SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
[X] Quarterly report pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934 for the quarterly period
ended September 30, 1998 or
[ ] Transition report pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934 for the transition period
from ______________ to ____________.
0-16533
(Commission File Number)
Old Guard Group, Inc.
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-2852984
(State of Incorporation) (IRS Employer ID Number)
2929 Lititz Pike, Lancaster, PA 17604
(Address of Principal Executive Offices) (Zip Code)
717-569-5361
(Registrant's Telephone Number)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Number of Shares Outstanding as of October 31, 1998:
Common Stock (No Par Value) 3,968,785
(Title of Class) (Outstanding Shares)
PAGE 1
<PAGE>
OLD GUARD GROUP, INC.
Form 10-Q
For the Quarter Ended September 30, 1998
Contents
Part I - FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 1998 and December 31,
1997 3
Consolidated Statements of Income and
Comprehensive Income for the Three
Months Ended September 30,
1998 and 1997 4
Consolidated Statements of Income and
Comprehensive Income for the Nine
Months Ended September 30, 1998 and
1997 5
Consolidated Statement of Shareholders'
Equity for the Nine Months Ended
September 30, 1998 6
Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 1998
and 1997 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Change in Securities 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of
Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
PAGE 2
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(UNAUDITED)
<TABLE>
<CAPTION>
As of As of
September 30, 1998 December 31, 1997
<S> <C> <C>
ASSETS
Investments:
Fixed income securities
Held to maturity, at amortized cost $ 36,481,692 $ 38,382,722
Available for sale, at fair value 53,671,892 57,237,836
Preferred stocks, available for sale, at fair value 5,319,142 4,626,565
Common stocks, available for sale, at fair value 12,464,330 12,208,318
Other invested assets 6,524,178 5,668,025
Total investments 114,461,234 118,123,466
Cash and cash equivalents 10,036,205 10,214,908
Receivables:
Premiums 9,891,324 7,945,218
Reinsurance 11,680,969 10,767,770
Investment income 1,184,128 1,236,186
Affiliates 1,532,052 1,093,062
Prepaid reinsurance premiums 2,139,203 6,285,844
Deferred policy acquisition costs 9,592,340 7,318,767
Deferred income taxes 758,756 262,750
Property and equipment 15,214,382 10,112,212
Goodwill 730,665 772,023
Other assets 3,632,436 1,266,509
Total assets $180,853,694 $175,398,715
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Losses and loss adjustment expenses 47,868,012 48,718,666
Unearned premiums 41,613,869 36,535,108
Accrued expenses 3,900,051 2,541,896
Capital lease obligations - 796,558
Long-term debt 3,461,111 -
ESOP liability 3,621,012 3,840,566
Other liabilities 2,366,476 3,662,423
Total liabilities 102,830,531 96,095,217
Minority Interest 699,886 649,125
Shareholders' Equity:
Preferred stock (5,000,000 shares authorized; 0 issued
and outstanding) - -
Common Stock (15,000,000 shares authorized; 4,247,417
and 4,204,910 shares issued; 4,032,585 and
4,084,370 shares outstanding; no par) 38,766,603 38,317,908
Additional paid-in capital 4,336,609 4,787,703
Deferred compensation (5,525,774) (6,277,553)
Retained earnings 40,188,085 40,259,736
Net unrealized investment gains, net of deferred income
taxes 3,267,287 3,856,612
Treasury stock, at cost (214,832 and 120,540 shares) (3,709,533) (2,290,033)
Total shareholders' equity 77,323,277 78,654,373
Total liabilities and shareholders' equity $180,853,694 $175,398,715
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
PAGE 3
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three For the Three
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Revenue:
Net premiums written $22,102,373 $15,856,700
Change in unearned premiums (2,263,023) (479,539)
----------- -----------
Net premiums earned 19,839,350 15,377,161
Investment income, net of expenses 1,302,936 1,560,464
Net realized investment gains (losses) (461,848) 1,052,593
Other revenue 616,858 106,772
----------- -----------
Total revenue 21,297,296 18,096,990
----------- -----------
Expenses:
