Pekin Insurance Company

Transcription

1 Report on Audits of Financial Statements - Statutory Basis For the Years Ended December 31, 2012 and 2011

2 Table of Contents Page(s) Independent Auditor s Report Financial Statements: Statutory Balance Sheets as of December 31, 2012 and Statutory Statements of Operations and Changes in Stockholder s Equity for the Years Ended December 31, 2012 and Statutory Statements of Cash Flow for the Years Ended December 31, 2012 and Notes to Statutory Basis Financial Statements Independent Auditor s Report on the Supplementary Information Summary Investment Schedule Investment Risks Interrogatories Reinsurance Interrogatories

3 INDEPENDENT AUDITOR S REPORT To the Board of Directors Pekin Insurance Company Pekin, Illinois We have audited the accompanying statutory balance sheets of Pekin Insurance Company (the Company) as of December 31, 2012 and 2011, and the related statutory statements of operations, changes in stockholder s equity, and cash flow for the years then ended, and the related notes to the statutory financial statements. Management s Responsibilities for the Statutory Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with the accounting practices prescribed or permitted by the Illinois Department of Insurance. Management is also responsible for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. 1

4 Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles As described in Note 1 to the financial statements, the financial statements are prepared by the Company in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance, which is a basis of accounting other than accounting principles generally accepted in the United States of America, to meet the requirements of the state of Illinois. The effects on the statutory financial statements of the variances between the statutory basis of accounting described in Note 1 and accounting principles generally accepted in the United States of America have not been determined but are presumed to be material. Adverse Opinion on U.S. Generally Accepted Accounting Principles In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles paragraph, the financial statements referred to above do not present fairly, in accordance with accounting principles generally accepted in the United States of America, the financial position of the Company as of December 31, 2012 and 2011, and the results of its operations and its cash flow for the years then ended. Opinion on Regulatory Basis of Accounting In our opinion, the statutory financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2012 and 2011, and the results of its operations, changes in stockholder s equity, and its cash flow for the years then ended, in accordance with the accounting practices prescribed or permitted by the Illinois Department of Insurance described in Note 1. Madison, Wisconsin May 15, 2013 Strohm Ballweg, LLP 2

5 Statutory Balance Sheets December 31, 2012 and Admitted Assets: Bonds $ 211,087,191 $ 196,656,381 Common Stocks: Affiliates 9,481,405 9,352,527 Other than Affiliates 9,654,025 8,538,935 Cash and Short-Term Investments 1,782,484 2,033,786 Securities Lending Reinvested Collateral Assets 20,040,865 23,004,130 Cash and Invested Assets 252,045, ,585,759 Current Federal Income Tax Recoverable 233, ,414 Net Deferred Tax Asset 6,165,884 6,446,498 Investment Income Accrued 2,313,167 2,346,012 Receivables from Parent, Subsidiaries and Affiliates 1,822, ,859 Intangible Pension Asset 113,414 - Total Admitted Assets $ 262,694,351 $ 250,011,542 Liabilities: Unpaid Losses $ 61,283,442 $ 58,809,421 Unpaid Loss Adjustment Expenses 14,098,958 14,641,146 Unearned Premiums 49,102,387 44,559,160 Commissions, Expenses, Fees and Taxes 4,989,248 3,981,738 Payable for Securities Lending 20,040,865 23,004,130 Additional Minimum Pension Liability 827,993 - Other Liabilities 740, ,314 Total Liabilities 151,083, ,748,909 Stockholder s Equity: Common C apital Stock, $28.75 Par Value, 70,000 Shares Authorized, Issued and Outstanding 2,012,500 2,012,500 Unassigned Surplus 109,598, ,250,133 Total Stockholder s Equity 111,611, ,262,633 Total Liabilities and Stockholder s Equity $ 262,694,351 $ 250,011,542 The accompanying notes are an integral part of the statutory financial statements. -3-

6 Statutory Statements of Operations and Changes in Stockholder s Equity Years Ended December 31, 2012 and Underwriting Income: Premiums Written $ 100,497,658 $ 92,127,105 Increase in Unearned Premiums (4,543,227) (3,916,281) Premiums Earned 95,954,431 88,210,824 Losses and Expenses Incurred: Losses 63,872,427 65,449,878 Loss Adjustment Expenses 8,154,712 8,221,772 Underwriting Expenses 27,360,191 25,235,500 Total Losses and Expenses Incurred 99,387,330 98,907,150 Underwriting Loss (3,432,899) (10,696,326) Net Investment Income Earned 8,543,998 8,980,238 Realized C apital Gains 3,788,173 1,561,799 Other Income 707, ,842 Net Income Before Federal Income Tax 9,606, ,553 Federal Income Tax Expense (Benefit) 1,957,596 (1,411,735) Net Income $ 7,648,881 $ 1,969,288 Statement of Changes in Stockholder's Equity: Stockholder's Equity - Beginning of Year $ 104,262,633 $ 97,819,637 Changes in Stockholder's Equity: Net Income 7,648,881 1,969,288 Net Unrealized Capital Gains (Losses): Affiliates 128, ,254 Other than Affiliates 566,026 (662,421) Net Deferred Income Tax (280,614) 604,384 Cumulative Effect of Changes in Accounting Principles - 2,808,051 Adoption of Statutory Accounting Principle No. 10R - 1,320,440 Additional Minimum Pension Liability (714,579) - Net Increase 7,348,592 6,442,996 Stockholder's Equity - End of Year $ 111,611,225 $ 104,262,633 The accompanying notes are an integral part of the statutory financial statements. -4-

