United Fire Group - 10-Q quarterly report FY

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

As of November 4, 2002, 10,037,344 shares of common stock were outstanding.

The terms “United Fire,” “we,” “us,” or “our” refer to United Fire & Casualty Company or United Fire & Casualty Company and its consolidated subsidiaries and affiliate, as the context requires. In the opinion of the management of United Fire, the accompanying unaudited Consolidated Financial Statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position, the results of operations, and cash flows for the periods presented. The results for the interim periods are not necessarily indicative of the results of operations that may be expected for the year. The financial statements contained herein should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2001. The review report of Ernst & Young LLP as of and for the three and nine month periods ended September 30, 2002 accompanies the unaudited Consolidated Financial Statements included in Item 1 of Part I.

We maintain our records in conformity with the accounting practices prescribed or permitted by the insurance departments of the states in which we are domiciled. To the extent that certain of these practices differ from accounting principles generally accepted in the United States, adjustments have been made in order to present the accompanying financial statements on the basis of accounting principles generally accepted in the United States.

To prepare our financial statements in conformity with accounting principles generally accepted in the United States, we make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.

We are a defendant in legal actions arising from normal business activities. Management, after consultation with legal counsel, is of the opinion that any liability resulting from these actions will not have a material impact on our financial position and operating results.

For purposes of reporting cash flows, cash and cash equivalents include cash and non-negotiable certificates of deposit with original maturities of three months or less. Net income taxes paid for the nine-month periods ended September 30, 2002 and 2001 were $5,602,000 and $4,652,000, respectively. We made no significant payments of interest through September 30, 2002 and 2001, other than interest credited to policyholders’ accounts.

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 141, “Business Combinations,” which became effective January 1, 2002. Statement of Financial Accounting Standard No. 141 requires all business combinations initiated after September 30, 2001 to be accounted for using the purchase method. Additionally, Statement of Financial Accounting Standard No. 141 requires an acquired intangible asset, whenever acquired, to be recognized separately from goodwill if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent to do so. Recognized intangible assets (other than those with an indefinite life) must then be amortized over their estimated useful lives. We have evaluated the intangible asset of $7,847,000 established in the purchase of American Indemnity Financial Corporation in 1999 in accordance with Statement of Financial Accounting Standard No.141, and determined that we are subject to the provision of Statement of Financial Accounting Standard No.141 requiring an intangible asset arising out of contractual or other legal rights to be recognized separately from goodwill and amortized over its estimated useful life. Through December 31, 2001, the basis of this intangible asset had been reduced by $3,744,000 as a result of adjustments to the deferred tax valuation allowance established in the acquisition of

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets,” which became effective January 1, 2002. Statement of Financial Accounting Standard No. 142 eliminates the amortization of goodwill over its estimated useful life, but requires goodwill to be subject to at least an annual assessment for impairment by applying a fair-value-based test. Pursuant to the adoption of Statement of Financial Accounting Standard No. 141, we do not have any unamortized goodwill reported at January 1, 2002. The adoption of Statement of Financial Accounting Standard No. 142 had no effect on our Consolidated Financial Statements.

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 143, “Accounting for Asset Retirement Obligations,” which becomes effective for fiscal years beginning after June 15, 2002. Statement of Financial Accounting Standard No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible, long-lived assets and the associated asset retirement costs. We have not yet determined the impact that the adoption of this statement will have on our Consolidated Financial Statements.

In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which becomes effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. Statement of Financial Accounting Standard No. 144 revises and clarifies the existing professional guidance addressing: (a) recognition and measurement of the impairment of long-lived assets to be held and used; (b) the measurement of long-lived assets to be disposed of by sale; and (c) the reporting of discontinued operations and components of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. The adoption of Statement of Financial Accounting Standard No. 144 had no effect on our Consolidated Financial Statements.

