
Available-for-sale
1,375

 
1,418

 
2,359

 
2,352

Trading securities
 
 
 
 
 
 
 
Change in fair value
(5
)
 
(430
)
 
325

 
(634
)
Sales
20

 
39

 
(6
)
 
85

Other long-term investments

 

 

 
(1,313
)
Cash equivalents

 

 
169

 

Total net realized investment gains
$
2,590

 
$
966

 
$
6,241

 
$
2,622

The proceeds and gross realized gains (losses) on the sale of available-for-sale fixed maturity securities are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Proceeds from sales
$
2,007

 
$

 
$
5,049

 
$
8,228

Gross realized gains
11

 

 
986

 
1,030

There were no sales of held-to-maturity securities during the three- and nine-month periods ended September 30, 2016 and 2015.

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 $17,898 and $16,975 at September 30, 2016 and December 31, 2015, respectively.

Funding Commitment

Pursuant to an agreement with one of our limited liability partnership investments, we are contractually committed through December 31, 2023 to make capital contributions upon request of the partnership. Our remaining potential contractual obligation was $9,709 at September 30, 2016.







15



Unrealized Appreciation
A summary of the changes in net unrealized investment appreciation during the reporting period is as follows:
 
Nine Months Ended September 30,
 
2016
 
2015
Change in net unrealized investment appreciation
 
 
 
Available-for-sale fixed maturities
$
83,498

 
$
(12,841
)
Available-for-sale equity securities
15,459

 
(19,119
)
Deferred policy acquisition costs
(19,857
)
 
2,113

Income tax effect
(27,685
)
 
10,447

Total change in net unrealized investment appreciation, net of tax
$
51,415

 
$
(19,400
)
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 or based on the value calculated using a discounted cash flow model. Credit-related impairments on fixed maturity securities that we do not plan to sell, and for which we are not more likely than not to be required to sell, are recognized in net income. Any non-credit related impairment is recognized as a component of other comprehensive income. 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 September 30, 2016 and December 31, 2015. 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 September 30, 2016, 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 determined that these losses did not warrant the recognition of an OTTI charge at September 30, 2016 or at September 30, 2015. 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 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 determined that these losses did not warrant the recognition of an OTTI charge at September 30, 2016 or September 30, 2015. Our largest unrealized loss greater than 12 months on an individual equity security at September 30, 2016 was $198. 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.







16


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
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
2

 
$
1,625

 
$
1

 

 
$

 
$

 
$
1,625

 
$
1

U.S. government agency
1

 
3,697

 
3

 

 

 

 
3,697

 
3

States, municipalities and political subdivisions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Midwest
2

 
9,909

 
90

 

 

 

 
9,909

 
90

South
7

 
16,784

 
314

 

 

 

 
16,784

 
314

West
6

 
16,353

 
180

 

 

 

 
16,353

 
180

Special revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Midwest
3

 
6,008

 
56

 

 

 

 
6,008

 
56

Northeast
6

 
13,978

 
98

 

 

 

 
13,978

 
98

South
14

 
$
37,375

 
542

 

 
$

 

 
$
37,375

 
542

West
9

 
19,130

 
184

 

 

 

 
19,130

 
184

Foreign bonds

 

 

 
3

 
6,929

 
894

 
6,929

 
894

Public utilities

 

 

 
5

 
3,097

 
83

 
3,097

 
83

Corporate bonds
 
 
 
 
 
 
 
 
 
 
 
 


 


Energy
3

 
5,345

 
40

 
4

 
9,209

 
147

 
14,554

 
187

Industrials

 

 

 
5

 
9,522

 
668

 
9,522

 
668

Technology, media and telecommunications
1

 
2,198

 
8

 
3

 
10,403

 
160

 
12,601

 
168

Financial services

 

 

 
2

 
8,036

 
20

 
8,036

 
20

Mortgage-backed securities

 

 

 
4

 
1,262

 
8

 
1,262

 
8

Collateralized mortgage obligations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government national mortgage association
5

 
12,340

 
88

 
9

 
14,097

 
201

 
26,437

 
289

Federal home loan mortgage corporation
7

 
31,530

 
175

 
3

 
5,977

 
87

 
37,507

 
262

Federal national mortgage association
1

 
5,001

 
21

 
4

 
4,712

 
110

 
9,713

 
131

Asset-backed securities
1

 
2,571

 
231

 

 

 

 
2,571

 
231

Total Available-for-Sale Fixed Maturities
68

 
$
183,844

 
$
2,031

 
42

 
$
73,244

 
$
2,378

 
$
257,088

 
$
4,409

Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Public utilities

 
$

 
$

 
3

 
$
109

 
$
198

 
$
109

 
$
198

Energy
1

 
150

 
1

 
2

 
339

 
38

 
489

 
39

Industrials

 

 

 
6

 
197

 
215

 
197

 
215

Consumer goods and services
3

 
299

 
39

 
2

 
14

 
4

 
313

 
43

Technology, media and telecommunications
4

 
15

 
1

 
11

 
519

 
36

 
534

 
37

Financial services
1

 
80

 
1

 
4

 
451

 
64

 
531

 
65

Total Available-for-Sale Equity Securities
9

 
$
544

 
$
42

 
28

 
$
1,629

 
$
555

 
$
2,173

 
$
597

Total Available-for-Sale Securities
77

 
$
184,388

 
$
2,073

 
70

 
$
74,873

 
$
2,933

 
$
259,261

 
$
5,006




17


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
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
6

 
$
6,408

 
$
26

 
2

 
$
1,634

 
$
12

 
$
8,042

 
$
38

U.S. government agency
38

 
104,621

 
1,771

 
6

 
18,821

 
629

 
123,442

 
2,400

States, municipalities and political subdivisions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Midwest
4

 
2,417

 
12

 
1

 
528

 
6

 
2,945

 
18

South
3

 
4,805

 
55

 
8

 
3,743

 
79

 
8,548

 
134

West
4

 
8,927

 
23

 
2

 
2,274

 
44

 
11,201

 
67

Special revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Midwest

 

 

 
1

 
2,494

 
30

 
2,494

 
30

Northeast
1

 
4,755

 
212

 

 

 

 
4,755

 
212

South
4

 
7,445

 
26

 
2

 
1,851

 
1

 
9,296

 
27

West
4

 
6,851

 
44

 

 

 

 
6,851

 
44

Foreign bonds
9

 
16,991

 
1,289

 
2

 
4,036

 
1,168

 
21,027

 
2,457

Public utilities
35

 
72,680

 
880

 
5

 
2,840

 
371

 
75,520

 
1,251

Corporate bonds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy
29

 
61,496

 
3,286

 
4

 
7,991

 
1,427

 
69,487

 
4,713

Industrials
38

 
78,588

 
3,631

 
3

 
6,649

 
3,032

 
85,237

 
6,663

Consumer goods and services
24

 
64,661

 
770

 
4

 
2,491

 
6

 
67,152

 
776

Health care
18

 
43,992

 
652

 
2

 
3,737

 
139

 
47,729

 
791

Technology, media and telecommunications
22

 
59,503

 
1,478

 
2

 
8,940

 
525

 
68,443

 
2,003

Financial services
49

 
92,814

 
1,143

 

 

 

 
92,814

 
1,143

Mortgage-backed securities
9

 
7,423

 
43

 
4

 
183

 
8

 
7,606

 
51

Collateralized mortgage obligations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government national mortgage association
17

 
29,769

 
437

 
14

 
40,027

 
1,548

 
69,796

 
1,985

Federal home loan mortgage corporation
20

 
35,343

 
644

 
6

 
19,887

 
698

 
55,230

 
1,342

Federal national mortgage association
15

 
32,800

 
524

 
11

 
11,962

 
417

 
44,762

 
941

Asset-backed securities
1

 
985

 
16

 

 

 

 
985

 
16

Total Available-for-Sale Fixed Maturities
350

 
$
743,274

 
$
16,962

 
79

 
$
140,088

 
$
10,140

 
$
883,362

 
$
27,102

Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Public utilities

 
$

 
$

 
3

 
$
115

 
$
193

 
$
115

 
$
193

Energy
10

 
2,868

 
266

 

 

 

 
2,868

 
266

Industrials
3

 
177

 
44

 
5

 
193

 
269

 
370

 
313

Consumer goods and services

 

 

 
2

 
14

 
3

 
14

 
3

Technology, media and telecommunications
9

 
438

 
91

 
2

 
12

 
14

 
450

 
105

Financial services
6

 
326

 
51

 
1

 
136

 
58

 
462

 
109

Total Available-for-Sale Equity Securities
28

 
$
3,809

 
$
452

 
13

 
$
470

 
$
537

 
$
4,279

 
$
989

Total Available-for-Sale Securities
378

 
$
747,083

 
$
17,414

 
92

 
$
140,558

 
$
10,677

 
$
887,641

 
$
28,091



18


NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS

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.
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. 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.
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 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 information 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 throughout this section.


