UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 Commission File Number 0-14243
ALLIED Group, Inc.
(Exact name of registrant as specified in its charter)
Iowa
(State or other jurisdiction of incorporation or organization)
42-0958655
(I.R.S. Employer Identification No.)
701 Fifth Avenue, Des Moines, Iowa 50391-2000
Address of principal executive offices) (Zip Code)
515-280-4211
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, no par value
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
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 and (2) has been subject to such filing requirements for
the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of February 27, 1998 the number of Registrant's Common Stock, no par value,
outstanding was 30,549,214. The aggregate market value of the Common Stock of
the Registrant held by nonaffiliates at February 27, 1998 was $944,868,332.
Documents Incorporated By Reference
The Registrant's definitive proxy statement (1998 Proxy Statement), which will
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1997, is incorporated by reference under Part III.
The index to the exhibits is located on page 76.
This document contains 93 pages.
<PAGE>
2
TABLE OF CONTENTS
Part I
Item 1. Business..........................................................3
Item 2. Properties.......................................................18
Item 3. Legal Proceedings................................................18
Item 4. Submission of Matters to a Vote of Security Holders..............18
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholders' Matters...........................................19
Item 6. Selected Financial Data...........................................20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................21
Item 8. Financial Statements and Supplementary Data.......................29
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................58
Part III
Item 10.Directors and Executive Officers of the Registrant...................59
Item 11.Executive Compensation...............................................59
Item 12.Security Ownership of Certain Beneficial Owners and Management.......59
Item 13.Certain Relationships and Related Transactions.......................59
Part IV
Item 14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....60
Index to Financial Statement Schedules........................................60
Signatures....................................................................75
Index to Exhibits.............................................................76
<PAGE>
3
Part I
Item 1. Business
ALLIED Group, Inc. (the Company) was incorporated in 1971 as an Iowa corporation
and operates as a regional insurance holding company headquartered in Des
Moines, Iowa. The Company and its subsidiaries operate exclusively in the United
States and primarily in the central and western states. At year-end 1997, The
ALLIED Group Employee Stock Ownership Trust owned 24.9% and ALLIED Mutual
Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance
company, controlled 18.2% of the outstanding voting stock of the Company. The
Company has two reportable business segments: property-casualty insurance and
excess & surplus lines insurance. Property-casualty insurance was the most
significant segment in 1997, accounting for 85.7% of consolidated revenues. The
Company's segment information is contained in note 18 of Notes to Consolidated
Financial Statements.
Property-casualty Insurance
The property-casualty segment operates through three subsidiaries: AMCO
Insurance Company (AMCO), ALLIED Property and Casualty Insurance Company (ALLIED
Property and Casualty), and Depositors Insurance Company (Depositors), which
write personal lines (primarily automobile and homeowners) and small commercial
lines. The segment and ALLIED Mutual pool their property-casualty business. See
notes 4 and 6 of Notes to Consolidated Financial Statements and "Business
Relationship with ALLIED Mutual--Pooling Agreement."
A.M. Best has assigned a rating of A+ (Superior) to each of the
property-casualty subsidiaries and to ALLIED Mutual for 1997 with respect to
their financial strength and their ability to meet policyholder and other
contractual obligations based on the review of the pool's 1996 statutory results
and operating performance.
The profitability of the property-casualty segment is affected by many factors,
including, but not limited to, industry price competition, the frequency and
severity of losses incurred in connection with weather-related and other
catastrophic events, the adequacy of prior-year estimates of loss and loss
adjusting expense reserves, insurance laws and regulations, fluctuations in the
financial markets, interest rates, reinsurance costs, and general business and
economic conditions.
The property-casualty segment pursues a strategy of growth in personal lines of
insurance primarily through a system of more than 2,300 independent agencies, a
growing number of which represent the property-casualty subsidiaries on an
exclusive basis for their personal lines of insurance. For the year ended
December 31, 1997, 68.1% of the property-casualty subsidiaries' net earned
premiums were attributable to personal lines of insurance. While the majority of
the revenues are attributable to personal lines, the segment also writes
commercial lines of insurance for small businesses through such agents. Because
the primary focus, and the primary market served by the segment's independent
agency force, is personal lines of insurance and because management perceives
the risks to be greater in commercial lines, the property-casualty segment has
been conservative in the types of commercial risks it underwrites and in the
pricing of the commercial risks. Historically, this has resulted in writing less
commercial business than the segment might otherwise have if a more aggressive
strategy in commercial lines was adopted. It has also resulted in a lower
combined ratio for the commercial lines compared with its core personal lines
business.
The property-casualty segment markets its products through three distribution
systems: independent agencies, exclusive agencies, and direct response
marketing. Generally, AMCO writes, through independent agencies, personal and
commercial property-casualty insurance lines, consisting primarily of private
passenger automobile and homeowners, with lesser emphasis on special multiple
peril, workers' compensation, inland marine, and other miscellaneous lines of
business. ALLIED Property and Casualty generally writes personal lines insurance
products through agents who sell ALLIED Property and Casualty personal lines
exclusively, and Depositors generally writes personal lines through a direct
mail and telemarketing agency, ALLIED Group Insurance Marketing Company, an
affiliate of ALLIED Mutual.
Neither the insurance subsidiaries in the property-casualty segment nor ALLIED
Mutual appoint managing general agents, and each retains all underwriting,
claims, and reinsurance authority. While the insurers provide contractual
binding authority to most agents, such authority is subject to express
limitations on the nature, type, and extent of each risk. With respect to the
<PAGE>
4
ability of the agents to bind the insurers, the insurers have no right to reject
any contracts entered into by the agents even if the agent exceeds the express
limitations; however, such instances occur infrequently and constitute no
material financial risk to the Company.
The pooling agreement provides that ALLIED Mutual, ALLIED Property and Casualty,
and Depositors cede to AMCO (pool administrator) premiums, losses, allocated
loss adjusting expenses, commissions, premium taxes, service charge income, and
dividends to policyholders and assume from AMCO an amount of this pooled
property-casualty business equal to their participation in the pooling
agreement. ALLIED Mutual's crop hail business is not pooled. AMCO pays certain
underwriting expenses, unallocated loss adjusting expenses, and premium
collection expenses for all of the pool participants and receives a fee equal to
a specified percentage of premiums as well as a performance fee based on the
attainment of certain combined ratios from each of the pool participants.
The pooling arrangement provides ALLIED Mutual, ALLIED Property and Casualty,
and Depositors more predictable expense levels by limiting such expenses to a
specified percentage of their premiums. AMCO has opportunities to profit from
the efficient administration of such underwriting, loss adjusting, and premium
collection activities and to provide similar services to nonaffiliated insurance
companies in the future. The property-casualty segment's participation in the
pool was 64% for 1997, 1996, and 1995. As of December 31, 1997, the statutory
capital and surplus of ALLIED Mutual and the Company's property-casualty segment
were $259.6 million and $335.7 million, respectively.
The following table sets forth statutory and generally accepted accounting
principles (GAAP) basis information for the property-casualty subsidiaries for
the years indicated.
<TABLE>
<CAPTION>
At or for the year ended December 31,
------------------------------------------
1997 1996 1995
----------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C>
Reinsurance pool percentage 64% 64% 64%
Net written premiums $ 531,679 $ 488,189 $ 440,838
=========== ========== ==========
Earned premiums $ 514,303 $ 466,211 $ 425,838
Losses and loss adjusting expenses 357,841 335,615 295,583
Underwriting expenses 131,071 124,622 114,511
----------- ---------- ----------
Statutory underwriting gain 25,391 5,974 15,744
GAAP adjustments 1,411 3,965 1,943
----------- ---------- ----------
GAAP underwriting gain 26,802 9,939 17,687
Investment income excluding realized gains 44,258 42,296 39,110
Realized investment gains 97 180 236
Other income 10,718 7,020 6,850
----------- ---------- ----------
Income before income taxes $ 81,875 $ 59,435 $ 63,883
=========== ========== ==========
GAAP combined ratio 94.8 97.9 95.8
Wind and hail losses, net of reinsurance $ 27,886 $ 39,111 $ 28,664
Impact of wind and hail losses on combined ratio 5.4 8.4 6.7
Invested assets $ 845,751 $ 710,629 $ 658,044
Loss and loss adjusting expense reserves, net of reinsurance $ 309,008 $ 297,343 $ 277,819
Statutory capital and surplus $ 335,694 $ 285,854 $ 257,845
</TABLE>
The underwriting experience of the pool is indicated by the statutory combined
ratio, a measure of underwriting profitability which excludes investment income
and income taxes. Generally, a ratio below 100 indicates underwriting
<PAGE>
5
profitability and a ratio exceeding 100 indicates an underwriting loss. The
following table sets forth the net earned premiums and the statutory combined
ratios (after policyholder dividends) by line of insurance business for the
property-casualty segment for the years indicated.
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ -------------------------
Net Statutory Net Statutory Net Statutory
earned combined earned combined earned combined
premiums ratio premiums ratio premiums ratio
----------- --------- ----------- --------- ----------- ---------
Line of business (dollars in thousands)
----------------
<S> <C> <C> <C> <C> <C> <C>
Personal automobile $ 256,398 94.5 $ 229,894 98.9 $ 208,873 96.5
Homeowners 93,833 96.7 81,617 102.4 71,035 99.2
----------- ---------- ----------
Personal lines 350,231 95.1 311,511 99.8 279,908 97.2
----------- ---------- ----------
Commercial automobile 25,991 90.3 25,272 98.8 23,873 95.2
Workers' compensation 23,838 93.6 25,499 76.5 29,443 70.2
Other property and liability 111,812 94.3 101,591 97.3 90,302 100.2
Other lines 2,431 59.7 2,338 45.7 2,312 50.2
----------- ---------- ----------
Commercial lines 164,072 93.1 154,700 93.5 145,930 92.7
----------- ---------- ----------
Total $ 514,303 94.4 $ 466,211 97.7 $ 425,838 95.7
=========== ========== ==========
</TABLE>
The following table sets forth the components of the statutory combined ratio
and wind and hail loss information for the property-casualty segment for the
years indicated.
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1997 1996 1995
---- ----- ----
<S> <C> <C> <C>
Statutory combined ratio
Loss ratio 58.7 62.6 60.1
Loss adjusting expense ratio 10.8 9.4 9.3
Underwriting expense ratio 24.7 25.5 26.0
Dividend ratio 0.2 0.2 0.3
---- ---- ----
Total 94.4 97.7 95.7
==== ==== ====
Impact of wind and hail losses
on the statutory combined ratio
- ---------------------------------
Personal automobile 1.9 3.9 1.8
Homeowners 15.4 23.6 21.7
Personal lines 5.5 9.1 6.8
Commercial lines 5.2 7.1 6.5
Total 5.4 8.4 6.7
</TABLE>
Wind and hail losses are calculated by adding together all claims with a cause
of loss from wind or hail and then deducting the related reinsurance recoveries.
The information provides an indication of how weather-related losses impact the
property-casualty segment's operating results for the years presented. Losses
not resulting from either wind or hail are excluded from these calculations.
<PAGE>
6
The following table sets forth premium information and agency counts for the
property-casualty pool (including ALLIED Mutual) for the years indicated.
<TABLE>
<CAPTION>
At or for the year ended December 31,
-----------------------------------------
1997 1996 1995
---------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C>
Direct written premiums by distribution system
Independent agency system $ 562,202 $ 549,598 $ 503,922
Exclusive agency system 263,046 210,648 180,799
Direct response marketing system 33,436 28,437 22,136
---------- ---------- ----------
Total direct written premiums,
excluding crop hail premiums 858,684 788,683 706,857
Crop hail premiums (non-pooled) 7,038 7,049 7,781
---------- ---------- ----------
Total direct written premiums $ 865,722 $ 795,732 $ 714,638
========== ========== ==========
Agency counts
Independent agencies 2,038 2,000 1,968
Exclusive agencies 293 257 192
Net written premiums $ 841,833 $ 773,593 $ 699,608
Net earned premiums $ 814,682 $ 739,251 $ 676,169
</TABLE>
The following table sets forth the geographic percentage distribution of
property-casualty pool (including ALLIED Mutual) direct written premiums for the
years indicated.
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
California 23.7% 24.5% 24.0%
Iowa 21.4 21.7 23.3
Kansas 8.0 8.1 8.4
Nebraska 7.4 7.4 7.9
Minnesota 7.1 7.3 7.6
Missouri 5.1 4.8 4.8
Illinois 3.7 3.5 3.1
Colorado 3.6 3.6 3.6
Utah 3.0 2.9 2.5
Tennessee 3.1 2.7 2.4
Washington 2.5 2.3 2.1
Other * 11.4 11.2 10.3
----- ----- -----
100.0% 100.0% 100.0%
===== ====== ======
*Includes all other states, none of which accounted for more than 2% in 1997.
</TABLE>
Excess & Surplus Lines
Western Heritage Insurance Company (Western Heritage) is an excess & surplus
lines insurance subsidiary, which primarily underwrites commercial lines. A.M.
Best has assigned a rating of A- (Excellent) to Western Heritage for 1997 based
on the review of their 1996 statutory results and operating performance.
For 1997, Western Heritage's net earned premiums were 58.1% specialty commercial
casualty, 9.5% commercial property, 29.3% commercial transportation, and 3.1%
personal lines coverages. Specialty commercial casualty lines include general
liability, multiple peril, and product liability coverages for special events,
such as concerts, fairs, exhibitions, and parades as well as coverages for
merchants and artisan contractors. Specialty commercial property lines include
coverages for buildings that are older, in higher risk locations, or vacant;
<PAGE>
7
agricultural and contractor equipment; and protection against vandalism.
Commercial transportation coverages include liability, physical damage, and
garagekeepers insurance written for used car dealers and repair shops. The
personal lines consist primarily of basic property coverages for dwellings.
Western Heritage agents are accorded contractual binding authority for risks
which meet the insurer's written underwriting guidelines and rules. Western
Heritage appoints no managing general agents, however, and retains all
underwriting, claims, and reinsurance authority. With respect to the ability of
the agents to bind Western Heritage, Western Heritage has no right to reject any
contracts entered into by the agents even if the agent exceeds the express
limitations; however, such instances occur infrequently and constitute no
material financial risk to the Company.
The following table sets forth statutory and GAAP basis information for the
excess & surplus lines segment for the years indicated.
<TABLE>
<CAPTION>
At or for the year ended December 31,
--------------------------------------------
1997 1996 1995
----------- ----------- -----------
(dollars in thousands)
<S> <C> <C> <C>
Net written premiums $ 34,056 $ 28,417 $ 30,606
=========== =========== ===========
Earned premiums $ 33,294 $ 27,314 $ 29,661
Losses and loss adjusting expenses 20,369 17,484 22,357
Underwriting expenses 9,884 8,106 8,202
----------- ----------- -----------
Statutory underwriting gain (loss) 3,041 1,724 (898)
GAAP adjustments 169 86 43
----------- ----------- -----------
GAAP underwriting gain (loss) 3,210 1,810 (855)
Investment income excluding realized gains 6,803 6,241 5,830
Realized investment gains (losses) (4) 2 (135)
----------- ----------- -----------
Income before income taxes $ 10,009 $ 8,053 $ 4,840
=========== =========== ===========
GAAP combined ratio 90.4 93.4 102.9
Invested assets $ 113,521 $ 104,403 $ 96,435
Loss and loss adjusting expense reserves, net of reinsurance $ 50,984 $ 49,319 $ 47,120
Statutory capital and surplus $ 40,501 $ 33,478 $ 27,770
</TABLE>
The following table sets forth the net earned premiums and statutory combined
ratios of the commercial casualty, commercial property, commercial
transportation, and personal lines written by Western Heritage for the years
indicated.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ -----------------------
Net Statutory Net Statutory Net Statutory
earned combined earned combined earned combined
premiums ratio premiums ratio premiums ratio
----------- --------- ----------- --------- ----------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Commercial casualty $ 19,329 88.6 $ 17,508 92.1 $ 22,031 103.9
Commercial property 3,158 95.6 2,513 70.2 2,676 91.2
Commercial transportation 9,768 91.9 6,538 103.7 4,254 98.6
Personal lines 1,039 86.0 755 86.9 700 115.1
----------- ----------- -----------
Total $ 33,294 90.2 $ 27,314 92.5 $ 29,661 102.2
=========== =========== ===========
</TABLE>
<PAGE>
8
The following table sets forth the geographic percentage distribution of excess
& surplus lines direct written premiums for the years indicated.
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Texas 21.3% 25.0% 23.3%
California 8.6 8.0 8.8
Illinois 7.8 8.6 9.9
Florida 6.0 5.5 7.2
Alabama 4.5 3.9 3.1
Connecticut 4.2 2.8 0.6
Louisiana 3.8 3.2 3.0
Missouri 3.7 3.9 3.0
Oklahoma 3.1 4.0 4.3
Colorado 2.7 2.9 2.8
Hawaii 2.5 3.0 3.7
Ohio 2.4 2.7 2.9
Washington 2.3 1.8 1.8
Indiana 2.1 2.0 1.9
Mississippi 2.1 2.9 2.6
Michigan 2.0 1.7 1.4
Other* 20.9 18.1 19.7
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
*Includes all other states, none of which accounted for more than 2% in 1997.
</TABLE>
Reinsurance
The insurance subsidiaries follow the industry practice of reinsuring a portion
of their insured risks, paying to the reinsurer a portion of the premiums
received on all policies. Insurance is ceded principally to reduce the net
liability on individual risks and to protect against catastrophic losses. The
subsidiaries monitor the availability of replacement coverages in the
reinsurance market, and believe that replacement coverages from financially
responsible reinsurers is available and accordingly do not deem existing
reinsurance arrangements to be material.
The basic reinsurance treaties benefiting the parties to the pooling agreement
insure risks in excess of specific amounts. Except for crop-hail reinsurance,
all reinsurance is obtained by the pool participants directly and the pool
administrator does not have any additional or special reinsurance arrangements
other than as a pool participant. The financial stability of each participating
reinsurer is independently monitored by the pool participants and by their
reinsurance intermediaries. See "Business Relationship with ALLIED Mutual Other
Relationships" for the pooled property catastrophe reinsurance agreement with
ALLIED Mutual and a nonaffiliated reinsurance company.
With the exception of Western Heritage, all retentions discussed in this section
are for the entire pool. The property-casualty subsidiaries are allocated a
portion of the stated pool retentions based upon their respective pool
participation percentage.
The parties to the pooling agreement are covered by a property treaty which
provides per risk property reinsurance in excess of a retention of $500,000 to a
maximum limit of $5,000,000 per risk. Such parties are also covered by a
property treaty that provides coverage on a facultative basis in excess of a
retention of $5,000,000 to a maximum limit of $15,000,000.
The pool participants purchase property catastrophe reinsurance from a large
number of reinsurers each of which provides a relatively small percentage of the
total cover. For 1998, the pool liability limit of the cover is 90% of
$120,000,000 with retention of $11,000,000. A reinstatement agreement exists
allowing purchases of reinsurance for an additional catastrophe occurring in the
same year.
<PAGE>
9
The pool's retention for most casualty risks is $375,000, with a reinsurance
limit of $1,000,000 per occurrence. Other treaties provide reinsurance for each
workers' compensation loss over $375,000 and up to $5,000,000. Catastrophe
workers' compensation treaties increase the reinsurance to $35,000,000.
Western Heritage, which is not a participant in the property-casualty pool,
purchased surplus reinsurance on property risks covering 75% of the risk with
limits in excess of $50,000 to a maximum of $1,000,000, which is the largest
property risk insured. Western Heritage also purchased casualty reinsurance
covering 92.5% of the risk in excess of $200,000 to a maximum of $1,000,000, the
largest casualty risk insured. Western Heritage also purchased two layers of
reinsurance, each of which covers $1,000,000 in excess of the underlying layers
for both property and casualty coverages. Each of the layers contain a
reinstallment provision. Western Heritage does not write workers' compensation
or primary auto coverage.
For 1998, Western Heritage's reinsurance program provides for all property and
casualty risks on a loss event basis. The first excess per event contract
provides reinsurance for an event in excess of $300,000 in loss and loss
adjusting expenses up to a maximum of $1 million. The second excess per event
contract provides reinsurance for an event in excess of $1 million in loss and
loss adjusting expenses up to a maximum of $5 million. The largest amount
insured by Western Heritage is $2 million. If limits exceed $1 million, Western
Heritage purchases facultative reinsurance for the limits in excess of $1
million. Also in place is an aggregate stop loss treaty, which provides
reinsurance for 10 percentage points of loss and loss adjusting expenses in
excess of 62.5% of net earned premiums.
Although reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the policies, it does make the assuming
reinsurer liable to the insurer to the extent of the reinsurance ceded. As of
December 31, 1997, the property-casualty subsidiaries had no past due amounts
from reinsurers and Western Heritage had $76,000 in dispute. Historically, the
Company has had no adverse collection experience with its reinsurers.
Losses and Loss Adjusting Expense Reserves
In many cases, several years may elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer, and the insurer's payment of
that loss. To recognize liabilities for unpaid losses, the insurance
subsidiaries establish reserves, which are balance sheet liabilities
representing estimates of future amounts needed to pay claims and related
expenses with respect to insured events which have occurred. The insurance
subsidiaries do not discount loss reserves for financial statement purposes.