In April 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 145, “Rescission of Financial Accounting Standards Board Statements No. 4, 44 and 64, Amendment of Financial Accounting Standards Board Statement No. 13, and Technical Corrections,” which becomes effective for fiscal years beginning after May 15, 2002. The rescission of Statement of Financial Accounting Standard No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and Statement of Financial Accounting Standard No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements,” which had amended Statement of Financial Accounting Standard No. 4, will affect income statement classification of gains and losses from extinguishment of debt. Statement of Financial Accounting Standard No. 4 required material gains and losses from extinguishment of debt to be classified as extraordinary items. Under Statement of Financial Accounting Standard No. 145, extinguishment of debt is now considered a risk management strategy by the reporting enterprise, and the Financial Accounting Standards Board does not believe it should be considered extraordinary under the criteria in Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” unless the debt extinguishment meets the unusual-in-nature and infrequency-of-occurrence criteria in Accounting Principles Board Opinion No. 30. Upon adoption of Statement of Financial Accounting Standard No. 145, we will classify extinguishments of debt, if any, under the criteria in Accounting Principles Board Opinion No. 30. We have not yet determined the impact that our adoption of this statement will have on our Consolidated Financial Statements.

In July 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No.146, “Accounting for Costs Associated with Exit or Disposal Activities.” Statement of Financial Accounting Standard No. 146 supersedes Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Statement of Financial Accounting Standard No. 146 requires that, in certain instances, costs associated with an exit or disposal plan be recognized when incurred rather than at the date of a commitment to an exit or disposal plan. Statement of Financial Accounting Standard No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. We have not yet determined the impact that the adoption of this statement will have on our Consolidated Financial Statements.

In October 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 147, “Acquisitions of Certain Financial Institutions,” which clarifies the accounting treatment for acquisitions of financial institutions. In addition, this Statement amends Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Statement of Financial Accounting Standard No. 147 is effective on October 1, 2002. Our adoption of Statement of Financial Accounting Standard No. 147 will not have a material impact on our Consolidated Financial Statements.

We have two reportable business segments in our operations, property and casualty insurance and life insurance. Our property and casualty insurance segment conducts business from four locations. All four locations are aggregated because they target a similar customer base, market the same products, and use the same marketing strategies. The life insurance segment operates from our home office. Our management evaluates the two segments on both the basis of accounting practices prescribed by our states of domicile and the basis of accounting principles generally accepted in the United States. We analyze results based on a variety of factors, including profitability, expenses and return on equity. The basis we use to determine and analyze segments and to measure segment profit has not changed from that reported in our annual report on Form 10-K for the year ended December 31, 2001. Because all insurance is sold domestically, we allocate no revenue to foreign operations. We report the following analysis on the basis of accounting principles generally accepted in the United States. We have reconciled the analysis to our unaudited Consolidated Financial Statements.

We write covered call options on our equity portfolio to generate additional portfolio income; we do not use these instruments for hedging purposes. We record covered call options at fair value and include them in accrued expenses and other liabilities. We recognize any income or loss associated with covered call options, including changes in the fair value of the covered call options, currently in earnings as a component of realized investment (losses) gains and other income. At September 30, 2002 we had $5,000 in open covered call options.

Our investment portfolio includes trading securities with embedded derivatives, primarily convertible debt and equity instruments. These securities are recorded at fair value. Any income or loss, including the change in the fair value of these trading securities, is recognized currently in earnings as a component of realized investment (losses) gains and other income. At September 30, 2002, our trading security portfolio had a market value of $2,265,000.

Comprehensive income includes all changes in equity during a period except those resulting from investments by shareholders and dividends to shareholders. The primary components of our comprehensive income are net income and net unrealized gains and losses on available-for-sale securities. Comprehensive income was $22,646,000 and $22,894,000 for the nine months ended September 30, 2002 and 2001, respectively. Comprehensive income (loss) was $(286,000) and $10,139,000 for the three months ended September 30, 2002 and 2001, respectively.