19


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 agreements. 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 and is classified as Level 2. 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 and 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.

Corporate-Owned Life Insurance

The Company formed a rabbi trust in 2014 to fund obligations under the United Fire & Casualty Company Non-qualified Deferred Compensation Plan and United Fire Group Supplemental Executive Retirement and Deferral Plan (collectively the "Executive Retirement Plans"). Within the rabbi trust, corporate-owned life insurance ("COLI") policies are utilized as an investment vehicle and source of funding for the Company's Executive Retirement Plans. The COLI policies invest in mutual funds, which are priced daily by independent sources. As of September 30, 2016, the cash surrender value of the COLI policies was $2,406, which is equal to the fair value measured using Level 2 inputs, based on the underlying assets of the COLI policies, and is included in other assets in the Consolidated Balance Sheets.




















20


A summary of the carrying value and estimated fair value of our financial instruments at September 30, 2016 and December 31, 2015 is as follows:
 
September 30, 2016
 
December 31, 2015
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Assets
 
 
 
 
 
 
 
Investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Held-to-maturity securities
$
655

 
$
652

 
$
675

 
$
672

Available-for-sale securities
2,916,464

 
2,916,464

 
2,824,961

 
2,824,961

Trading securities
13,253

 
13,253

 
12,622

 
12,622

Equity securities:
 
 
 
 
 
 
 
Available-for-sale securities
251,101

 
251,101

 
236,247

 
236,247

Trading securities
4,645

 
4,645

 
4,353

 
4,353

Mortgage loans
4,063

 
3,772

 
4,237

 
3,961

Policy loans
5,300

 
5,300

 
5,618

 
5,618

Other long-term investments
57,787

 
57,787

 
54,151

 
54,151

Short-term investments
175

 
175

 
175

 
175

Cash and cash equivalents
140,944

 
140,944

 
106,449

 
106,449

Corporate-owned life insurance
2,406

 
2,406

 
1,716

 
1,716

Liabilities
 
 
 
 
 
 
 
Policy reserves
 
 
 
 
 
 
 
Annuity (accumulations) (1)
$
702,251

 
$
685,591

 
$
707,190

 
$
744,931

Annuity (benefit payments)
142,013

 
95,798

 
131,899

 
95,467

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

The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at September 30, 2016 and December 31, 2015:
September 30, 2016
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
22,246

 
$

 
$
22,246

 
$

U.S. government agency
74,607

 

 
74,607

 

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
Midwest
158,362

 

 
158,362

 

Northeast
61,209

 

 
61,209

 

South
136,973

 

 
136,973

 

West
128,296

 

 
128,296

 

Special revenue
 
 
 
 
 
 
 
Midwest
168,111

 

 
167,857

 
254

Northeast
55,874

 

 
55,874

 

South
215,604

 

 
215,604

 

West
104,110

 

 
104,110

 

Foreign bonds
73,601

 

 
73,601

 

Public utilities
228,126

 

 
228,126

 

Corporate bonds
 
 
 
 
 
 
 


21


Energy
113,905

 

 
113,905

 

Industrials
243,612

 

 
243,612

 

Consumer goods and services
188,924

 

 
187,779

 
1,145

Health care
87,425

 

 
87,425

 

Technology, media and telecommunications
147,655

 

 
147,655

 

Financial services
278,818

 

 
269,636

 
9,182

Mortgage-backed securities
18,879

 

 
18,879

 

Collateralized mortgage obligations
 
 
 
 
 
 
 
Government national mortgage association
135,546

 

 
135,546

 

Federal home loan mortgage corporation
158,743

 

 
158,743

 

Federal national mortgage association
111,260

 

 
111,260

 

Asset-backed securities
4,578

 

 
3,906

 
672

Total Available-for-Sale Fixed Maturities
$
2,916,464

 
$

 
$
2,905,211

 
$
11,253

Equity securities:
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
19,914

 
$
19,914

 
$

 
$

Energy
14,463

 
14,463

 

 

Industrials
47,424

 
47,424

 

 

Consumer goods and services
25,340

 
25,340

 

 

Health care
28,863

 
28,863

 

 

Technology, media and telecommunications
15,108

 
15,108

 

 

Financial services
99,517

 
95,525

 

 
3,992

Nonredeemable preferred stocks
472

 
472

 

 

Total Available-for-Sale Equity Securities
$
251,101

 
$
247,109

 
$

 
$
3,992

Total Available-for-Sale Securities
$
3,167,565

 
$
247,109

 
$
2,905,211

 
$
15,245

TRADING
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Corporate bonds


 


 


 


Industrials
$
3,833

 
$

 
$
3,833

 
$

Consumer goods and services
538

 

 
538

 

Health care
2,794

 

 
2,794

 

Technology, media and telecommunications
810

 

 
810

 

Financial services
4,155

 

 
4,155

 

Asset-backed securities

 

 

 

Redeemable preferred stocks
1,123

 
1,123

 

 

Equity securities:
 
 
 
 
 
 
 
Public utilities
594

 
594

 

 

Energy
287

 
287

 

 

Industrials
812

 
812

 

 



22


Consumer goods and services
788

 
788

 

 

Health care
361

 
361

 

 

Financial services
232

 
232

 

 

Nonredeemable preferred stocks
1,571

 
1,571

 

 

Total Trading Securities
$
17,898

 
$
5,768

 
$
12,130

 
$

Short-Term Investments
$
175

 
$
175

 
$

 
$

Money Market Accounts
$
58,262

 
$
58,262

 
$

 
$

Corporate-Owned Life Insurance
$
2,406

 
$

 
$
2,406

 
$

Total Assets Measured at Fair Value
$
3,246,306

 
$
311,314

 
$
2,919,747

 
$
15,245




23


December 31, 2015
 
 
Fair Value Measurements
Description
Total
 
Level 1
 
Level 2
 
Level 3
AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
U.S. Treasury
$
21,649

 
$

 
$
21,649

 
$

U.S. government agency
233,030

 

 
233,030

 

States, municipalities and political subdivisions
 
 
 
 
 
 
 
General obligations
 
 
 
 
 
 
 
Midwest
165,456

 

 
165,456

 

Northeast
58,445

 

 
58,445

 

South
128,789

 

 
128,789

 

West
106,814

 

 
106,814

 

Special revenue
 
 
 
 
 
 
 
Midwest
157,706

 

 
157,363

 
343

Northeast
24,599

 

 
24,599

 

South
148,437

 

 
148,437

 

West
82,041

 

 
82,041

 

Foreign bonds
82,528

 

 
82,528

 

Public utilities
215,683

 

 
215,683

 

Corporate bonds
 
 
 
 
 
 
 
Energy
113,119

 

 
113,119

 

Industrials
224,255

 

 
224,255

 

Consumer goods and services
174,597

 

 
173,364

 
1,233

Health care
93,509

 

 
93,509

 

Technology, media and telecommunications
142,400

 

 
142,400

 

Financial services
263,485

 

 
253,823

 
9,662

Mortgage-backed securities
16,738

 

 
16,738

 

Collateralized mortgage obligations
 
 
 
 
 
 
 
Government national mortgage association
119,626

 

 
119,626

 

Federal home loan mortgage corporation
138,909

 

 
138,909

 

Federal national mortgage association
107,480

 

 
107,480

 

Asset-backed securities
5,666

 

 
4,630

 
1,036

Total Available-for-Sale Fixed Maturities
$
2,824,961

 
$

 
$
2,812,687

 
$
12,274

Equity securities:
 
 
 
 
 
 
 
Common stocks
 
 
 
 
 
 
 
Public utilities
$
19,060

 
$
19,060

 
$

 
$

Energy
11,211

 
11,211

 

 

Industrials
44,810

 
44,810

 

 

Consumer goods and services
23,315

 
23,315

 

 

Health care
28,217

 
28,217

 

 

Technology, media and telecommunications
13,364

 
13,364

 

 

Financial services
95,694

 
91,588

 
128

 
3,978



24


Nonredeemable preferred stocks
576

 
576

 

 

Total Available-for-Sale Equity Securities
$
236,247

 
$
232,141

 
$
128

 
$
3,978

Total Available-for-Sale Securities
$
3,061,208

 
$
232,141

 
$
2,812,815

 
$
16,252

TRADING
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Bonds
 
 
 
 
 
 
 
Corporate bonds
 
 
 
 
 
 
 
Industrials
$
3,558

 
$

 
$
3,558

 
$

Consumer goods and services
118

 

 
118

 

Health care
2,032

 

 
2,032

 

Technology, media and telecommunications
335

 

 
335

 

Financial services
4,094

 

 
4,094

 

Redeemable preferred stocks
2,485

 
2,485

 

 

Equity securities:
 
 
 
 
 
 
 
Energy
267

 
267

 

 

Industrials
986

 
986

 

 

Consumer goods and services
942

 
942

 

 

Health care
304

 
304

 

 

Financial services
229

 
229

 

 

Nonredeemable preferred stocks
1,625

 
1,625

 

 

Total Trading Securities
$
16,975

 
$
6,838

 
$
10,137

 
$

Short-Term Investments
$
175

 
$
175

 
$

 
$

Money Market Accounts
$
20,805

 
$
20,805

 
$

 
$

Corporate-Owned Life Insurance
$
1,716

 
$

 
$
1,716

 
$

Total Assets Measured at Fair Value
$
3,100,879

 
$
259,959

 
$
2,824,668

 
$
16,252

The fair value of securities that are categorized as Level 1 is based on quoted market prices that are readily and regularly available.