7 Statutory Statements of Cash Flow Years Ended December 31, 2012 and Cash from Operations: Net Premiums Collected $ 100,497,658 $ 92,127,105 Net Investment Income Received 9,097,101 9,471,665 Other Income Received 707, ,842 Total Cash Received 110,301, ,310,612 Benefits and Loss Related Payments 61,398,406 63,317,609 C ommissions, Expenses Paid and Other Deductions 35,049,579 33,349,439 Federal Income Taxes Paid 1,305, ,807 Total Cash Disbursed 97,753,552 96,962,855 Net Cash from Operations 12,548,413 5,347,757 Cash from Investments: Proceeds from Investments Sold, Matured or Repaid: Bonds 51,125,302 33,308,327 Stocks 7,142,055 7,112,348 Miscellaneous 2,963,265 4,807,721 Total Investment Proceeds 61,230,622 45,228,396 Cost of Investments Acquired: Bonds 62,879,281 40,887,038 Stocks 7,100,033 7,215,851 Miscellaneous 24,994 - Total Investments Acquired 70,004,308 48,102,889 Net Cash from Investments (8,773,686) (2,874,493) Cash from Financing and Miscellaneous Sources: Other C ash Applied (4,026,029) (3,592,299) Net Cash from Financing and Miscellaneous Sources (4,026,029) (3,592,299) Net Change in Cash and Short-Term Investments (251,302) (1,119,035) Cash and Short-Term Investments at Beginning of Year 2,033,786 3,152,821 Cash and Short-Term Investments at End of Year $ 1,782,484 $ 2,033,786 The accompanying notes are an integral part of the statutory financial statements. -5-

8 Notes to Financial Statements Statutory Basis 1. Nature of Operations and Summary of Significant Accounting Practices Pekin Insurance Company (the Company ) is a regional Midwest property and casualty insurance company domiciled in the State of Illinois. The Company sells insurance through independent agents. Insurance products primarily include private passenger and commercial automobile, homeowners, workers compensation, commercial multi-peril, general liability and business owners policies. Approximately 57 percent and 60 percent of the direct premium was written in the state of Illinois in 2012 and 2011, respectively. The accompanying financial statements have been prepared principally for filing with regulatory agencies and, as such, are prepared in conformity with accounting practices prescribed or permitted by the Illinois Department of Insurance (statutory accounting practices). Prescribed statutory accounting practices include the National Association of Insurance Commissioners (NAIC) Accounting Practices and Procedures Manual, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed when such practices are approved by the insurance department of the insurer s state of domicile. The Company does not use any permitted practices. Accounting Estimates The preparation of statutory financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near term relate to: 1) the estimated unpaid losses and loss adjustment expenses, 2) the assumptions regarding the other than temporary impairment analysis of the investment portfolio, and 3) the assumptions, including the discount rate, used to determine the benefit obligations for the defined benefit pension plan and post-retirement benefit plan, and 4) the amount of deferred tax assets expected to be realized in future years. Subsequent Events The Company adopted Statements of Statutory Accounting Principles (SSAP) No. 102, Accounting for Pensions effective January 1, The Company elects to phase-in the surplus impact by recognizing the entire surplus impact from applying paragraph 84 of SSAP 102, on an individual plan basis, over a period not to exceed ten (10) years. The reduction to surplus on January 1, 2013 was $365,014. Additionally, the Company adopted Statements of Statutory Accounting Principles No. 92, Accounting for Postretirement Benefits Other than Pensions effective January 1, The Company elects to phase-in the impact to surplus over a period not to exceed ten (10) years. The reduction to surplus on January 1, 2013 was $425,387. Subsequent events were evaluated through May 15, 2013, which is the date the financial statements were available to be issued. -6-

9 Notes to Financial Statements Statutory Basis Summary of Significant Differences Between Statutory Accounting and GAAP A description of the significant accounting practices used by the Company and significant variances from accounting principles generally accepted in the United States of America (GAAP) are as follows: A. Investments Bonds and stocks are valued in accordance with rules prescribed by the NAIC. Investment grade bonds (i.e., NAIC designation 1 or 2) not backed by other loans are stated at amortized cost using a scientific method. Below investment grade bonds (i.e., NAIC designation 3 or higher) not backed by other loans are stated at the lesser of fair value or amortized cost with any change in the carrying value of the bond being treated as an unrealized gain/loss and credited/charged directly to surplus. Common stocks of nonaffiliated companies are carried at market value and common stocks of insurance company affiliates are accounted for using the statutory equity method in which undistributed earnings are reported as unrealized gains and losses; under GAAP, the financial statements of wholly owned subsidiaries would be consolidated with those of the parent. Loan-backed securities (mortgage-backed and asset-backed securities) are stated at amortized cost using a prospective basis. The prospective approach recognizes, through the recalculation of the effective yield to be applied to future periods, the effects of all cash flow whose amounts differ from those estimated earlier. Changes in amortization and amortized cost will occur in future periods. Assumptions for loan-backed securities are updated on a quarterly basis. Agency pass-through and collateralized mortgage obligations use the threemonth generic prepayment speed assumption. Non-agency collateralized mortgage obligations and asset-backed securities are updated using projected principal payment windows. Investment income is recorded when earned. Realized gains and losses on sale or maturity of investments are determined on the basis of specific identification. Aggregate unrealized capital gains and losses are credited or charged directly to unassigned surplus without income tax effect. Statutory accounting requires that unrealized capital losses on investments that are determined to be other than temporary declines in value must be recognized as realized capital losses. The Company reviews its investment portfolio on a periodic basis to determine other than temporary declines in value. In evaluating whether a decline in value is other than temporary, management considers several factors including, but not limited to: 1) the Company s ability and intent to retain the security for a sufficient amount of time for it to recover, 2) the extent and duration of the decline in value, 3) the probability of collecting all cash flows according to contractual terms in effect at acquisition or restructuring, 4) relevant industry conditions and trends, and 5) the financial condition and current and future business prospects of the issuer. The amount of declines deemed other than temporary was $0 for the years ended December 31, 2012 and Under GAAP, equity securities that have readily determinable fair values and debt securities would be classified into three categories: held-to-maturity, trading, and available-for-sale. Held-to-maturity securities would be reported at amortized cost. Trading securities would be reported at fair value, with unrealized gains and losses included in earnings. Availablefor-sale securities would be reported at fair value, with unrealized gains and losses, net of applicable taxes, reported as a separate component of unassigned surplus. B. Unpaid Losses and Loss Adjustment Expenses The liabilities for unpaid losses and loss adjustment expenses are based upon management s estimates of reported and unreported losses determined on the basis of claim evaluation and past statistical experience. These liabilities are reported net of estimated salvage and subrogation receivable. Reinsurance recoverables related to unpaid losses and loss adjustment expenses are netted with the respective liabilities; under GAAP, these reinsurance recoverables would be shown on a separate gross basis. -7-