During the third quarter of 2001, we presented a claim against an escrow account held for the deferred payment of $1.00 per share to prior shareholders of American Indemnity Financial Corporation, which was acquired by us in August 1999. The amount of this escrow totaled $1,990,000 and is recorded as a part of other assets on our Consolidated Balance Sheet. Representatives of American Indemnity Financial Corporation have responded to our claim. We anticipate further correspondence with American Indemnity Financial Corporation’s stockholder representatives prior to the resolution of the escrow claim.

We compute earnings per share in accordance with Statement of Financial Accounting Standard No. 128, “Earnings per Share”. Accordingly, we compute basic earnings per share by dividing net income or loss available to common shareholders (net income or loss less dividends to preferred shareholders and accretions of preferred stock issuance costs) by the weighted-average number of common shares outstanding during the period. Diluted earnings per share gives effect to all potentially dilutive common shares outstanding during the period. The potentially dilutive shares we consider in our diluted earnings per share calculation relate to our convertible preferred stock outstanding as well as our outstanding stock options.

The dilutive effect of our convertible preferred stock is determined using the if-converted method. Under this method, we add to the denominator of the earnings per share calculation a number determined by multiplying the number of convertible preferred shares by the stated conversion rate. We also add the amount of preferred dividends and accretions back to the numerator of the earnings per share equation due to the assumed conversion of all the convertible preferred stock to common stock. If the effect of the if-converted method is anti-dilutive, the effect on diluted earnings per share of our convertible preferred stock is disregarded. This was the case in our diluted earnings per share calculation for the three and nine month periods ended September 30, 2002.

The dilutive effect of our stock options outstanding is determined using the treasury stock method. Under this method, we assume the exercise of all of the outstanding options whose exercise price is less than the weighted-average fair market value of our stock during the period. This method also assumes that the proceeds from the hypothetical stock option exercises are used to repurchase shares of common stock at the weighted-average fair market value of the stock during the period. The net of the assumed options exercised and assumed common shares repurchased represents the number of potentially dilutive common shares, which we add to the denominator of the earnings per share calculation. The components of basic and diluted earnings per share are displayed in the following table.

On May 6, 2002 we issued 2,760,000 shares of 6.375 percent Convertible Preferred Stock, Series A at $25 per share. In connection with the preferred stock issuance, we collected net proceeds of $64,888,000. The preferred shares are nonvoting. Dividends on the preferred stock are cumulative from the date of original issuance and are payable on March 15, June 15, September 15 and December 15 of each year, beginning on June 15, 2002. Dividends paid and accrued on our preferred stock through September 30, 2002 totaled $1,759,000. The preferred stock has a liquidation preference and redemption price of $25 per share.

Issuance costs in connection with our preferred stock offering totaled $4,112,000. We will accrete these costs over a 12 year period. We will review the accretion period annually to determine if we need to accelerate the accretion.

The preferred stock is convertible at the option of the holder at any time, unless previously redeemed, into shares of common stock at an initial conversion price of $40.26 per share of common stock, which is equivalent to .621 shares of common stock for each share of preferred stock converted. The conversion price is subject to adjustment upon the occurrence of certain events.

We may redeem all or any shares of preferred stock on or after May 15, 2005. The preferred stock will be subject to mandatory redemption on May 15, 2014.

To the Stockholders and Board of Directors of

United Fire & Casualty Company

We have reviewed the accompanying consolidated balance sheet of United Fire & Casualty Company (an Iowa corporation) and subsidiaries as of September 30, 2002, and the related consolidated statement of income for the three-month and nine-month periods ended September 30, 2002, and the consolidated statement of cash flows for the nine-month period ended September 30, 2002. These financial statements are the responsibility of the Company’s management. We did not make a similar review of the consolidated financial statements for the corresponding periods of the prior year (2001).

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing 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 accompanying consolidated financial statements at September 30, 2002, and for the three-month and nine-month periods then ended, for them to be in conformity with accounting principles generally accepted in the United States.