We use a market-based approach for valuing all of our Level 2 securities and submit them primarily to a third-party valuation service provider. Any of these securities not valued by this service provider are submitted to another third-party valuation service provider. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the valuation process for each security on any given day.
At least annually, we review the methodologies and assumptions used by our valuation service providers and verify that they are reasonable and representative of the fair value of the underlying securities held in the investment portfolio. 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


25


for unusual fluctuations. Unusual fluctuations outside of our expectations are independently corroborated with additional third-party sources that use similar valuation techniques as discussed above. In addition, we also randomly select securities and independently corroborate the valuations obtained from our third-party valuation service providers. In our opinion, the pricing obtained at September 30, 2016 and December 31, 2015 was reasonable.
For the three- and nine-month periods ended September 30, 2016, 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. During the three- and nine-month periods ended September 30, 2016, there were no securities transferred between Level 1 and Level 2.
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. However, securities are categorized as Level 3 if these quotes cannot be corroborated by other market observable data due to the unobservable nature of the brokers’ valuation processes. If pricing cannot be obtained from these sources, which occurs on a limited basis, management will perform a discounted cash flow analysis, using an appropriate risk-adjusted discount rate, on the underlying security to estimate fair value. During the three- and nine-month periods ended September 30, 2016, there were no securities transferred in or out of Level 3.

The following table provides a summary of the changes in fair value of our Level 3 securities for the three-month period ended September 30, 2016:
 
States, municipalities and political subdivisions
 
Corporate bonds
 
Asset-backed securities
 
Equities
 
Total
Balance at June 30, 2016
$
254

 
$
10,500

 
$
807

 
$
3,992

 
$
15,553

Net unrealized gains (losses)(1)

 
156

 
22

 

 
178

Disposals

 
(329
)
 
(157
)
 

 
(486
)
Balance at September 30, 2016
$
254

 
$
10,327

 
$
672

 
$
3,992

 
$
15,245

(1) Unrealized gains (losses) are recorded as a component of comprehensive income.

The following table provides a summary of the changes in fair value of our Level 3 securities for the nine-month period ended September 30, 2016:
 
States, municipalities and political subdivisions
 
Corporate bonds
 
Asset-backed securities
 
Equities
 
Total
Balance at January 1, 2016
$
343

 
$
10,895

 
$
1,036

 
$
3,978

 
$
16,252

Net unrealized gains (losses)(1)
(9
)
 
318

 
91

 

 
400

Purchases

 

 

 
132

 
132

Disposals
(80
)
 
(886
)
 
(455
)
 
(118
)
 
(1,539
)
Balance at September 30, 2016
$
254

 
$
10,327

 
$
672

 
$
3,992

 
$
15,245

(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.





26




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 September 30,
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net periodic benefit cost
 
 
 
 
 
 
 
Service cost
$
1,623

 
$
1,669

 
$
932

 
$
1,305

Interest cost
1,663

 
1,500

 
754

 
713

Expected return on plan assets
(1,988
)
 
(1,950
)
 

 

Amortization of net loss
992

 
1,136

 
379

 
731

Net periodic benefit cost
$
2,290

 
$
2,355

 
$
2,065

 
$
2,749


 
Pension Plan
 
Postretirement Benefit Plan
Nine Months Ended September 30,
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net periodic benefit cost
 
 
 
 
 
 
 
Service cost
$
4,869

 
$
5,007

 
$
2,796

 
$
3,915

Interest cost
4,989

 
4,500

 
2,262

 
2,139

Expected return on plan assets
(5,964
)
 
(5,850
)
 

 

Amortization of net loss
2,976

 
3,408

 
1,137

 
2,193

Net periodic benefit cost
$
6,870

 
$
7,065

 
$
6,195

 
$
8,247


Employer Contributions

We previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015 that we expected to contribute $6,384 to the pension plan in 2016. For the nine-month period ended September 30, 2016, we contributed $16,383 to the pension plan. In September 2016, the Company contributed an additional $10,000 to the pension plan for tax advantages and to reduce future obligations.

NOTE 5. STOCK-BASED COMPENSATION

Non-qualified Employee Stock Award Plan
The United Fire Group, Inc. 2008 Stock Plan (the "2008 Stock Plan") authorized the issuance of restricted and unrestricted stock awards, restricted stock units, stock appreciation rights, incentive stock options, and non-qualified stock options for up to 1,900,000 shares of UFG common stock to employees. In May 2014, the Registrant's shareholders approved an additional 1,500,000 shares of UFG common stock issuable at any time and from time to time pursuant to the 2008 Stock Plan, among other amendments, and renamed such plan as the United Fire Group, Inc. Stock Plan (as amended, the "Stock Plan"). At September 30, 2016, there were 1,245,650 authorized shares remaining available for future issuance. 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 UFG.
Options granted pursuant to the Stock Plan are granted to buy shares of UFG'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


27


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 units fully vest after 3 years or 5 years from the date of issuance, unless accelerated upon the approval of the Board of Directors, at which time UFG common stock will be issued to the awardee.
The activity in the Stock Plan is displayed in the following table:
Authorized Shares Available for Future Award Grants
Nine Months Ended September 30, 2016
 
From Inception to September 30, 2016
Beginning balance
1,394,578

 
1,900,000

Additional shares authorized

 
1,500,000

Number of awards granted
(249,528
)
 
(2,612,456
)
Number of awards forfeited or expired
100,600

 
458,106

Ending balance
1,245,650

 
1,245,650

Number of option awards exercised
209,352

 
859,871

Number of unrestricted stock awards granted
870

 
7,215

Number of restricted stock awards vested
18,394

 
36,970


Non-qualified Non-employee Director Stock Option and Restricted Stock Plan
The United Fire Group, Inc. 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 UFG's common stock to non-employee directors. At September 30, 2016, we had 74,771 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 (subject to limits set forth in the plan). 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
Nine Months Ended September 30, 2016
 
From Inception to September 30, 2016
Beginning balance
69,938

 
300,000

Number of awards granted
(13,167
)
 
(249,232
)
Number of awards forfeited or expired
18,000

 
24,003

Ending balance
74,771

 
74,771

Number of option awards exercised
31,886

 
46,693

Number of restricted stock awards vested
11,385

 
31,556

Stock-Based Compensation Expense

For the three-month periods ended September 30, 2016 and 2015, we recognized stock-based compensation expense of $865 and $616, respectively. For the nine-month periods ended September 30, 2016 and 2015, we recognized stock-based compensation expense of $2,731 and $1,817, respectively. Stock-based compensation expense is recognized over the vesting period of the stock options.

As of September 30, 2016, we had $8,000 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 2016 and


28


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.
2016
 
$
865

2017
 
2,964

2018
 
2,264

2019
 
1,194

2020
 
640

2021
 
73

Total
 
$
8,000


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 in Cedar Rapids, Iowa. Because all of our insurance is sold domestically, we have no revenues from foreign operations.

We evaluate the two segments on the basis of both statutory accounting principles 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, 2015.
 
We have reconciled the amounts in the following table for the three-month periods ended September 30, 2016 and 2015 to the amounts reported in our unaudited Consolidated Financial Statements, adjusting for intersegment eliminations.
 