10 Notes to Financial Statements Statutory Basis C. Policy Acquisition Costs The costs of acquiring premium income are immediately charged against operations, whereas premium income is deferred over the periods covered by the policies. Under GAAP, costs, which vary directly with the production of new and renewal business, would be capitalized and amortized as premium is earned. D. Pension Under GAAP, net periodic pension expense would be based on the cost of incremental benefits for employee service during the period, interest on the projected benefit obligation, actual return on plan assets and amortization of actuarial gains and losses. Statutory accounting adopts a similar actuarial approach to estimate pension costs; however, costs related to non-vested participants are excluded. A liability has been recorded only for employees who are fully vested in the defined benefit retirement plan, and the funded status of the plan was determined using the accumulated benefit obligation; under GAAP, a liability would be recorded for vested and non-vested employees, and the funded status of the plan would be determined using the projected benefit obligation. E. Income Taxes Deferred income taxes are provided for differences between the financial statement and the tax bases of assets and liabilities and are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Additionally, under statutory accounting practices, limitations are placed on the admissibility of deferred tax assets. Most changes in deferred tax assets and liabilities are reported as changes in surplus, and state income taxes are not included in deferred tax calculations; under GAAP, there is no admissibility concept, and changes in deferred tax assets and liabilities would be reported through operations and/or surplus depending on their characteristics. F. Premium Income Recognition Premiums are earned over the terms of the related insurance policies and reinsurance contracts on a daily pro rata basis. Unearned premium reserves are established to cover the unexpired portion of premiums written and are computed on a pro rata basis. The Company determined that a premium deficiency reserve was not necessary for the years ended December 31, 2012 and The Company does not anticipate investment income as a factor in the calculation of a potential premium deficiency reserve. G. Cash and Short-Term Investments For purposes of reporting cash flows, the Company follows statutory accounting practices and considers cash in checking accounts, certain money market funds, and highly liquid debt instruments purchased with an original maturity of one year or less to be cash and short-term investments. The Company has on deposit in a financial institution a balance in excess of amounts insured by the Federal Deposit Insurance Corporation. The Company does not believe it is exposed to any significant credit risks on this account. -8-

11 Notes to Financial Statements Statutory Basis H. Other Commissions on reinsurance ceded are credited to income at the time the premium is ceded; under GAAP, commissions on ceded premium would be deferred and recognized as income over the periods covered by the policies. Statutory financial statements are prepared in a form using language and groupings substantially the same as the annual statement filed with the NAIC and state regulatory authorities which differ from the presentation and disclosure of financial statements that would be presented under GAAP. Necessary reclassifications are made in prior period financial statements, whenever appropriate, to conform to the current presentation. 2. Affiliated Entity Transactions The Company and its parent, The Farmers Automobile Insurance Association (the Association), owned percent and percent of the Pekin Life Insurance Company (PLIC) at December 31, 2012 and 2011, respectively. Specifically, the Company owned 7.58 percent of PLIC as of these dates. The Company and the Association occupy the same building and, along with PLIC, utilize many common facilities, management, administrative and office personnel and services. Since 1966, the Company and the Association have had a reinsurance pooling agreement under which underwriting income and expense and other administrative expenses are prorated to the Association (80%) and to the Company (20%). Intercompany balances are paid periodically throughout the year based on estimates and settled within 45 days after year-end based on actual allocated expenses. The proration does not include provisions for federal income taxes or results of investment transactions. 3. Bonds and Common Stocks The admitted value, unrealized gain and loss, and market value of investments in bonds as of December 31, 2012, are as follows: 2012 Admitted Unrealized Unrealized Market Obligation Value Gain Loss Value U.S. Government $ 2,417,141 $ 105,958 $ - $ 2,523,099 Other Government 670,837 84, ,961 U.S. States, Territories and Possessions 7,891,733 1,035,262-8,926,995 U.S. Political Subdivisions of States and Territories 7,585,318 1,066,239-8,651,557 U.S. Special Revenue and Special Assessment 29,114,426 3,743,046-32,857,472 Industrial and Miscellaneous 112,830,768 11,639,544 92, ,377,615 Loan-Backed Securities 50,576,968 3,220, ,797,655 Total $ 211,087,191 $ 20,894,987 $ 92,824 $ 231,889,354-9-