/S/    ERNST & YOUNG LLP

November 4, 2002

Chicago, Illinois

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are not historical facts and that involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. Such forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry in which we operate, management’s beliefs and assumptions made by management. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “continues,” “seeks,” “estimates,” “predicts,” “should,” “could,” “may,” “will continue,” “might” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed in such forward-looking statements. Among the factors that could cause our actual outcomes and results to differ are the following: uncertainties with respect to loss reserving; the occurrence of catastrophic events or other insured or reinsured events with a frequency or severity exceeding our estimates; the actual amount of new and renewal business and demand for our products and services; the competitive environment in which we operate, including price, product and service competition; developments in domestic and global financial markets that could affect our investment portfolio and financing plans; estimates of the financial statement impact of regulatory actions; uncertainties relating to government and regulatory policies; legal developments; changing rates of inflation, interest rates and other economic conditions; the impact of mergers and acquisitions, including our ability to successfully integrate acquired businesses and achieve cost savings; a continuation or worsening of current global economic and political conditions; a continuation of, or a slow recovery from the United States recession; our relationship with our agencies; the valuation of invested assets; the recovery of deferred acquisition costs; or our relationship with our reinsurers. 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. We caution readers not to place undue reliance on these forward-looking statements, which speak only as of their dates. Except as required under the federal securities laws and the rules and regulations of the Securities and Exchange Commission, 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.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our discussion and analysis of our results of operations and financial condition are based upon our condensed Consolidated Financial Statements, which we have prepared in accordance with accounting principles generally accepted in the United States. As we prepare these 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 during the reporting period. We evaluate our estimates on an on-going 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. We believe that our most critical accounting policies are as follows.

We continually monitor the difference between our cost basis and the estimated fair value of our investments. We record an impairment charge when we determine that a decline in value of an investment is deemed to be other-than-temporary. Factors we consider in evaluating whether a decline in value is other-than-temporary include the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery and other factors. Impairment charges on investments are included in net realized gains and losses.

We defer and amortize policy acquisition costs, including commissions, premium taxes and other variable costs incurred in connection with writing our property and casualty lines of business, over the life of the policies written. We assess the recoverability of deferred policy acquisition costs on a quarterly basis. We do not consider anticipated investment income in determining the recoverability of these costs. The loss and loss adjustment expense ratio we use in the recoverability estimate is based primarily on the assumption that the future loss and loss adjustment expense ratio will approximate that of the recent past. Such adjustments are recorded through operations in the period identified. Actual results could differ materially from such estimates, requiring adjustments to deferred policy acquisition costs.

We defer and amortize policy acquisition costs on traditional life insurance policies, with interest, over the anticipated premium-paying period of the related policies in relation to anticipated premium income on those policies.

We use the retrospective deposit method to defer and amortize policy acquisition costs related to investment contracts and universal life contracts sold by our life insurance segment. Under the retrospective deposit method, we amortize acquisition costs in proportion to the present value of expected gross profits from investment, mortality and expense margins and surrender charges. Actual gross profits can vary from our estimates, resulting in increases or decreases in the rate of amortization. We periodically review these estimates and evaluate the recoverability of the deferred acquisition costs asset. When appropriate, we revise our assumptions on the estimated gross profits of these contracts, and we re-estimate and adjust cumulative amortization for our books of business by a cumulative charge or credit to income.

A material adverse deviation in certain critical assumptions, including surrender rates, mortality experience, or investment performance, would negatively affect our reported earnings and stockholders’ equity.

We base reserves for the life insurance segment on applicable Iowa insurance laws. Our life insurance subsidiary’s reserves meet or exceed the minimum statutory requirements. We calculate the reserves reflected in our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States; we base our calculations on our best estimates of mortality and morbidity, persistency, expenses and investment income. Reserves determined for statutory purposes are based upon mortality rates and interest rates specified by state law. All of our reserves are developed and analyzed annually by independent consulting actuaries.