Property and Casualty Insurance
 
Life Insurance
 
Total
As of and for the Three Months Ended September 30, 2016
 
 
 
 
Net premiums earned
$
239,469

 
$
20,600

 
$
260,069

Investment income, net of investment expenses
14,065

 
12,663

 
26,728

Net realized investment gains
2,129

 
461

 
2,590

Other income

 
145

 
145

Total reportable segment
$
255,663

 
$
33,869

 
$
289,532

Intersegment eliminations
(38
)
 

 
(38
)
Total revenues
$
255,625

 
$
33,869

 
$
289,494

Net income
$
11,628

 
$
740

 
$
12,368

Assets
$
2,468,258

 
$
1,638,779

 
$
4,107,037

Invested assets
$
1,735,153

 
$
1,517,996

 
$
3,253,149

 
 
 
 
 
 
As of and for the Three Months Ended September 30, 2015
 
 
 
 
Net premiums earned
$
218,993

 
$
20,627

 
$
239,620

Investment income, net of investment expenses
10,741

 
13,334

 
24,075

Net realized investment gains
732

 
234

 
966

Other income

 
123

 
123

Total reportable segment
$
230,466

 
$
34,318

 
$
264,784

Intersegment eliminations
(25
)
 
(199
)
 
(224
)
Total revenues
$
230,441

 
$
34,119

 
$
264,560

Net income
$
18,020

 
$
1,514

 
$
19,534

Assets
$
2,231,851

 
$
1,644,165

 
$
3,876,016

Invested assets
$
1,572,222

 
$
1,524,232

 
$
3,096,454




29


We have reconciled the amounts in the following table for the nine-month periods ended September 30, 2016 and 2015 to the amounts reported in our unaudited Consolidated Financial Statements, adjusting for intersegment eliminations.
 
Property and Casualty Insurance
 
Life Insurance
 
Total
As of and for the Nine Months Ended September 30, 2016
 
 
 
 
Net premiums earned
$
691,976

 
$
62,878

 
$
754,854

Investment income, net of investment expenses
35,129

 
38,404

 
73,533

Net realized investment gains
4,832

 
1,409

 
6,241

Other income

 
436

 
436

Total reportable segment
$
731,937

 
$
103,127

 
$
835,064

Intersegment eliminations
(112
)
 

 
(112
)
Total revenues
$
731,825

 
$
103,127

 
$
834,952

Net income
$
37,083

 
$
826

 
$
37,909

Assets
$
2,468,258

 
$
1,638,779

 
$
4,107,037

Invested assets
$
1,735,153

 
$
1,517,996

 
$
3,253,149

 
 
 
 
 
 
As of and for the Nine Months Ended September 30, 2015
 
 
 
 
Net premiums earned
$
628,396

 
$
54,009

 
$
682,405

Investment income, net of investment expenses
33,610

 
40,623

 
74,233

Net realized investment gains
316

 
2,306

 
2,622

Other income

 
318

 
318

Total reportable segment
$
662,322

 
$
97,256

 
$
759,578

Intersegment eliminations
(28
)
 
(588
)
 
(616
)
Total revenues
$
662,294

 
$
96,668

 
$
758,962

Net income
$
54,420

 
$
3,811

 
$
58,231

Assets
$
2,231,851

 
$
1,644,165

 
$
3,876,016

Invested assets
$
1,572,222

 
$
1,524,232

 
$
3,096,454


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, restricted stock awards and restricted stock unit 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.



30


The components of basic and diluted earnings per share were as follows for the three-month periods ended September 30, 2016 and 2015:
 
Three Months Ended September 30,
(In Thousands Except Share Data)
2016
 
2015
 
Basic
 
Diluted
 
Basic
 
Diluted
Net income
$
12,368

 
$
12,368

 
$
19,534

 
$
19,534

Weighted-average common shares outstanding
25,389,633

 
25,389,633

 
25,067,080

 
25,067,080

Add dilutive effect of restricted stock unit awards

 
155,270

 

 
125,135

Add dilutive effect of stock options

 
270,443

 

 
187,133

Weighted-average common shares
25,389,633

 
25,815,346

 
25,067,080

 
25,379,348

Earnings per common share
$
0.49

 
$
0.48

 
$
0.78

 
$
0.77

Awards excluded from diluted earnings per share calculation(1)

 

 

 
260,035

(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.

The components of basic and diluted earnings per share were as follows for the nine-month periods ended September 30, 2016 and 2015:
 
Nine Months Ended September 30,
(In Thousands Except Share Data)
2016
 
2015
 
Basic
 
Diluted
 
Basic
 
Diluted
Net income
$
37,909

 
$
37,909

 
$
58,231

 
$
58,231

Weighted-average common shares outstanding
25,322,427

 
25,322,427

 
25,027,382

 
25,027,382

Add dilutive effect of restricted stock unit awards

 
155,270

 

 
125,135

Add dilutive effect of stock options

 
233,317

 

 
19,364

Weighted-average common shares
25,322,427

 
25,711,014

 
25,027,382

 
25,171,881

Earnings per common share
$
1.50

 
$
1.47

 
$
2.33

 
$
2.31

Awards excluded from diluted earnings per share calculation(1)

 

 

 
410,425

(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. CREDIT FACILITY

On February 2, 2016, the Company, as borrower, entered into a Credit Agreement (the "New Credit Agreement") by and among the Company, with the lenders from time to time party thereto and KeyBank National Association ("Key Bank"), as administrative agent, swingline lender and letter of credit issuer. The New Credit Agreement provides for a $50,000 four-year unsecured revolving credit facility that includes a $20,000 letter of credit subfacility and a swingline subfacility in the amount up to $5,000. The New Credit Agreement allows the Company to increase the aggregate amount of the commitments thereunder by up to $100,000, provided that no event of default has occurred and is continuing and certain other conditions are satisfied.
The New Credit Agreement is available for the Company's general corporate purposes, including liquidity, acquisitions and working capital. All unpaid principal and accrued interest under the New Credit Agreement is due and payable in full at maturity on February 2, 2020. Based on the type of loan, advances under the New Credit Agreement would bear interest on either the London interbank offered rate ("LIBOR") or a base rate plus, in each case, a calculated margin amount.
The unused commitments under the New Credit Agreement will be subject to a commitment fee that will be calculated at a per annum rate. The applicable margins for borrowings under the New Credit Agreement and the commitment fee thereunder will be determined by reference to a pricing grid based on the Company’s issuer credit rating by A.M. Best Company, Inc.


31


The New Credit Agreement contains customary representations, conditions to borrowing, covenants and events of default, including certain covenants that limit or restrict, subject to certain exceptions, the ability of the Company and its subsidiaries to sell or transfer assets, enter into a merger or consolidate with another company, create liens, impose restrictions on subsidiary dividends, enter into sale-leaseback transactions, make investments or acquisitions, enter into certain reinsurance agreements, pay dividends during any period of default, enter into transactions with affiliates, change the nature of its business, or incur indebtedness. The New Credit Agreement also includes financial covenants that require the Company to (i) maintain a minimum consolidated net worth, (ii) maintain a minimum consolidated statutory surplus and (iii) not exceed a 0.35 to 1.0 debt to total capitalization ratio.
Prior to December 22, 2015, the Company had a credit agreement (the "Previous Credit Agreement") with a syndicate of financial institutions as lenders. KeyBank National Association was the administrative agent, lead arranger, sole book runner, swingline lender, and letter of credit issuer, and Bankers Trust Company was the syndication agent. The Previous Credit Agreement provided for a $100,000 unsecured revolving credit facility that included a $20,000 letter of credit subfacility and a swingline subfacility of up to $5,000. The Previous Credit Agreement terminated by expiration on its stated termination date of December 22, 2015.
There was no outstanding balance on either the New Credit Agreement or Previous Credit Agreement at September 30, 2016 and 2015, respectively. For the nine-month periods ended September 30, 2016 and 2015, we did not incur any interest expense related to either credit facility. We were in compliance with all covenants of the New Credit Agreement at September 30, 2016.


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 September 30, 2016:

 
 
 
Liability for
 
 
 
Net unrealized
 
underfunded
 
 
 
appreciation
 
employee
 
 
 
on investments
 
benefit costs(1)
 
Total
Balance as of June 30, 2016
$
187,428

 
$
(46,149
)
 
$
141,279

Change in accumulated other comprehensive income before reclassifications
(6,136
)
 

 
(6,136
)
Reclassification adjustments from accumulated other comprehensive income (loss)
(1,508
)
 
891

 
(617
)
Balance as of September 30, 2016
$
179,784

 
$
(45,258
)
 
$
134,526

(1) Estimates and Assumptions: The preparation of financial statements in conformity with GAAP requires us to make various estimates and assumptions that affect the reporting of net periodic benefit cost, plan assets and plan obligations for each plan at the date of the financial statements. Actual results could differ from these estimates. One significant estimate relates to the calculation of the benefit obligation for each plan. We annually establish the discount rate, which is an estimate of the interest rate at which these benefits could be effectively settled, that is used to determine the present value of the respective plan's benefit obligations as of December 31.