Losses and loss adjustment expenses incurred 12,514,531 9,597,204
Operating expenses 9,808,831 6,031,650
Stock option compensation - 2,016,931
Interest expense 145,935 154,389
----------- -----------
Total expenses 22,469,297 17,800,174
----------- -----------
Income (loss) before income tax (benefit) and minority interest (1,172,001) 296,816
Income tax expense (benefit) (543,849) 40,802
----------- -----------
Income (loss) before minority interest (628,152) 256,014
Minority interest in earnings (loss) of consolidated subsidiary 7,856 (2,407)
----------- -----------
Net income (loss) (636,008) 258,421
----------- -----------
Other comprehensive income (loss), before tax:
Unrealized holding gains (losses) (2,646,799) 2,362,527
Less: Reclassification adjustment for gains (losses)
included in net income (209,618) 1,052,593
----------- -----------
Other comprehensive income (loss), before tax (2,437,181) 1,309,934
Income tax expense (benefit) related to items of other
comprehensive income (828,642) 395,953
----------- -----------
Other comprehensive income (loss), net of tax (1,608,539) 913,981
----------- -----------
Comprehensive income (loss) $(2,244,547) $ 1,172,402
=========== ===========
Earnings (loss) per share
Basic (0.17) 0.07
Diluted (0.17) 0.07
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
PAGE 4
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(UNAUDITED)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Revenue:
Net premiums written $65,241,517 $50,670,470
Change in unearned premiums (9,225,402) (4,785,536)
----------- -----------
Net premiums earned 56,016,115 45,884,934
Investment income, net of expenses 4,354,760 4,494,461
Net realized investment gains 1,282,351 1,935,680
Other revenue 1,825,071 338,462
----------- -----------
Total revenue 63,478,297 52,653,537
----------- -----------
Expenses:
Losses and loss adjustment expenses incurred 36,329,102 28,528,660
Operating expenses 26,488,876 18,038,457
Stock option compensation - 2,016,931
Interest expense 361,148 450,270
----------- -----------
Total expenses 63,179,126 49,034,318
----------- -----------
Income before income tax (benefit) and minority interest 299,171 3,619,219
Income tax expense (benefit) (43,736) 1,295,516
----------- -----------
Income before minority interest 342,907 2,323,703
Minority interest in earnings of consolidated subsidiary 50,761 12,368
----------- -----------
Net income 292,146 2,311,335
----------- -----------
Other comprehensive income (loss), before tax:
Unrealized holding gains 640,943 4,820,853
Less: Reclassification adjustment for gains included
in net income 1,534,581 1,935,680
----------- -----------
Other comprehensive income (loss), before tax (893,638) 2,885,173
Income tax expense (benefit) related to items of other
comprehensive income (304,313) 929,636
----------- -----------
Other comprehensive income (loss), net of tax (589,325) 1,955,537
----------- -----------
Comprehensive income (loss) $ (297,179) $ 4,266,872
=========== ===========
Earnings per share
Basic 0.08 0.61
Diluted 0.07 0.60
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
PAGE 5
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Shareholders' Equity
For the Nine Months Ended September 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Net
Unrealized
Investment
Additional Gains, Net
Common Stock Paid-In Deferred Retained of Deferred Treasury
Shares Amount Capital Compensation Earnings Income Taxes Stock Total
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1998 4,084,370 $38,317,908 $4,787,703 ($6,277,553) $40,259,736 $3,856,612 ($2,290,033) $78,654,373
Comprehensive income:
Net income $292,146 $292.146
Unrealized gains on
investments, net of
reclassification adjustment ($589,325) ($589,325)
Comprehensive income ($297,179)
Dividends ($.05 per share) ($363,797) ($363,797)
Exercise of common stock options 40,257 402,570 $402,570
Purchase of treasury stock (122,800) ($1,907,219) ($1,907,219)
Reissuance of treasury stock 1,088 476 16,456 $16,932
Stock-based compensation 29,670 46,125 (451,570) 751,779 471,263 $817,597
Balance, September 30, 1998 4,032,585 38,766,603 4,336,609 (5,525,774) $40,188,085 $3,267,287 ($3,709,533) $77,323,277
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statement.