Our most significant estimates relate to our reserves for property and casualty losses and loss adjustment expenses. We establish reserves for the estimated total unpaid cost of losses and loss adjustment expenses for events that have already occurred and for those claims that have been incurred but not reported to us. Our estimate of these reserves is subjective and complex and is based on our estimates about the future payout of claims, which are inherently uncertain. When we establish reserves, we do so based on our knowledge of the circumstances and claim facts. We continually review our reserves, and as experience develops and additional information becomes known, we adjust the reserves. Such adjustments are recorded through operations in the period identified. Because of the high degree of uncertainty involved in establishing reserves, revisions to recorded reserves could have a material impact on our results of operations in the period recognized.

We are required to establish a valuation allowance for the portion of any deferred tax asset that management believes may not be realized. We have recorded a valuation allowance of $8,090,000 for deferred tax assets relating to American Indemnity Financial Corporation NOLs, which can only be used to offset future taxable income of the property and casualty insurance segment.

Premiums earned through September 30, 2002 were $306,787,000 compared to $275,112,000 through September 30, 2001. Three-month premiums earned were $107,333,000 compared to $97,373,000 for the same period of 2001. The nine-month and three-month premium growth was primarily attributable to pricing increases in the property and casualty insurance segment. Investment income, net of expenses, increased by $4,269,000 or 6 percent, compared to the first nine months of 2001, and increased by $1,764,000 or 7 percent, compared to the third quarter of 2001. We attribute investment income growth between quarters to an increase in cash provided by premiums and annuity deposits, which was offset by a decrease in the average investment yield. Proceeds from maturing bonds have been reinvested at lower investment yields during 2002 due to market conditions. Pre-tax net realized investment losses totaled $11,030,000, versus pre-tax net realized investment losses of $139,000 for the first nine months of 2001. For the third quarter of 2002, pre-tax net realized investment losses were $2,942,000, compared to net realized investment losses of $1,637,000 in the third quarter of 2001.

Nine-month net premiums written increased by $38,145,000, or 14 percent, primarily as the result of continued pricing increases. During the third quarter of 2002, we filed for rate increases of as little as 3 percent to as much as 18 percent in various states for our personal lines of business. We filed for commercial lines premium rate increases in various states from 2 to 10 percent. Premium rates already approved for the fourth quarter of 2002 reflect further increases.

The nine-month combined ratio, determined on the basis of accounting principles generally accepted in the United States, was 100 percent in 2002, compared to 107 percent for the same period of 2001. The loss and loss adjustment expense ratio improved to 70 percent, compared to 76 percent through September 30, 2001. The growth in premiums earned contributed to this improvement. In addition, there has been a decrease in catastrophe losses for the three and nine month periods ended September 30, 2002, when compared with the same periods of 2001.

Nine-month pre-tax catastrophe losses, net of reinsurance, totaled $9,136,000, with an after-tax earnings impact of 59 cents per share. Catastrophe losses contributed 3 points to the combined ratio of 100 percent. For the same period of

Pre-tax catastrophe losses for the third quarter of 2002, net of reinsurance, totaled $4,063,000, with an after-tax earnings impact of 26 cents per share. Catastrophe losses contributed 4 points to the quarter’s combined ratio of 105 percent. For the same period of 2001, pre-tax catastrophe losses totaled $9,305,000, with an after-tax earnings impact of 60 cents per share. In the same period for 2001, catastrophe losses added 10 points to the quarter’s combined ratio of 110 percent.

Included in the nine-month and three-month 2002 catastrophe figures are incurred losses and expenses of approximately $500,000 related to Hurricane Isidore, which occurred in the later part of September. We expect our final incurred losses and expenses related to Hurricane Isidore will not exceed $1,000,000.

The nine-month direct pure loss ratio for commercial business was 50 percent through September 30, 2002, compared to 54 percent for the first nine months of 2001.The nine-month personal lines direct pure loss ratio was 69 percent, compared to 85 percent for the same period of 2001. Premiums earned on the personal lines were nearly identical between years, but losses decreased. The 2001 personal lines direct ratio included the impact of claims related to multiple hail storms which occurred in the upper Midwest.