12 Notes to Financial Statements Statutory Basis The admitted value, unrealized gain and loss, and market value of investments in bonds as of December 31, 2011 are as follows: 2011 Admitted Unrealized Unrealized Market Obligation Value Gain Loss Value U.S. Government $ 2,442,356 $ 135,910 $ - $ 2,578,266 Other Government 1,004,052 50,971-1,055,023 U.S. States, Territories and Possessions 7,965,111 1,131,390-9,096,501 U.S. Political Subdivisions of States and Territories 7,647,783 1,038,820-8,686,603 U.S. Special Revenue and Special Assessment 29,534,675 3,802,646-33,337,321 Industrial and Miscellaneous 99,886,924 9,780, , ,382,302 Loan-Backed Securities 48,175,480 2,814, ,989,590 Total $ 196,656,381 $ 18,754,353 $ 285,128 $ 215,125,606 The admitted value and market value of bonds at December 31, 2012, by contractual maturity, are shown below: Admitted Market Value Value Due in One Year or Less $ 500,070 $ 501,095 Due After One Year Through Five Years 31,980,444 34,019,398 Due After Five Years Through Ten Years 110,164, ,359,941 Due After Ten Years 17,865,435 20,211,265 Total 160,510, ,091,699 Loan-Backed Securities 50,576,968 * 53,797,655 Total $ 211,087,191 $ 231,889,354 * The admitted value of loan-backed securities includes $672,895 and $1,053,789 of U.S. Government Guaranteed Securities for 2012 and 2011, respectively. The adjusted cost, unrealized gain and loss, and statement value of investments in stocks as of December 31, 2012 are as follows: 2012 Adjusted Unrealized Unrealized Statement Common Stocks Cost Gain Loss Value Other Than Affiliates $ 8,271,359 $ 1,589,475 $ 206,809 $ 9,654,025 Affiliates 457,868 9,023,537-9,481,405 Total Stocks $ 8,729,227 $ 10,613,012 $ 206,809 $ 19,135,

13 Notes to Financial Statements Statutory Basis The adjusted cost, unrealized gain and loss, and statement value of investments in stocks as of December 31, 2011 are as follows: 2011 Adjusted Unrealized Unrealized Statement Common Stocks Cost Gain Loss Value Other Than Affiliates $ 7,722,300 $ 1,191,578 $ 374,943 $ 8,538,935 Affiliates 457,868 8,894,659-9,352,527 Total Stocks $ 8,180,168 $ 10,086,237 $ 374,943 $ 17,891,462 Securities with unrealized losses based on estimated market values as of December 31, 2012 are shown below: Less Than 12 Months 12 Months or More Total Market Unrealized Market Unrealized Market Unrealized Description of Securities Value Losses Value Losses Value Losses Industrial and Miscellaneous $ 13,225,212 $ 92,697 $ - $ - $ 13,225,212 $ 92,697 Loan-Backed Securities 105, , , Subtotal Debt Securities 13,330,985 92,768 9, ,340,901 92,824 Common Stock - Unaffiliated 1,786, ,596 1,066,104 88,213 2,852, ,809 Total Securities With Unrealized Losses $ 15,116,987 $ 211,364 $ 1,076,020 $ 88,269 $ 16,193,007 $ 299,633 Securities with unrealized losses based on estimated market values as of December 31, 2011 are shown below: Less Than 12 Months 12 Months or More Total Market Unrealized Market Unrealized Market Unrealized Description of Securities Value Losses Value Losses Value Losses Industrial and Miscellaneous $ 3,849,229 $ 200,319 $ 1,942,330 $ 84,450 $ 5,791,559 $ 284,769 Loan-Backed Securities 225, , Subtotal Debt Securities 4,074, ,678 1,942,330 84,450 6,017, ,128 Common Stock - Unaffiliated 2,158, , ,239 69,905 2,525, ,943 Total Securities With Unrealized Losses $ 6,233,030 $ 505,716 $ 2,309,569 $ 154,355 $ 8,542,599 $ 660,071 Proceeds from sales of bonds, excluding calls and maturities, during 2012 and 2011 were $50,435,302 and $19,939,417 respectively. Gross gains of $3,217,107 and $1,160,474 and gross losses of $20,016 and $24,752 were realized on those sales, respectively. Bonds carried at $2,309,191 and $2,332,323 at December 31, 2012 and 2011, respectively, were on deposit with the Illinois Department of Insurance as required by law. A certificate of deposit in the amount of $100,000 was on deposit with the Arizona Department of Insurance at December 31, 2012 and 2011 as required by law. -11-

14 Notes to Financial Statements Statutory Basis Securities Lending The Company lends securities to agreed upon borrowers through an agreement with its custodian. The Company s policy is to require initial collateral from the borrower in an amount not less than 102 percent and 105 percent of the fair value of the domestic and foreign securities loaned at the outset of the contract as collateral. All collateral so received is held either in the physical custody of the custodian or for the account of the custodian by their agent or a central bank. The offsetting collateral liability is included in Payable for Securities Lending. At December 31, 2012 and 2011, the amount of securities loaned was $19,644,592 and $22,456,147, respectively, and the related collateral was $20,016,901 and $22,967,748. At December 31, 2012, collateral assets valued at $954,806 had maturity dates beyond one year. The aggregate amount of cash collateral received as of December 31, 2012 and 2011, is shown below by maturity date: Maturity Date Fair Value Fair Value Open $ 3,034,562 $ 6,945, Days or Less 3,250,745 2,319, to 60 Days 3,092,611 3,447, to 90 Days 3,819,225 2,622,917 Greater Than 90 Days 6,819,758 7,632,183 Total Collateral Received $ 20,016,901 $ 22,967,748 The aggregate amount of cash collateral reinvested as of December 31, 2012 and 2011, is shown below by maturity date: Amortized Fair Amortized Fair Cost Value Cost Value 30 Days or Less $ 5,621,571 $ 5,621,620 $ 7,495,057 $ 7,495, to 60 Days 3,060,494 3,060,664 2,800,441 2,800, to 90 Days 1,844,749 1,844, , , to 120 Days 1,681,802 1,682, , , to 180 Days 2,462,200 2,462,858 1,659,616 1,659, to 365 Days 2,019,817 2,020,880 2,846,383 2,847,476 1 to 2 Years 780, ,140 2,166,322 2,168,027 2 to 3 Years , ,489 Greater Than 3 Years 2,569,337 2,565,922 4,074,437 4,062,620 Total Collateral Reinvested $ 20,040,865 $ 20,040,220 $ 23,004,130 $ 22,995,