When a claim is reported, a case reserve for the estimated amount of the
ultimate payment is established. The estimate reflects an informed judgment
based on general corporate reserving practices and the Company's experience and
knowledge regarding the nature and value of the specific type of claim. Reserves
are also established on an aggregate basis to provide for losses incurred but
not yet reported to the insurer and the overall adequacy of case reserves. The
insurance subsidiaries also establish reserves representing the estimated
expenses of settling claims, including legal and other fees and general expenses
of administering the claims adjustment process.
As part of the reserving process, historical data is reviewed and consideration
is given to the anticipated impact of various factors such as known and
anticipated legal developments, changes in social attitudes, inflation, and
economic conditions. This process relies on the basic assumption that past
experience, adjusted for the effect of current developments and likely trends,
is an appropriate basis for predicting future events. Reserve amounts are
necessarily based on management's informed estimates, and as other data becomes
available and is reviewed, these estimates and judgments are revised, resulting
in increases or decreases to existing reserves.
While the methods for setting the reserve structure are well tested, some
assumptions about loss patterns have changed. In particular, recent higher jury
verdicts and judicial decisions which expand coverage to new theories of
liability have increased the demands against the loss and loss adjusting expense
reserves of the insurance subsidiaries. Not only have anticipated claims
increased in severity, but unanticipated claims have risen. In establishing
reserves, management considers exposure the Company may have to environmental
claims. Because reported claim activity levels are minimal and the emphasis of
the Company's property-casualty business is primarily on personal lines and
small commercial business, management believes exposure to material liability on
environmental claims to be remote as of December 31, 1997. Management continues
to monitor legal developments as they relate to the Company's exposure to
environmental claims.
<PAGE>
10
The following table presents the development of losses and loss adjusting
expense reserves for 1987 to 1996 for the pool (which includes ALLIED Mutual)
and Western Heritage. The top line of the table shows the estimated reserve for
losses and loss adjusting expenses at the balance sheet date for each of the
indicated years. These figures represent the estimated amount of losses and loss
adjusting expenses, net of reinsurance recoverables, for claims arising in the
current and all prior years that were unpaid at the balance sheet date,
including losses that had been incurred but not yet reported. The lower portion
of the table shows the re-estimated amount of net reserves as a percentage of
the previously recorded net reserves based on experience as of the end of each
succeeding year. The re-estimated reserves change as more information becomes
known about the frequency and severity of claims for individual years.
<TABLE>
<CAPTION>
At or for the year ended December 31,
------------------------------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for
losses and loss
adjusting
expenses, net $160,152 $210,746 $248,870 $280,443 $312,089 $355,092 $386,936 $424,595 $471,247 $503,638 $522,317
Paid (cumulative)
as of (1)
1 year later 47.5% 41.7% 43.6% 44.2% 43.6% 40.1% 40.8% 39.9% 43.1% 43.2%
2 years later 70.8 64.0 65.8 67.2 66.3 61.9 60.7 61.7 63.4
3 years later 85.8 77.2 79.3 80.4 79.8 72.6 73.2 73.9
4 years later 93.6 84.1 86.3 88.5 86.0 78.8 79.6
5 years later 97.9 87.7 91.5 92.5 89.6 82.8
6 years later 101.0 90.2 94.1 95.2 92.2
7 years later 102.8 92.1 96.0 96.9
8 years later 104.3 93.6 97.4
9 years later 106.0 94.4
10 years later 106.7
Net reserves re-
estimated as of
end of year (1) 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
1 year later 103.6 98.3 100.4 101.0 100.2 97.7 98.3 100.1 100.0 99.7
2 years later 106.3 97.6 99.6 101.1 101.1 96.8 98.9 98.9 99.1
3 years later 106.8 97.3 99.6 102.6 102.4 97.2 97.4 98.1
4 years later 107.1 97.5 101.5 104.6 103.1 96.3 97.4
5 years later 107.8 98.1 103.4 105.7 102.9 96.4
6 years later 108.9 99.3 104.5 105.7 102.8
7 years later 110.5 100.4 104.8 105.6
8 years later 111.8 100.7 104.6
9 years later 112.1 100.2
10 years later 111.9
Net cumulative redundancy (deficiency)
Dollars $(19,031) $ (476) $(11,400) $(15,725) $ (8,637) $ 12,773 $ 10,247 $ 8,230 $ 4,039 $ 1,284
Percentage (11.9)% (0.2)% (4.6)% (5.6)% (2.8)% 3.6% 2.6% 1.9% 0.9% 0.3%
Gross reserves- end of year $373,958 $400,912 $447,311 $492,304 $522,366 $544,696
Reinsurance recoverables 18,866 13,976 22,716 21,057 18,728 22,379
-------- -------- -------- -------- -------- --------
Net reserves- end of year $355,092 $386,936 $424,595 $471,247 $503,638 $522,317
======== ======== ======== ======== ======== ========
Gross re-estimated reserves - latest (2) 99.0% 100.6% 100.0% 100.3% 100.9%
Re-estimated recoverables - latest (2) 148.6% 191.1% 136.0% 126.1% 131.0%
Net re-estimated reserves - latest (2) 96.4% 97.4% 98.1% 99.1% 99.7%
Gross cumulative redundancy (deficiency)
Dollars $ 3,612 $ (2,483) $ 43 $ (1,449) $ (4,518)
Percentage 0.9% (0.6)% 0.0% (0.3)% (0.9)%
(1) Shown as a percentage of reserves for losses and loss adjusting expenses.
(2) Shown as a percentage of gross reserves, reinsurance recoverables and net reserves.
</TABLE>
The cumulative redundancy or deficiency represents the aggregate change in the
estimates over all prior years. It should be emphasized that the table presents
a run-off of balance sheet reserves rather than accident or policy year loss
development. Therefore, each amount in the table includes the effects of changes
in reserves for all prior years.
<PAGE>
11
The following table reconciles the reserves for losses and loss adjusting
expenses from the previous table to the amount shown on the Company's
consolidated balance sheets.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1997 1996
---------- ----------
(in thousands)
<S> <C> <C>
Loss and loss adjusting expense reserves for the property-casualty pool
and Western Heritage $ 522,317 $ 503,638
Less: Loss and loss adjusting expense reserves of ALLIED Mutual 162,324 156,975
---------- ----------
359,993 346,663
Add: Reinsurance recoverables 18,033 15,528
---------- ----------
Loss and loss adjusting expense reserves (GAAP) $ 378,026 $ 362,191
========== ==========
</TABLE>
The next table sets forth a reconciliation of beginning and ending GAAP reserves
for losses and loss adjusting expenses for the years indicated, net of
reinsurance recoverables. The table includes property-casualty and excess &
surplus lines insurance loss and loss adjusting expense reserves. Developments
for losses and loss adjusting expenses on prior years is immaterial to the
Company's consolidated financial statements taken as a whole.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1997 1996 1995
---------- ---------- ----------
(in thousands)
<S> <C> <C> <C>
Net reserves for losses and loss adjusting
expenses at beginning of year $ 346,663 $ 324,939 $ 292,674
---------- ---------- ----------
Incurred losses and loss adjusting expenses
Provision for insured events of current year 379,952 353,675 315,956
(Decrease) increase in provision for
insured events of prior years (1,853) (680) 1,984
---------- ---------- ----------
Total incurred losses and loss adjusting expenses 378,099 352,995 317,940
---------- ---------- ----------
Payments
Losses and loss adjusting expenses
attributable to insured events of current year 216,920 194,735 169,254
Losses and loss adjusting expenses
attributable to insured events of prior years 147,849 136,536 116,421
---------- ---------- ----------
Total payments 364,769 331,271 285,675
---------- ---------- ----------
Net reserves for losses and loss
adjusting expenses at end of year $ 359,993 $ 346,663 $ 324,939
========== ========== ==========
</TABLE>
Noninsurance Operations
ALLIED Group Mortgage Company (ALLIED Mortgage), purchases, originates, and
services single-family residential mortgages. It acquires mortgage servicing
rights from savings and loan associations, banks, other mortgage companies, and
other financial institutions. The market in which ALLIED Mortgage originates
mortgages is primarily Polk County, Iowa, which includes the Des Moines area.
ALLIED Mortgage purchases and services mortgages on a nationwide basis. See
"Business Competition."
ALLIED Mortgage began operations in 1987, and by year-end 1997, its servicing
portfolio included 53,078 mortgages for a total value of $2.9 billion. ALLIED
Mortgage is an approved seller-servicer of mortgages guaranteed by Government
National Mortgage Association, Federal National Mortgage Association, and
<PAGE>
12
Federal Home Loan Mortgage Corporation. See "Business--Regulation." Working
capital requirements are managed through short-term financing with commercial
banks. See note 8 of Notes to Consolidated Financial Statements.
The Company's data processing segment consists of The Freedom Group, Inc.
(Freedom) and its subsidiary ALLIED Group Information Systems, Inc. (AGIS),
which have a line of property-casualty and life insurance software products and
data processing services which are marketed under the name "Freedom Group"
primarily to nonaffiliated insurance companies. Prior to March 1, 1996, AGIS
provided management information services to ALLIED Mutual, ALLIED Life Insurance
Company (ALLIED Life), the Company and other company subsidiaries. These
services included the processing of policies and claims, billing, rating,
statistical and regulatory reporting, and recordkeeping. AGIS also provided
automated systems to the property-casualty segment's agency force. Prior to
March 1, 1996, the majority of the AGIS's revenues and operating profits came
from affiliated companies. See note 4 of Notes to Consolidated Financial
Statements.
Through its direct sales force, AGIS licenses property-casualty insurance
software to property-casualty insurance companies generally on a national basis.
AGIS also provides certain consulting services and software maintenance
services. On a nationwide basis, Freedom licenses statutory accounting insurance
software to property-casualty and life insurance companies on primarily a direct
sales basis.
Investments
The Company uses its investments to generate the majority of its operating
profit and provide liquidity. Investments in fixed maturities are classified as
available for sale. See note 1-"Investments" of Notes to Consolidated Financial
Statements. The Company's invested assets are managed by Conning & Company,
subject to restrictions on permissible investments under applicable state
insurance codes and the Company's investment policies. Those policies require
that the fixed maturity portfolio be invested primarily in debt obligations
rated "BBB" (investment grade) or higher by Standard & Poor's Corporation
(Standard & Poor's) or a recognized equivalent at the time the security is
acquired by the Company. The policy also states that equity securities are to be
of United States and Canadian Corporations listed on established exchanges or
publicly traded in the over-the-counter market. Preferred stocks are to be
comprised primarily of issues rated at least A3/A- by Standard & Poor's
Corporation or Moody's. The Company monitors the investment quality of the fixed
maturity portfolio subsequent to acquisition by reviewing on a quarterly basis
the current debt ratings assigned to each of the securities in the fixed
maturity portfolio.
Fixed income securities comprised 90.1% of the Company's invested assets, 99.7%
of those had a "BBB" rating or higher from Standard & Poor's (or the equivalent
from Moody's) at December 31, 1997. Equity Securities comprised 8.7% of the
invested assets at December 31, 1997. The portfolio contained no real estate or
mortgage loans. At year-end 1997, the Company held $2.7 million of nonrated
securities. Evaluation of the issuers' rating and ratings for the issuers' other
securities supports management's view that the nonrated securities are
investment grade. At December 31, 1997, the fair value of the Company's fixed
maturity portfolio was $26.3 million over amortized cost.
The carrying values of all the Company's investments in fixed maturities are
reviewed for impairment on an ongoing basis. If this review indicates a decline
in fair value below cost is other than temporary, the Company's carrying value
in the investment is reduced to its estimated realizable value and a specific
write-down is taken. Such reductions in carrying value are recognized as
realized losses and charged to income.
<PAGE>
13
The table below shows the classifications of the Company's investments at
December 31, 1997.
<TABLE>
<CAPTION>
Carrying Percent
value of total
---------- --------
<S> <C> <C>
(dollars in thousands)
Fixed maturities
U.S. Government obligations (1) $ 95,312 10.5%
U.S. Government corporations and agencies 117,727 13.0
State municipalities and political subdivisions 400,490 44.1
Public utilities 9,747 1.1
All other corporate bonds 194,940 21.4
---------- -----
Total fixed maturities 818,216 90.1
---------- -----
Equity securities
Common stock
Public utilities 798 0.1
Banks, trusts, and insurance companies 7,534 0.8
Industrial, miscellaneous and all other 28,162 3.1
---------- -----
36,494 4.0
Preferred stock 42,688 4.7
---------- -----
79,182 8.7
Short-term investments at cost 10,846 1.2
---------- -----
$ 908,244 100.0%
========== =====
(1) All such securities are backed by the full faith and credit of the United States Government.
</TABLE>
The following table sets forth the composition of the Company's fixed maturity
investment portfolio by rating at December 31, 1997.
<TABLE>
<CAPTION>
Carrying Percent of
value portfolio
---------- ----------
Rating (1) (dollars in thousands)
---------
<S> <C> <C>
AAA $ 542,556 66.3%
AA 144,456 17.7
A 116,584 14.2
BBB 11,945 1.5
Nonrated 2,675 0.3
---------- -----
Total $ 818,216 100.0%
========== =====
(1) Ratings are assigned primarily by Standard & Poor's with remaining ratings assigned by Moody's and
converted to the equivalent Standard & Poor's ratings.
</TABLE>
The following table sets forth contractual maturities in the fixed maturity
investment portfolio at December 31, 1997. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Carrying Percent of
value portfolio
---------- ----------
Maturity (dollars in thousands)
<S> <C> <C>
One year or less $ 23,499 2.9%
Over 1 year through 5 years 314,202 38.4
Over 5 years through 10 years 276,560 33.8
Over 10 years 42,979 5.2
---------- ------
657,240 80.3
Mortgaged-backed securities 160,976 19.7
---------- ------
Total $ 818,216 100.0%
========== ======
</TABLE>
<PAGE>
14
Investment results of the Company for each year in the three years ended
December 31, 1997 are shown in the following table.
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ---------
(dollars in thousands)
<S> <C> <C> <C>
Average invested assets $ 856,008 $ 784,247 $ 714,720
Investment income (1) 51,124 49,222 47,242
Average annual yield on total investments 6.0% 6.3% 6.6%
Tax equivalent yield on total investments (2) 7.2% 7.4% 7.8%
Realized investment gains $ 391 $ 49 $ 505
(1) Investment income is net of investment expenses and does not include realized investment gains or
losses or provision for income taxes.
(2) Assuming an effective tax rate of 35%.
</TABLE>
Competition
The insurance subsidiaries compete in a highly competitive industry with
numerous insurance companies, many of which are substantially larger and have
considerably greater financial resources. Because the insurance subsidiaries
operate through independent agents and such agents represent more than one
company, they face competition within each agency. The insurance subsidiaries
compete by underwriting criteria, pricing, automation, service, and product
design. The Company believes that its management information systems and
procedures for selecting and rating risks accord it a competitive advantage.
Competition in the excess & surplus lines market stiffened in recent years as
standard market capacity increased and prices decreased. Western Heritage
competes in its chosen market (primarily in the Midwest, West, and South) with
numerous insurers on the basis of service, price, and financial strength.
ALLIED Mortgage, in originating residential mortgages in central Iowa and
servicing residential mortgages nationally, competes through competitive pricing
and service. Nationally, ALLIED Mortgage is a small-sized company servicing
mortgages with remaining principal balances aggregating $2.9 billion at December
31, 1997. The largest competitors service in excess of $214 billion of
mortgages. With greater capital and greater efficiencies, the larger companies
have an advantage in originating and purchasing mortgages to obtain the
servicing rights. ALLIED Mortgage has access to capital due to its association
with the Company and competes in the purchase of servicing on the basis of price
and in mortgage originations on the basis of price and quality of service.
Regulation
The insurance subsidiaries are subject to varying degrees of regulation and
supervision in the jurisdictions in which they transact business under statutes
which delegate regulatory, supervisory, and administrative powers to state
insurance commissioners. Such regulation is designed generally to protect
policyholders rather than investors and relates to such matters as the standards
of solvency which must be met and maintained; the licensing of insurers and
their agents; the nature of and examination of the affairs of insurance
companies, which includes periodic market conduct and financial examinations by
the regulatory authorities; annual and other reports, prepared on a statutory
accounting basis, required to be filed on the financial condition of insurers
for other purposes; establishment and maintenance of reserves for unearned
premiums and losses and loss adjusting expenses; and requirements regarding
numerous other matters. In general, the insurance subsidiaries must file all
rates for insurance directly underwritten with the insurance department of each
state in which they operate; reinsurance generally is not subject to rate
regulation. Further, state insurance statutes typically place limitations on the
amount of dividends or other distributions payable by insurance companies in
order to protect their solvency. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations Regulations".
<PAGE>
15
California has been the source of approximately 25% of the pool's direct written
premiums for the past ten years. Proposition 103, approved by California voters
in 1988, provides for a rollback of rates on premiums collected in calendar year
1989 to the extent that the insurer's return on equity for each Proposition 103
line of business exceeded 10%. The rollback liability, if any has not been
finalized. Management of the Company continues to believe that the insurance
subsidiaries will not be liable for any material rollback of premiums.
The Company is also subject to statutes governing insurance holding company
systems in various jurisdictions. Typically, such statutes require the Company
periodically to file information with the state insurance regulatory authority,
including information concerning its capital structure, ownership, financial
condition and general business operations. Under the terms of applicable state
statutes, any person or entity desiring to acquire more than a specified
percentage (commonly 10%) of the Company's outstanding voting securities is
required first to obtain approval from the applicable state insurance
regulators. Chapter 521A of the Iowa Code relating to holding companies, to
which the Company is subject, requires disclosure of transactions between the
Company and its insurance subsidiaries or between an insurer and another
subsidiary, that such transactions satisfy certain standards, including that
they be fair, equitable, and reasonable and that certain material transactions
be specifically non-disapproved by the Iowa Insurance Division. Further, prior
approval by the Iowa Insurance Division is required of affiliated sales,
purchases, exchanges, loans or extensions of credit, guarantees, or investments,
any of which involve 5% or more of the insurer's admitted assets as of the
preceding December 31st.
Under insolvency or guaranty fund laws in most states in which the insurance
subsidiaries and ALLIED Mutual operate, insurers doing business in those states
can be assessed, up to prescribed limits, for losses incurred by policyholders
as a result of the insolvency of other insurance companies. The amounts and
timing of such assessments are beyond the control of the Company and generally
have an adverse impact on the Company's earnings. Additionally, the insurance
subsidiaries are required to participate in various mandatory pools or
underwriting associations in amounts related to the amount of direct writings in
the applicable state.
Recently, the insurance regulatory framework has received increased scrutiny by
various states, the federal government, and the National Association of
Insurance Commissioners (NAIC). The NAIC has recommended to the states for
adoption and implementation several regulatory initiatives designed to reduce
the risk of insurance company insolvencies. None of these are expected to be
significant to the Company.
ALLIED Mortgage is subject to the rules and regulations of, and examination by,
the United States Department of Housing and Urban Development, Federal National
Mortgage Association (FNMA), and Government National Mortgage Association (GNMA)
with respect to originating, processing, selling, and servicing mortgage loans.
These rules and regulations, among other things, prohibit discrimination,
provide for inspection and appraisals of properties, require credit reports on
prospective borrowers, and sometimes fix maximum interest rates, fees, and loan
amounts. GNMA requires the maintenance of specified amounts of net worth that
vary with the amount of GNMA mortgage-backed securities issued by ALLIED
Mortgage. There are also various state laws affecting mortgage banking
operations.
Relationship with ALLIED Mutual
The Company is operated as a part of the ALLIED Group of insurance companies.
ALLIED Mutual has operated as a mutual property-casualty insurance company since
1929. In 1971, it organized the Company as a wholly owned subsidiary and
transferred to it certain assets, including the stock of AMCO, which had
operated as a subsidiary of ALLIED Mutual since 1959. In 1985, the Company
effected an initial public offering which then resulted in public ownership of
approximately 22% of its common stock. As of December 31, 1997, ALLIED Mutual
controlled 18.2% of the outstanding voting stock of ALLIED.
The operations of the Company are interrelated with the operations of ALLIED
Mutual. The Company and ALLIED Mutual share common executive officers, and three
directors of the Company are also directors of ALLIED Mutual.
For the year ended December 31, 1997, ALLIED Mutual reported, in accordance with
Statutory Accounting Practices, net income of $13.7 million, a statutory
combined ratio of 101.1, and admitted assets and surplus at December 31, 1997 of
$576.2 million and $259.6 million, respectively. As of December 31, 1997, ALLIED
Mutual's invested assets were $520.6 million. Invested assets included a fixed
<PAGE>
16
maturity portfolio of $367.8 million (at amortized cost), of which over 98.5%
was rated "BBB" or higher by Standard & Poor's or a recognized equivalent rating
agency. Invested assets also included $83.7 million in equity investments in
affiliates (which includes the Company, ALLIED Life Financial Corporation
(ALFC), which is a 56.2% owned subsidiary of ALLIED Mutual, and AID Finance
Services, Inc.). ALLIED Mutual files its statutory-basis financial reports with
the state insurance departments in the territories in which it operates.