PAGE 6
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(UNAUDITED)
<TABLE>
<CAPTION> For the Nine For the Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 292,146 $ 2,311,335
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 912,841 1,077,766
Net realized investment gains (1,534,581) (1,935,680)
Deferred income tax provision (191,694) 347,607
Non-cash compensation expense 817,597 2,016,931
Other 47,761 235,176
(Increase) decrease in assets:
Receivables (3,246,237) 192,052
Prepaid reinsurance premiums 4,146,641 1,186,225
Deferred policy acquisition costs (2,273,573) (1,025,277)
Other assets (2,365,927) 306,012
Increase (decrease) in liabilities: -
Losses and loss adjustment expenses (850,654) (5,037,042)
Unearned premiums 5,078,761 2,785,636
Accrued expenses 1,358,155 (1,042,491)
Other liabilities 23,398 204,203
----------- -----------
Net cash provided by operating activities 2,214,634 1,622,453
----------- -----------
Cash flows from investing activities:
Cost of purchases of fixed income securities
Held to maturity (9,690,924) -
Available for sale (15,981,005) (39,326,489)
Proceeds from sales of fixed income securities
Available for sale 17,946,190 8,293,481
Proceeds from maturities of fixed income securities
Held to maturity 11,543,645 318,333
Available for sale 3,036,032 9,265,962
Cost of equity securities acquired (5,741,691) (8,153,320)
Proceeds from sales of equity securities 4,433,771 6,677,189
Cost of purchases of other invested assets (1,250,000) (2,640,000)
Proceeds from sales of other invested assets - 588,582
FDIC acquisition, net of cash acquired - (626,175)
Cost of purchases of property and equipment (5,966,497) (3,365,744)
Proceeds from sales of property and equipment 3,000 20,700
----------- -----------
Net cash used by investing activities (1,667,479) (28,947,481)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of stock, net of costs 402,570 33,721,482
Purchase of treasury stock (3,209,632) -
Payment of dividends (363,797) (210,246)
Proceeds from issuance of long-term debt 3,500,000 5,054,770
Repayment of long-term debt (1,054,999) (2,270,399)
----------- -----------
Net cash provided (used) by financing activities (725,858) 36,295,607
----------- -----------
Net increase (decrease) in cash and cash equivalents (178,703) 8,970,579
----------- -----------
Cash and cash equivalents at beginning of period 10,214,908 5,668,369
----------- -----------
Cash and cash equivalents at end of period $10,036,205 $14,638,948
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
PAGE 7
<PAGE>
OLD GUARD GROUP, INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
The consolidated financial statements include the accounts
of Old Guard Group, Inc. (OGGI) and its wholly-owned subsidiaries
(the Group), Old Guard Insurance Company (Old Guard), Old Guard
Fire Insurance Company (Old Guard Fire), First Patriot Insurance
Company (First Patriot), Old Guard Insurance Management Company
(OGIM), 2929 Service Corporation and OGGI's 80% owned subsidiary,
First Delaware Insurance Company (First Delaware).
The Group is a regional insurance holding company that, on
February 11, 1997, completed a subscription offering in which it
raised $38.3 million, net of issuance costs of $3.7 million, in
exchange for 4.2 million shares of no par common stock.
Concurrent with the offering and in accordance with a plan of
conversion, Old Guard, Old Guard Fire and First Patriot
(collectively, the Insurance Companies) were converted from
mutual to stock insurance companies and issued shares of common
stock to the Group in exchange for $16.0 million. As a result of
the conversion, the Insurance Companies are wholly-owned
subsidiaries of the Group.