The nine-month expense ratio was 29 percent in 2002, compared to 31 percent for the same period of 2001. The improvement has resulted from relatively steady underwriting expenses, as compared with the growth in premiums written. In addition, our expenses, net of capitalized deferred policy acquisition costs, have decreased between years, primarily in our homeowners line of business.

The life insurance segment’s three-month net operating income was $2,446,000, compared to $2,260,000 for the third quarter of 2001. For both the three-month and nine-month period, growth in investment income was offset by increases in losses incurred and interest on policyholders’ accounts. Net income, including realized investment losses, contributed by the life insurance segment was $1,226,000 for the third quarter of 2002, compared to $860,000 for the third quarter of 2001.

The life insurance segment’s nine-month net operating income was $7,145,000, compared to $6,679,000 for the third quarter of 2001. Net income recorded by the life insurance segment was $945,000, compared to $5,843,000 for the nine months ended September 30, 2001. Net income was negatively impacted by pre-tax investment write-downs of $10,033,000 through September 30, 2002, versus pre-tax investment write-downs of $3,796,000 through the first nine months of 2001.

We recorded consolidated pre-tax investment income of $77,865,000 for the first nine months of 2002, compared with $73,596,000 for the same period in 2001. During the first nine months of 2002, our invested assets grew from $1,560,962,000 to $1,727,443,000.

Pre-tax net realized investment losses totaled $11,030,000, versus pre-tax net realized investment losses of $139,000 for the first nine months of 2001. Our largest investment write-down to date was WorldCom Inc., which we wrote down in the second quarter, resulting in pre-tax charges of $5,537,000. Seven other securities were written down through September 30, 2002, which resulted in an additional pre-tax charge to net income of $5,781,000.

The composition of our investment portfolio at September 30, 2002 is presented in the following table in accordance with accounting principles generally accepted in the United States:

The effective income tax rate through September 30, 2002 was 23 percent, compared to 15 percent for the same period of 2001. This variance is primarily attributable to a reduction of the municipal bond interest deduction we are allowed for tax purposes.

At September 30, 2002, our consolidated total assets were $2,124,299,000 compared to $1,851,839,000 at December 31, 2001. Invested assets, primarily fixed income securities, increased $166,481,000, or 11 percent, from December 31, 2001. This increase was primarily a result of the continued growth in the universal-life and annuity business of our life insurance segment, the cash flows from which totaled $128,637,000 for the nine months ended September 30, 2002. Also included in this growth is an increase of $31,229,000 attributable to changes in the market prices of our securities classified as available-for-sale and other invested assets, both of which are reported at fair value. The unrealized appreciation from these investments is reported net of tax as a separate component of stockholders’ equity.

At September 30, 2002, $1,384,915,000 or 87 percent, of our fixed income security portfolio was classified as available-for-sale, compared to $1,142,614,000, or 83 percent, at December 31, 2001. At September 30, 2002, our portfolio of trading securities was comprised primarily of convertible preferred equities. We did not have securities classified as trading at December 31, 2001. Our remaining fixed income securities are classified as held-to-maturity and are reported at amortized cost.

Our property and casualty insurance segment’s deferred policy acquisition costs asset increased $9,913,000, or 34 percent, to $39,226,000 at September 30, 2002, from the deferred policy acquisition costs asset at December 31, 2001. The growth was attributable primarily to the increase in net premiums written.

One component of our life insurance segment’s estimate of the deferred policy acquisition costs asset related to universal life and annuity business is the impact of unrealized gains and losses resulting from certain available-for-sale securities in our investment portfolio. While deferrable expenses increased by $8,433,000, the unrealized investment component of our life insurance segment’s deferred acquisition costs calculation contributed a decrease of $22,808,000 in the reported deferred acquisition costs asset.