15 Notes to Financial Statements Statutory Basis 4. Fair Value Measurement Statutory Accounting Practices establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets (level one measurements) and the lowest priority to unobservable inputs (level three measurements). The three levels of the fair value hierarchy under statutory accounting are described below: Level 1 Inputs to the valuation methodology are unadjusted quoted prices for identical assets in active markets that the Company has the ability to access. Level 2 Inputs to the valuation methodology include quoted prices for similar assets in active markets; quoted prices for identical or similar assets in inactive markets; inputs other than quoted prices that are observable; or inputs that are derived principally from or corroborated by observable market data by correlation or other means. The fair values of the Level 2 securities are obtained from independent pricing services or from the Company s investment manager and are determined using quoted market prices from an orderly market at the reporting date for those or similar investments. Level 3 Inputs to the valuation methodology are unobservable and significant to the fair value measurement. The following tables set forth by level, within the fair value hierarchy, the Company s financial instruments that are reported at fair value as of December 31, 2012 and 2011: 2012 Description Level 1 Level 2 Level 3 Total Common Stock - Other Than Affiliates $ 8,773,616 $ 880,409 $ - $ 9,654, Description Level 1 Level 2 Level 3 Total Common Stock - Other Than Affiliates $ 7,840,227 $ 669,960 $ 28,748 $ 8,538,935 The Company did not have any liabilities measured at fair value at December 31, 2012 and In 2012, the Level 3 asset, valued at $28,748 as of January 1, 2012, was transferred into Level 1 and subsequently sold. The Company did not have any transfers between levels in The aggregate fair value of all financial instruments as of December 31, 2012, is shown below. Aggregate Admitted Fair Value Assets (Level 1) (Level 2) (Level 3) Bonds $ 231,889,354 $ 211,087,191 $ 2,523,099 $ 228,582,800 $ 783,455 Common Stock Affiliates 9,481,405 9,481,405-9,035, ,152 Other Than Affiliates 9,654,025 9,654,025 8,773, ,409 - Short-Term Investments 1,470,606 1,470,606 1,470,

16 Notes to Financial Statements Statutory Basis The type of security included within each hierarchy in the above table is as follows: Level 1 Measurements Bonds: Comprised of actively traded U.S. Treasury notes. Common Stock: Comprised of actively traded exchange listed mutual funds and common stocks. Short-Term Investments: Comprised of money market mutual funds. Level 2 Measurements Bonds: Comprised primarily of Political Subdivisions, Special Revenue, Industrial and Miscellaneous, and Loan-Backed securities. Common Stock: Comprised of common stock of affiliate which is not actively traded and is recorded at the statutory equity method; and comprised of common stock other than affiliates with an NAIC market indicator of U for which the price given for a share of common stock is the price listed on any market or exchange, including a foreign exchange, other than the New York Stock Exchange, the American Stock Exchange or the NASDAQ National Market System. Level 3 Measurements Bonds: Certain asset-backed bonds comprised primarily of corporate pass-through bonds. Common Stock: Comprised of common stock of affiliates recorded at the statutory equity method for which no appraisal is available. 5. Liability for Unpaid Losses and Loss Adjustment Expenses Activity in the liability for loss and loss adjustment expense reserves is summarized as follows: Balance at January 1 $ 76,907,600 $ 77,192,625 Less Reinsurance Recoverable (3,457,033) (3,558,892) Net Balance at January 1 73,450,567 73,633,733 Incurred Related to: Current Year 76,965,741 79,515,047 Prior Years (4,938,602) (5,843,398) Total Incurred 72,027,139 73,671,649 Paid Related to: Current Year 44,268,898 46,123,849 Prior Years 25,826,408 27,730,966 Total Paid 70,095,306 73,854,815 Net Balance at December 31 75,382,400 73,450,567 Plus Reinsurance Recoverable 5,724,349 3,457,033 Balance at December 31 $ 81,106,749 $ 76,907,