The Company and ALLIED Mutual formalized their relationship by entering into an
Intercompany Operating Agreement, a Pooling Agreement, and a Stock Rights
Agreement.
Intercompany Operating Agreement
The Company, ALLIED Mutual, ALFC, and each of their respective subsidiaries are
parties to an Intercompany Operating Agreement providing for the sharing of
employees, office space, agency forces, data processing, and other services and
facilities. The Company receives from and pays to ALLIED Mutual and its
subsidiaries fees and cost reimbursements for the employees, services, and
facilities provided. In determining the allocated costs to the companies, each
provider of the various services (e.g., ALLIED Mutual leases office facilities,
the Company leases employees etc.) attempts to set fees on a basis consistent
with that which would apply in an arm's length transaction with nonaffiliates.
However, there can be no assurance that the actual rates charged reflect those
which would be obtained if the Company and ALLIED Mutual were not affiliated and
had agreed upon rates following arm's length negotiation. See "Relationship with
ALLIED Mutual Pooling Agreement" for a further discussion of expense sharing
arrangements between ALLIED Mutual and the Company.
The Company leases to ALLIED Mutual and certain of its subsidiaries all of the
employees utilized in their operations for a fee and reimbursement of personnel
costs based on certain allocation methods. The Company is obligated to provide
the entire requirements for employees of ALLIED Mutual and certain of its
subsidiaries, but ALLIED Mutual reserves the right to hire employees
independently rather than leasing them from the Company. In 1997, 1996, and
1995, ALLIED Mutual and its subsidiaries paid the Company $2.6 million, $2.5
million, and $2.5 million, respectively, for leased employees, substantially all
of which represented cost reimbursement.
The Intercompany Operating Agreement (IOA) also provides for the leasing by
ALLIED Mutual to the Company of substantially all of the office space utilized
by the Company and its subsidiaries. ALLIED Mutual and property-casualty
subsidiaries share agency forces as well as other services and facilities. The
IOA contains a covenant not to compete that binds each of the Company, ALLIED
Mutual, and ALFC not to engage in a business Intercompany Operating Agreement
and five years thereafter. The IOA is in effect to December 31, 2004 and
continues thereafter subject to any party providing two years notice that such
party intends to cease participation. Termination prior to December 31, 2004
requires the Coordinating Committee's approval.
Pooling Agreement
The Pooling Agreement provides that ALLIED Mutual, ALLIED Property and Casualty,
and Depositors cede to AMCO premiums, losses, allocated loss adjusting expenses,
commissions, premium taxes, service charge income, and dividends to
policyholders and assume from AMCO an amount of this pooled property-casualty
business equal to their participation in the Pooling Agreement. ALLIED Mutual's
crop hail business is not pooled. AMCO pays certain underwriting expenses,
unallocated loss adjusting expenses, and premium collection expenses for all of
the pool participants and receives a fee equal to a specified percentage of
premiums as well as a performance fee based on the attainment of certain
combined ratios from each of the pool participants. AMCO charges each of the
other pool participants 12.85% of written premiums for underwriting services,
7.25% of earned premiums for unallocated loss adjusting expenses, and 0.75% of
earned premiums for premium collection services. AMCO received pool
administrative fees of $66.8 million, $61.3 million, and $55.7 million from
ALLIED Mutual in 1997, 1996, and 1995, respectively. In 1997, AMCO also received
a performance fee of $4.2 million from ALLIED Mutual. The administrative fees
are subject to renegotiation during the term of the pooling agreement upon five
years notice.
The pooling agreement provides ALLIED Mutual, ALLIED Property and Casualty, and
Depositors more predictable expense levels by limiting such expenses to a
specified percentage of their premiums. These arrangements give AMCO
opportunities to profit from the efficient administration of such underwriting,
loss settlement, and premium collection activities and to provide similar
services to nonaffiliated insurance companies in the future.
<PAGE>
17
The Pooling Agreement may be terminated by a participant to the agreement on or
after December 31, 2004 upon giving notice at least five years prior to the date
of termination. Termination of the Pooling Agreement prior to December 31, 2004
must be approved by the Coordinating Committee. The Pooling Agreement may also
be terminated or extended by ALLIED Mutual upon the occurrence of certain
events. See "Relationship with ALLIED Mutual--Intercompany Operating Agreement."
In addition, ALLIED Mutual, the Company, and ALFC have certain rights under the
Pooling Agreement and the IOA in the event a nonaffiliated party acquires the
ownership of 50% or more of the voting stock of the Company or ALFC. If such an
event were to occur, ALLIED Mutual, the Company, or ALFC, as the case may be,
have the right to (i) terminate such agreements upon six months notice (ii)
extend the term such agreements for up to ten additional years beyond December
31, 2004, upon six months notice, or (iii) allow such agreements to continue in
effect.
Stock Rights Agreement
The Company and ALLIED Mutual are parties to a Stock Rights Agreement, which
grants certain rights to, and imposes certain restrictions on, ALLIED Mutual in
respect of its holdings of the Company's common and preferred stock.
This Agreement expires in 2005.
Pursuant to the Stock Rights Agreement, ALLIED Mutual is entitled to nominate,
and the Company is required to use its best efforts to cause the election or
retention of, a number of members of the Company's Board of Directors in
proportion to ALLIED Mutual's percentage ownership of the total number of shares
of the Company's voting stock outstanding at the time of nomination. In
addition, the Company is required to elect to its Executive Committee at least
one director who has been nominated by ALLIED Mutual but who is not an officer
or employee of ALLIED Mutual. The Stock Rights Agreement also restricts the
ability of ALLIED Mutual to grant proxies and solicit other shareholders of the
Company. Under the Stock Rights Agreement, ALLIED Mutual is prohibited from
initiating or accepting a tender offer for shares of the Company's common stock
except under certain conditions. The Company has a right of first refusal with
respect to any sale by ALLIED Mutual of the Company's common stock, subject to
certain exceptions, including a distribution of such stock to the public in a
registered public offering or sale pursuant to Rule 144. ALLIED Mutual has
incidental registration rights and three demand registration rights with respect
to the Company's common and 6-3/4% Series preferred stock (6-3/4% Series) it
owns.
The limitations on ALLIED Mutual's ability to initiate, or tender shares, in a
tender offer as well as the limitations on its ability to grant proxies and
solicit other shareholders of the Company terminate upon a consolidation or
merger of the Company with another corporation in which the Company is not the
surviving corporation, a sale of substantially all of its assets, or the
holding, by any person other than ALLIED Mutual, of 50% or more of the voting
securities of the Company then outstanding. The Stock Rights Agreement will be
suspended for as long as ALLIED Mutual holds less than 10% of the outstanding
common stock and 6-3/4% Series stock of the Company.
The Coordinating Committee
Under the IOA, the Company, ALLIED Mutual, and ALFC have formed a Coordinating
Committee comprised of two independent directors of the Company, two directors
of ALLIED Mutual, and two independent directors of ALFC, none of whom serve on
other ALLIED boards. All disputes arising under the IOA as well as other
intercompany agreements are to be submitted to the Coordinating Committee for
resolution. Decisions of this Coordinating Committee must be unanimous and are
binding on the parties. Historically, all issues that have been submitted to the
Coordinating Committee have been resolved by the Committee. The Company
anticipates that any future issues would be similarly resolved. If an issue is
not resolved by the Coordinating Committee, it will be submitted to arbitration.
In such arbitration, each party to the dispute selects one arbitrator, and if
such dispute involves only two parties, such arbitrators select a third
arbitrator.
Other Relationships
Effective January 1, 1997, the Company's property-casualty subsidiaries entered
into a property catastrophe reinsurance agreement with ALLIED Mutual and a
nonaffiliated reinsurer. ALLIED Mutual's participation in the agreement was 90%.
<PAGE>
18
The reinsurance agreement was an aggregate catastrophe program that covers the
property-casualty segment's share of pooled losses up to $30 million in excess
of $20 million in the aggregate for any one quarter or in excess of $50 million
in the aggregate for any one year. See notes 4 and 6 of Notes to Consolidated
Financial Statements for additional information concerning transactions between
the Company and ALLIED Mutual.
Prior to 1997, ALLIED Mutual's and American Re-Insurance Company's respective
participation in the reinsurance agreement were 90% and 10% and covered the
property-casualty segment's share of pooled losses up to $5,000,000 in excess of
$5,000,000. This agreement was canceled effective December 31, 1996.
Employees
At December 31, 1997, the Company was the direct employer of personnel for all
subsidiaries of the Company and of ALLIED Mutual and its subsidiaries other than
ALFC, employing 2,646 persons. None of the Company's employees are members of a
collective bargaining unit. Management believes that its employee relations are
good.
Item 2. Properties
The majority of the real property occupied by the Company and its subsidiaries
are owned or leased by ALLIED Mutual. A portion of the costs of the properties
is paid by the Company. See "Relationship with ALLIED Mutual--Intercompany
Operating Agreement." Management considers the properties to be adequate for its
needs. The primary properties owned by ALLIED Mutual are the home office in Des
Moines, Iowa, a data processing facility and claims center in Urbandale, Iowa,
and regional offices in Denver, Colorado and Lincoln, Nebraska. The Company and
its subsidiaries lease office space in Des Moines and Cedar Rapids, Iowa,
Minneapolis, Minnesota, Lincoln, Nebraska, and Scottsdale, Arizona.
Item 3. Legal Proceedings
The Company is party to various lawsuits arising in the normal course of
business. The Company believes the resolution of these lawsuits will not have a
material adverse effect on its financial condition, results of operations, or
liquidity.
For a description of certain lawsuits pending against the Company, see item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," of this report which is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Securities Holders
During the fourth quarter of 1997 no matters were submitted to a vote of holders
of ALLIED Group, Inc. stock.
<PAGE>
19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholders' Matters
ALLIED Group, Inc.'s common stock traded on The New York Stock Exchange under
the symbol GRP. As of December 31, 1997, there were 1,252 stockholders of
record. The following table shows the high and low market prices and dividends
paid per share for each calendar quarter for the two most recent years. The
prices and dividends per share have been restated for the November 28, 1997
3-for-2 stock split and rounded to the nearest 1/64.
<TABLE>
<CAPTION>
First Second Third Fourth
1997 Quarter Quarter Quarter Quarter
--------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
High $ 25- 3/4 $ 27- 1/2 $ 35-51/64 $ 33-53/64
Low 20- 2/3 22- 5/32 25- 5/32 26- 1/4
Dividends 0.11- 1/3 0.11- 1/3 0.11- 1/3 0.12
First Second Third Fourth
1996 Quarter Quarter Quarter Quarter
--------- ------------ ------------ ------------ ------------
High $ 19- 2/3 $ 19- 1/3 $ 19- 7/32 $ 22- 5/32
Low 15- 9/16 15-49/64 14-57/64 16-57/64
Dividends 0.09- 3/4 0.09- 3/4 0.09- 3/4 0.10
</TABLE>
There are certain regulatory restrictions relating to the payment of dividends
(see Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources). It is the present intention of the
Board of Directors to declare quarterly cash dividends.
<PAGE>
20
Item 6. Selected Financial Data *
<TABLE>
<CAPTION>
At or for the year ended December 31,
-------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data
Premiums earned
Personal $ 350,231 $ 311,511 $ 279,908 $ 252,916 $ 225,594
Commercial 164,072 154,700 145,930 133,816 118,728
----------- ----------- ----------- ----------- -----------
Total property-casualty 514,303 466,211 425,838 386,732 344,322
Excess & Surplus Lines 33,294 27,314 29,661 25,786 24,014
----------- ----------- ----------- ----------- -----------
Total 547,597 493,525 455,499 412,518 368,336
Investment income 51,124 49,222 47,242 41,070 39,030
Realized investment gains 391 49 505 2,888 1,396
Other income 65,570 53,558 49,519 50,888 73,680
----------- ----------- ----------- ----------- -----------
Total revenues 664,682 596,354 552,765 507,364 482,442
Losses and expenses 572,770 525,043 478,917 440,665 425,685
----------- ----------- ----------- ----------- -----------
Income from before income taxes
and minority interest 91,912 71,311 73,848 66,699 56,757
Income taxes 25,973 20,227 21,471 19,074 16,835
----------- ----------- ----------- ----------- -----------
65,939 51,084 52,377 47,625 39,922
Minority interest in net income
of consolidated subsidiary 503 --- --- --- ---
----------- ----------- ----------- ----------- -----------
Net income $ 65,436 $ 51,084 $ 52,377 $ 47,625 $ 39,922
=========== =========== =========== =========== ===========
Diluted earnings per share
Net income $ 2.01 $ 1.51 $ 1.54 $ 1.40 $ 1.17
=========== =========== =========== =========== ===========
Realized investment gain $ .01 $ --- $ .01 $ .06 $ .02
=========== =========== =========== =========== ===========
Balance Sheet Data
Total investments $ 908,244 $ 819,645 $ 772,299 $ 655,906 $ 606,511
Total assets $ 1,201,233 $ 1,077,659 $ 1,010,598 $ 892,751 $ 855,525
Notes payable $ 56,938 $ 34,094 $ 39,465 $ 43,541 $ 82,459
Guarantee of ESOP obligations $ 22,380 $ 24,370 $ 26,270 $ 28,150 $ 29,500
Shares outstanding (in thousands)
Preferred shares 1,827 1,827 4,820 4,981 5,070
Common shares 30,532 20,383 9,445 9,000 9,026
Other Data
Book value per share $ 13.44 $ 11.59 $ 10.77 $ 8.75 $ 7.99
Closing stock price per share $ 28.63 $ 21.75 $ 16.00 $ 11.00 $ 11.67
Property-casualty wind
and hail losses $ .59 $ .82 $ .60 $ .51 $ .40
Dividends paid $ .46 $ .39 $ .30 $ .27 $ .23
Return on average book
value per share 16.3% 13.7% 15.9% 16.8% 16.1%
Pretax investment yield 6.0% 6.3% 6.6% 6.5% 7.1%
Effective tax rate 28.3% 28.4% 29.1% 28.6% 29.7%
Cash dividends to closing
stock price 1.6% 1.8% 1.9% 2.4% 1.9%
Closing stock price to
earnings ratio 14.2 14.4 10.4 7.9 10.0
Property-casualty statutory
combined ratio 94.4 97.7 95.7 97.1 99.3
* Per share data have been restated to retroactively reflect the 3-for-2 stock split issued in 1997.
</TABLE>
<PAGE>
21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Forward-looking Information
The Private Securities Litigation Reform Act of 1995 provides a safe harbor to
encourage companies to provide prospective information so long as it is
identified as forward-looking and accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed. Forward-looking statements are related
to the plans and objectives of management for the future operations, economic
performance, or projections of revenues, income, earnings per share, capital
expenditures, dividends, capital structure, or other financial items. In the
following discussion and elsewhere in this report, statements containing words
such as expect, anticipate, believe, goal, objective, or similar words are
intended to identify forward-looking statements. ALLIED Group, Inc. (the
Company) undertakes no obligation to update such forward-looking statements, and
it wishes to identify important factors that could cause actual results to
differ materially from those projected in the forward-looking statements
contained in the following discussion and elsewhere in this report. The risks
and uncertainties that may affect the operations, performance, development, and
results of the Company's business include but are not limited to the following:
(1) heightened competition, particularly intensified price competition; (2)
adverse state and federal legislation and regulations; (3) changes in interest
rates causing a reduction of investment income; (4) general economic and
business conditions which are less favorable than expected; (5) unanticipated
changes in industry trends; (6) adequacy of loss reserves; (7) catastrophic
events or the occurrence of a significant number of storms and wind and hail
losses; and (8) other risks detailed herein and from time to time in the
Company's other reports.
Overview
The following analysis of the consolidated results of operations and financial
condition of the Company should be read in conjunction with the Selected
Financial Data, Consolidated Financial Statements, and Notes to Consolidated
Financial Statements included elsewhere herein.
The Company, a regional insurance holding company, and its subsidiaries operate
exclusively in the United States and primarily in the central and western
states. The Company's largest segment includes three property-casualty insurance
companies that write personal lines (primarily automobile and homeowners) and
small commercial lines of insurance. The other reportable segment is excess &
surplus lines insurance. The property-casualty insurance segment accounted for
85.7% of consolidated revenues in 1997 and 86.5% in 1996.
At December 31, 1997, The ALLIED Group Employee Stock Ownership Trust (ESOP
Trust) owned 24.9% and ALLIED Mutual Insurance Company (ALLIED Mutual), an
affiliated property-casualty insurance company, controlled 18.2% of the
outstanding voting stock of the Company.
The Board of Directors authorized a 3-for-2 stock split issuable November 28,
1997 to common stockholders of record on November 14, 1997. All fractional
shares were paid in cash. All share and per share amounts included throughout
this report have been restated to reflect the stock split.
On December 31, 1997, the Company adopted Statement of Financial Accounting
Standard 128, "Earnings per Share." The adoption of SFAS 128 changed the way
earnings per share are calculated and required restatement of amounts in prior
periods. All per share amounts included throughout this report have been
restated to reflect the adoption of SFAS 128. See notes 1 and 17 of Notes to
Consolidated Financial Statements for a further discussion of earnings per
share.
The operating results of the property-casualty insurance industry are subject to
significant fluctuations from quarter to quarter and from year to year due to
the effects of the competition on pricing, the frequency and severity of losses
incurred in connection with weather-related and other catastrophic events, the
general economic conditions, and other factors such as changes in tax laws and
the regulatory environment.
<PAGE>
22
1997 Compared with 1996
Consolidated revenues for 1997 were $664.7 million, up 11.5% over the $596.4
million reported for 1996. The increase was primarily due to the 11% growth in
earned premiums and in other income, which rose 22.4%. Other income includes
service charges and other miscellaneous income in the property-casualty segment
and total revenues generated by noninsurance operations.
Income before income taxes increased 28.9% to $91.9 million from $71.3 million
for 1996. The improvement was due primarily to revenue growth and only a slight
increase in losses for the year ended December 31, 1997. Wind and hail losses
decreased 28.7% to $27.9 million from $39.1 million in 1996.
Net income for the year ended December 31, 1997 was up 28.1% to $65.4 million,
raising diluted earnings per share to $2.01 from $1.51 in 1996. Diluted earnings
per share excluding net realized investment gains were $2.00 for 1997 compared
with $1.51. On a diluted basis, the impact of wind and hail losses was $0.59 per
share versus $0.82 in 1996.
Book value per share at December 31, 1997 increased to $13.44 from $11.59 at
year-end 1996. Higher dividend payments and the stock repurchase program had a
dilutive effect on book value during 1997 that was ameliorated by larger
unrealized gains in the investment portfolio. The fair value of investments in
fixed maturities was $26.3 million above amortized cost compared with $17.1
million above amortized cost at December 31, 1996. If investments in fixed
maturities were reported at amortized cost, book value per share at December 31,
1997 would have been $12.88 compared with $11.23 at December 31, 1996.
Property-casualty
Pooled net written premiums (including ALLIED Mutual's) totaled $835.4 million,
an 8.9% increase over 1996 production. Growth in personal lines net written
premiums was 11.2% for 1997. The average premium per policy for personal lines
was up 3.5% to $618 while the policy count grew 6%. Commercial lines premiums
grew by 4.1%. The average premium per policy for commercial lines increased 3.7%
to $1,152, and policy count was up 3%. Earned premiums for the property-casualty
segment were 68.1% personal lines and 31.9% commercial lines in 1997. The
business mix for 1996 was 66.8% personal and 33.2% commercial lines.
Revenues for the property-casualty segment increased 10.4% to $569.4 million
from $515.7 million for 1996. Direct earned premiums for the segment were $568.2
million for 1997 compared with $497.1 million one year earlier. Earned premiums
increased 10.3% to $514.3 million from $466.2 million. The increase resulted
primarily from growth in insurance exposure as well as from a larger average
premium per policy.
Investment income for 1997 was $44.3 million compared with $42.3 million for
1996. The pretax yield on invested assets was 6%, down from 6.3% one year
earlier. Investment income increased due to a larger average balance of invested
assets in 1997, which more than offset the decrease experienced in the pretax
yield. Realized investment gains for 1997 were $96,000 compared with $180,000.
Other income increased to $10.7 million from $7 million in 1996. The 1997 amount
included a $4.2 million performance fee paid by ALLIED Mutual to AMCO as pool
administrator. See note 4 of the Notes to Consolidated Financial Statements for
a discussion of the reinsurance pooling agreement.
Income before income taxes increased 37.8% to $81.9 million from $59.4 million
in 1996. The improvement was due to revenues that increased faster than losses,
which increased only slightly because of lower wind and hail loss experience in
1997. Since 1996 wind and hail experience was the worst on record, the 1997
improvement was anticipated.
The statutory combined ratio (after policyholder dividends) improved to 94.4
from the 97.7 reported in 1996, primarily due to a 2.5-point decrease in the
loss and loss adjusting expense ratio. The Company's underwriting expense ratio
also improved 0.8 points. Wind and hail losses decreased to $27.9 million from
<PAGE>
23
$39.1 million in 1996, which accounted for a 3-point improvement in the loss and
loss adjusting ratio. The impact of wind and hail losses on the statutory
combined ratio was 5.4 points for 1997 and 8.4 points for 1996. The 1997
underwriting gain, on a generally accepted accounting principles basis (GAAP),
rose to $26.8 million from the previous year's $9.9 million.
