UNITED FIRE GROUP INC annual report, FY2011

Business context and reporting period

United Fire Group, Inc. (formerly United Fire & Casualty Company) filed this Form 10-K for the fiscal year ended December 31, 2011. It writes property and casualty (P&C) and life insurance and sells annuities through independent agencies. The 2011 results include Mercer Insurance Group from its acquisition on March 28, 2011; the holding-company reorganization was completed February 1, 2012. The filing also reports unaudited fourth-quarter results.

Financial performance and condition

Metric20112010
Total revenue$705.0 million$591.1 million
Net income$11,000$47.5 million
P&C net premiums earned$533.8 million$420.4 million
P&C combined ratio112.1%99.9%
Net investment income$109.5 million$111.7 million
Operating cash flow$74.4 million$71.2 million
Cash and investments$3.053 billion$2.663 billion
Total assets$3.619 billion$3.007 billion
Stockholders’ equity$696.1 million$716.4 million
Debt and trust preferred securities$45.0 million and $15.6 millionNo balances reported

Full-year diluted earnings per share were reported as zero after rounding; the fourth-quarter net income was $16.9 million (unaudited). Year-end book value was $27.29 per share. Cash and cash equivalents were $144.5 million; the company also had a $100 million unsecured revolving credit facility, with no amount drawn under that facility reported at year-end.

Material changes versus the prior comparable period

  • Revenue rose 19.3%, primarily reflecting the Mercer acquisition; net premiums written increased 30.4% to $604.9 million. P&C direct premiums written rose 33.3%, including $115.3 million attributable to Mercer.
  • Net income fell from $47.5 million to $11,000. Catastrophe losses increased to $80.8 million from $19.8 million, while benefits, losses and expenses rose 34.7% to $717.7 million.
  • The P&C segment swung from $38.8 million pretax income to a $24.2 million pretax loss. Its combined ratio rose to 112.1%, indicating underwriting losses before investment income. The life segment’s pretax income declined to $11.5 million from $19.5 million, chiefly amid low investment yields and higher benefit costs.
  • Prior-year P&C reserve development was favorable by $61.1 million, versus $45.9 million favorable in 2010; this included $6.5 million of adverse development related to Hurricane Katrina litigation.
  • Equity declined 2.8%, reflecting dividends, share repurchases and higher employee-benefit-plan underfunding, partly offset by investment appreciation. Net unrealized investment gains after tax increased to $124.4 million from $102.6 million.

Outlook, commentary, risks and unusual items

  • Management cited 2011 catastrophe losses as a major drag and said it strengthened underwriting guidelines, including measures informed by updated catastrophe modeling. It planned further exposure management and identified about $1.5 million of expected 2012 savings from consolidating Mercer’s reinsurance programs.
  • Management estimated the 2012 adoption of updated insurance acquisition-cost accounting guidance could reduce pretax income by approximately $11 million to $17 million; this was preliminary, and the actual effect could differ.
  • Mercer integration remained underway, with system conversions planned during 2012. The acquisition generated $8.3 million of transaction costs in 2011 and accelerated amortization of acquired value of business, with the remaining $1.7 million VOBA asset expected to be fully amortized in first-quarter 2012.
  • Key risks include catastrophe frequency and severity, reserve-estimation uncertainty, investment and interest-rate exposure, municipal-bond credit risk, reinsurance availability and collectability, geographic concentration, and execution of Mercer integration. A.M. Best assigned the P&C pooled groups an “A” rating with a negative outlook; the life subsidiary had an “A-” rating with a stable outlook.
  • About 49 Hurricane Katrina policyholder cases remained pending at year-end. The company considered its reserves adequate but warned that estimates could change with adverse litigation developments. Other pending litigation was described as ordinary and routine.
  • Management and the independent auditor reported effective internal controls; the auditor issued unqualified opinions on the financial statements and internal control over financial reporting.

Most important facts for investors to verify

  1. How much of premium growth, earnings and balance-sheet expansion reflects Mercer versus underlying organic performance, and whether integration and projected savings are achieved.
  2. Whether catastrophe losses and the 112.1% P&C combined ratio improve, including the effects of rate changes, underwriting actions and reinsurance renewals.
  3. The adequacy of P&C reserves, especially long-tail liability and construction-defect claims, and any further Hurricane Katrina litigation development.
  4. Investment portfolio credit quality, municipal exposure and sensitivity to interest rates, alongside life-segment investment spreads and annuity behavior.
  5. Debt repayment, trust-preferred redemption, revolving-credit availability, and the actual 2012 earnings impact of the acquisition-cost accounting change.