2. Basis of Presentation
The financial information for the interim periods included
herein is unaudited; however, such information reflects all
adjustments, consisting of normal recurring adjustments, which
are, in the opinion of management, necessary to a fair
presentation of the financial position, results of operations,
and cash flows for the interim periods. The results of
operations for interim periods are not necessarily indicative of
results to be expected for the full year.
<PAGE 8>
These consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes
for the year ended December 31, 1997 included in the Group's 1997
Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
Certain amounts in the 1997 financial statements have been
reclassified to conform with the current year presentation.
3. Earnings Per Share
The following table reconciles the numerator and denominator
used in basic earnings per share to diluted earnings per share
for the nine months ended:
September 30, 1998 September 30, 1997
Net income for
basic and diluted
earnings per share $ 292,146 $2,311,335
Weighted average
common shares -
Basic EPS 3,727,011 3,805,246
Dilutive shares
Treasury stock in
MRP trust 123,288 -
Outstanding stock
options 89,761 17,426
Weighted average common
shares Diluted EPS 3,940,060 3,822,672
4. Supplemental Cash Flow Disclosure
Interest paid for the nine months ended September 30, 1998
and 1997 was $361,148 and $423,261, respectively. Net income
taxes paid for the nine months ended September 30, 1998 and 1997
was $1,480,328 and $706,532, respectively.
<PAGE 9>
5. New Accounting Pronouncements
In June 1997, Statement of Financial Accounting Standards
(SFAS) No. 130, "Comprehensive Income," was issued. SFAS No. 130
establishes standards for the reporting and disclosure of
comprehensive income and its components (revenues, expenses,
gains and losses). SFAS No. 130 requires that all items that are
required to be recognized under accounting standards as
components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 requires that an enterprise
(a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance
of other comprehensive income separately from retained earnings
and additional paid-in capital in the equity section of a
statement of financial position. The effects of adopting SFAS
No. 130 are included in the consolidated financial statements
included herein.
In June 1997, SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," was issued. SFAS No. 131
establishes standards for the way that public business
enterprises report information about operating segments in annual
financial statements and requires that those enterprises report
selected information about operating segments in interim
financial reports issued to shareholders. SFAS No. 131 also
establishes standards for related disclosures about products and
services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997.
The Group is currently in the process of determining the effect
of SFAS No. 131 upon its financial reporting requirements and
will adopt SFAS No. 131 for its year-end 1998 financial
reporting.
In June 1998, SFAS No. 133 was issued. SFAS No. 133
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in
<PAGE 10> other contracts (collectively referred to as
"derivatives") and for hedging activities. SFAS No. 133 requires
that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met,
a derivative may be specifically designated as (i) a hedge of the
exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (ii) a hedge of the
exposure of variable cash flows of a forecasted transaction, or
(iii) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. The accounting for
changes in the fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the
resulting designation. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. While
the Group is presently evaluating the impact of SFAS No. 133, the
adoption of SFAS No. 133 is not expected to have a material
impact on the Group's financial condition or results of
operations.
In December 1997, the Accounting Standards Executive
Committee of the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 97-3, "Accounting
by Insurance and Other Enterprises for Insurance-Related
Assessments." The accounting guidance of this SOP focuses on the
timing of recognition and the measurement of liabilities for
insurance-related assessments. The SOP is effective for fiscal
years beginning after December 15, 1998. The Group believes that
they are in compliance with the provisions of this SOP and no
impact on its financial reporting is expected.
PAGE 11
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Premiums. Gross premiums written increased $2.6 million, or
11.6%, to $25.0 million, and $8.2 million, or 12.2%, to $75.6
million for the three and nine months ended September 30, 1998
compared to the three and nine months ended September 30, 1997.
The primary cause of this increase was the assumption of 100% of
the net premiums of New Castle Insurance Company of Delaware (New
Castle), which for the periods presented was affiliated with the
Group through a management contract. Effective on October 7,
1998, OGGI acquired 100% of the common stock of New Castle.