32


The following table shows the changes in the components of our accumulated other comprehensive income (loss), net of tax, for the nine-month period ended September 30, 2016:

 
 
 
Liability for
 
 
 
Net unrealized
 
underfunded
 
 
 
appreciation
 
employee
 
 
 
on investments
 
benefit costs(1)
 
Total
Balance as of January 1, 2016
$
128,369

 
$
(47,932
)
 
$
80,437

Change in accumulated other comprehensive income before reclassifications
54,448

 

 
54,448

Reclassification adjustments from accumulated other comprehensive income (loss)
(3,033
)
 
2,674

 
(359
)
Balance as of September 30, 2016
$
179,784

 
$
(45,258
)
 
$
134,526

(1) Estimates and Assumptions: The preparation of financial statements in conformity with GAAP requires us to make various estimates and assumptions that affect the reporting of net periodic benefit cost, plan assets and plan obligations for each plan at the date of the financial statements. Actual results could differ from these estimates. One significant estimate relates to the calculation of the benefit obligation for each plan. We annually establish the discount rate, which is an estimate of the interest rate at which these benefits could be effectively settled, that is used to determine the present value of the respective plan's benefit obligations as of December 31.


33


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. (the "Company") as of September 30, 2016, and the related consolidated statements of income and comprehensive income for the three- and nine-month periods ended September 30, 2016 and 2015, the consolidated statements of cash flows for the nine-month periods ended September 30, 2016 and 2015, and the consolidated statement of stockholders' equity for the nine-month period ended September 30, 2016. 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, 2015, 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 February 26, 2016. In our opinion, the accompanying consolidated balance sheet of United Fire Group, Inc. as of December 31, 2015 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
November 2, 2016



34


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

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

CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are representative of significant judgments and uncertainties and that potentially may result in materially different results under different assumptions and conditions. We base our discussion and analysis of our results of operations and financial condition on the amounts reported in our Consolidated Financial Statements, which we have prepared in accordance with GAAP. As we prepare these Consolidated Financial Statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical accounting policies are more fully described in our Management's Discussion and Analysis of Financial Condition and Results of Operations presented in our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes in our critical accounting policies from December 31, 2015.

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, 2015. 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.
When we provide information on a statutory or other 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. ("UFG," 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 46 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 1,350 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.



35


For the nine-month period ended September 30, 2016, property and casualty insurance business accounted for approximately 91.7 percent of our net premiums earned, of which 92.4 percent was generated from commercial lines. Life insurance business accounted for approximately 8.3 percent of our net premiums earned, of which 75.6 percent was generated from traditional life insurance products.

Pooling Arrangement

All of our property and casualty insurance subsidiaries are members of an intercompany reinsurance pooling arrangement. The Company's pooling arrangement permits 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 nine-month period ended September 30, 2016, approximately 48.5 percent of our property and casualty premiums were written in Texas, California, Iowa, Missouri and New Jersey; approximately 61.4 percent of our life insurance premiums were written in Iowa, Minnesota, Illinois, Wisconsin and Nebraska.

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.




















36


CONSOLIDATED FINANCIAL HIGHLIGHTS
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands)
2016
 
2015
 
%
 
2016
 
2015
 
%
Revenues
 
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
260,069

 
$
239,421

 
8.6
 %
 
$
754,854

 
$
681,817

 
10.7
 %
Investment income, net of investment expenses
26,690

 
24,050

 
11.0

 
73,421

 
74,205

 
(1.1
)
Net realized investment gains
2,590

 
966

 
168.1

 
6,241

 
2,622

 
138.0

Other income
145

 
123

 
17.9

 
436

 
318

 
37.1

Total revenues
$
289,494

 
$
264,560

 
9.4
 %
 
$
834,952

 
$
758,962

 
10.0
 %
 

 
 
 
 
 
 
 
 
 
 
Benefits, Losses and Expenses

 
 
 
 
 
 
 
 
 
 
Losses and loss settlement expenses
$
176,555

 
$
144,526

 
22.2
 %
 
$
499,095

 
$
421,297

 
18.5
 %
Increase in liability for future policy benefits
14,091

 
12,784

 
10.2

 
42,645

 
32,503

 
31.2

Amortization of deferred policy acquisition costs
54,116

 
48,697

 
11.1

 
156,932

 
135,526

 
15.8

Other underwriting expenses
24,574

 
26,161

 
(6.1
)
 
76,099

 
73,241

 
3.9

Interest on policyholders' accounts
4,983

 
5,568

 
(10.5
)
 
15,368

 
18,207

 
(15.6
)
Total benefits, losses and expenses
$
274,319

 
$
237,736

 
15.4
 %
 
$
790,139

 
$
680,774

 
16.1
 %
 


 
 
 
 
 
 
 
 
 
 
Income before income taxes
$
15,175

 
$
26,824

 
(43.4
)%
 
$
44,813

 
$
78,188

 
(42.7
)%
Federal income tax expense
2,807

 
7,290

 
(61.5
)
 
6,904

 
19,957

 
(65.4
)
Net income
$
12,368

 
$
19,534

 
(36.7
)%
 
$
37,909

 
$
58,231

 
(34.9
)%


The following is a summary of our financial performance for the three- and nine-month periods ended September 30, 2016:

Consolidated Results of Operations

For the three-month period ended September 30, 2016, net income was $12.4 million compared to $19.5 million for the same period of 2015. The decrease in net income was driven by an increase in losses and loss settlement expenses from higher catastrophe losses, commercial auto losses and large commercial fire losses, and an increase in deferred acquisition cost amortization from continued organic growth; partially offset by an increase in net premiums earned from organic growth and geographical expansion and higher investment income. Consolidated net premiums earned increased to $260.1 million compared to $239.4 million for the same period of 2015.

For the nine-month period ended September 30, 2016, net income was $37.9 million compared to $58.2 million for the same period of 2015. The decrease in net income was driven by an increase in losses and loss settlement expenses from higher catastrophe losses and large commercial fire losses, and an increase in deferred acquisition cost amortization from continued organic growth; partially offset by an increase in net premiums earned from organic growth and geographical expansion. Consolidated net premiums earned increased to $754.9 million compared to $681.8 million for the same period of 2015.

Losses and loss settlement expenses increased by $32.0 million during the three-month period ended September 30, 2016 compared to the same period of 2015 due to an increase written premiums and a deterioration in the loss ratio. The net loss ratio increased by 7.8 percentage points during the three-month period ended September 30, 2016 compared to the same period of 2015. The increase in the net loss ratio is primarily due to higher catastrophe losses,


37


higher commercial auto losses and an increase in large commercial fire losses during the three-month period ended September 30, 2016.

Pre-tax catastrophe losses were $12.5 million for the three-month period ended September 30, 2016 compared to $7.0 million in the same period of 2015. Catastrophe losses were lower than our 10-year historical average for the third quarter, adding 5.2 percentage points to the combined ratio in the third quarter of 2016 compared to adding 3.2 percentage points to the combined ratio in the third quarter of 2015. Our 10-year historical average in the third quarter adds an average of 7.8 percentage points to the combined ratio.

Losses and loss settlement expenses increased by $77.8 million during the nine-month period ended September 30, 2016 compared to the same period of 2015 due to an increase written premiums and a deterioration in the loss ratio. The net loss ratio increased by 5.0 percentage points during the nine-month period ended September 30, 2016 compared to the same period of 2015 primarily due to an increase in catastrophe losses in the second and third quarter and due to an increase in commercial auto losses and large commercial fire losses in the third quarter. Pre-tax catastrophe losses for the nine-months year-to-date were $52.4 million compared to $27.3 million in the same period of 2015.

Investment income increased by $2.6 million and decreased $0.8 million during the three- and nine-month periods ended September 30, 2016 compared to the same periods of 2015. The increase in the three-month period ended September 30, 2016 was primarily due to the change in value of our investments in limited liability partnerships as compared to the same periods in 2015.

Consolidated Financial Condition

At September 30, 2016, the book value per share of our common stock was $37.83. During the nine-month period ended September 30, 2016, 67,492 shares of common stock were repurchased under our share repurchase program at a total cost of $2.9 million and an average share price of $42.48. Under our share repurchase program, which is scheduled to expire on August 31, 2018, we were authorized to repurchase an additional 2,961,394 shares of our common stock as of September 30, 2016.

Net unrealized investment gains totaled $179.8 million as of September 30, 2016, an increase of $51.4 million, net of tax, or 40.1 percent, since December 31, 2015. The increase in net unrealized investment gains is primarily the result of a decrease in interest rates, which positively impacted the valuation of our fixed maturity security portfolio during 2016 and to a lesser extent an increase in the fair value of our equity security portfolio.

Our stockholders' equity increased to $959.2 million at September 30, 2016, from $878.9 million at December 31, 2015. The increase was attributable to net income of $37.9 million and an increase in net unrealized investment gains of $51.4 million, net of tax, partially offset by stockholder dividends of $18.2 million.


