The personal auto statutory combined ratio decreased to 94.5 from 98.9 for 1996,
reflecting a 3.4-point improvement in the loss and loss adjusting expense ratio.
The statutory combined ratio for the homeowners line was 96.7 compared with
102.4 for 1996. The impact of wind and hail losses on the homeowners combined
ratio was 15.4 points in 1997 and 23.6 points in 1996. Overall, the personal
lines statutory combined ratio improved to 95.1 from 99.8 in 1996. The statutory
combined ratio for commercial lines decreased slightly to 93.1 from 93.5 for the
previous year.
Excess & Surplus Lines
Earned premiums for 1997 increased to $33.3 million from $27.3 million for 1996.
Net written premiums were up 19.8% to $34.1 million from $28.4 million. The
segment's major product lines all experienced increases in net written premiums
due to intensified marketing efforts and the addition of 19 new agencies (a
27.1% increase) over the last 24 months. The segment's 1997 book of business was
comprised of 3.1% personal and 96.9% commercial lines; the 1996 business mix was
2.8% personal and 97.2% commercial lines.
The segment's invested assets rose 8.7% from the previous year-end to $113.5
million at December 31, 1997. Investment income increased 9% to $6.8 million
from $6.2 million because a larger average balance of invested assets more than
offset a 20 basis-point decline in the pretax yield to 6.2% from the previous
year's 6.4%. Realized investment losses were $4,000 compared with gains of
$2,000 for the year ended December 31, 1996.
The statutory combined ratio (after policyholder dividends) was 90.2, which
produced a GAAP underwriting gain of $3.2 million. The statutory combined ratio
of 92.5 for 1996 resulted in a GAAP underwriting gain of $1.8 million. The 1997
growth in earned premiums outpaced the increase in losses and loss adjusting
expenses, resulting in a 2.8-point improvement in the loss and loss adjusting
expense ratio.
Income before income taxes for 1997 increased 24.3% to $10 million from $8.1
million. The increase was primarily due to top line growth.
Noninsurance Operations
Revenues for the noninsurance operations (including mortgage banking, data
processing, and employee leasing to affiliates) after eliminations increased
17.2% to $55.2 million from $47.1 million in 1996. The increase was primarily
due to a 35.4% increased in data processing revenues to $23 million from $17
million. In 1997, outside sales increased $1.8 million and license fees to
nonaffiliates were up $ 4.3 million . On a consolidated basis, revenues from
nonaffiliates for the noninsurance operations are reported as other income.
Income before income taxes was $29,000 for the year ended December 31, 1997
compared with $3.8 million in 1996. The increase in operating costs, primarily
in the data processing operations and the holding company, more than offset the
increase in revenues for the noninsurance operations.
Investments and Investment Income
The investment policy for the Company's insurance segments requires that the
fixed maturity portfolio be invested primarily in debt obligations rated
investment grade (BBB) or higher by Standard & Poor's Corporation or a
recognized equivalent at the time of acquisition. The policy also states that
equity securities are to be of United States and Canadian corporations listed on
established exchanges or publicly traded in the over-the-counter market.
Preferred stocks are to be comprised primarily of issues rated at least A3/A- by
Standard & Poor's Corporation or Moody's. At December 31, 1997, the Company's
investment portfolios consisted almost exclusively of fixed income securities
and equity securities 90.1% and 8.7%, respectively. The ratings on 99.7% of the
fixed income securities were investment grade or higher at December 31, 1997.
The portfolios contained no real estate or mortgage loans at December 31, 1997.
<PAGE>
24
Consolidated invested assets were up 10.8% to $908.2 million from $819.6 million
at year-end 1996. Fixed maturities at amortized cost increased 2.2%.
Consolidated investment income increased 3.9% to $51.1 million from $49.2
million in 1996. The increase was due primarily to a larger average balance of
invested assets. The tax-equivalent yield was down in 1997 to 7.0% compared with
7.2% one year earlier due to lower short- and intermediate-term interest rates
on investments. The aftertax yield for 1997 and 1996 was 4.6% and 4.7%,
respectively.
Income Taxes
The Company's effective income tax rate was down slightly to 28.3% from 28.4%
for 1996. The decrease was the result of the decline in operating results of
subsidiaries that have higher statutory tax rates. Higher 1997 consolidated
operating income increased the income tax expense 28.4% to $26 million.
1996 Compared with 1995
Consolidated revenues for 1996 were $596.4 million, up 7.9% over the $552.8
million reported for 1995. The increase occurred primarily because of the 8.3%
growth in earned premiums.
Income before income taxes decreased 3.4% to $71.3 million from $73.8 million
for 1995. The decrease was due primarily to the highest ever wind and hail
losses for the year ended December 31, 1996. Wind and hail losses increased
36.4% to $39.1 million from $28.7 million in 1995.
Net income for the year ended December 31, 1996 was down 2.5% to $51.1 million,
lowering diluted earnings per share to $1.51 from $1.54 in 1995. Diluted
earnings per share excluding net realized investment gains were $1.51 for 1996
compared with $1.53. On a diluted basis, the impact of wind and hail losses was
$0.82 per share versus $0.60 in 1995.
Book value per share at December 31, 1996 increased to $11.59 from $10.77. The
increase in book value was constrained by higher dividend payments, increased
wind and hail losses, and the stock repurchase program. The fair value of
investments in fixed maturities was $17.1 million above amortized cost compared
with $27.8 million above amortized cost at December 31, 1995. If the investments
in fixed maturities were reported at amortized cost, book value per share at
December 31, 1996 would have been $11.23 compared with $10.20 at December 31,
1995.
Property-casualty
Revenues for the property-casualty segment increased to $515.7 million from $472
million for 1995. Direct earned premiums for the segment were $497.1 million for
1996 compared with $435.2 million for 1995. Earned premiums in 1996 increased
9.5% to $466.2 million from $425.8 million. The increase resulted primarily from
growth in insurance exposure as well as a larger average premium per policy.
Pooled net written premiums (including ALLIED Mutual's) totaled $767.2 million,
a 10.8% increase over 1995 production. The average premium per policy for
personal lines was up 4.6% to $613 while the policy count grew 8.7%. The average
premium per policy for commercial lines increased 2.2% to $1,110, and policy
count was up 4.3%. Earned premiums for the property-casualty segment were 66.8%
personal lines and 33.2% commercial lines in 1996. The business mix for 1995 was
65.7% personal and 34.3% commercial lines.
Investment income for 1996 was $42.3 million compared with $39.1 million in
1995. The pretax yield on invested assets was 6.3%, down from 6.4%. Investment
income increased due to a larger average balance of invested assets, which more
than offset the decrease experienced in the pretax yield. Realized investment
gains were $180,000 compared with $236,000 for 1995. Other income increased
slightly to $7 million from $6.9 million.
Income before income taxes decreased 7% to $59.4 million for 1996 from $63.9
million for 1995. The decrease was due primarily to higher losses and loss
adjusting expenses brought on by higher wind and hail losses in the second and
third quarters.
<PAGE>
25
The statutory combined ratio (after policyholder dividends) deteriorated to 97.7
from the 95.7 reported in 1995, primarily due to a 2.6-point increase in the
loss and loss adjusting expense ratio. Higher wind and hail losses accounted for
2.2 points of the deterioration. The deterioration was partially offset by a
0.5-point reduction in the Company's underwriting expense ratio achieved through
improved efficiency and productivity. Wind and hail losses increased to $39.1
million from $28.7 million in 1995. The impact of wind and hail losses on the
statutory combined ratio was 8.4 points for 1996 and 6.7 points for 1995. The
1996 GAAP underwriting gain was $9.9 million compared with $17.7 million for
1995.
The personal auto statutory combined ratio increased to 98.9 from 96.5 for 1995,
reflecting a 2.8-point increase in the loss and loss adjusting expense ratio.
The statutory combined ratio for the homeowners line was 102.4 compared with
99.2 for 1995. Wind and hail losses increased the homeowners combined ratio 23.6
points in 1996 and 21.7 points in 1995. Overall, the personal lines statutory
combined ratio deteriorated to 99.8 from 97.2. The statutory combined ratio for
commercial lines increased to 93.5 from 92.7 for the prior year.
Excess & Surplus Lines
Earned premiums for 1996 decreased to $27.3 million from $29.7 million for 1995,
primarily because of higher reinsurance costs. Direct earned premiums were
nearly flat at $37.6 million compared with $37.2 million. Net written premiums
were down 7.2% to $28.4 million from $30.6 million, reflecting a continuing soft
market and management's decision not to sacrifice underwriting results for
premium growth. For the year ended December 31, 1996, the segment's book of
business was comprised of 2.8% personal and 97.2% commercial lines. For 1995,
the business mix was 2.4% personal and 97.6% commercial lines.
The segment's invested assets rose 8.3% from the previous year-end to $104.4
million at December 31, 1996. Investment income increased 7% to $6.2 million
from $5.8 million because a larger average balance of invested assets more than
offset a decline in the pretax yield of 30 basis points to 6.4% from the prior
year's 6.7%. Realized investment gains were $2,000 compared with losses of
$136,000 for 1995.
The statutory combined ratio (after policyholder dividends) was 92.5, which
produced an underwriting gain (on a generally accepted accounting principles
basis) of $1.8 million. The statutory combined ratio of 102.2 for 1995 resulted
in an underwriting loss of $855,000. The 1996 combined ratio improved primarily
because of a 21.8% decrease in losses and loss adjusting expenses (11.4 points
on the combined ratio). The decrease in the loss and loss adjusting expense
ratio was primarily due to favorable loss development in 1996.
Income before income taxes for 1996 increased 66.4% to $8.1 million from $4.8
million for the previous year. The increase was primarily due to favorable loss
development.
Noninsurance Operations
Revenues for the noninsurance operations increased 3.8% to $47.1 million from
$45.4 million in 1995. The increase was primarily due to higher data processing
revenues. Income before income taxes was $3.8 million for 1996 compared with
$5.1 million for 1995. Effective March 1, 1996, personnel of the Company
previously providing computer-related services to a certain affiliate were
employed by the affiliate. Since the effective date, those employees have been
paid directly by the affiliate.
Investments and Investment Income
At December 31, 1996 the Company's investment portfolios consisted almost
exclusively of fixed income securities; 99.7% were rated investment grade or
higher. The portfolios contained no real estate or mortgage loans at December
31, 1996.
Consolidated invested assets were up 6.1% to $819.6 million from $772.3 million
at year-end 1995. Fixed maturities at amortized cost increased 6.7%.
Consolidated investment income increased 4.2% to $49.2 million from $47.2
million in 1995. The increase was due primarily to a larger average balance of
invested assets. The tax-equivalent yield was down in 1996 to 7.2% from 7.6% in
1995. The aftertax yield for 1996 and 1995 was 4.7% and 4.9%, respectively.
<PAGE>
26
Income Taxes
The Company's effective income tax rate for 1996 was 28.4% compared with 29.1%
for 1995. The decrease in the effective rate was due primarily to a higher
percentage of income from tax-exempt securities. The income tax expense
decreased 5.8% to $20.2 million.
Liquidity and Capital Resources
Substantial cash inflows for the Company are generated from premiums, pool
administration fees, investment income, and proceeds from sales and maturities
of investments. The principal outflows of cash are payments of claims,
commissions, premium taxes, operating expenses, and income taxes and the
purchase of fixed income and equity securities. In developing its strategy, the
Company establishes a level of cash and highly liquid short- and
intermediate-term securities that, combined with expected cash flow, is believed
adequate to meet anticipated short-term and long-term payment obligations.
In 1997, operating activities generated cash flows of $94.2 million; in 1996,
the total was $95.1 million; in 1995, the total was $97.9 million. For each
year, the primary source of funds was from premiums written in the
property-casualty insurance operations. In 1997, the funds generated from
operating activities were primarily used to purchase fixed maturities and equity
securities, repurchase the Company's common stock, and pay cash dividends. In
1996 and 1995, the funds generated from operating activities in those years were
primarily used to purchase investment-grade securities and to repurchase the
Company's common stock. The net cash used in investing activities in 1997, 1996,
and 1995 was $79.2 million, $65.7 million, and $88.8 million, respectively.
In 1997, 1996, and 1995, the Company paid dividends of $17.5 million, $16.3
million, and $13.5 million, respectively. Dividend payments to common
stockholders totaled $14 million for the year ended December 31, 1997, up from
$12.2 million and $6.3 million in 1996 and 1995, respectively. In each year,
dividends of $3.5 million on the 6-3/4% Series Preferred Stock was paid. In 1996
and 1995, dividends paid on the ESOP Series Preferred Stock (ESOP Series) were
$595,000 and $3.7 million, respectively. The increase in dividends to common
shareholders and the decrease in dividends on the ESOP Series were due to the
conversion of the ESOP Series completed on March 7, 1996. See note 10 of the
Notes to Consolidated Financial Statements for a further discussion of the
conversion. Prior to the conversion, the Company and the ESOP Trustee entered
into an agreement whereby the Company agreed to release additional shares held
by the ESOP Trustee if the dividend paid on common stock is less than $0.09 per
share per quarter on a post-split basis. The agreement is in effect from March
7, 1996 through March 7, 2000. The agreement ensures that the allocated shares
in the ESOP Trust receive at least the same amount of dividends that would have
been paid on the ESOP Series shares had they not been converted to common stock.
The Company relies primarily on dividends from its insurance subsidiaries to pay
preferred and common stock dividends to shareholders. During 1997, the Company
received dividend payments of $16.2 million from the property-casualty
subsidiaries and $836,000 from noninsurance subsidiaries. During 1996 and 1995,
the property-casualty subsidiaries paid the Company dividends of $23.7 million
and $12 million, respectively; noninsurance subsidiaries paid dividends of
$916,000 and $974,000, respectively.
The Iowa state insurance regulations restrict the maximum amount of dividends
the property-casualty subsidiaries can pay without prior regulatory approval.
The maximum dividend allowed is the greater of either 10% of the subsidiary's
statutory capital stock and surplus as of the preceding December 31 or net
income of the preceding calendar year. In 1998 the maximum amount legally
available for distribution to the Company without prior approval is $54.5
million. The excess & surplus lines subsidiary is domiciled in Arizona and
operates under Arizona state laws. The maximum amount available for distribution
as dividends from the excess & surplus lines subsidiary is limited to the lesser
of 10% of stockholders' surplus as of the preceding December 31 or net
investment income of the preceding year. The excess & surplus lines segment
could pay $4 million in 1998 without prior notice to the insurance commissioner.
The Company anticipates the excess & surplus lines segment will not pay
dividends in 1998.
<PAGE>
27
In 1997 and 1996, the Company repurchased $10.2 million and $16.5 million of its
common stock, respectively. No shares were repurchased in 1995. During 1997, the
Company repurchased 412,850 shares of its common stock on the open market at an
average price per share of $24.77. The first 85,500 shares were repurchased
under a program approved by the Board of Directors (Board) on July 16, 1996 and
completed March 13, 1997. An additional 327,350 shares were repurchased under a
program approved by the Board March 4, 1997 and completed December 4, 1997.
During 1996, the Company canceled 664,500 shares of its common stock purchased
on the open market at an average price per share of $24.87.
The Company guaranteed the ESOP Trust's obligations under the terms of a Term
Credit Agreement and Guaranty. See note 9 of Notes to Consolidated Financial
Statements for a discussion of ESOP obligations. At December 31, 1997, the
balance of the obligations was $22.4 million. Contributions plus dividends on
leveraged shares held by the ESOP are used by the ESOP Trust to service the ESOP
obligations. Dividends and payments for the employee lease fees from its
subsidiaries are used by the Company to fund the amounts paid to the ESOP Trust.
The Company made contributions to the ESOP Trust of $312,000 in 1997, $529,000
in 1996, and $733,000 in 1995. The Company paid dividends of $3.6 million in
1997, $3.5 million in 1996, and $2.8 million in 1995, which were used for such
debt service. In connection with its guarantee of ESOP obligations, the Company
is required to maintain minimum stockholders' equity and to comply with certain
other financial covenants.
Historically, the insurance subsidiaries have generated sufficient funds from
operations to pay their claims. While the property-casualty and excess & surplus
lines insurance companies have maintained adequate investment liquidity, they
have in the past required additional capital contributions to support premium
growth. Industry guidelines suggest that a property-casualty insurer's annual
net written premiums should not exceed approximately 300% of statutory surplus.
At December 31, 1997, the property-casualty and excess & surplus lines segments'
net written premiums were 160% and 84% of their statutory surplus, respectively.
Management anticipates that short-term and long-term capital expenditures, cash
dividends, and operating cash needs will be met from existing capital and
internally generated funds. As of December 31, 1997, the Company had no material
commitments for capital expenditures. Future debt and stock issuance will be
considered as additional capital needs arise. The method of funding will depend
upon financial market conditions.
Insurance premiums are established before the amount of losses and loss
adjusting expenses or the extent to which inflation may affect such expenses is
known. Consequently, the Company attempts to anticipate the impact of inflation
in establishing premiums. Inflation is implicitly considered in the
determination of reserves for losses and loss adjusting expenses since portions
of the reserves are expected to be paid over extended periods of time. The
importance of continually reviewing reserves is even more pronounced in periods
of extreme inflation.
The Company's mortgage banking subsidiary, ALLIED Group Mortgage Company (ALLIED
Mortgage), has separate credit agreements to support its operations. Short-term
and long-term notes payable to nonaffiliated companies are used by ALLIED
Mortgage to finance its mortgage loans held for sale, to purchase servicing
rights, and to purchase short-term investments. These notes payable are not
guaranteed by the Company. At December 31, 1997, ALLIED Mortgage had short-term
borrowings of $39 million, which are to be repaid through the subsequent sale of
its mortgage loan inventory. The amount of short-term borrowings fluctuates
daily depending on the level of inventory being financed. Long-term borrowings
amounted to $10.5 million to be repaid over the next seven years. See note 8 of
Notes to Consolidated Financial Statements for a further discussion of ALLIED
Mortgage's finance arrangements. In the normal course of its business, ALLIED
Mortgage also makes commitments to buy and sell securities that may result in
credit and market risk in the event the counterparty is unable to fulfill its
obligation. See note 14 of Notes to Consolidated Financial Statements for a
further discussion of such commitments.
At its March 3, 1998 meeting, the Board approved a first-quarter 1998 common
stock dividend of $0.13 per share. The dividend is $0.01 per share (8.3%) higher
than the amount paid in the fourth quarter of 1997.
<PAGE>
28
Year 2000
The Company began converting its computer systems to be year 2000 compliant in
1996 and anticipates completion by the end of 1998. The Company actively
monitors its progress and plans to start retesting applications in the spring of
1998. The costs associated with year 2000 are expensed as incurred; the Company
does not expect such costs to have a material effect on its future financial
position or results of operations.
The Company's data processing segment has a line of property-casualty and life
insurance software products which it markets to affiliated and nonaffiliated
insurance companies. Management believes the segment's products are year 2000
compliant while operating in the Company's environment and will continue to
retest the products throughout 1998. The segment's customers have been advised
to test the software products in their operating environment for year 2000
compliance. Management believes any exposure to material liability was remote as
of December 31, 1997.
Contingencies
California has been the source of approximately 25% of the pool's direct written
premiums for the past ten years. Proposition 103, approved by California voters
in 1988, provides for a rollback of rates on premiums collected in calendar year
1989 to the extent that the insurer's return on equity for each Proposition 103
line of business exceeded 10%. The rollback liability, if any, has not been
finalized. Management continues to believe the insurance subsidiaries will not
be liable for any material rollback of premiums.
On December 31, 1997, a complaint was filed by Mary M. Rieff, a policyholder of
ALLIED Mutual, in the Iowa District Court in and for Polk County Iowa, against
the Company and certain other individuals who are or were officers and/or
directors of ALLIED Mutual and the Company. The complaint, an alleged
policyholder derivative action brought on behalf of ALLIED Mutual, asserts,
among other things, (a) that the defendants were responsible for the
inappropriate transfer of ALLIED Mutual's corporate assets, the seizure of
certain corporate opportunities, and the implementation of an improper de facto
demutualization without informing or compensating policyholders or receiving the
appropriate approval from regulatory authorities; (b) that this allegedly
wrongful demutualization began on or about January 1, 1985 and was accomplished
through transfers of ALLIED Mutual's assets to the Company and to the individual
defendants for inadequate consideration; (c) that the individual defendants
breached fiduciary duties owed to ALLIED Mutual, wasted its corporate assets,
and intentionally interfered with its contracts, prospective business advantage,
and business relationships; and (d) that the defendants improperly transferred
substantial ownership of and control over the Company and ALLIED Mutual's
insurance business. The complaint further asserts that as a result of the
foregoing, ALLIED Mutual and its policyholders have suffered damages in excess
of $500 million. The complaint requests an accounting of the assets allegedly
wrongfully transferred to the Company and compensation to ALLIED Mutual for the
value of such assets, for the seizure of corporate opportunities, and for the de
facto demutualization of ALLIED Mutual. The complaint also asks for certain
other relief, including attorneys' fees and costs, equitable relief and
interest, and restitution for any assets wrongfully transferred or conveyed. The
Company believes the suit is without merit and intends to defend this action
vigorously. As is the case in all pending actions, the ultimate outcome is
uncertain.