Assumed premiums from New Castle amounted to $1,647,000 in the
third quarter of 1998 versus $104,000 in 1997 and $7,463,000 for
the first nine months of 1998 versus $608,000 in 1997. Of the
$7,463,000 of premiums assumed from New Castle, $3,015,000 is
attributable to the one time transfer of New Castle's unearned
premium reserve as of January 1, 1998. The remainder of the
increase in gross premiums written is attributable to an increase
in direct written premiums, primarily in workers' compensation
and automobile lines of business.
Premiums ceded to reinsurers decreased $3,656,000, or 55.7%,
to $2,903,000 and $6,576,000, or 39.3%, to $10,169,000 for the
three and nine months ended September 30, 1998 compared to the
three and nine months ended September 30, 1997. The decrease in
premiums ceded was attributable to the cancellation, on a run-off
basis, of the quota share reinsurance agreement effective
January 1, 1998 and a decrease in reinsurance rates, offset by
the cancellation of the surplus reinsurance treaty on January 1,
1997 which resulted in $1,395,000 negative ceded premiums during
the nine months ended September 30, 1997. As a result of the
elimination of the quota share agreement, no premiums are ceded
under the quota share reinsurance treaty in 1998. This compares
to $1,839,000 and $5,970,000 of ceded premiums ceded under this
<PAGE 12> treaty for the three and nine months ended
September 30, 1997, respectively.
Net premiums written increased $6,246,000, or 39.4%, to
$22,102,000, and $14,571,000, or 28.8%, to $65,242,000 for the
three and nine months ended September 30, 1998 compared to the
three and nine months ended September 30, 1997. Net premiums
earned increased $4,462,000, or 29.0%, to $19,839,000, and
$10,131,000, or 22.1%, to $56,016,000 during the three and nine
months ended September 30, 1998 compared to the three and nine
months ended September 30, 1997. The increases in net premiums
written and earned were directly attributable to the effects of
the changes instituted in the Group's reinsurance program and
increases in gross premiums written as previously discussed.
Net Investment Income. Cash and invested assets decreased
$3,841,000 million, or 3.0%, to $124.5 million on September 30,
1998 from $128.3 million on December 31, 1997. This decrease is
primarily a result of additional investments in computer software
and hardware, construction costs associated with the Group's home
office expansion in Lancaster, Pennsylvania and purchases of
treasury stock. For the nine months ended September 30, 1998,
the yield on average cash and invested assets was 4.9% compared
to 5.2% for the comparable period of 1997. As a result of this
decrease in invested assets and yield, net investment income for
the nine months ended September 30, 1998 decreased $140,000 over
the comparable period in 1997.
Net Realized Investment Gains (Losses). Net realized
investment gains (losses) were $(462,000) and $1,282,000 for the
three and nine months ended September 30, 1998, respectively,
compared to $1,053,000 and $1,936,000 for the comparable periods
in 1997. The decrease can be attributed to a pre-tax charge of
$707,000 related to the acquisition of New Castle. OGGI
completed its acquisition of New Castle in early October, 1998
and recognized a loss in September, 1998 as a result of writing
down the carrying value of its surplus note investment in New
<PAGE 13> Castle, forgiveness of interest on the note, and costs
related to the transaction.
Other Revenue. Other revenue increased $510,000, or 478%,
to $617,000, and $1,487,000 or 439%, to $1,825,000 for the three
and nine months ended September 30, 1998 compared to the three
and nine months ended September 30, 1997. The increase is
attributable to the management agreement entered into with New
Castle effective January 1, 1998. Future fees relative to the
management agreement with New Castle will be eliminated in
consolidation since New Castle became a wholly-owned subsidiary
of OGGI effective with its acquisition.
Losses and Loss Adjustment Expenses. Net losses and loss
adjustment expenses incurred increased by $2,917,000, or 30.4%,
to $12,515,000, and $7,800,000, or 27.3%, to $36,329,000 for the
three and nine months ended September 30, 1998 compared to the
three and nine months ended September 30, 1997. The loss and
loss adjustment expense ratio was 63.1% and 64.9% for the three
and nine months ended September 30, 1998, respectively, versus
62.4% and 62.2% for the comparable periods in 1997. The increase
in the loss and loss adjustment expenses can be attributed to
nearly $3,400,000 of losses from tornadoes and severe
thunderstorms during the first week of June 1998 and more losses
being retained by the Group as a result of the termination of the
quota share reinsurance treaty.