17 Notes to Financial Statements Statutory Basis As a result of actual claim payments varying from previous estimates of insured events and subsequent reserve changes, the provision for loss and loss adjustment expenses decreased by $4,938,602 and $5,843,398 in 2012 and 2011, respectively. The decrease in incurred loss and loss adjustment expenses in 2012 and 2011 is primarily attributable to favorable development of general liability, workers compensation, automobile liability, and homeowners estimated loss and loss adjustment expense reserves. Estimates of anticipated salvage and subrogation recoveries on losses and loss adjustment expenses have been recorded as a reduction to the liabilities for unpaid loss and unpaid loss adjustment expenses amounting to $2,883,920 and $2,808,051 at December 31, 2012 and 2011, respectively. 6. Reinsurance The Company has reinsurance treaties in place for its property and casualty insurance business to reduce exposure to large losses. Although reinsurance does not relieve the Company of its legal liability to its policyholders, it provides a measure of protection against catastrophic losses and provides a means of risk reduction on individual losses. In order to maintain an appropriate balance between the cost of reinsurance and surplus growth, the Company periodically evaluates its retention levels correlated to specific types of property and casualty insurance policies. The Company is also a party to an intercompany pooling agreement with the Association. All direct business written by the Company is ceded 100% to the intercompany pool. No direct business is ceded to third parties by the Company. Under this agreement, underwriting income and expenses and other administrative expenses are prorated to the Association (80%) and to the Company (20%). At December 31, 2012 Assumed Reinsurance Ceded Reinsurance Net Premium Commission Premium Commission Premium Commission Reserve Equity Reserve Equity Reserve Equity Intercompany Pooling Agreement $ 49,102,387 $ 7,185,231 $ 138,024,363 $ 22,222,208 $ (88,921,976) $ (15,036,977) At December 31, 2011 Intercompany Pooling Agreement $ 44,559,160 $ 6,502,826 $ 119,863,172 $ 19,443,929 $ (75,304,012) $ (12,941,103) The direct unearned premium reserve was $138,024,363 and $119,863,172 at December 31, 2012 and 2011, respectively. Commission equity is computed as the maximum amount of return commission which would be due to the reinsurer if all reinsurance contracts were cancelled at year-end. -15-

18 Notes to Financial Statements Statutory Basis 7. Pension Plan, Post-Retirement Benefits, and Deferred Compensation Retirement Benefits The Company and its parent, The Farmers Automobile Insurance Association, and its affiliate, Pekin Life Insurance Company, participate in a trusteed non-contributory defined benefit pension plan. The Company has no legal obligation for benefits under this plan. This plan covers fulltime employees who have completed one year of service and have reached the age of 21. Effective January 1, 2013, the Company adopted Amendment No. 2 to freeze participation in the Plan for employees hired or rehired on or after January 1, As described in Note 2, the Company and its parent maintain a reinsurance pooling agreement under which certain income and expenses are prorated to the Association (80%) and to the Company (20%). The Company s allocated pension cost based on the reinsurance pooling agreement amounted to $742,814 in 2012 and $747,493 in Pursuant to a retirement plan for Directors elected prior to 2004, eligible Directors will receive a retirement benefit equal to the annual retainer in effect on the Directors retirement date. The benefits paid were $58,300 in 2012 and The liability for the Directors retirement benefit is $316,870 and $311,134 at December 31, 2012 and 2011, respectively. 401(k) Savings Plan The Company and its affiliates participate in a voluntary 401(k) savings plan for eligible participants. New full-time employees are automatically enrolled in the Plan with instant entry after approximately 30 days of employment. The Company may elect, at its sole discretion, to contribute a matching contribution to the savings plan. The Company elected to match 25 percent of each employee s contributions up to a maximum match of $400 in 2012 and Employer contributions of $31,426 and $30,367 respectively, were made to this plan in 2012 and Employees hired or rehired on or after January 1, 2013, may receive, at the discretion of the Company, a contribution from the Company based on a percentage of eligible earnings and a Company match of the employee s percentage of contribution. For 2013, the Company will contribute 3.5 percent of an employee s eligible earnings and a 75.0 percent Company match of the employee s percentage of contribution not to exceed 6.0 percent. Post-Retirement Benefits In addition to providing pension benefits, the Company and its affiliates provide certain health care and life insurance benefits (post-retirement benefits) for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. Net post-retirement benefit cost for the years ended December 31, 2012 and 2011, was $469,200 and $620,919, respectively, and includes the expected cost of such benefits for newly-eligible or vested employees, interest cost, and gains and losses arising from differences between actuarial assumptions and actual experience, and amortization of the transition obligation. Deferred Compensation The Company maintains a deferred compensation plan for its Directors. This plan allows for voluntary deferral of all or any part of compensation to which a Director might otherwise be entitled to as Directors fees, in accordance with the plan provisions. During 2012 and 2011 Directors fees of $9,000 were deferred. The liability for Directors deferred compensation was $185,701 and $180,895 at December 31, 2012 and 2011, respectively. -16-

19 Notes to Financial Statements Statutory Basis 8. Income Taxes Current law governing the taxation of property and casualty insurance companies requires substantial adjustments to statutory net income in arriving at taxable income. The statutory federal income tax rate is 35 percent in 2012 and 34 percent in The effective tax rate differs from the statutory federal income tax rate due to the following differences between statutory and tax valuations of assets and liabilities: Federal Income Tax, at Expected Rates $ 3,362,267 $ 189,343 Tax Exempt Interest (515,206) (520,170) Capital Gains, Book vs. Taxable (1,325,861) (531,011) Dividends Received Deduction (61,189) (66,944) Adjustment for Prior Year (Over) Under Accrual 341,178 (1,435,705) Unearned Premium 318, ,307 Loss Reserve Discounting (297,606) 74,800 Salvage and Subrogation 3,360 1,353 Pension Benefits 179,033 84,381 Alternative Minimum Tax - 423,557 Other (46,406) 102,354 Federal Income Tax Expense (Benefit) $ 1,957,596 $ (1,411,735) -17-