38


RESULTS OF OPERATIONS

Property and Casualty Insurance Segment Results
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands Except Ratios)
2016
 
2015
 
2016
 
2015
Net premiums earned
$
239,469

 
$
218,993

 
$
691,976

 
$
628,396

Losses and loss settlement expenses
(169,303
)
 
(137,696
)
 
(475,568
)
 
(400,087
)
Amortization of deferred policy acquisition costs
(52,240
)
 
(46,847
)
 
(151,216
)
 
(130,305
)
Other underwriting expenses
(20,047
)
 
(21,505
)
 
(61,469
)
 
(59,625
)
Underwriting gain (loss)
$
(2,121
)
 
$
12,945

 
$
3,723

 
$
38,379

 
 
 
 

 
 
 
 
Investment income, net of investment expenses
14,027

 
10,716

 
35,017

 
33,582

Net realized investment gains
2,129

 
732

 
4,832

 
316

Income before income taxes
$
14,035

 
$
24,393

 
$
43,572

 
$
72,277

 
 
 
 

 
 
 
 
GAAP Ratios:
 
 
 

 
 
 
 
Net loss ratio (without catastrophes)
65.5
%
 
59.7
%
 
61.1
%
 
59.3
%
Catastrophes - effect on net loss ratio
5.2

 
3.2

 
7.6

 
4.4

Net loss ratio(1)
70.7
%
 
62.9
%
 
68.7
%
 
63.7
%
Expense ratio(2)
30.2

 
31.2

 
30.8

 
30.2

Combined ratio(3)
100.9
%
 
94.1
%
 
99.5
%
 
93.9
%
(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 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 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- and nine-month periods ended September 30, 2016, our property and casualty segment reported income before taxes of $14.0 million and $43.6 million, a decrease of $10.4 million and $28.7 million, respectively, compared to the same periods of 2015. The decrease in the three- and nine-month periods ended September 30, 2016 was driven by an increase in losses and loss settlement expenses from higher catastrophe losses, higher commercial auto losses, an increase in large commercial fire losses and an increase in deferred acquisition cost amortization from continued organic growth; partially offset by an increase in net premiums earned from organic growth and geographical expansion and an increase in investment income.

Net premiums earned increased 9.4 percent to $239.5 million in the three-month period ended September 30, 2016, compared to $219.0 million in the same period of 2015. Net premiums earned increased 10.1 percent to $692.0 million in the nine-month period ended September 30, 2016, compared to $628.4 million in the same period of 2015. These increases are a result of organic growth from a combination of new business writings and geographic expansion.

The combined ratio increased 6.8 percentage points to 100.9 percent, for the three-month period ended September 30, 2016, compared to 94.1 percent for the same period of 2015. The combined ratio increased 5.6 percentage points to 99.5, for the nine-month period ended September 30, 2016, compared to 93.9 percent for the same period of 2015. The increase in the combined ratio in the three- and nine-month periods ended September 30, 2016, as compared to the same period of 2015, was primarily attributable to an increase in the net loss ratio from higher catastrophe losses, higher commercial auto losses and an increase in large commercial fire losses.



39


The net loss ratio, a component of the combined ratio, increased by 7.8 percentage points to 70.7 percent and 5.0 percentage points to 68.7 percent in the three- and nine-month periods ended September 30, 2016, as compared to the same periods of 2015 due to higher catastrophe losses and an increase in large commercial fire losses. Pre-tax catastrophe losses totaled $12.5 million and $52.4 million for the three- and nine-month periods ended September 30, 2016, as compared to $7.0 million and $27.3 million in the same periods of 2015.

The expense ratio, a component of the combined ratio, was 30.2 percent and 30.8 percent for the three- and nine-month periods ended September 30, 2016, a decrease of 1.0 percentage point and an increase of 0.6 percentage points, respectively, as compared with the same periods of 2015. The decrease in the three-month period ended September 30, 2016 was primarily due to a decrease in post-retirement benefit expenses and contingent commission expenses. The increase in the expense ratio in the nine-month period ended September 30, 2016 was primarily due to
an increase in deferred acquisition cost amortization.

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

2016 Development

The property and casualty insurance segment experienced $0.7 million and $27.1 million of favorable development in our net reserves for prior accident years for the three- and nine-month periods ended September 30, 2016, respectively. For the three-month period ended September 30, 2016 the majority of favorable development came from two lines, workers compensation with $4.3 million of favorable development and commercial liability with $2.7 million of favorable development. This was offset by unfavorable development from two other lines, commercial auto with $4.9 million of unfavorable development and commercial fire and allied lines with $2.4 million of unfavorable development. The unfavorable development in commercial auto was driven by an increase frequency and severity from an overall increase in miles driven. The unfavorable development in commercial fire and allied lines was due to latent development on weather-related claims. During the three-month period ended September 30, 2016 all other lines combined contributed favorable development of $1.0 million. The lines of business with favorable development in the three-month period ended September 30, 2016 are primarily attributable to successful management of litigation expenses.


40


For the nine-month period ended September 30, 2016 the majority of favorable development came from four lines, commercial liability with $16.4 million of favorable development, workers compensation with $11.5 million of favorable development, fidelity and surety with $2.2 million of favorable development and personal auto with $2.1 million of favorable development. This was partially offset by unfavorable development from commercial fire and allied lines with $6.9 million. The unfavorable development in commercial fire and allied lines was due to latent development on weather-related claims. During the nine-month period ended September 30, 2016 all other lines combined contributed favorable development of $1.8 million. The favorable development in the nine-month period ended September 30, 2016 is primarily attributable to reductions in reserves for loss adjustment expense which continues to benefit from successful management of litigation expenses.

2015 Development

The property and casualty insurance segment experienced $0.7 million and $24.1 million of favorable development in our net reserves for prior accident years for the three- and nine-month periods ended September 30, 2015, respectively. Three lines in aggregate accounted for a majority of the favorable development. The largest single contributor was workers' compensation with $1.9 million and $13.6 million, respectively, of favorable development followed by long-tail liability with $2.4 million and $8.8 million, respectively, of favorable development, and auto physical damage with $0.4 million and $4.1 million, respectively, of favorable development in the three- and nine-month periods ended September 30, 2015. The favorable development is attributable to reductions in reserves for reported claims as well as reductions in required reserves for incurred but not reported claims due to continued successful management of litigation expenses. These reserve decreases were more than sufficient to offset claim payments. The favorable development was partially offset by adverse development from commercial auto liability of $6.2 million and $2.7 million, respectively, in the three- and nine-month periods ended September 30, 2015. This adverse development experience is the result of lower fuel prices and an increase in highway roadway use by commercial vehicles. Development on assumed property and liability reinsurance is mixed with favorable development of $1.7 million for the three-month period ended September 30, 2015 and adverse development of $4.2 million for the nine-month period ended September 30, 2015. No other line of business contributed a significant portion of the total 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 September 30, 2016, our total reserves were within our actuarial estimates.

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


41


 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
2016
 
2015
 
 
 
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
$
74,784

 
$
32,714

 
43.7
 %
 
$
67,752

 
$
32,483

 
47.9
 %
Fire and allied lines
56,451

 
47,086

 
83.4

 
51,913

 
29,534

 
56.9

Automobile
55,111

 
53,330

 
96.8

 
47,840

 
45,326

 
94.7

Workers' compensation
26,766

 
21,772

 
81.3

 
24,721

 
14,654

 
59.3

Fidelity and surety
5,711

 
908

 
15.9

 
5,709

 
(85
)
 
(1.5
)
Miscellaneous
453

 
39

 
8.6

 
386

 
57

 
14.8

Total commercial lines
$
219,276

 
$
155,849

 
71.1
 %
 
$
198,321

 
$
121,969

 
61.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
Personal lines
 
 
 
 
 
 
 
 
 
 
 
Fire and allied lines
$
10,986

 
$
6,606

 
60.1
 %
 
$
11,084

 
$
9,295

 
83.9
 %
Automobile
6,386

 
6,328

 
99.1

 
6,119

 
4,952

 
80.9

Miscellaneous
277

 
(276
)
 
(99.6
)
 
260

 
116

 
44.6

Total personal lines
$
17,649

 
$
12,658

 
71.7
 %
 
$
17,463

 
$
14,363

 
82.2
 %
Reinsurance assumed
$
2,544

 
$
796

 
31.3
 %
 
$
3,209

 
$
1,364

 
42.5
 %
Total
$
239,469

 
$
169,303

 
70.7
 %
 
$
218,993

 
$
137,696

 
62.9
 %

 
Nine Months Ended September 30,
2016
 
2015
 
 
 
Net Losses
 
 
 
 
 
Net Losses
 
 
 
 
 
and Loss
 
 
 
 
 
and Loss
 
 
 