Operating Expenses. Operating expenses increased by
$1,760,000, or 21.9%, to $9,809,000 and $6,433,000, or 32.1% to
$26,489,000 for the three and nine months ended September 30,
1998 compared to the three and nine months ended September 30,
1997. The increases are primarily the result of the loss of
commission income because of the unwinding of the quota share
reinsurance agreement in 1998 and additional commission expense
on the assumed business from New Castle offset by a non-recurring
non-cash charge of $2.0 million taken in 1997 under FASB 123
related to the Company's Stock Compensation Plan. <PAGE 14>
Federal Income Tax Expense (Benefit). Federal income tax as
a percentage of pre-tax income was (14.6%) and 35.8% for the nine
months ended September 30, 1998 and 1997, respectively. The
decrease in effective tax rate is primarily attributable to
additional tax exempt interest on the investment portfolio in
1998.
Liquidity and Capital Resources
The principal sources of the Group's cash flow are premiums,
investment income, maturing investments and proceeds from sales
of invested assets. In addition to the need for cash flow to
meet operating expenses, the liquidity requirements of the Group
relate primarily to the payment of losses and loss adjustment
expenses. The short and long-term liquidity requirements of the
Group vary because of the uncertainties regarding the settlement
dates for liabilities for unpaid claims and because of the
potential for large losses, either individually or in the
aggregate.
The Group and its subsidiaries have in place unsecured lines
of credit with a local financial institution under which they may
borrow up to an aggregate of $1.5 million. As of September 30,
1998, no amounts were borrowed against these lines of credit.
Net cash provided by operating activities was $2,215,000 and
$1,622,000 during the first nine months of 1998 and 1997,
respectively. The change in cash flow from operating activities
from 1997 to 1998 is primarily attributable to increases in net
premiums written as a result of growth, increases in assumed
reinsurance from New Castle, and less ceded reinsurance.
In 1998, cash used by investing activities was $1,667,000 as
the Group continued to invest in new computer systems and its
home office expansion. In 1997, cash used for investing
activities was $28.9 million because the Group invested the net
<PAGE 15> proceeds from the subscription offering and made
investments in computer systems.
In 1998, cash used by financing activities was $726,000
resulting from the Group's purchase of treasury stock offset by
mortgage financing obtained on the newly constructed office
building. The $3,500,000 mortgage requires principal payments
over fifteen years and interest floating monthly at LIBOR plus
1.5%. $2,000,000 of the mortgage was converted to a fixed rate
of 7.70% over fifteen years through the use of an interest rate
swap. In 1997, cash provided by financing activities of $36.3
million resulted primarily from the net proceeds from the
subscription offering less repayments of capital leases and other
debt.
The principal source of liquidity for Old Guard Group, Inc.
(OGGI) will be dividend payments and other fees received from its
subsidiaries. OGGI's insurance subsidiaries are restricted by
the insurance laws of the state of domicile as to the amount of
dividends or other distributions they may pay to the OGGI without
the prior approval of the state regulatory authority. Under
Pennsylvania law, the maximum amount that may generally be paid
by an insurance company during any twelve-month period after
notice to, but without prior approval of, the Pennsylvania
Insurance Department, cannot exceed the greater of 10% of the
insurance company's statutory surplus as reported on the most
recent annual statement filed with the Department, or the net
income of the insurance company for the period covered by such
annual statement. However, the Insurance Companies are further
restricted as to the amount of dividends that may be paid to
OGGI. These restrictions do not allow the Insurance Companies to
pay a dividend to OGGI without prior approval of the Pennsylvania
Insurance Department for a 36 month period following the
conversion.