20 Notes to Financial Statements Statutory Basis The components of the net deferred tax asset at December 31, 2012 and 2011 are as follows: 2012 Ordinary Capital Total Gross Deferred Tax Assets $ 6,169,649 $ 1,267,686 $ 7,437,335 Statutory Valuation Allowance Adjusted Gross Deferred Tax Assets 6,169,649 1,267,686 7,437,335 Deferred Tax Assets Nonadmitted Subtotal Net Admitted Deferred Tax Asset 6,169,649 1,267,686 7,437,335 Deferred Tax Liabilities 52,142 1,219,309 1,271,451 Net Admitted Deferred Tax Assets $ 6,117,507 $ 48,377 $ 6,165, Ordinary Capital Total Gross Deferred Tax Assets $ 5,682,270 $ 2,522,432 $ 8,204,702 Statutory Valuation Allowance Adjusted Gross Deferred Tax Assets 5,682,270 2,522,432 8,204,702 Deferred Tax Assets Nonadmitted Subtotal Net Admitted Deferred Tax Asset 5,682,270 2,522,432 8,204,702 Deferred Tax Liabilities 118,741 1,639,463 1,758,204 Net Admitted Deferred Tax Assets $ 5,563,529 $ 882,969 $ 6,446,498 Change Ordinary Capital Total Gross Deferred Tax Assets $ 487,379 $ (1,254,746) $ (767,367) Statutory Valuation Allowance Adjusted Gross Deferred Tax Assets 487,379 (1,254,746) (767,367) Deferred Tax Assets Nonadmitted Subtotal Net Admitted Deferred Tax Asset 487,379 (1,254,746) (767,367) Deferred Tax Liabilities (66,599) (420,154) (486,753) Net Admitted Deferred Tax Assets $ 553,978 $ (834,592) $ (280,614) -18-

21 Notes to Financial Statements Statutory Basis The net admitted deferred tax asset was determined using the guidance related to admissibility provided in the following paragraphs of NAIC Statement of Statutory Accounting Principles No. 101 (SSAP 101). SSAP 101 was adopted by the Company effective January 1, Ordinary Capital Total Admissible Under Paragraph: 11a. Ability to Recover Taxes Paid in Prior Years $ 1,626,166 $ - $ 1,626,166 11b. Expected to be Realized, After Application of Threshold Limitations 4,539,718-4,539,718 11c. Offset of Deferred Tax Liabilities 3,765 1,267,686 1,271,451 Total Admitted Deferred Tax Assets $ 6,169,649 $ 1,267,686 $ 7,437, Ordinary Capital Total Admissible Under Paragraph: 11a. Ability to Recover Taxes Paid in Prior Years $ 2,359,441 $ - $ 2,359,441 11b. Expected to be Realized, After Application of Threshold Limitations * 3,204,088 2,522,432 5,726,520 11c. Offset of Deferred Tax Liabilities 118, ,741 Total Admitted Deferred Tax Assets $ 5,682,270 $ 2,522,432 $ 8,204,702 Change Ordinary Capital Total Admissible Under Paragraph: 11a. Ability to Recover Taxes Paid in Prior Years $ (733,275) $ - $ (733,275) 11b. Expected to be Realized, After Application of Threshold Limitations $ 1,335,630 $ (2,522,432) $ (1,186,802) 11c. Offset of Deferred Tax Liabilities $ (114,976) $ 1,267,686 $ 1,152,710 Total Admitted Deferred Tax Assets $ 487,379 $ (1,254,746) $ (767,367) *Amounts recognized for December 31, 2011, follow SSAP 10R, which was effective prior to January 1, Ratio used to determine recovery period and threshold limitation amount under paragraph 11b 1292% N/A Amount of Adjusted Capital and Surplus used to determine recovery period and threshold limitation under paragraph 11b $105,877,935 N/A -19-

22 Notes to Financial Statements Statutory Basis The major components of current income taxes incurred and net deferred tax assets as of December 31, 2012 and 2011, are as follows: Change Current Income Tax Federal $ 1,626,166 $ (399,587) $ 2,025,753 Prior Year Under (Over) Accrual of Tax Reserves 331,430 (271,338) 602,768 Conditional Tax Reserve - (760,000) 760,000 Alternative Minimum Tax - 423,557 (423,557) Refund related to carryback of 2011 NOL - (404,367) 404,367 Federal Income Tax Expense $ 1,957,596 $ (1,411,735) $ 3,369,331 Deferred Tax Assets: Ordinary Discounting of unpaid losses $ 1,620,586 $ 1,908,216 $ (287,630) Unearned premium reserve 3,405,488 3,030, ,465 Compensation and benefits accrual 688, , ,234 Postretirement accrual 438, ,110 31,093 Other 17,260 80,043 (62,783) Total Ordinary Deferred Tax Assets 6,169,649 5,682, ,379 Statutory Valuation Allowance Adjustment Non-admitted Admitted Ordinary Deferred Tax Assets 6,169,649 5,682, ,379 Capital: Investments $ - $ - $ - Net capital loss carry-forward 1,267,686 2,522,432 (1,254,746) Total Capital Deferred Tax Assets 1,267,686 2,522,432 (1,254,746) Statutory Valuation Allowance Adjustment Non-admitted Admitted Capital Deferred Tax Assets 1,267,686 2,522,432 (1,254,746) Admitted Deferred Tax Assets $ 7,437,335 $ 8,204,702 $ (767,367) Deferred Tax Liabilities: Ordinary Other $ 52,142 $ 118,741 $ (66,599) Total Ordinary Deferred Tax Liabilities 52, ,741 (66,599) Capital Unrealized Capital Gains $ 1,219,309 $ 1,639,463 $ (420,154) Total Capital Deferred Tax Liabilities 1,219,309 1,639,463 (420,154) Total Deferred Tax Liabilities $ 1,271,451 $ 1,758,204 $ (486,753) Net Deferred Tax Assets $ 6,165,884 $ 6,446,498 $ (280,614) The Company has no tax planning strategies that had a material impact on adjusted gross and net admitted deferred tax assets. Federal income tax incurred of $1,957,596 includes tax of $0-20-