Net
 
Settlement
 
Net
 
Net
 
Settlement
 
Net
(In Thousands, Except Ratios)
Premiums
 
Expenses
 
Loss
 
Premiums
 
Expenses
 
Loss
Unaudited
Earned
 
Incurred
 
Ratio
 
Earned
 
Incurred
 
Ratio
Commercial lines
 
 
 
 
 
 
 
 
 
 
 
Other liability
$
215,572

 
$
101,378

 
47.0
%
 
$
191,725

 
$
101,162

 
52.8
%
Fire and allied lines
164,503

 
133,823

 
81.3

 
149,732

 
98,602

 
65.9

Automobile
157,106

 
140,397

 
89.4

 
136,966

 
116,588

 
85.1

Workers' compensation
77,009

 
53,106

 
69.0

 
71,224

 
36,464

 
51.2

Fidelity and surety
16,221

 
432

 
2.7

 
15,030

 
2,540

 
16.9

Miscellaneous
1,292

 
357

 
27.6

 
1,735

 
181

 
10.4

Total commercial lines
$
631,703

 
$
429,493

 
68.0
%
 
$
566,412

 
$
355,537

 
62.8
%
 
 
 
 
 
 
 
 
 
 
 
 
Personal lines
 
 
 
 
 
 
 
 
 
 
 
Fire and allied lines
$
32,794

 
$
25,442

 
77.6
%
 
$
32,990

 
$
24,364

 
73.9
%
Automobile
18,686

 
16,872

 
90.3

 
17,917

 
12,807

 
71.5

Miscellaneous
808

 
319

 
39.5

 
759

 
228

 
30.0

Total personal lines
$
52,288

 
$
42,633

 
81.5
%
 
$
51,666

 
$
37,399

 
72.4
%
Reinsurance assumed
$
7,985

 
$
3,442

 
43.1
%
 
$
10,318

 
$
7,151

 
69.3
%
Total
$
691,976

 
$
475,568

 
68.7
%
 
$
628,396

 
$
400,087

 
63.7
%

Below are explanations regarding significant changes in the net loss ratios by line of business;
 
Commercial fire and allied lines - The net loss ratio deteriorated 26.5 percentage points and 15.4 percentage points in the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods of 2015. The change in the three-month period ended September 30, 2016 is primarily attributable to an increase in severity in commercial fire losses as compared to the same period in 2015. The change in the nine-month period ended September 30, 2016 is primarily due to an increase in severity of


42


weather-related catastrophe claims in the second quarter and from an increase in severity in commercial fire losses in the third quarter of 2016 as compared to the same periods in 2015.

Commercial automobile - The net loss ratio deteriorated 2.1 percentage points and 4.3 percentage points in the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods of 2015. The change was due to an increase in frequency and severity of claims in 2016 which was primarily due to an increase in miles driven as compared to the same periods of 2015.

Workers' compensation - The net loss ratio deteriorated 22.0 percentage points and 17.8 percentage points in the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods of 2015. The change was primarily due to an increase in severity of claims, which were over $100 thousand in 2016 as compared to the same periods of 2015. Despite the increases, the loss ratios continue to be within our expectations for this line of business.

Fidelity and surety - The net loss ratio improved in the nine-month period ended September 30, 2016, compared to the same period of 2015. The change was primarily due to salvage and subrogation received in the second quarter of 2016.

Personal fire and allied lines - The net loss ratio improved 23.8 percentage points and deteriorated 3.7 percentage points in the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods of 2015. The change in the three months ended September 30, 2016 as compared to the same period in 2015 is primarily attributable to lower average claim severity. The change in the nine months ended September 30, 2016 as compared to the same period in 2015 is primarily attributable to a significant increase in weather-related catastrophe claims during the second quarter of 2016 when compared to the second quarter of 2015.

Personal automobile - The net loss ratio deteriorated 18.2 percentage points and 18.8 percentage points in the three- and nine-month periods ended September 30, 2016, respectively, compared to the same periods of 2015. The change is primarily attributable to an increase in claim frequency due to catastrophe losses during the second quarter of 2016 and an increase in severity of claims during the third quarter of 2016 when compared to the same periods of 2015.


43


Life Insurance Segment Results
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands)
2016
 
2015
 
2016
 
2015
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
20,600

 
$
20,428

 
$
62,878

 
$
53,421

Investment income, net of investment expenses
12,663

 
13,334

 
38,404

 
40,623

Net realized investment gains
461

 
234

 
1,409

 
2,306

Other income
145

 
123

 
436

 
318

Total revenues
$
33,869

 
$
34,119

 
$
103,127

 
$
96,668

 
 
 
 
 
 
 
 
Benefits, Losses and Expenses
 
 
 
 
 
 
 
Losses and loss settlement expenses
$
7,252

 
$
6,830

 
$
23,527

 
$
21,210

Increase in liability for future policy benefits
14,091

 
12,784

 
42,645

 
32,503

Amortization of deferred policy acquisition costs
1,876

 
1,850

 
5,716

 
5,221

Other underwriting expenses
4,527

 
4,656

 
14,630

 
13,616

Interest on policyholders' accounts
4,983

 
5,568

 
15,368

 
18,207

Total benefits, losses and expenses
$
32,729

 
$
31,688

 
$
101,886

 
$
90,757

 
 
 
 
 
 
 
 
Income before income taxes
$
1,140

 
$
2,431

 
$
1,241

 
$
5,911


Income before income taxes decreased $1.3 million, in the three-month period ended September 30, 2016 as compared to the same period of 2015. The decrease in net income was due to a decrease in investment income, an increase in losses and loss settlement expenses and an increase in the increase in liability for future policy benefits, all partially offset by a decrease in interest credited on policyholders' annuity accounts.

Income before income taxes decreased $4.7 million in the nine-month period ended September 30, 2016, as compared to the same period of 2015. The decrease in net income was due to a decrease in investment income, an increase in losses and loss settlement expenses and an increase in the increase in liability for future policy benefits, all partially offset by an increase in net premiums earned from higher sales of single premium whole life policies ("SPWL") and a decrease in interest credited on policyholders' annuity accounts.

Net premiums earned increased 0.8 percent to $20.6 million for the three-month period ended September 30, 2016, compared to $20.4 million in the same period of 2015. Net premiums earned increased 17.7 percent to $62.9 million for the nine-month period ended September 30, 2016, compared to $53.4 million in the same period of 2015. The increase in net premiums earned was primarily due to an increase in sales of SPWL policies.

Net investment income decreased 5.0 percent to $12.7 million for the three-month period ended September 30, 2016, compared to $13.3 million for the same period of 2015. Net investment income decreased 5.5 percent to $38.4 million for the nine-month period ended September 30, 2016, compared to $40.6 million for the same period of 2015. The decrease is primarily due to declining reinvestment interest rates.

The increase in liability for future policy benefits increased in the three- and nine-month periods ended September 30, 2016, compared to the same periods of 2015, due to an increase in sales of SPWL policies.

Deferred annuity deposits decreased 16.1 percent and 24.2 percent, respectively, for the three- and nine-month periods ended September 30, 2016 compared to the same periods of 2015. We continue to execute our strategy to maintain profitability rather than market share in the low interest rate environment, as spreads increased 20 basis points as compared to the same period of 2015.



44


Net cash outflow related to our annuity business was $23.8 million and $63.5 million, respectively, in the three- and nine-month periods ended September 30, 2016, compared to a net cash outflow of $27.3 million and $106.5 million in the same periods of 2015. We attribute this to our strategy to maintain profitability on annuity products as previously described.

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

Investment Portfolio

Our invested assets totaled $3.3 billion at September 30, 2016, compared to $3.1 billion at December 31, 2015, an increase of $110.4 million. At September 30, 2016, fixed maturity securities and equity securities made up 90.1 percent and 7.9 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.

The composition of our investment portfolio at September 30, 2016 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
$
600

 
%
 
$
52

 
%
 
$
652

 
%
Available-for-sale
1,446,133

 
83.4

 
1,470,331

 
96.9

 
2,916,464

 
89.7

Trading securities
13,253

 
0.8

 

 

 
13,253

 
0.4

Equity securities
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale
228,158

 
13.1

 
22,943

 
1.5

 
251,101

 
7.7

Trading securities
4,645

 
0.3

 

 

 
4,645

 
0.1

Mortgage loans

 

 
3,772

 
0.3

 
3,772

 
0.1

Policy loans

 

 
5,300

 
0.3

 
5,300

 
0.2

Other long-term investments
42,189

 
2.4

 
15,598

 
1.0

 
57,787

 
1.8

Short-term investments
175

 

 

 

 
175

 

Total
$
1,735,153

 
100.0
%
 
$
1,517,996

 
100.0
%
 
$
3,253,149

 
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 September 30, 2016, we classified $2.9 billion, or 99.5 percent, of our fixed maturities portfolio as available-for-sale, compared to $2.8 billion, or 99.5 percent, at December 31, 2015. 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.