OGGI's Employee Stock Ownership Plan (ESOP) borrowed
$4.1 million from an unaffiliated lender and $100,000 from OGGI
<PAGE 16> to purchase 10% of the common stock issued in the
Conversion. The loans bear an 8.45% interest rate, and will
require the ESOP to make monthly payments of approximately
$50,000 for a term of 10 years. The loans are secured by the
shares of common stock. Shares purchased with such loan proceeds
will be held in a suspense account for allocation among
participants as the loan is repaid. OGGI expects to contribute
sufficient funds as necessary to the ESOP to repay such loan,
plus such other amounts as the OGGI's Board of Directors may
determine at its discretion.
In February 1996, OGIHC and American Technologies, Inc., a
California based software lessor, entered into a lease financing
agreement in connection with the acquisition by the Group of a
new policy processing software system for approximately $2.5
million. The terms of the lease financing agreement provide for
an aggregate lease facility up to $1.5 million. The implied
interest rate under the lease is 9.5%. As of September 30, 1998,
the lease obligation was repaid in full.
Effects of Inflation
The effects of inflation on the Group are implicitly
considered in estimating reserves for unpaid losses and loss
adjustment expenses, and in the premium rate-making process. The
actual effects of inflation on the Group's results of operations
cannot be accurately known until the ultimate settlement of
claims. However, based upon the actual results reported to date,
it is management's opinion that the liability for losses and LAE,
including losses that have been incurred but not yet reported,
make adequate provision for the effects of inflation.
Year 2000 Issue
General
<PAGE 17>
As the year 2000 approaches, concerns arise involving
business interruptions or failures of specific operations
performed by computer chips as a result of date sensitive
information. The problem results because some current
information technology ("IT") systems and non-IT systems with
embedded computer chips are not prepared to recognize the year
change from 1999 to 2000. Absent remediation of non-compliant
systems, there is a substantial risk to the Group of business
interruption or failure. Therefore, it is important to prepare a
contingency plan whereby all effected areas within the Group have
been reviewed.
Y2K Project
The Group developed a Year 2000 Readiness Initiative Program
to identify the enterprise-wide business impact(s) of the arrival
of the year 2000. A plan was developed to ensure all applicable
systems, equipment, vendors and external agents are compliant.
The Group has utilized the recommendations from an outside
consultant as a tool for project management.
In the process of identifying assets affected by the year
2000 problem, a Y2K representative was selected from each
department within the Group. Each representative completed an
inventory of year 2000 affected assets utilized by their
department. The inventory included infrastructure, including
non-IT assets such as elevators and security systems,
applications software, third-party suppliers and customers
(external agents).
The representatives prioritized assets by assigning a
criticality factor. These factors consisted of "fatal,"
"critical," "marginal" and "desirable." "Fatal" is defined as
the asset is necessary for uninterrupted operations of the
Company and will fail or terminate when it is needed due to year
2000 date processing errors. "Critical" is defined as the asset
is necessary for the operation of the Company, and year 2000
<PAGE 18>-related failures will produce an inaccurate or
incorrect result. "Marginal" is defined as the asset is
necessary for the operation of the business, but year 2000-
related failures will cause minor inconveniences, annoyances, or
irritations. "Desirable" is defined as the asset is not
mandatory for operating the business, but would be desirable.
All assets will continue to be evaluated to determine whether
they need to be replaced, repaired or are compliant. The Group
has evaluated the majority of assets and expects all assessment
work to be completed by December 1998.
The Group's most "fatal" asset are older personal computers.
The Company has developed a plan to ensure these systems will be
compliant by the first quarter of 1999. Information regarding
BIOS upgrades and recommendations have been received from the
manufacturers of each of the different computer systems that are
not year 2000 compliant. The software programs identified as not
yet compliant continue to be reviewed and remediation will be
implemented according to manufacturer recommendations. Some of
the computer software programs currently being utilized will be
replaced by compliant systems. Testing of software systems
believed to be compliant is underway and will be completed by the
end of 1998.