Cash flow and liquidity is primarily derived from operating cash flows. We invest premiums and annuity deposits in assets maturing at regular intervals in order to meet our obligations to pay policy benefits, claims and claim adjusting expenses. Net cash provided by our operating activities was $45,692,000 through the nine months ended September 30, 2002, compared to $17,235,000 through the nine months ended September 30, 2001. The increase in cash provided by operating activities was primarily due to growth in premiums. We also have significant cash flows from sales of investments and scheduled and unscheduled investment security maturities, redemptions and prepayments. These cash flows totaled $142,241,000 through September 30, 2002 and $159,342,000 through September 30, 2001. If our operating and investment cash flows are not sufficient to support our operations, we have the ability to sell short-term investments. We may also borrow up to $20,000,000 on a bank line of credit. Our credit agreement provides for interest to be paid at the lender’s prevailing prime rate, minus one percent. We did not utilize our line of credit during 2002 or 2001.

We invest funds in money market accounts and fixed income securities for our short-term cash needs. At September 30, 2002, our consolidated invested assets included $24,999,000 of short-term investments.

Cash provided by financing activities was $186,565,000 through the first nine months of 2002, compared to $90,737,000 through the first nine months of 2001. Most of this increase resulted from net proceeds of $64,888,000 related to the issuance of 2,760,000 shares of convertible preferred stock on May 6, 2002. Of the net proceeds, $20,000,000 was invested in our life insurance subsidiary. We are planning on investing another $10,000,000 in our life insurance subsidiary before the end of the year. Because of the current unsettled nature of the financial markets, most of the funds are still being held in cash or short-term securities. Other cash provided by financing activities included annuity and universal life deposits, less withdrawals, of $128,637,000 through September 30, 2002, compared to $96,156,000 for the same period of 2001.

Stockholders’ equity increased from $278,988,000 at December 31, 2001 to $294,351,000 at September 30, 2002, an increase of 6 percent. Net income of $17,730,000 increased stockholders’ equity, and unrealized appreciation (net of tax) increased stockholders’ equity by $4,724,000. Decreases to stockholders’ equity included stockholder dividends and preferred stock accretion of $7,319,000. At September 30, 2002, book value was $29.33 per common share, compared to $27.80 per common share at December 31, 2001.

We have exposure to market risk arising from potential losses due to adverse changes in interest rates and market prices. Our primary market risk exposure is changes in interest rates, although we have some exposure to changes in equity prices and limited exposure to foreign currency exchange rates.

The active management of market risk is integral to our operations. We have investment guidelines that define the overall framework for managing our market and other investment risks, including accountability and controls. In addition, we have for each of our subsidiaries 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 rebalancing our existing asset portfolio or by changing the character of future investment purchases.

Covered call options are written from time to time on common stocks that we own. Generally, the calls are written on stocks we view as over-priced relative to their market value. We have not written in-the-money calls at transaction date, but we are not restricted in any way from doing so. The practice of writing covered calls is considered a conservative equity strategy by market analysts.

There have been no material changes in our market risk or market risk factors from that reported in our annual report on Form 10-K for the year ended December 31, 2001.

On May 6, 2002 we issued 2,760,000 shares of 6.375 % Convertible Preferred Stock, Series A. The purchase price was $25 to the public with an underwriting discount of $1.25. We collected $23.75 per share, resulting in proceeds of $64,888,000. Our preferred stock will rank, with respect to dividend rights and rights upon liquidation, senior to our common stock. Our registration statement on Form S-3 was declared effective on May 3, 2002.

1. to increase the amount of our authorized capital stock,

2. to authorize the issuance of preferred stock, and

3. to authorize the Board of Directors to provide for the issuance of the shares of preferred stock in series, to establish from time to time the number of shares to be included in each such series and to fix the preferences, limitations, and relative rights of the series.

Our common shareholders approved the above amendments pursuant to the following vote:

At United Fire’s Annual Stockholders’ Meeting on May 15, 2002, the following proposal was adopted by the margins indicated.

To elect directors to hold office until the next annual stockholders’ meeting or until their respective successors have been elected or appointed.