45



As of September 30, 2016 and December 31, 2015, 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 September 30, 2016 and December 31, 2015. Information contained in the table is generally based upon the issued credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain credit ratings from Standard & Poor's.
(In Thousands)
September 30, 2016
 
December 31, 2015
Rating
Carrying Value
 
% of Total
 
Carrying Value
 
% of Total
AAA
$
756,179

 
25.8
%
 
$
838,318

 
29.6
%
AA
851,669

 
29.0

 
724,023

 
25.5

A
673,697

 
23.0

 
670,098

 
23.6

Baa/BBB
571,127

 
19.5

 
556,667

 
19.6

Other/Not Rated
77,697

 
2.7

 
49,149

 
1.7

 
$
2,930,369

 
100.0
%
 
$
2,838,255

 
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 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.

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 11.0 percent and decreased 1.1 percent in the three- and nine-month periods ended September 30, 2016, respectively, compared with the same period of 2015. The increase in the three-month period ended September 30, 2016 was primarily due to the change in value of our investments in limited liability partnerships as compared to the same period in 2015. The decrease in the nine-month period ended September 30, 2016 is primarily due to a decrease in reinvestment interest rates on our life segment portfolio. We are maintaining our investment philosophy of purchasing fixed income investments rated investment grade or better.
We hold certain investments in limited liability partnerships that are recorded on the equity method of accounting, with changes in value of these investments recorded in investment income. In the three- and nine-month periods ended September 30, 2016, the change in value of our investments in limited liability partnerships resulted in investment income of $4.0 million and investment income of $3.7 million, respectively as compared to investment income of $0.4 million and $3.3 million, respectively, in the same periods of 2015. This resulted in a $3.6 million and a $0.4 million increase in investment income in the three- and nine-month periods ended September 30, 2016, respectively, as compared to the same periods of 2015.


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Our net realized investment gains were $2.6 million and $6.2 million, respectively, during the three- and nine-month periods ended September 30, 2016, as compared with $1.0 million and $2.6 million, respectively in the same periods of 2015.
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 September 30, 2016 are temporary based upon our current analysis of the issuers of the securities that we hold and current market conditions. It is possible that we could recognize impairment charges in future periods on securities that we own at September 30, 2016 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 assets to provide protection from future credit quality issues and corresponding other-than-temporary impairment write-downs. In the three- and nine-month periods ended September 30, 2016 and 2015, there were no 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.




47


The following table displays a summary of cash sources and uses in 2016 and 2015.
Cash Flow Summary
Nine Months Ended September 30,
(In Thousands)
2016
 
2015
Cash provided by (used in)
 
 
 
Operating activities
$
128,069

 
$
124,407

Investing activities
(20,024
)
 
22,430

Financing activities
(73,550
)
 
(113,350
)
Net increase in cash and cash equivalents
$
34,495

 
$
33,487

Operating Activities
Net cash flows provided by operating activities totaled $128.1 million and $124.4 million for the nine-month periods ended September 30, 2016 and 2015, respectively. Our cash flows from operations were sufficient to meet our liquidity needs for the nine-month periods ended September 30, 2016 and 2015.
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 of this item.
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, $0.9 billion, or 30.4 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 September 30, 2016, our cash and cash equivalents included $58.3 million related to these money market accounts, compared to $20.8 million at December 31, 2015.
Net cash flows used in investing activities were $20.0 million for the nine-month period ended September 30, 2016 compared to $22.4 million for the nine-month period ended September 30, 2015. For the nine-month periods ended September 30, 2016 and 2015, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments of $435.3 million and $539.9 million, respectively.
Our cash outflows for investment purchases were $449.2 million for the nine-month period ended September 30, 2016, compared to $506.7 million for the same period of 2015.
Financing Activities
Net cash flows used in financing activities were $73.6 million and $113.4 million for the nine-month periods ended September 30, 2016 and 2015, respectively. The decrease reflects a lower level of net annuity withdrawals and the increase in the issuance of common stock in the nine-month period ended September 30, 2016, compared to the same period of 2015.
Credit Facilities
On February 2, 2016, the Company, as borrower, entered into a Credit Agreement by and among the Company, with the lenders from time to time party thereto and KeyBank National Association, as administrative agent, swingline lender and letter of credit issuer. As of September 30, 2016, there were no balances outstanding under this credit agreement. For further discussion of our credit agreement, refer to Part I, Item 1, Note 8 "Credit Facility" to the unaudited Consolidated Financial Statements.



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Dividends
Dividends paid to shareholders totaled $18.2 million and $16.0 million in the nine-month periods ended September 30, 2016 and 2015, 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, and if applicable, commercially 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, 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 September 30, 2016, United Fire Group Inc.'s sole direct insurance company subsidiary, United Fire & Casualty Company, is able to make a maximum of $58.2 million in dividend payments without prior regulatory approval. These restrictions will not have a material impact in meeting the cash obligations of United Fire Group, Inc.
Stockholders' Equity
Stockholders' equity increased 9.1 percent to $959.2 million at September 30, 2016, from $878.9 million at December 31, 2015. The increase was primarily attributable to net income of $37.9 million and an increase in net unrealized investment gains of $51.4 million, net of tax, during the first nine months of 2016, partially offset by shareholder dividends of $18.2 million. At September 30, 2016, the book value per share of our common stock was $37.83 compared to $34.94 at December 31, 2015.

Funding Commitments

Pursuant to an agreement with one of our limited liability partnership investments, we are contractually committed through December 31, 2023, to make capital contributions upon request of the partnership. Our remaining potential contractual obligation was $9.7 million at September 30, 2016.

MEASUREMENT OF RESULTS
Management evaluates our operations by monitoring key measures of growth and profitability. The following section provides further explanation of the key measures management uses to evaluate our results.

Catastrophe losses is a commonly used financial measure that uses the designations of the Insurance Services Office (ISO) and are reported with losses 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


49


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 September 30,
 
Nine Months Ended September 30,
(In Thousands)
2016
 
2015
 
2016
 
2015
ISO catastrophes
$
10,517

 
$
4,916

 
$
49,686

 
$
24,950

Non-ISO catastrophes (1)
2,014

 
2,039

 
2,711

 
2,386

Total catastrophes
$
12,531

 
$
6,955

 
$
52,397

 
$
27,336

(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 September 30, 2016, 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, 2015.

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 SEC’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
In the normal course of its business, the Company is a party to a variety of legal proceedings. While the final outcome of these legal proceedings cannot be predicted with certainty, management believes all of the proceedings pending as of September 30, 2016 to be ordinary and routine and does not expect these legal proceedings to have a material adverse effect on the Company's financial position or results of operations.
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 2015 Annual Report on Form 10-K filed with the SEC on February 26, 2016, 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 UFG 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.

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 September 30, 2016.
 
 
 
 
 
Total Number of Shares
 
Maximum Number of
 
Total
 
 
 
Purchased as a Part of
 
Shares that may yet be
 
Number of
 
Average Price
 
Publicly Announced
 
Purchased Under the
Period
Shares Purchased
 
Paid per Share
 
Plans or Programs
 
Plans or Programs(1)
7/1/2016 - 7/31/2016

 
$

 

 
1,528,886

8/1/2016 - 8/30/2016
26,564

 
42.74

 
26,564

 
3,002,322

9/1/2016 - 9/30/2016
40,928

 
42.31

 
40,928

 
2,961,394

Total
67,492

 
$
42.48

 
67,492

 
 
(1) Our share repurchase program was originally announced in August 2007. In August 2016, our Board of Directors authorized the repurchase of up to an additional 1,500,000 shares of common stock through the end of August 2018. This is in addition to the 1,528,886 shares of common stock remaining under its previous authorizations.

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
31.1
 
Certification of Randy A. Ramlo pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
X
31.2
 
Certification of Dawn M. Jaffray 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 Dawn M. Jaffray 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 September 30, 2016 formatted in XBRL: (i) Consolidated Balance Sheets at September 30, 2016 (unaudited) and December 31, 2015; (ii) Consolidated Statements of Income and Comprehensive Income (unaudited) for the three and nine months ended September 30, 2016 and 2015; (iii) Consolidated Statement of Stockholders’ Equity (unaudited) for the nine months ended September 30, 2016; (iv) Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2016 and 2015; and (v) Notes to Unaudited Consolidated Financial Statements, tagged as a block of text.

 
X



53


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/ Dawn M. Jaffray
Randy A. Ramlo
 
Dawn M. Jaffray
President, Chief Executive Officer,
 
Senior Vice President, Chief Financial Officer and
Director and Principal Executive Officer
 
Principal Accounting Officer
 
 
 
November 2, 2016
 
November 2, 2016
(Date)
 
(Date)
 



54