Vendors and external agents also have been contacted by
phone and/or letter to request information regarding their Y2K
status. The Company has received some responses to date but all
vendors have not yet responded. Alternative vendors have been
identified for those vendors that do not respond. Therefore,
should they not be compliant, the Company does not expect a
significant impact expected on operations.
In addition, a process also was established for reviewing
new and existing contracts and maintenance agreements for
appropriate Y2K compliance language. This process is projected
to be completed by the end of 1998.
<PAGE 19>
Costs
The Company presently expects that substantially all future
costs associated with year 2000 compliance will be internal and
are estimated to be less than $50,000. Costs incurred to date
have been approximately $150,000.
Contingency Plans
Although the Group expects to confirm its year 2000
compliance in the near future, it has considered contingencies in
case any of its fatal or critical assets, not already confirmed
as compliant, fail year 2000 compliance testing. For such assets
the Group has identified assets that can be used as an
alternative without significant interruptions to service or
operation.
Policy Coverage
Many experts now believe that the Year 2000 problem may have
a material adverse impact on the national and global economy
generally. In addition, it seems likely that if businesses are
materially damaged as a result of Year 2000 problems, at least
some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies.
And, although management has concluded that under a fair reading
of the various policies of insurance issued by it, no coverage
for Year 2000 problems should be considered to exist, it is not
possible to predict whether or to what extent any such coverage
could ultimately be found to exist by courts in the various
jurisdictions. Accordingly, important factors which could cause
actual results to differ materially from those expressed in the
forward looking statements include, but are not limited to, the
inability of the Group to accurately estimate the impact of the
Year 2000 problem on the insurance issued by, or other business
operations of the Group.
<PAGE 20>
Forward-Looking Statements
Certain statements contained in the Management's Discussion
and Analysis of Financial Condition and Results of Operations and
other statements made throughout this report constitute "forward-
looking statements" (as such term is defined in the Private
Securities Litigation Reform Act of 1995). Such forward-looking
statements involve certain assumptions, risks and uncertainties
that could cause actual results to differ materially from those
included in or contemplated by the statements. These
assumptions, risks and uncertainties include, but are not limited
to those associated with factors affecting the property-casualty
insurance industry generally, including price competition, size
and frequency of claims, escalating damage awards, natural
disasters, fluctuations in interest rates and general business
conditions; the Group's dependence on investment income; the
geographic concentration of the Group's business in the Northeast
United States, the adequacy of the Group's liability for losses
and loss adjustment expenses; government regulation of the
insurance industry; the inability of the Company or third parties
to achieve Y2K compliance and the other risks and uncertainties
discussed or indicated in all documents filed by the Group with
the Securities and Exchange Commission. The Group expressly
disclaims any obligation to update any forward-looking statements
as a result of developments occurring after the release of this
report.
PAGE 21
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. In February, 1997, four policyholders, purportedly on
behalf of all policyholders, filed an action against the Group,
the Insurance Companies, and their directors in the United States
District Court for the Eastern District of Pennsylvania.
Plaintiffs seek damages for the loss of their alleged equity
interest in the Insurance Companies as a result of the
conversion, based on numerous theories including breach of
fiduciary duty and civil rights claims. In April 1997,
defendants filed a motion to dismiss for failure to state a cause
of action. The motion to dismiss was granted as to two counts
and denied as to the remaining nine counts. In January 1998,
plaintiffs filed a motion for class certification and in
July 1998, defendants filed a motion for summary judgment, which
motions are currently pending before the Court.
ITEM 2. Change in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders -
None
ITEM 5. Other Information - None
ITEM 6. Exhibits and Reports on Form 8-K
(A.) Exhibit 27 - Financial Data Schedule
(B.) Reports on Form 8-K - None
PAGE 22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
OLD GUARD GROUP, INC.
Date:__________________ __________________________________
Henry J. Straub,
Chief Financial Officer and
Treasurer (principal financial
officer and principal accounting
officer) <PAGE 23>
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