<PAGE>
29
Item 8. Financial Statements and Supplementary Data
Management Representation
The management of ALLIED Group, Inc. is responsible for the integrity and fair
presentation of the consolidated financial statements, related notes, and all
other information presented herein. The statements were prepared in accordance
with generally accepted accounting principles and include amounts that are based
on management's best estimates and judgments.
Management maintains a system of internal control designed to provide reasonable
assurance as to the integrity and reliability of the financial statements, the
protection of assets from unauthorized use or disposition, the prevention and
detection of fraudulent financial reporting, and the appropriate division of
responsibility. In addition, the Company's internal audit department
systematically reviews these controls, evaluates their adequacy and
effectiveness, and reports thereon. Management has considered internal audit
recommendations and those of KPMG Peat Marwick LLP and has in its opinion
responded appropriately to those recommendations. Management believes that as of
December 31, 1997 the Company's system of internal control is adequate to
accomplish the objectives discussed herein.
The Company's financial statements have been audited by KPMG Peat Marwick LLP,
independent certified public accountants. The audit was conducted in accordance
with generally accepted auditing standards, which included consideration of the
Company's system of internal control to the extent necessary to form an
independent opinion on the financial statements prepared by management.
The audit committee of the Board of Directors, composed solely of outside
directors, oversees management's discharge of its financial reporting
responsibilities. The committee meets periodically with management, internal
auditors, and representatives of KPMG Peat Marwick LLP to discuss auditing,
financial reporting, and internal control matters. Both internal and independent
auditors have access to the audit committee without management's presence.
/s/ Jamie H. Shaffer
- -------------------------------------
Jamie H. Shaffer
Chief Financial Officer
<PAGE>
30
Report of Independent Auditors
The Board of Directors and Stockholders
ALLIED Group, Inc.
We have audited the accompanying consolidated balance sheets of ALLIED Group,
Inc. and subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of income and comprehensive income, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based upon our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ALLIED Group, Inc.
and subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
- ---------------------------------------
KPMG Peat Marwick LLP
Des Moines, Iowa
February 3, 1998
<PAGE>
31
<TABLE>
<CAPTION>
ALLIED Group, Inc. and Subsidiaries
Consolidated Balance Sheets(in thousands)
December 31,
-----------------------------------
1997 1996
---------------- ---------------
<S> <C> <C>
Assets
Investments (notes 2 and 3)
Fixed maturities at fair value $ 818,216 $ 792,268
Equity securities at fair value 79,182 20,384
Short-term investments at cost (note 4) 10,846 6,993
---------------- ---------------
Total investments 908,244 819,645
Cash 2,168 1,067
Accrued investment income 11,634 11,563
Indebtness from affiliates (note 4) 3,035 ---
Accounts receivable 91,596 84,706
Current income taxes recoverable (note 16) 3,005 2,878
Reinsurance receivables for losses and loss adjusting expenses 23,906 18,183
Mortgage loans held for sale (notes 2 and 8) 29,521 12,054
Deferred policy acquisition costs 50,695 46,671
Prepaid reinsurance premiums 8,866 7,838
Mortgage servicing rights (note 8) 35,931 33,094
Other assets 32,632 39,960
---------------- ---------------
Total assets $ 1,201,233 $ 1,077,659
================ ===============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
32
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1997 1996
---------------- ---------------
<S> <C> <C>
Liabilities
Losses and loss adjusting expenses (notes 5 and 6) $ 378,026 $ 362,191
Unearned premiums 239,763 220,596
Indebtedness to affiliates (note 4) --- 2,130
Notes payable to nonaffiliates (notes 2 and 8) 51,038 31,744
Notes payable to affiliates (notes 2 and 4) 5,900 2,350
Guarantee of ESOP obligations (notes 2 and 9) 22,380 24,370
Deferred income taxes (note 16) 5,515 2,244
Other liabilities (notes 14 and 15) 68,527 61,443
---------------- ---------------
Total liabilities 771,149 707,068
---------------- ---------------
Stockholders' equity
Preferred stock, no par value, issuable in series,
authorized 7,500 shares (note 10)
6-3/4% Series, 1,827 shares issued and outstanding 37,812 37,812
Common stock, no par value, $1 stated value, authorized
80,000 shares, issued and outstanding 30,532 shares
in 1997 and 20,383 shares in 1996 (notes 11 and 12) 30,532 20,383
Additional paid-in capital 112,490 126,078
Retained earnings (note 13) 244,079 195,276
Accumulated other comprehensive income 23,314 12,699
Unearned compensation related to ESOP (note 9) (18,143) (21,657)
---------------- ---------------
Total stockholders' equity 430,084 370,591
---------------- ---------------
Commitments and contingent liabilities (notes 6 and 14)
Total liabilities and stockholders' equity $ 1,201,233 $ 1,077,659
================ ===============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
33
<TABLE>
<CAPTION>
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
(in thousands, except per share data)
Year ended December 31,
------------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Revenues
Earned premiums (notes 4 and 6) $ 547,597 $ 493,525 $ 455,499
Investment income (note 3) 51,124 49,222 47,242
Realized investment gains (notes 3 and 7) 391 49 505
Income from affiliates (note 4) 5,125 4,880 5,285
Other income 60,445 48,678 44,234
------------- ------------- -------------
664,682 596,354 552,765
------------- ------------- -------------
Losses and expenses (note 4)
Losses and loss adjusting expenses (notes 5 and 6) 378,099 352,995 317,940
Amortization of deferred policy acquisition costs 120,256 108,315 100,120
Other underwriting expenses 19,177 20,438 20,583
Other expenses 53,652 41,650 38,713
Interest expense (note 8) 1,586 1,645 1,561
------------- ------------- -------------
572,770 525,043 478,917
------------- ------------- -------------
Income before income taxes and minority interest 91,912 71,311 73,848
------------- ------------- -------------
Income taxes (note 16)
Current 28,482 17,890 22,293
Deferred (2,509) 2,337 (822)
------------- ------------- -------------
25,973 20,227 21,471
------------- ------------- -------------
Net income before minority interest 65,939 51,084 52,377
Minority interest in net income of consolidated subsidiary 503 --- ---
------------- ------------- -------------
Net income 65,436 51,084 52,377
------------- ------------- -------------
Other comprehensive income, net of tax
Unrealized holding gain arising during the period (net
of deferred income tax of $(5,934), $3,207, and $(12,956)) 10,826 (6,000) 23,847
Reclassification adjustment for (gains) losses included
in net income (net of income tax expense (benefit)
of $139, ($207), and $182) (211) 364 (271)
------------- ------------- -------------
10,615 (5,636) 23,576
------------- ------------- -------------
Comprehensive Income $ 76,051 $ 45,448 $ 75,953
============= ============= =============
Net income applicable to common stock $ 61,921 $ 46,973 $ 45,160
============= ============= =============
Earnings per share
Basic $ 2.03 $ 1.61 $ 2.18
============= ============= =============
Diluted $ 2.01 $ 1.51 $ 1.54
============= ============= =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
34
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------
1997 1996 1995
------------- ------------- --------------
<S> <C> <C> <C>
Preferred stock
Beginning of year $ 37,812 $ 83,648 $ 85,566
Issuance of shares of ESOP Series (note 10) --- --- 699
ESOP Series shares converted to
common shares (note 11) --- (45,836) (2,617)
------------- ------------- --------------
End of year 37,812 37,812 83,648
------------- ------------- --------------
Common stock
Beginning of year 20,383 9,445 9,000
Issuance of shares of common stock (notes 11 and 12) 270 4,597 445
Repurchase of shares of common stock (note 11) (307) (443) ---
Effect of 3-for-2 stock split 10,186 6,784 ---
------------- ------------- --------------
End of year 30,532 20,383 9,445
------------- ------------- --------------
Additional paid-in capital
Beginning of year 126,078 104,596 98,926
Issuance of shares of common stock (notes 11 and 12) 7,609 44,356 5,670
Repurchase of shares of common stock (note 11) (9,919) (16,082) ---
Effect of 3-for-2 stock split (10,186) (6,792) ---
Minority interest (1,092) --- ---
------------- ------------- --------------
End of year 112,490 126,078 104,596
------------- ------------- --------------
Retained earnings
Beginning of year 195,276 159,470 119,752
Net income 65,436 51,084 52,377
Dividends paid on preferred stock (note 10) (3,515) (4,111) (7,217)
Dividends paid on common stock (note 11) (14,027) (12,156) (6,291)
Tax benefits attributable to tax-deductible dividends
on unallocated shares of the ESOP 909 989 849
------------- ------------- --------------
End of year 244,079 195,276 159,470
------------- ------------- --------------
Accumulated other comprehensive income
Beginning of year 12,699 18,335 (5,241)
Change in unrealized appreciation (depreciation), net 10,615 (5,636) 23,576
------------- ------------- --------------
End of year 23,314 12,699 18,335
------------- ------------- --------------
Unearned compensation related to ESOP
Beginning of year (21,657) (23,908) (26,122)
Cost of ESOP Series shares allocated 3,514 2,251 2,214
------------- ------------- --------------
End of year (18,143) (21,657) (23,908)
------------- ------------- --------------
Total stockholders' equity $ 430,084 $ 370,591 $ 351,586
============= ============= ==============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
35
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 65,436 $ 51,084 $ 52,377
Adjustments to reconcile net income to net cash
provided by operating activities
Losses and loss adjusting expenses 15,835 20,327 30,868
Unearned premiums, net 18,139 23,081 15,945
Deferred policy acquisition costs (4,024) (4,983) (3,419)
Accounts receivable, net (12,612) (7,478) (6,009)
Depreciation and amortization 15,009 11,030 9,583
Realized investment gains (391) (49) (505)
Mortgage loans held for sale, net 326 (2,602) (1,529)
Indebtedness with affiliates (5,165) 1,111 1,591
Accrued investment income (71) (1,096) (118)
Other assets (4,607) (8,376) (6,644)
Cost of ESOP shares allocated 3,514 2,251 2,214
Current income taxes (127) (1,548) 1,264
Deferred income taxes (2,509) 2,337 (822)
Other, net 5,482 10,053 3,109
------------- ------------- -------------
Net cash provided by operating activities 94,235 95,142 97,905
------------- ------------- -------------
Cash flows from investing activities
Purchase of fixed maturities (149,420) (222,566) (184,600)
Purchase of equity securities (53,101) (10,990) (4,819)
Purchase of equipment (6,132) (8,313) (7,794)
Sale of fixed maturities (note 3) 51,391 81,689 48,012
Maturities, calls, and principal reductions of
fixed maturities 80,067 90,907 61,966
Sale of equity securities 1,624 682 2,072
Short-term investments, net (3,853) 2,809 (4,146)
Sale of equipment 220 86 470
------------- ------------- -------------
Net cash used in investing activities (79,204) (65,696) (88,839)
------------- ------------- -------------
Cash flows from financing activities
Notes payable to nonaffiliates, net 1,500 --- (2,180)
Notes payable to affiliates, net 3,550 (1,150) 1,500
Issuance of preferred stock --- --- 699
Issuance of common stock 7,879 3,109 3,498
Repurchase of common stock (10,226) (16,525) ---
Dividends paid to stockholders, net of
income tax benefit (16,633) (15,278) (12,659)
------------- -------------- -------------
Net cash used in financing activities (13,930) (29,844) (9,142)
------------- -------------- -------------
Net increase (decrease) in cash 1,101 (398) (76)
Cash at beginning of year 1,067 1,465 1,541
------------- -------------- -------------
Cash at end of year $ 2,168 $ 1,067 $ 1,465
============= ============== =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
36
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of
ALLIED Group, Inc. (the Company) and its subsidiaries. The consolidated
financial statements have been prepared in conformity with generally accepted
accounting principles (GAAP). The preparation of the financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities for 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. All significant intercompany
balances and transactions have been eliminated. Certain amounts in the financial
statements for prior years have been reclassified to conform to the current
year's presentation.
The Company's property-casualty segment operates through three subsidiaries:
AMCO Insurance Company (AMCO), ALLIED Property and Casualty Insurance Company,
and Depositors Insurance Company, which underwrite personal lines (primarily
automobile and homeowners) and small commercial lines.
Western Heritage Insurance Company is the excess & surplus lines subsidiary,
which primarily underwrites commercial lines.
The noninsurance subsidiaries are ALLIED Group Mortgage Company (ALLIED
Mortgage), The Freedom Group, Inc., ALLIED Group Information Systems, Inc.,
Midwest Printing Services, Ltd., ALLIED General Agency Company, and Premier
Agency, Inc.
During 1997, the Board of Directors authorized a 3-for-2 stock split issuable
November 28, 1997 to stockholders of record on November 14, 1997. All fractional
shares were paid in cash. All weighted average shares outstanding, per share
amounts, and references in the footnotes to share information have been restated
retroactively to reflect the stock splits.
At year-end 1997, the ALLIED Group Employee Stock Ownership Trust (ESOP Trust)
owned 24.9% and ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated
property-casualty insurance company, controlled 18.2% of the outstanding voting
stock of the Company.
Investments
Investments in fixed maturities where there is the positive intent and ability
to hold to maturity are classified as held to maturity and carried at cost
adjusted for amortization of premium or discount. Amortization of premiums and
discounts on mortgage-backed securities incorporates a prepayment assumption to
estimate the securities' expected lives. Except for declines that are other than
temporary, changes in fair value are not reflected in the financial statements.
Investments in fixed maturities that may be sold prior to maturity and are not
bought and held principally for the purpose of selling in the near term are
segregated into an available for sale portfolio and are carried at fair value.
Unrealized appreciation and depreciation of securities classified as available
for sale are reported as accumulated other comprehensive income in stockholders'
equity net of deferred income taxes. All of the Company's investments in fixed
maturity securities were designated as available for sale at December 31, 1997,
although the Company is not precluded from designating the securities as held to
maturity at some future date.
The carrying values of all investments in fixed maturities are reviewed for
impairment on an ongoing basis. If this review indicates that a decline in fair
value below cost is other than temporary, the Company's carrying value in the
investment is reduced to its estimated realizable value and a specific
write-down is taken. Such reductions in carrying value are recognized as
realized losses and charged to income. Realized gains and losses on disposition
of investments are based on specific identification of the investments sold.
<PAGE>
37
Equity securities are carried at fair value with any unrealized appreciation and
depreciation reported net of deferred income taxes as accumulated other
comprehensive income in stockholders' equity. All short-term investments are
recorded at cost, which approximates fair value.
Property-casualty and Excess & Surplus Lines
Premiums are recognized as revenue ratably over the terms of the respective
policies. Unearned premiums are calculated on the monthly pro rata basis.
Amounts paid for ceded reinsurance premiums are reported as prepaid reinsurance
premiums and amortized over the remaining contract period in proportion to the
amount of insurance protection provided. Premiums receivable from policyholders
and agents are recorded at cost less an allowance for doubtful accounts.
Policy acquisition costs such as commissions, premium taxes, and certain other
underwriting and agency expenses that vary with and are directly related to the
production of business have been deferred. Such deferred policy acquisition
costs are being amortized as premium revenue is recognized. The method followed
in computing deferred policy acquisitions costs limits the amount of such
deferred costs to their estimated realizable value, which gives effect to the
premium to be earned, related investment income, losses and loss adjusting
expenses, and certain other costs expected to be incurred as the premium is
earned.
Liabilities for losses are based upon case-basis estimates of reported losses,
estimates of unreported losses based upon prior experience adjusted for current
trends, and estimates of losses expected to be paid under assumed reinsurance
contracts. Liabilities for loss adjusting expenses are provided by estimating
expenses expected to be incurred in settling the claims provided for in the loss
reserve. Changes in estimates are reflected in current operating results (note
5).
Ceded reinsurance amounts with nonaffiliated re-insurers relating to reinsurance
receivables for paid and unpaid losses and loss adjusting expenses and prepaid
reinsurance are reported on the balance sheets on a gross basis. Amounts ceded
to ALLIED Mutual relating to the affiliated reinsurance pooling agreement and
the property catastrophe reinsurance agreement have not been grossed up because
the contracts provide that receivables and payables may be offset upon
settlement.
The liabilities for losses and loss adjusting expenses are considered adequate
to cover the ultimate cost of losses and claims incurred to date net of
estimated salvage and subrogation recoverable. Since the provisions are
necessarily based on estimates, the ultimate liability may be more or less than
such provisions.
Noninsurance Operations
Mortgage loans held for sale by ALLIED Mortgage are reported at the lower of
cost or fair value on an aggregate basis. The fair value calculation includes
consideration of all open positions, outstanding commitments from investors,
related fees paid, and unrealized gains and losses from open options and
financial futures contracts. Loan origination fees and certain direct costs
related to loan origination are deferred and recognized at the time the related
loans are sold. In the normal course of business, ALLIED Mortgage protects its
position in mortgages by taking positions in options, futures, and cash markets.
Market risk exists in the event of fluctuations in market prices on the unhedged
portions of mortgage loans held for sale and outstanding commitments.
ALLIED Mortgage recognizes as separate assets the rights to service mortgage
loans for others, whether acquired through purchases or loan originations.
Capitalized mortgage servicing rights are assessed periodically for impairment
based on the fair value of those rights. ALLIED Mortgage stratifies its mortgage
servicing portfolio on the basis of certain risk characteristics, including loan
type and note rate, and determines fair value based upon the present value of
estimated future cash flows. Impairment is recognized through a valuation
allowance for each impaired stratum. The total valuation allowance for
capitalized mortgage servicing rights was $3 million as of December 31, 1997 and
$2.7 million at December 31, 1996. The fair value of capitalized mortgage
servicing rights as of December 31, 1997 and 1996 was approximately $53.3
million and $44.8 million, respectively. Capitalized mortgage servicing rights
are amortized over twelve years using the straight-line method, which management
<PAGE>
38
believes approximates the realization of the related net servicing income.
Amortization of servicing rights for the years ended December 31, 1997, 1996,
and 1995 was $4.7 million, $5.4 million, and $4.7 million, respectively.
Depreciation and Amortization
Equipment and software are included in other assets at historic cost net of
accumulated depreciation and amortization. For financial reporting purposes,
depreciation and amortization are provided primarily on the straight-line basis
over the estimated useful lives of the assets, ranging from two to seven years.
Accelerated depreciation methods are utilized for income tax purposes.
Stock Option Plans
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) 123, "Accounting for Stock-Based Compensation." SFAS 123
permits entities to recognize the fair value of stock options on the date of
grant as compensation expense over the vesting period of such options.
Alternatively, the standard allows entities to continue to apply the accounting
provisions of Accounting Principles Board (APB) Opinion 25, "Accounting for
Stock Issued to Employees," and related interpretations. Compensation expense
then would be recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price. The Company has elected to
apply the accounting provisions of APB 25 and, as required by SFAS 123, provide
pro forma net income and earnings per share disclosures for stock option grants
made in 1995 and future years as if the fair-value-based method defined in SFAS
123 had been applied. The adoption of this statement had no effect on the
Company's financial position, results of operations, or liquidity.
Retirement Plan Costs
The amount of compensation cost related to The ALLIED Group Employee Stock
Ownership Plan (ESOP) is based on the cost of the shares allocated to
participants plus interest expense incurred related to the debt of the ESOP
reduced by dividends paid used to service the ESOP's debt (the shares allocated
method). The income tax benefit for the tax deductible dividends paid on
unallocated shares of the ESOP available for debt service is included as a
direct addition to retained earnings.
Income Taxes
Deferred income taxes reflect the impact of temporary differences between the
tax basis of assets and liabilities and the reported amounts of those assets and
liabilities for financial reporting purposes. Deferred tax assets and
liabilities are measured using enacted tax rates expected to be applicable to
taxable income in the years in which the temporary differences are expected to
be recovered or settled. Income tax expense provisions increase or decrease in
the same period in which a change in tax rates is enacted.
Minority Interest
The minority interest in a subsidiary represents the minority common
stockholders proportionate share of the net assets and the results of operations
of the majority-owned mortgage banking subsidiary. Options exercised by key
employees of the mortgage banking subsidiary resulted in a 20% ownership in the
outstanding common stock of the subsidiary on January 2, 1997. No additional
options are outstanding. The minority interest in the subsidiary was $2.1
million at December 31, 1997 and is included in other liabilities. This
transaction did not have a material impact on the Company's financial position,
results of operations, or liquidity.
<PAGE>
39
Earnings per Share
On December 31, 1997, the Company adopted the provisions of SFAS 128, "Earnings
per Share." SFAS 128 specifies the computation, presentation, and disclosure
requirements for earnings per share (note 17). SFAS 128 supersedes APB 15,
"Earnings per Share," and required restatement of all prior period per share
data. If APB 15 had prevailed, the Company would have reported fully diluted
earnings per share of $2.03.
Basic earnings per share are computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding.