23 Notes to Financial Statements Statutory Basis on realized capital gains. At December 31, 2012, the Company had no net operating loss carryforwards. Federal income taxes which would be available for recoupment in the event of future tax losses are $1,626,166 and $0 for 2012 and 2011, respectively. There are capital losses of $3,728,488 available to be carried forward to offset future capital gains, which will expire over the next two years if unused. Federal income tax returns of the Company have been examined by the Internal Revenue Service for all years through In the opinion of management, the liability for federal income taxes is sufficient to cover computed taxes for the current and prior years that are currently payable. A state income tax benefit incurred of $256,669 and $232,103 in 2012 and 2011, respectively, are included in underwriting expenses. As of December 31, 2012, the Company has not identified any material loss contingencies arising from uncertain tax positions. 9. Structured Settlements The Company has purchased annuities of which the claimant is payee, but for which the Company is contingently liable. The aggregate amount of annuities from all life insurers was $1,601,737 and $1,616,565 at December 31, 2012 and 2011, respectively. 10. Accounting Changes and Corrections of Errors In 2011, the Company elected to anticipate salvage and subrogation recoveries as a reduction in the estimate of the liability for losses and loss adjustment expenses. This change in accounting principle was made to conform to the widely accepted industry practice of netting anticipated salvage and subrogation recoverable against the liability for losses and loss adjustment expenses. This recoverable has not been reflected in financial statements prior to Reporting standards require the cumulative effect of this change to be reported on the statutory statement of changes in stockholder s equity as an addition to surplus amounting to $2,808,051 in The change in accounting for anticipated salvage and subrogation recoveries created a deferred tax liability which decreased surplus in 2011 by $52, Capital and Surplus and Dividends The Company is required to maintain minimum capital and surplus as established by the Department. The Company is also subject to Risk-Based Capital (RBC) requirements promulgated by the NAIC and adopted by the Department. The RBC standards establish uniform minimum capital requirements for insurance companies. The RBC formula applies various weighting factors to financial balances or various levels of activities based on the perceived degree of risk. At December 31, 2012, the Company s surplus exceeded the minimum levels required by the Department and RBC standards. The Company s unassigned surplus was increased (reduced) by the following cumulative amounts at December 31, 2012 and 2011, respectively: Net Unrealized Gains (Losses) $ 10,406,202 $ 9,711,

24 SUPPLEMENTAL FINANCIAL INFORMATION

25 Independent Auditor s Report on the Supplementary Information Board of Directors Pekin Insurance Company Pekin, Illinois Our audits were made for the purpose of forming an opinion on the statutory financial statements taken as a whole. The supplementary information is presented for purposes of additional analysis and is not a required part of the statutory financial statements. The supplementary information is the responsibility of management and was derived from, and relates directly to, the underlying accounting and other records used to prepare the financial statements. This information is presented in a format consistent with the Annual Statement filed by the Company with the regulatory authorities. Such information has been subjected to the auditing procedures applied in the audit of the statutory financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the statutory financial statements as a whole. Madison, Wisconsin May 15, 2013 Strohm Ballweg, LLP -22-

26 Summary Investment Schedule December 31, 2012 Gross Investment Holdings Admitted Assets as Reported in the Annual Statement Amount % Amount % 1. Bonds: 1.1 U.S. Treasury Securities $ 2,417, $ 2,417, U.S. Government Agency Obligations: 1.21 Issued by U.S. Government Agencies Issued by U.S. Government Sponsored Agencies Foreign Government (Including Canada, Excluding MBS) 670, , Securities Issued by States, Territories, and Possessions and Political Subdivisions in the U.S.: 1.41 U.S. States and Territories and Possessions General Obligations 7,891, ,891, Political Subdivisions of U.S. States, Territories and Possessions and Political Subdivisions General Obligations 7,585, ,585, Revenue and Assessment Obligations 29,114, ,114, Industrial Development and Similar Obligations Mortgage-Backed Securities (Includes Residential and Commercial MBS): 1.51 Pass-Through Securities: Issued or Guaranteed by GNMA 672, , Issued or Guaranteed by FNMA and FHLMC 28,359, ,359, All Other CMO's and REMIC's Issued by GNMA, FNMA and FHLMC or VA 2,245, ,245, Issued by Non-U.S. Government Issuers and Collateralized by Mortgage-Backed Securities Issued or Guaranteed by Agencies Shown in Line All Other 19,299, ,299, Other Debt Securities (Excluding Short Term): 2.1 Unaffiliated Domestic Securities (Includes Credit Tenant Loans and Hybrid Securities) 87,561, ,561, Unaffiliated Foreign Securities (Including Canada) 25,269, ,269, Affiliated Securities Equity Interests: 3.1 Investments in Mutual Funds Preferred Stocks Publicly Traded Equity Securities (Excl. Preferred Stocks): 3.31 Affiliated Unaffiliated 8,773, ,773, Other Equity Securities 3.41 Affiliated 9,481, ,481, Unaffiliated 880, , Tangible Personal Property Under Lease 4. Mortgage Loans Real Estate Investments 6. C ontract Loans Derivatives Receivable for Securities Securities Lending Reinvested Collateral Assets 20,040, ,040, Cash and Short-Term Investments 1,782, ,782, Other Invested Assets Total Invested Assets $ 252,045, $ 252,045, See Independent Auditor s Report on the Supplementary Information. -23-