Diluted earnings per share are computed by dividing income available to common
stockholders by the weighted average number of common shares and dilutive
potential common shares outstanding. Securities that entitle their holders to
obtain common stock during or after the reporting period (primarily stock
options) are referred to as dilutive potential common shares.
Cash Flows
For purposes of reporting cash flows, changes in notes payable issued by ALLIED
Mortgage to purchase mortgage loans held for sale are included in cash flows
from operating activities.
Other New Accounting Pronouncements
On December 31, 1997, the Company adopted SFAS 130, "Reporting Comprehensive
Income," and restated prior years' financial statements to conform to the
reporting standard. SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general-purpose
financial statements. Comprehensive income includes all changes in stockholders'
equity during a period except those resulting from investments by owners and
distributions to owners. The adoption of SFAS 130 resulted in revised and
additional disclosures but had no effect on the financial position, results of
operations, or liquidity of the Company.
The Company also adopted SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information," on December 31, 1997 (note 18). SFAS 131 specifies the
presentation and disclosure of operating segment information reported in the
annual and interim reports issued to stockholders. SFAS 131 supersedes SFAS 14,
"Financial Reporting for Segments of a Business Enterprise," and requires that
segment information of earlier years be restated to conform to the new standard.
The adoption of SFAS 131 resulted in revised and additional disclosures but had
no effect on the financial position, results of operations, or liquidity of the
Company.
(2) Fair Value of Financial Instruments
The estimated fair value amounts have been determined by using available market
information and appropriate valuation methods. The estimates presented herein
are not necessarily indicative of the amounts that would be realized in a
current market exchange, and the use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The following methods and assumptions were used in estimating the fair value
disclosures for financial instruments:
Fixed maturities -- The estimated fair value is based upon the quoted
market prices for the same or similar issues or from independent pricing
services (note 3).
Equity securities -- The estimated fair value is based upon the quoted
market prices where available or from independent pricing services (note 3).
Short-term investments -- Due to their short-term nature, their carrying
amount approximates fair value.
<PAGE>
40
Mortgage loans held for sale -- The fair value is estimated using quoted
market prices and includes commitments to extend credit and forward sales
commitments (note 14).
Notes payable to affiliates and nonaffiliates -- Due to the short maturity
of the short-term notes payable, carrying value approximates fair value. The
fair value of the long-term notes payable is estimated using current rates
available for similar issues (notes 4 and 8).
Guarantee of ESOP obligations -- Due to its floating interest rate, the
guarantee approximates its fair value (note 9).
Interest rate swap agreement (derivative) -- The fair value reflects the
estimated amount the Company would pay to terminate the contract at year-end,
thereby taking into account the current unrealized gains or losses of the open
contract. Dealer quotes are available for the Company's derivative (note 9).
Other financial instruments -- Due to their short-term nature, their
carrying amount approximates fair value.
The following table presents the carrying value and estimated fair value of the
financial instruments at December 31, 1997 and 1996.
<TABLE>
<CAPTION>
Estimated
Carrying fair
value value
------------- -------------
(in thousands)
1997
<S> <C> <C>
Fixed maturities $ 818,216 $ 818,216
Equity securities 79,182 79,182
Short-term investments 10,846 10,846
Mortgage loans held for sale 29,521 29,621
Notes payable to nonaffiliates (51,038) (51,180)
Notes payable to affiliates (5,900) (5,900)
Guarantee of ESOP obligations (22,380) (22,380)
1996
Fixed maturities $ 792,268 $ 792,268
Equity securities 20,384 20,384
Short-term investments 6,993 6,993
Mortgage loans held for sale 12,054 12,115
Notes payable to nonaffiliates (31,744) (31,604)
Notes payable to affiliates (2,350) (2,350)
Guarantee of ESOP obligations (24,370) (24,370)
Interest rate swap agreement --- (449)
</TABLE>
The estimated fair values presented in the table are based on pertinent
information available to management as of December 31, 1997 and 1996. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been revalued for purposes
of these financial statements since those dates; current estimates of fair value
may differ significantly from the amounts presented herein.
<PAGE>
41
(3) Investments
Following is a schedule of amortized costs and estimated fair values of
investments in fixed maturities and equity securities as of December 31, 1997
and 1996. The estimated fair values for fixed maturities and equity securities
are based on quoted market prices for the same or similar issues or from
independent pricing services.
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
----------- ----------- ----------- -----------
(in thousands)
1997
<S> <C> <C> <C> <C>
Fixed maturities
U.S. Treasury securities $ 55,578 $ 1,133 $ --- $ 56,711
U.S. government corporations
and agencies 27,277 619 7 27,889
Obligations of states and political
subdivisions 383,941 14,475 10 398,406
Foreign governments 2,036 48 --- 2,084
Corporate securities and public utilities 168,340 3,839 29 172,150
Mortgage-backed securities 154,773 6,255 52 160,976
----------- ----------- ----------- -----------
$ 791,945 $ 26,369 $ 98 $ 818,216
=========== =========== =========== ===========
Equity securities
Common stock
Public utilities $ 679 $ 122 $ 3 $ 798
Banks, trusts, and insurance
companies 5,940 1,604 10 7,534
Industrial, misc., and all other 21,412 7,145 395 28,162
----------- ----------- ----------- -----------
28,031 8,871 408 36,494
Preferred stock 41,421 1,304 37 42,688
=========== ----------- ----------- -----------
Total $ 69,452 $ 10,175 $ 445 $ 79,182
=========== =========== =========== ===========
1996
Fixed maturities
U.S. Treasury securities $ 61,557 $ 1,074 $ 9 $ 62,622
U.S. government corporations
and agencies 27,453 480 13 27,920
Obligations of states and political
subdivisions 327,487 9,613 379 336,721
Foreign governments 2,064 32 9 2,087
Corporate securities and public
utilities 190,244 2,860 415 192,689
Mortgage-backed securities 166,361 4,049 181 170,229
----------- ----------- ----------- -----------
$ 775,166 $ 18,108 $ 1,006 $ 792,268
=========== =========== =========== ===========
Equity securities
Common stock
Public utilities $ 476 $ 11 $ 22 $ 465
Banks, trusts, and insurance
companies 4,128 480 --- 4,608
Industrial, misc., and all other 10,679 2,240 202 12,717
----------- ----------- ----------- -----------
15,283 2,731 224 17,790
Preferred stock 2,597 9 12 2,594
----------- ----------- ----------- -----------
Total $ 17,880 $ 2,740 $ 236 $ 20,384
=========== =========== =========== ===========
</TABLE>
<PAGE>
42
The following table presents the amortized cost and estimated fair value table
of fixed maturities by contractual maturity at December 31, 1997. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations without call or prepayment penalties.
<TABLE>
<CAPTION>
Estimated
Amortized fair
cost value
----------- -----------
(in thousands)
<S> <C> <C>
Due in 1 year or less $ 23,268 $ 23,499
Due after 1 year through 5 years 305,807 314,202
Due after 5 years through 10 years 266,035 276,560
Due after 10 years 42,062 42,979
----------- -----------
637,172 657,240
Mortgage-backed securities 154,773 160,976
----------- -----------
Totals $ 791,945 $ 818,216
=========== ===========
</TABLE>
The following table presents the gross realized gains and losses by portfolio
included in the proceeds from calls, principal reductions, and sales of fixed
maturities for the years ended December 31, 1997, 1996, and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- ----------
(in thousands)
<S> <C> <C> <C>
Available for sale
Gross realized gains $ 172 $ 406 $ 957
Gross realized losses (152) (1,022) (910)
----------- ----------- ----------
20 (616) 47
----------- ----------- ----------
Held to maturity
Gross realized gains --- --- 54
Gross realized losses --- --- (1)
----------- ----------- ----------
--- --- 53
----------- ----------- ----------
Net realized gains (losses) $ 20 $ (616) $ 100
=========== ============ ==========
</TABLE>
As required by law, fixed maturities and short-term investments amounting to
$12.5 million at December 31, 1997 and $10.5 million at year-end 1996 were on
deposit with various insurance regulatory authorities.
As of December 31, 1997 and 1996, there were no investments that were non-income
producing for the previous twelve months.
A summary of net investment income for the years ended December 31, 1997, 1996,
and 1995 follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Interest on fixed maturities $ 49,969 $ 48,770 $ 47,160
Dividends on equity securities 1,287 478 167
Interest on short-term investments 782 771 665
Equity earnings in unconsolidated subsidiaries 48 52 11
Other, net --- 703 20
----------- ----------- -----------
Total investment income 52,086 50,774 48,023
Investment expense 812 705 584
Interest expense 150 847 197
----------- ----------- -----------
Net investment income $ 51,124 $ 49,222 $ 47,242
=========== =========== ===========
</TABLE>
<PAGE>
43
A summary of net realized investment gains (losses) and net changes in
unrealized appreciation (depreciation) of investments for the years ended
December 31, 1997, 1996, and 1995 follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Net realized investment gains (losses)
Fixed maturities
Available for sale $ 20 $ (616) $ 47
Held to maturity --- --- 53
Equity securities 371 45 405
Other investments (note 7) --- 620 ---
----------- ----------- -----------
391 49 505
----------- ----------- -----------
Net changes in unrealized appreciation
(depreciation) of investments
Fixed maturities
Available for sale 9,169 (10,719) 36,063
Held to maturity --- --- 13,231
Equity securities 7,226 2,083 289
----------- ----------- -----------
16,395 (8,636) 49,583
----------- ----------- -----------
Net realized investment gains (losses) and changes in
unrealized appreciation (depreciation) of investments $ 16,786 $ (8,587) $ 50,088
=========== =========== ===========
</TABLE>
(4) Transactions with Affiliates
The property-casualty segment and ALLIED Mutual participate in a reinsurance
pooling agreement. The pooling agreement provides that AMCO (pool administrator)
assumes from the pool participants premiums, losses, allocated loss adjusting
expenses, commissions, premium taxes, service charge income, and dividends to
policyholders. The pool participants assume from AMCO an amount of this pooled
property-casualty business equal to their participation in the pooling
agreement. AMCO pays certain underwriting expenses, unallocated loss adjusting
expenses, and premium collection expenses for all of the pool participants and
receives a fee equal to a specified percentage of premiums as well as a
performance fee based on the attainment of certain combined ratios from each of
the pool participants. AMCO charges each of the participants 12.85% of written
premiums for underwriting services, 7.25% of earned premiums for unallocated
loss adjusting expenses, and 0.75% of earned premiums for premium collection
services. The administrative fees are subject to renegotiation during the term
of the agreement upon at least five years' notice. AMCO received pool
administrative fees of $66.8 million, $61.3 million, and $55.7 million from
ALLIED Mutual in 1997, 1996, and 1995, respectively. In 1997, the Company also
received a performance fee of $4.2 million from ALLIED Mutual. The pooling
agreement extends through December 31, 2004 and may be terminated after such
date upon notice. Changes to the pooling agreement must be approved by the
coordinating committee of the Board of Directors.
Pursuant to the terms of the Intercompany Operating Agreement, the Company
leases employees to its subsidiaries and ALLIED Mutual and certain of its
subsidiaries. Each company that leases employees is charged a fee based upon
costs incurred for salaries, related benefits, taxes, and expenses associated
with the employees it leases. For the years ended December 31, 1997, 1996, and
1995, the Company received revenues of $2.6 million, $2.5 million, and $2.5
million, respectively, for employees leased to affiliates.
The Intercompany Operating Agreement between the Company and ALLIED Mutual also
provides for the continued availability of office space, marketing services,
agency forces, and computer and other facilities. Expenses are charged to the
Company based on specific identification, or, if undeterminable, the expenses
are allocated on the basis of cost and time studies that are updated annually.
The agreement extends through December 31, 2004 and may be terminated after such
date by either ALLIED Mutual or the Company upon two years notice.
Included in income from affiliates are revenues of $2.5 million, $2.4 million,
and $2.8 million for the years ended December 31, 1997, 1996, and 1995,
respectively, relating to data processing services provided by subsidiaries of
the Company to ALLIED Mutual and its subsidiaries under a Management Information
Services Agreement. Effective March 1, 1996, the agreement was amended and
personnel previously providing computer-related services to a certain affiliate
were employed by the affiliate. Fees paid for services provided by such
personnel are now paid directly by the affiliate.
<PAGE>
44
ALLIED Mutual participated with a nonaffiliated reinsurance company in a
property catastrophe reinsurance agreement to cover the property-casualty
segment's share of the pooled losses. ALLIED Mutual's participation in the
agreement was 90%. Premiums paid by the property-casualty segment to ALLIED
Mutual were $2.9 million, $2.7 million, and $2.3 million in 1997, 1996, and
1995, respectively. There were recoveries from ALLIED Mutual of $2 million, $3.4
million, and $2.6 million in 1997, 1996, and 1995, respectively.
All expenses incurred on the Company's behalf by its affiliates have been
reflected in the accompanying financial statements. Management believes the
costs incurred by its affiliates and allocated to the Company are reasonable and
would not be materially different than if they had been incurred from a third
party nonaffiliate. During the normal course of business the aforementioned
transactions result in intercompany balances that are created and are settled on
a monthly basis.
The Company and its affiliates deposit their excess cash into a short-term
investment fund. The fund was established to concentrate short-term cash in a
single account to maximize yield. AID Finance Services, Inc., a wholly owned
subsidiary of ALLIED Mutual, is the administrator of the fund. At December 31,
1997 and 1996, the Company had $8.3 million and $3.4 million, respectively,
invested in the fund. The Company also had several unsecured short-term notes
payable to the fund at December 31, 1997 that totaled $5.9 million; the interest
rate on each was 8.8%. At December 31, 1996, the Company had three unsecured
notes totaling $2.4 million payable to the investment fund.
The Company paid interest to affiliates of $424,000, $270,000, and $127,000 in
1997, 1996, and 1995, respectively.
(5) Losses and Loss Adjusting Expenses
The following table sets forth the reconciliation of beginning and ending
reserves for losses and loss adjusting expenses for the years indicated.
Reinsurance recoverables on unpaid losses and loss adjusting expenses are
included on the consolidated balance sheets within reinsurance receivables for
losses and loss adjusting expenses. The following table includes
property-casualty and excess & surplus lines reserves for losses and loss
adjusting expenses.
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
----------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Reserves for losses and loss adjusting expenses
at beginning of year $ 362,191 $ 341,864 $ 310,996
Less reinsurance recoverables 15,528 16,925 18,322
----------- ----------- -----------
Net reserves for losses and loss adjusting
expenses at beginning of year 346,663 324,939 292,674
----------- ----------- -----------
Incurred losses and loss adjusting expenses
Provision for insured events of current year 379,952 353,675 315,956
(Decrease) increase in provisions for insured
events of prior years (1,853) (680) 1,984
----------- ----------- -----------
Total incurred losses and loss adjusting expenses 378,099 352,995 317,940
----------- ----------- -----------
Payments
Losses and loss adjusting expenses attributable
to insured events of current year 216,920 194,735 169,254
Losses and loss adjusting expenses attributable
to insured events of prior years 147,849 136,536 116,421
----------- ----------- -----------
Total payments 364,769 331,271 285,675
----------- ----------- -----------
Net reserves for losses and loss adjusting expenses
at end of year 359,993 346,663 324,939
Plus reinsurance recoverables 18,033 15,528 16,925
----------- ----------- -----------
Reserves for losses and loss adjusting expenses
at end of year $ 378,026 $ 362,191 $ 341,864
=========== =========== ===========
</TABLE>
<PAGE>
45
The reserving process relies on the basic assumption that past experience,
adjusted for current developments and likely trends, is an appropriate basis for
predicting future events. Reserve amounts are necessarily based on management's
informed estimates; as other data become available and are reviewed, these
estimates and judgments are revised, resulting in increases and decreases to
existing reserves. As a result of changes in estimates of insured events in
prior years, the provision for losses and loss adjusting expenses decreased $1.9
million in 1997, decreased $680,000 in 1996, and increased $2 million in 1995.
Development for losses and loss adjusting expenses on prior years is immaterial
to the financial statements taken as a whole.
In establishing reserves, management considers exposure the Company may have to
environmental claims. Because reported claim activity levels are minimal and the
emphasis of the property-casualty business is primarily on personal lines and
small commercial business, management believes exposure to material liability on
such claims to be remote as of December 31, 1997. The Company routinely reviews
its overall reserve position and reserving techniques as they relate to its
exposure to environmental claims.
(6) Reinsurance
In the ordinary course of business, the property-casualty and excess & surplus
lines subsidiaries cede insurance to other insurers for the purpose of limiting
their maximum loss exposure through diversification of their risks. See note 4
for discussion of reinsurance contracts with ALLIED Mutual. Reinsurance
contracts do not relieve the Company's insurance subsidiaries from their
obligations to policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company's insurance subsidiaries; consequently,
allowances are established for amounts deemed uncollectible. Management
evaluates the financial condition of the reinsurers and monitors concentrations
of credit risk arising from similar geographic regions, activities, or economic
characteristics of the reinsurers to minimize exposure to significant losses
from reinsurer insolvencies. As of December 31, 1997, reinsurance receivables
and prepaid reinsurance premiums associated with three nonaffiliated reinsurers
aggregated approximately $16.4 million, which represented a significant portion
of the total prepaid reinsurance premiums and reinsurance receivables for losses
and loss adjusting expenses. The property-casualty subsidiaries also assume
insurance as members of various pools and associations.
The effect of reinsurance on premiums written and earned and losses and loss
adjusting expenses incurred for the years ended December 31, 1997, 1996, and
1995 was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -----------
(in thousands)
<S> <C> <C> <C>
Direct written premiums $ 638,997 $ 568,277 $ 494,462
Assumed from nonaffiliates 5,461 6,536 8,572
Net ceded to ALLIED Mutual (47,840) (26,639) (6,151)
Ceded to nonaffiliates (30,883) (31,568) (25,439)
------------ ------------ -----------
Net written premiums $ 565,735 $ 516,606 $ 471,444
============ ============ ===========
Direct earned premiums $ 611,415 $ 534,738 $ 472,407
Assumed from nonaffiliates 5,630 7,231 8,831
Net ceded to ALLIED Mutual (39,591) (17,933) (703)
Ceded to nonaffiliates (29,857) (30,511) (25,036)
------------ ------------ -----------
Net earned premiums $ 547,597 $ 493,525 $ 455,499
============ ============ ===========
Direct losses and loss adjusting expenses $ 427,909 $ 398,748 $ 335,779
Assumed from nonaffiliates 5,285 4,239 5,889
Net ceded to ALLIED Mutual (37,365) (37,957) (14,648)
Ceded to nonaffiliates (17,730) (12,035) (9,080)
------------ ------------ -----------
Net losses and loss adjusting
expenses incurred $ 378,099 $ 352,995 $ 317,940
============ ============ ===========
</TABLE>
<PAGE>
46
(7) Dispositions
During 1996, the Company received $620,000 as the final settlement on the 1994
sale of its investment in a savings and loan holding company. The payment
represents the Company's share of the contingent purchase price held by the
buyer until all known claims were settled.
(8) Notes Payable to Nonaffiliates
The short-term notes payable to nonaffiliated companies include line of credit
agreements used by ALLIED Mortgage primarily to finance its mortgage loans held
for sale. At December 31, 1997 and 1996, ALLIED Mortgage had borrowed $39
million and $19.7 million, respectively, under mortgage loan warehousing
agreements with three different commercial banks. Two of the agreements expire
in May and June of 1998 and the third in May of 1999. Under the terms of the
agreements, ALLIED Mortgage can borrow up to the lesser of $67 million or 98% of
the mortgage credit borrowing base, which includes related sublines. At December
31, 1997, the outstanding borrowings of ALLIED Mortgage under these line of
credit agreements were secured by mortgage loans held for sale of $29.5 million,
mortgage servicing rights on loans with a principal balance of $2.9 billion, and
foreclosure loans of $5.2 million. Interest rates applicable to these borrowing
arrangements vary with the level of investable deposits maintained at the
respective commercial banks.
ALLIED Mortgage entered into an agreement with a life insurance company for $15
million of 8.4% senior secured notes due September 1, 2004. The notes are
secured by mortgage servicing rights and are payable in equal annual
installments of $1.5 million every September 1; interest is payable
semiannually. At December 31, 1997 and 1996, the outstanding balance was $10.5
million and $12 million, respectively.
The Federal Home Loan Bank of Des Moines provides a $3 million committed credit
facility through a line of credit agreement with AMCO that expires February 27,
1998. Interest on any outstanding borrowings is payable at an annual rate equal
to the federal funds unsecured rate for federal reserve member banks, which was
5.8% as of December 31, 1997. The Company had an outstanding balance of $1.5
million as of December 31, 1997 and no outstanding balance as of December 31,
1996.
The Company paid interest to nonaffiliates of $1.2 million, $1.5 million, and
$1.6 million in 1997, 1996, and 1995, respectively.
(9) Guarantee of ESOP Obligations
On July 12, 1990, the ESOP Trust issued Remarketed Floating Rate Notes (FRN)
totaling $35 million with a final maturity of July 12, 2005. The proceeds from
the FRN were used to acquire Series A ESOP Convertible Preferred Stock. During
1995, the ESOP Trust refinanced its $28.2 million of FRN under the terms of a
Term Credit Agreement and Guaranty (Credit Agreement) with two separate
commercial banks. The loans mature July 12, 2005, and interest rates applicable
to the borrowings are adjusted at the beginning of each interest period. The
interest periods may be one, three, or six months at the discretion of the ESOP
Trust.
The Company has guaranteed on an unsecured basis the ESOP Trust's reimbursement
obligations under the Credit Agreement. The guarantee has been recorded in the
consolidated balance sheets as a liability under the caption, "Guarantee of ESOP
obligations." At December 31, 1997 and 1996, the Company had an outstanding
guarantee of principal of $22.4 million and $24.4 million, respectively.
Contributions to the ESOP Trust plus dividends on leveraged shares held by the
ESOP Trust are used to meet interest and principal payments on the notes. As
principal payments are made, the recorded ESOP guarantee is reduced.
The Company was party to an interest rate swap agreement with a broker-dealer to
reduce the financial statement impact of fluctuations in the Credit Agreement
interest rate. The interest rate swap agreement expired on December 12, 1997.
The interest rate swap involved the exchange of fixed and floating rate interest
payments without the exchange of the underlying principal amount. During 1997,
the Credit Agreement interest rates ranged from 6% to 6.3%. During 1996 and
1995, they ranged from 6% to 6.6% and from 6% to 6.8%, respectively.
The Credit Agreement includes various financial and operating covenants with
which the Company must comply. The covenants include the maintenance of certain
contractual relationships with ALLIED Mutual, continued ownership of certain
subsidiaries, limitations on the issuance of security interests in certain
assets, maintenance of various financial ratios, and minimum net equity
requirements.
<PAGE>
47
(10) Preferred Stock
The Company is authorized to issue 7,500,000 shares of preferred stock without
par value. The preferred stock may be issued from time to time by the Board of
Directors in one or more series with such dividend rights, conversion rights,
voting rights, redemption provisions, liquidation preferences, and other rights
and restrictions as the Board of Directors may determine.
6-3/4% Series
The 6-3/4% Series preferred stock (6-3/4% Series), issued to ALLIED Mutual at a
value of $28.50 per share, is perpetual, nonconvertible, voting, and cumulative
with respect to dividends. The 6-3/4% Series has no preemptive rights and is not
registered or traded. Upon any transfer by ALLIED Mutual, the 6-3/4% Series is
callable under certain conditions and becomes nonvoting. Each share of the
6-3/4% Series has 3-3/8 votes. The annual dividend rate is 6-3/4% of the
liquidation preference of $28.50 ($1.92 per share) and is payable quarterly.
The Company entered into a Stock Rights Agreement with ALLIED Mutual to grant
both parties certain rights in terms of registration, transfer, voting, board
nominations, and other matters. Pursuant to the Stock Rights Agreement executed
July 5, 1990, ALLIED Mutual is entitled to nominate for election to the
Company's Board of Directors a number of director nominees that most closely
approximates the same percentage of the total number of members of the Company's
Board of Directors as is equal to ALLIED Mutual's percentage ownership of the
total number of shares of the Company voting stock.
ESOP Series
On March 7, 1996, the commercial bank acting on behalf of the ESOP participants
as the trustee for the ESOP Trust (Trustee) converted all of its shares of ESOP
Convertible Preferred Stock (ESOP Series) to shares of common stock.
(11) Common Stock
The Company has reserved 3,037,500 shares of common stock to be issued through
the ALLIED Group, Inc. Dividend Reinvestment and Stock Purchase Plan. Any
stockholder of record may participate in the plan and have cash dividends
reinvested in additional shares of common stock. The plan also provides for
optional cash payments. During 1997, 62,174 shares, purchased on the open
market, were issued at a weighted average price per share of $26.35. During 1996
and 1995, 92,171 and 96,087 shares, purchased on the open market, were issued at
a weighted average price per share of $17.65 and $13.34, respectively. At
December 31, 1997, 1,256,277 shares were available for issuance.
The Company has reserved 562,500 shares of common stock for issuance under the
ALLIED Life Employee Stock Purchase Plan. The Company receives fair market value
for the shares issued under the plan. During 1997, 1,242 shares were issued at a
weighted average price per share of $25.81. During 1996 and 1995, 834 and 4,512
shares were issued at a weighted average price per share of $17.81 and $12.78,
respectively. At December 31, 1997, 555,113 shares were available for issuance.
During 1997, the Company canceled 412,850 shares of its common stock repurchased
on the open market at an average cost of $24.71 per share. During 1996, the
Company canceled 996,750 shares of its common stock repurchased on the open
market at an average cost of $16.58 per share. No shares were repurchased in
1995.
As of December 31, 1997, the ESOP Trust was the holder of 9,146,633 shares, or
30% of the Company's common stock. The Trustee is entitled to vote the shares
held in the ESOP Trust on all matters submitted to a vote of the holders of the
common stock of the Company. The ESOP Trust generally provides that each ESOP
participant is entitled to direct the Trustee how to vote (or whether to tender
or exchange) the shares allocated to the participant's account. During 1997, the
ESOP Trust purchased 18,865 common shares at an average price per share of
$28.62. During 1996, 2,992,710 ESOP Series shares were converted to 10,100,396
shares of common stock and the ESOP Trust purchased 36,572 shares at an average
price per share of $21.93. During 1995, 174,960 ESOP Series shares were
converted to 590,490 shares of common stock.
The dividend rate per common share was $0.46, $0.39, and $0.30 for 1997, 1996,
and 1995, respectively.
<PAGE>
48
(12) Stock-based Compensation Plans
The Company has granted stock options to key employees under four nonqualified
plans as defined by the Internal Revenue Service: the ALLIED Group, Inc.
Restated and Amended Stock Option Plan (Option Plan), the ALLIED Group, Inc.
Nonqualified Stock Option Plan (Nonqualified Plan), the ALLIED Group Executive
Equity Incentive Plan (Equity Plan), and the Freedom Group Incentive Plan
(Freedom Plan). No options remain to be granted under the plans. During 1997,
all Freedom Plan options were exercised; during 1996, all Equity Plan options
were exercised. Upon exercise of the stock options under each plan, the Company
receives an amount equal to the common stock's fair market value at the grant
date. The options vest at various times and must be exercised ten years after
the date of grant.
In addition, the Company has reserved 1,350,000 shares of common stock for
issuance to key employees under the ALLIED Group, Inc. Long-Term Management
Incentive Plan (Incentive Plan). Under the Incentive Plan, shares of common
stock are available for grant until December 31, 2003 as incentive and
nonqualified stock options (collectively, Options), SARs, and restricted stock.
Options, SARs, and restricted stock granted prior to November of 1996 begin to
vest two years after the date of grant; those granted after November of 1996
begin to vest three years after the date of grant. Options, SARs, and restricted
stock prices are based upon the fair market values as of the date of grant.
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Weighted average
----------------------
Weighted
Exercise price Remaining average
Compensation range per Options contractual Exercise Options exercise
plan share outstanding life price exercisable price
- ------------------ --------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Option Plan $ 9.39 - 12.94 306,853 5.7 $11.41 145,126 $11.07
Nonqualified Plan 12.22 - 12.94 114,824 6.9 12.38 6,550 12.94
Incentive Plan 10.78 - 30.84 575,842 7.9 17.72 20,801 12.29
----------- -----------
997,519 172,477
=========== ===========
</TABLE>
A summary of stock option activity and prices for 1997, 1996, and 1995 is
presented below:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------- -------------------- ---------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Stock options Shares price Shares price Shares price
- --------------------------- --------- --------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 931,056 $12.67 851,034 $10.71 904,869 $ 7.75
Granted 240,000 25.26 193,500 17.98 292,500 12.25
Exercised (173,537) 9.69 (113,478) 7.14 (308,259) 4.18
Canceled --- --- --- --- (38,076) 4.97
--------- --------- --------- -------- --------- -------
Outstanding at end
of year 997,519 $16.09 931,056 $12.67 851,034 $10.71
========= ========= ========= ======== ========= =======
Options exercisable
at end of year 172,477 154,517 105,686
========= ========= =========
Weighted average fair
value of options granted
during the year $ 7.79 $ 6.13 $ 4.61
========= ========= =========
</TABLE>
<PAGE>
49
The issuance of SARs and restricted stock under the Incentive Plan reduces the
number of options available for future issuance. During 1997 SARs or restrictive
stocks were issued. During 1996 and 1995, 9,581 and 29,951 shares of restricted
stock were awarded at $19.17 per share and $12.17 per share, respectively.
During 1997 and 1996, the restriction was lifted on 11,137 and 2,359 shares,
respectively. During 1997, 1996, and 1995, the number of restricted shares
forfeited was 3,819, 260, and 914, respectively. At December 31, 1997, 24,577
restricted shares were outstanding. The following table presents SAR activity
and prices for the years ended December 31, 1997, 1996, and 1995:
<TABLE>
<CAPTION>
Weighted
Number average
SARs of shares price
------------------------------------------- --------------- -----------
<S> <C> <C>
Outstanding at January 1, 1995 18,000 $ 10.82
Granted 17,252 12.28
Exercised (2,250) 10.78
--------
Outstanding at December 31, 1995 33,002 11.59
Granted 19,125 17.89
Exercised (2,813) 10.87
--------
Outstanding at December 31, 1996 49,314 14.02
Exercised (10,202) 12.24
--------
Outstanding at December 31, 1997 39,112 $ 14.56
========
</TABLE>
The Company has reserved 1,687,500 and 843,750 shares of common stock for
issuance under the ALLIED Group, Inc. Employee Stock Purchase Plan (ESPP) and
the ALLIED Group, Inc. Outside Director Stock Purchase Plan (DSPP),
respectively. Under the plans, participants pay 85% of the fair market value of
the shares issued, which are fully vested on the dates purchased. During 1997,
56,564 shares were issued at a weighted average price per share of $22.83.
During 1996 and 1995, 62,447 and 69,065 shares were issued at a weighted average
price per share of $14.62 and $11.39, respectively. At December 31, 1997,
526,483 and 789,763 shares were available for issuance under the ESPP and DSPP,
respectively.
During 1997, the Company reserved 750,000 shares of common stock for issuance
semiannually under the ALLIED Group, Inc. Agency Stock Purchase Plan (ASPP).
Eligible agencies and agents pay 90% of the fair market value of the shares
issued, which are fully vested on the dates purchased. During 1997, 128,703
shares were issued at an average price per share of $26.20. At December 31,
1997, 621,297 shares were available for issuance under the ASPP.
The Company applies APB 25 in accounting for its stock-based compensation plans,
as permitted by SFAS 123. Accordingly, no compensation cost for the Company's
stock option plans has been recognized in the accompanying financial statements.
Compensation cost of $690,000, $386,000, and $167,000 was recognized in 1997,
1996, and 1995, respectively, under the Company's DSPP and ASPP and from the
SARs. Had compensation cost been determined based on the fair value at the grant
date of the stock option plans in accordance with SFAS 123, the Company's net
income and earnings per share would have been reduced to the pro forma amounts
presented in the following table:
<TABLE>
<CAPTION>
Basic Diluted
Net earnings earnings
income per share per share
--------- --------- ---------
(in thousands, except per share data)
1997
<S> <C> <C> <C>
As reported $ 65,436 $ 2.03 $ 2.01
Pro forma 64,443 2.01 1.99
1996
As reported $ 51,084 $ 1.61 $ 1.51
Pro forma 50,624 1.58 1.50
1995
As reported $ 52,377 $ 2.18 $ 1.54
Pro forma 52,140 2.15 1.54
</TABLE>
<PAGE>
50
The pro forma amounts presented are not necessarily indicative of future
amounts; SFAS 123 does not apply to awards granted prior to 1995. Therefore, the
full impact of calculating comprehensive cost for stock options under SFAS 123
is not reflected in the pro forma amounts presented above because compensation
cost is reflected over the options' vesting periods and grants awarded prior to
1995 are not considered.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model. The following table shows weighted average
assumptions for grants in 1997 and 1996:
<TABLE>
<CAPTION>
Risk-free
Dividend interest Expected Expected
Plans yield rate volatility life (yrs)
--------------------------------- -------- --------- ---------- ---------
<S> <C> <C> <C> <C>
1997
Incentive 2.0% 6.3% 22.4% 7.0
1996
Incentive 2.0% 6.2% 32.8% 5.5
1995
Option and Nonqualified 2.0% 7.2% 31.7% 7.0
Incentive 2.0 7.1 33.4 5.5
</TABLE>
(13) Retained Earnings
In 1997, 1996, and 1995, the Company paid dividends of $17.5 million, $16.3
million, and $13.5 million, respectively.
Retained earnings of the property-casualty and excess & surplus lines
subsidiaries available for distribution as dividends are limited by law to the
amount of statutory unassigned surplus as of the date a dividend is authorized
or paid. The maximum amount legally available for distribution in 1997 without
regulatory approval is $58.5 million.
The following table includes selected information for the insurance subsidiaries
as determined in accordance with accounting practices prescribed or permitted by
insurance regulatory authorities:
<TABLE>
<CAPTION>
As of December 31, 1997 1996
- --------------------------------------- ------------- -------------
(in thousands)
<S> <C> <C>
Statutory capital and surplus
Property-casualty $ 335,694 $ 285,854
============= =============
Excess & surplus lines $ 40,501 $ 33,478
============= =============
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1997 1996 1995
- --------------------------------------- ------------- ------------- -------------
(in thousands)
<S> <C> <C> <C>
Statutory net income
Property-casualty $ 53,436 $ 47,492 $ 41,995
============= ============= =============
Excess & surplus lines $ 7,056 $ 5,669 $ 2,773
============= ============= =============
</TABLE>
<PAGE>
51
(14) Commitments and Contingencies
Commitments
The Company and its subsidiaries lease data processing equipment and certain
office facilities under operating leases expiring in various years through 2003.
Rental expense amounted to $3.9 million, $3.2 million, and $2.6 million for the
years ended December 31, 1997, 1996, and 1995, respectively. At December 31,
1997 future minimum lease payments under noncancelable operating leases amounted
to $13.5 million; they will amount to $2.7 million in 1998, $2.8 million in
1999, $1.4 million in 2000, $768,000 in 2001, $782,000 in 2002, and $5 million
in later years.
In the normal course of business, ALLIED Mortgage grants mortgage loan
commitments to borrowers, subject to normal loan underwriting standards. As of
December 31, 1997, ALLIED Mortgage had granted loan commitments of approximately
$91.6 million, including floating rate commitments of $25.5 million. ALLIED
Mortgage may enter into options, futures, or cash delivery contracts to reduce
interest risk on certain mortgage loans held for sale and loan commitments. As
of December 31, 1997, ALLIED Mortgage had cash delivery contracts to sell
mortgage securities totaling approximately $69.8 million and had no outstanding
options or future contracts. In connection with its commitments to buy and sell
mortgages, ALLIED Mortgage is exposed to credit risk in the event the
counterparty is unable to fulfill its contractual obligations.
Although loans serviced for others are not on the accompanying balance sheets,
ALLIED Mortgage has credit risk associated with the mortgage servicing
portfolio. As the loan servicer, ALLIED Mortgage is required to process
delinquent loans through the foreclosure process, thereby incurring certain
direct expenses which generally are, but may not be, reimbursed. At December 31,
1997, ALLIED Mortgage had sold loans totaling approximately $12.9 million while
retaining recourse risk. ALLIED Mortgage established allowances for losses in
connection with these various risks. These allowances are included in other
liabilities on the accompanying balance sheets.
Contingencies
California has been the source of approximately 25% of the pool's direct written
premiums for the past ten years. Proposition 103, approved by California voters
in 1988, provides for a rollback of rates on premiums collected in calendar year
1989 to the extent that the insurer's return on equity for each Proposition 103
line exceeded 10%. The rollback liability, if any, has not been finalized.
Management of the Company continues to believe that the insurance subsidiaries
will not be liable for any material rollback of premiums.
The Company is party to various lawsuits arising in the normal course of
business. Management believes the resolution of these lawsuits will not have a
material adverse effect on its financial condition or its results of operations.
On December 31, 1997, a complaint was filed by Mary M. Rieff, a policyholder of
ALLIED Mutual in the Iowa District Court in and for Polk County, Iowa, against
the Company and certain other individuals who are or were officers and/or
directors of ALLIED Mutual and the Company. The complaint, an alleged
policyholder derivative action brought on behalf of ALLIED Mutual, asserts,
among other things, (a) that the defendants were responsible for the
inappropriate transfer of ALLIED Mutual's corporate assets, the seizure of
certain corporate opportunities, and the implementation of an improper de facto
demutualization without informing or compensating policyholders or receiving the
appropriate approval from regulatory authorities; (b) that this allegedly
wrongful demutualization began on or about January 1, 1985 and was accomplished
through transfers of ALLIED Mutual's assets to the Company and to the individual
defendants for inadequate consideration; (c) that the individual defendants
breached fiduciary duties owed to ALLIED Mutual, wasted its corporate assets and
intentionally interfered with its contracts, prospective business advantage and
business relationships; and (d) that defendants improperly transferred
substantial ownership of and control over the Company and ALLIED Mutual's
insurance business. The complaint further asserts that as a result of the
foregoing, ALLIED Mutual and its policyholders have suffered damages in excess
of $500 million. The complaint requests an accounting of the assets allegedly
wrongfully transferred to the Company and compensation to ALLIED Mutual for the
value of such assets, for the seizure of corporate opportunities, and for the de
facto demutualization of ALLIED Mutual. The complaint also asks for certain
other relief, including attorneys' fees and costs, equitable relief and
interest, and restitution for any assets wrongfully transferred or conveyed. The
Company believes that the suit is without merit and intends to defend this
action vigorously. As is the case in all pending actions, the ultimate outcome
is uncertain.
<PAGE>
52
(15) Employee Benefit Plans
Retirement Plan
The ESOP established by the Company covers all of its employees who meet age and
service requirements. Shares of common stock are allocated annually to each
employee's account pursuant to a formula and held in trust until the employee's
termination, retirement, or death. As shares of common stock are allocated to
parti- cipants, the cost of such shares is expensed and deducted from unearned
compensation related to ESOP included in stockholders' equity.
The Company's ESOP expense was $2.4 million in 1997, $1 million in 1996, and
$2.7 million in 1995. Of those respective amounts, $44,000, $14,000, and $65,000
were included in the employee lease fee received from affiliates pursuant to the
terms of the Intercompany Operating Agreement for the years ended December 31,
1997, 1996, and 1995, respectively.
During 1997, 1996, and 1995, the ESOP Trust received $3.6 million, $3.5 million,
and $2.8 million, respectively, from dividends on the leveraged shares used to
service debt on the ESOP obligations and to purchase stock for participants. The
Company made ESOP contributions of $312,000 in 1997, $529,000 in 1996, and
$733,000 in 1995. Interest incurred on the ESOP debt, which is included as a
component of ESOP expense, was $1.5 million, $1.6 million, and $1.8 million in
1997, 1996, and 1995, respectively. The ESOP shares as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
------------- ------------
<S> <C> <C>
Allocated shares 4,783,464 4,318,791
Unallocated shares 4,363,167 5,404,544
------------- ------------
Total ESOP shares 9,146,631 9,723,335
============= ============
</TABLE>
In 1997, the Company and the ESOP Trustee entered into an agreement whereby the
Company agreed to release additional shares held by the ESOP Trustee in the
event the Company pays a dividend on the common stock of less than $0.09 per
share per quarter on a post-split basis. The agreement is in effect from March
7, 1997 through March 7, 2000. The purpose of the agreement is to ensure that
the allocated shares in the ESOP Trust receive at least the same amount of
dividends that would have been paid on the ESOP Convertible Preferred Stock had
it not been converted to common stock.
Other Postretirement Benefit Plan
In addition to the ESOP, the Company sponsors a health care plan that provides
postretirement medical benefits to full-time employees who meet age and service
requirements. The plan is contributory with retiree contributions adjusted
annually, and contains other cost-sharing features such as deductibles and
coinsurance. The Company's policy is to fund the cost of medical benefits in
amounts determined at the discretion of management.
The following table presents the plan's postretirement benefit obligations as of
December 31, 1997 and 1996 reconciled with the plan's funded status and the
amount recognized in the Company's consolidated balance sheets:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
(in thousands)
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees $ (4,130) $ (3,520)
Other fully eligible plan participants (690) (680)
Other active plan participants (2,780) (2,700)
------------ ------------
(7,600) (6,900)
Plan assets --- ---
------------ ------------
Funded status (7,600) (6,900)
Unrecognized transition obligation 3,620 3,860
Unrecognized net loss 440 230
Fourth-quarter payments 110 80
------------ ------------
Accrued postretirement benefit liability $ (3,430) $ (2,730)
============ ============
</TABLE>
<PAGE>
53
A 7.5% weighted average discount rate was used to determine the accumulated
postretirement benefit obligation at December 31, 1997 and 1996.
Net periodic postretirement benefit cost for the years ended December 31, 1997,
1996, and 1995 included the following:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
(In thousands)
<S> <C> <C> <C>
Service cost $ 380 $ 340 $ 350
Interest cost 500 460 420
Return on assets --- --- ---
Amortization of transition obligation 240 240 240
----------- ----------- -----------
Net periodic postretirement benefit cost $ 1,120 $ 1,040 $ 1,010
=========== =========== ===========
</TABLE>
For measurement purposes, an 7% annual rate of increase in the per capita cost
of covered benefits (i.e., health care cost trend rate) was assumed for 1998;
the rate was assumed to decrease in equal annual increments to 5% by the year
2000 and to remain at that level thereafter. The health care cost trend rate
assumption has a significant effect on the amounts reported. For example,
increasing the assumed health care cost trend rates by one percentage point in
each year would increase the accumulated postretirement benefit obligation by
approximately $540,000 and the aggregate of the service and interest cost
components of net periodic postretirement benefit cost by approximately $40,000.
(16) Income Taxes
Total income taxes for the years ended December 31, 1997, 1996, and 1995 were
allocated as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ------------ ------------
(in thousands)
<S> <C> <C> <C>
Net income $ 25,973 $ 20,277 $ 21,471
----------- ------------ ------------
Stockholders' equity
Unrealized appreciation (depreciation) of investments 5,780 (3,000) 12,776
Tax-deductible dividends paid on unallocated
ESOP Series shares (909) (989) (849)
Tax-basis compensation expense in excess of amounts
recognizedfor financial reporting purposes from the
exercise of stock options (1,007) (371) (1,064)
----------- ----------- ------------
3,864 (4,360) 10,863
----------- ----------- ------------
Total $ 29,837 $ 15,867 $ 32,334
=========== =========== ============
</TABLE>
<PAGE>
54
The tax effects of temporary differences that gave rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 1997 and
1996 relate to the following:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
(in thousands)
<S> <C> <C>
Deferred tax assets
Loss and loss adjusting expense reserve discounting $ 13,808 $ 14,258
Unearned premium reserve 16,163 14,893
Accrued employee benefits 3,250 2,858
Other 2,561 1,314
------------ -----------
Total gross deferred tax assets 35,782 33,323
Less valuation allowance --- ---
------------ -----------
Net deferred tax assets 35,782 33,323
------------ -----------
Deferred tax liabilities
Deferred policy acquisition costs (17,743) (16,335)
Mortgage servicing rights (4,939) (4,533)
Unrealized appreciation of investments (12,687) (6,907)
Deferred software development costs and fees (2,761) (4,886)
Other (3,167) (2,906)
------------ -----------
Total gross deferred tax liabilities (41,297) (35,567)
------------ -----------
Net deferred tax liabilities $ (5,515) $ (2,244)
============ ===========
</TABLE>
Since the adoption of SFAS 109, there has not been a valuation allowance for
deferred income tax assets. In assessing the realization of deferred tax assets,
management considers whether it is more likely than not that the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent upon the recognition of future taxable income during the periods in
which those temporary differences become deductible. Management considers tax
planning strategies and the scheduled reversal of deferred tax liabilities in
making this assessment and believes it is more likely than not the Company
ultimately will realize the benefits of the deductible differences recognized at
December 31, 1997.
The actual income tax expense for the years ended December 31, 1997, 1996, and
1995 differed from the expected tax expense (computed by applying the federal
corporate tax rate of 35% to income before income taxes). The difference was
primarily a result of investment income exempt from federal income tax, which
decreased tax expense by $5.5 million, $4.7 million, and $4.5 million in 1997,
1996, and 1995, respectively.
Included in income tax expense is a state income tax benefit of $84,000 for the
year ended December 31, 1997 and state income tax expense of $55,000 and
$402,000 for the years ended December 31, 1996, and 1995, respectively. The
Company paid federal and state income taxes of $26.2 million, $18 million, and
$19.1 million in 1997, 1996, and 1995, respectively.
The IRS is currently examining the 1995 and 1996 income tax returns. Any
proposed adjustments are not expected to have a material impact on the Company's
financial condition, results of operations, or liquidity.
<PAGE>
55
(17) Earnings per Share
Presented in the following table is a reconciliation of the numerators and
denominators of the basic and diluted earnings per share computation for the
three years ended December 31, 1997, 1996, and 1995:
<TABLE>
<CAPTION>
Basic earnings per share Dilutive earnings per share
------------------------------------- ---------------------------------------------------
Income Dilutive Income
available to ESOP(1) Stock(2) potential available to
Net Preferred common Series if options in common common
income dividends stockholders converted subsidiaries shares stockholders
--------- --------- ------------ --------- ------------ --------- ------------
1997
<S> <C> <C> <C> <C> <C> <C> <C>
Income $ 65,436 $ (3,515) $ 61,921 --- --- --- $ 61,921
Weighted
average
shares
outstanding 30,487 --- 30,487 --- --- 325 30,812
------------ ------------
Earnings
per share $ 2.03 $ 2.01
============ ============
1996
Income $ 51,084 $ (4,111) $ 46,973 $ 595 $ (470) --- 47,098
Weighted
average
shares
outstanding 29,112 --- 29,112 1,838 --- 193 31,143
------------ ------------
Earnings
per share $ 1.61 $ 1.51
============= ============
1995
Income $ 52,377 $ (7,217) $ 45,160 $ 3,534 $ (388) --- 48,306
Weighted
average
shares
outstanding 20,710 --- 20,710 10,417 --- 179 31,306
------------- -----------
Earnings
per share $ 2.18 $ 1.54
============= ===========
</TABLE>
(1) The ESOP Series was converted on March 7, 1996 (note 10).
(2) Options in subsidiary were exercised in 1997, producing minority interest
reported on the Statements of Income and Comprehensive Income.
Options to purchase 75,000 shares of common stock at a weighted average price of
$30.42 per share were outstanding at December 31, 1997 but not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average 1997 market price of common shares.
<PAGE>
56
(18) Segment Information
The Company has two reportable operating segments: property-casualty and excess
& surplus lines. The segments are managed separately due to the differences in
the insurance products sold, underwriting risk, and the environments in which
they operate.
The property-casualty segment accounted for 85.7% of 1997 consolidated revenues.
It underwrites personal lines (primarily automobile and homeowners) and small
commercial lines through three subsidiaries and markets its products through
three distribution systems: independent agencies, exclusive agencies, and direct
response marketing. The segment operates primarily in central and western
states. California and Iowa accounted for 23.7% and 21.4%, respectively, of 1997
direct written premiums. The Company evaluates the property-casualty segment's
performance on the basis of growth in direct written premiums and profit.
The excess & surplus lines segment accounted for 6% of 1997 consolidated
revenues, and its performance is evaluated on profit. Included in all other are
mortgage banking, data processing operations, and employee leasing services to
affiliated companies. All segments of the Company operate exclusively in the
United States.
The Company accounts for intercompany sales and transactions as if they were to
third parties and attempts to set fees consistent with those that would apply in
an arm's length transaction with a nonaffiliate. There can be no assurance the
rates charged reflect those that would have been agreed upon following an arm's
length negotiation.
<PAGE>
57
The following table presents a summary of the Company's operating segment for
the three years ended December 31, 1997:
<TABLE>
<CAPTION>
Property- Excess & All Intersegment Reported
casualty surplus other eliminations balances
----------- ----------- ----------- ------------ ----------
(in thousands)
1997
<S> <C> <C> <C> <C> <C>
Revenues from nonaffiliates $ 524,109 $ 33,291 $ 51,033 $ --- $ 608,433
Revenues from affiliates 1,008 --- 117,209 (113,092) 5,125
Net investment income 44,258 6,802 383 (319) 51,124
Income before income taxes
and minority interest* 81,875 10,009 28 --- 91,912
Income taxes 18,247 1,323 1,901 --- 21,471
Depreciation & amortization 9,039 66 5,904 --- 15,009
Capital expenditures 5,148 65 919 --- 6,132
Segment assets 1,012,926 141,814 560,270 (513,777) 1,201,233
1996
Revenues from nonaffiliates $ 472,931 $ 27,316 $ 42,005 $ --- $ 542,252
Revenues from affiliates 479 --- 105,156 (100,755) 4,880
Net investment income 42,296 6,241 756 (71) 49,222
Income before income taxes* 59,435 8,053 3,823 --- 71,311
Income taxes 16,689 2,373 1,165 --- 20,227
Depreciation & amortization 3,812 65 7,153 --- 11,030
Capital expenditures 7,101 34 1,178 --- 8,313
Segment assets 917,537 131,405 477,760 (449,043) 1,077,659
1995
Revenues from nonaffiliates $ 432,924 $ 29,526 $ 37,788 $ --- $ 500,238
Revenues from affiliates --- --- 121,247 (115,962) 5,285
Net investment income 39,110 5,830 2,302 --- 47,242
Income before income taxes* 63,883 4,840 5,125 --- 73,848
Income taxes 23,503 2,953 (483) --- 25,973
Depreciation & amortization 851 58 8,674 --- 9,583
Capital expenditures 3,390 131 4,273 --- 7,794
Segment assets 847,401 122,200 466,459 (425,462) 1,010,598
</TABLE>
*includes realized gains or losses
The following table shows the detail of intersegment eliminations for segment
assets shown in the previous table:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Segment assets eliminations
Investment in subsidiaries $ 503,785 $ 437,979 $ 416,951
Other consolidating adjustments 9,992 11,064 8,511
----------- ----------- -----------
$ 513,777 $ 449,043 $ 425,462
=========== =========== ===========
</TABLE>
<PAGE>
58
(19) Unaudited Interim Financial Information
<TABLE>
<CAPTION>
Quarter ended March 31 June 30 September 30 December 31
- -------------------------------- ------------- -------------- ------------- -------------
(in thousands, except per share data)
1997 Operating Summary
<S> <C> <C> <C> <C>
Earned premiums $ 131,867 $ 135,876 $ 137,816 $ 142,038
============= ============== ============= =============
Investment income $ 12,652 $ 12,874 $ 12,968 $ 12,630
============= ============== ============= =============
Realized investment gains (losses) $ (7) $ 7 $ 17 $ 374
============= ============== ============= =============
Total revenues $ 158,744 $ 163,707 $ 166,166 $ 176,065
============= ============== ============= =============
Losses and expenses $ 136,168 $ 141,821 $ 143,429 $ 151,352
============= ============== ============= =============
Net income $ 15,942 $ 15,655 $ 16,067 $ 17,772
============= ============== ============= =============
Diluted earnings per share
Net income $ .49 $ .48 $ .49 $ .55
============= ============== ============= =============
1996 Operating Summary
Earned premiums $ 118,870 $ 121,114 $ 124,246 $ 129,295
============ ============== ============= =============
Investment income $ 12,119 $ 12,044 $ 12,445 $ 12,614
============= ============== ============= =============
Realized investment gains (losses) $ 8 $ 31 $ 26 $ (16)
============= ============== ============= =============
Total revenues $ 143,335 $ 146,585 $ 150,719 $ 155,715
============= ============== ============= =============
Losses and expenses $ 123,551 $ 136,044 $ 130,438 $ 135,010
============= ============== ============= =============
Net income $ 13,948 $ 7,548 $ 14,459 $ 15,129
============= ============== ============= =============
Diluted earnings per share
Net income $ .41 $ .21 $ .44 $ .46
============= ============== ============= =============
Caution should be exercised in comparing the results of consecutive quarters.
</TABLE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.
None.
<PAGE>
59
PART III
Item 10. Directors and Executive Officers of the Registrant
The information under the caption "Directors and Executive Officers" in the 1998
Proxy Statement is incorporated herein by reference.
Item 11. Executive Compensation
The information under the caption "Compensation of Executive Officers" in the
1998 Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information under the caption "Security Ownership of Directors and Executive
Officers" in the 1998 Proxy Statement is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The information under the caption "Certain Transactions and Relationships" in
the 1998 Proxy Statement is incorporated herein by reference.
<PAGE>
60
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) List of Financial Statements and Schedules.
Form 10-K
Page(s)
---------
1. Financial Statements.
Independent Auditors' Report. 30
Consolidated Balance Sheets as of December 31, 1997 and 1996. 31
Consolidated Statements of Income and Comprehensive Income
for the Years ended December 31, 1997, 1996 and 1995. 33
Statements of Stockholders' Equity for the Years ended
December 31, 1997, 1996 and 1995. 34
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995. 35
Notes to Consolidated Financial Statements. 36
2. Schedules.
Report of Independent Auditors on Schedules.
I - Summary of Investments Other Than Investments in
Related Parties. 67
II - Condensed Financial Information of Registrant. 68
III - Supplementary Insurance Information. 72
IV - Reinsurance. 73
VI - Supplemental Information. 74
All other schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedule, or
because the information required is included in the consolidated financial
statements and notes thereto.
3. Executive Compensation Plans and Arrangements.
ALLIED Group Restated and Amended Stock Option Plan (Incorporated by
reference to Exhibit 10.19 to the Company's December 31, 1992 Form
10-K on file with the Commission), Exhibit 10.18.
ALLIED Group, Inc. Nonqualified Stock Option Plan (Incorporated by
reference to Exhibit 10.20 to the Company's December 31, 1992 Form
10-K on file with the Commission), Exhibit 10.19.
<PAGE>
61
ALLIED Group, Inc. Outside Director Stock Purchase Plan (Incorporated
by reference to Exhibit 10.21 to the Company's December 31, 1992 Form
10-K on file with the Commission), Exhibit 10.20.
ALLIED Group, Inc. Long-Term Management Incentive Plan (Incorporated
by reference to Exhibit 10.42 to the Company's March 31, 1994 Form
10-Q on file with the Commission), Exhibit 10.42.
Consulting Agreement between John E. Evans and ALLIED Group, Inc.,
ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation
(Incorporated by reference to Exhibit 10.48 to the Company's December
31, 1994 Form 10-K on file with the Commission), Exhibit 10.48.
ALLIED Group Short Term Management Incentive Plan for 1995
(Incorporated by reference to Exhibit 10.49 to the Company's December
31, 1994 Form 10-K on file with the Commission), Exhibit 10.49.
ALLIED Group Short Term Management Incentive Plan for 1996,
(Incorporated by reference to Exhibit 10.49 to the Company's December
31, 1995 Form 10-K on file with the Commission), Exhibit 10.52.
Amendment to Consulting Agreement between John E. Evans and ALLIED
Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life
Financial Corporation (Incorporated by reference to Exhibit 10.54 to
the Company's December 31, 1996 Form 10-K on file with the
Commission), Exhibit 10.54.
ALLIED Group Short Term Management Incentive Plan for 1997
(Incorporated by reference to Exhibit 10.55 to the Company's December
31, 1996 Form 10-K on file with the Commission), Exhibit 10.55.
Second Amendment to Consulting Agreement between John E. Evans and
ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life
Financial Corporation (Incorporated by reference to Exhibit 10.62 to
the Company's June 30, 1997 Form 10-Q on file with the Commission),
Exhibit 10.61.
ALLIED Group Short Term Management Incentive Plan for 1998, Exhibit
10.63.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
NOTE: See "Index to Exhibits" on page number 76, which discloses the
specific page numbers for the exhibits included in this Form 10-K.
2. Plan of acquisition, reorganization, arrangement, liquidation or
succession.
2.2 Stock Rights Agreement between ALLIED Mutual Insurance Company
and ALLIED Group, Inc. dated July 5, 1990 (Incorporated by
reference to Exhibit 2.4 to the Company's July 1, 1990 Form 8-K
on file with the Commission).
2.3 First Amendment to Stock Rights Agreement between ALLIED Mutual
Insurance Company and ALLIED Group, Inc. (Incorporated by
reference to Exhibit 2.5 to the Company's September 30, 1992
Form 10-Q on file with the Commission).
3. Articles of incorporation and bylaws.
3.1 Amended and Restated Articles of Incorporation of ALLIED Group,
Inc. as of May 1, 1996 (Incorporated by reference to Exhibit 3.1
to the Company's March 31, 1996 Form 10-Q on file with the
Commission).
<PAGE>
62
3.2 Bylaws of the Company as of July 9, 1991, as amended March 3,
1992, December 2, 1992, October 14, 1993, December 14, 1994, and
March 4, 1997 (Incorporated by reference to Exhibit 3.2 to the
Company's December 31, 1996 Form 10-K on file with the
Commission).
3.3 Articles of Amendment dated May 13, 1997 to the Amended and
Restated Articles of Incorporation (Incorporated by reference to
Exhibit 3.3 to the Company's June 30, 1997 Form 10-Q on file
with the Commission)
4. Instruments defining the rights of security holders including
indentures.
4.7 Agreement between ALLIED Group, Inc. and State Street Bank and
Trust Company, dated March 7, 1996. (Incorporated by reference
to Exhibit 4.7 to the Company's December 31, 1995 Form 10-K on
file with the Commission).
4.8 Stock Purchase Agreement between ALLIED Group, Inc. and State
Street Bank and Trust Company dated December 30, 1994.
(Incorporated by reference to Exhibit 4.8 to the Company's
December 31, 1995 Form10-K on file with the Commission).
4.9 Stock Purchase Agreement between ALLIED Group, Inc. and State
Street Bank and Trust Company dated December 29, 1995.
(Incorporated by reference to Exhibit 4.9 to the Company's
December 31, 1995 Form 10-K on file with the Commission).
4.10 Stock Purchase Agreement between ALLIED Group, Inc. and State
Street Bank and Trust Company dated December 31, 1996.
(Incorporated by reference to Exhibit 4.10 to the Company's
December 31, 1996 Form 10-K on file with the Commission).
10. Material contracts.
10.7 Amended and Restated Management Information Services Agreement
between AMCO Insurance Company and certain of its affiliated
companies (Incorporated by reference to Exhibit 10.7 to the
Company's December 31, 1996 Form 10-K on file with the
Commission).
10.8 First Amendment to Amended and Restated Management Information
Services Agreement (Incorporated by reference to Exhibit 10.8 to
the Company's December 31, 1996 Form 10-K on file with the
Commission).
10.14 Second Amended and Restated Reinsurance Pooling Agreement
between ALLIED Mutual Insurance Company and the Company's
property-casualty insurance subsidiaries (Incorporated by
reference to Exhibit 10.13 to the Company's Registration
Statement on Form S-3 filed with the Commission on December 15,
1992, Registration No. 33-55714).
10.15 First Amendment to the Second Amended and Restated Reinsurance
Pooling Agreement between ALLIED Mutual Insurance Company and
the Company's property-casualty insurance subsidiaries
(Incorporated by reference to Exhibit 10.43 to the Company's
March 31, 1993 Form 10-Q on file with the Commission).
10.16 Amended and Restated ALLIED Group Intercompany Operating
Agreement between the Company and its affiliated companies dated
August 25, 1993 and amendment thereto dated November 1, 1993
(Incorporated by reference to Exhibit 10.14 to the Company's
September 30, 1993 Form 10-Q on file with the Commission).
10.17 ALLIED Group, Inc. Federal Income Tax Sharing Agreement.
10.18 ALLIED Group Restated and Amended Stock Option Plan
(Incorporated by reference to Exhibit 10.19 to the Company's
December 31, 1992 Form 10-K on file with the Commission).
<PAGE>
63
10.19 ALLIED Group, Inc. Nonqualified Stock Option Plan (Incorporated
by reference to Exhibit 10.20 to the Company's December 31, 1992
Form 10-K on file with the Commission).
10.20 ALLIED Group, Inc. Outside Director Stock Purchase Plan
(Incorporated by reference to Exhibit 10.21 to the Company's
December 31, 1992 Form 10-K on file with the Commission).
10.21 ALLIED Group Executive Equity Incentive Plan (Incorporated by
reference to Exhibit 10.22 to the Company's December 31, 1992
Form 10-K on file with the Commission).
10.22 Agency Agreement between ALLIED Group Insurance Marketing
Company and Depositors Insurance Company, AMCO Insurance
Company, and ALLIED Property and Casualty Insurance Company
(Incorporated by reference to Exhibit 10.17 to the Company's
December 31, 1991 Form 10-K on file with the Commission).
10.28 The ALLIED Group Employee Stock Ownership Trust (Incorporated by
reference to Exhibit 10.27 to the Company's March 31, 1991 Form
10-Q on file with the Commission).
10.29 The ALLIED Group Employee Stock Ownership Plan, as amended and
restated effective January 1, 1996 (Incorporated by reference to
Exhibit 10.29 to the Company's September 30, 1997 Form 10-Q on
file with the Commission).
10.32 Term Credit Agreement and Guaranty between ALLIED Group, Inc.,
ALLIED Group Employee Ownership Trust, Bank of Montreal, and
Norwest Bank Iowa, N.A. (Incorporated by reference to Exhibit
10.29 to the Company's March 31, 1995 Form 10-Q on file with the
Commission).
10.33 First Amendment to the Term Credit Agreement and Guaranty, dated
October 12, 1995. (Incorporated by reference to Exhibit 10.30 to
the Company's September 30, 1995 Form 10-Q on file with the
Commission).
10.34 Second Amendment to the Term Credit Agreement and Guaranty,
dated March 6, 1996 (Incorporated by reference to Exhibit 10.30
to the Company's March 31, 1996 Form 10-Q on file with the
Commission).
10.35 Third Amendment to the Term Credit Agreement and Guaranty, dated
September 26, 1997 (Incorporated by reference to Exhibit 10.35
to the Company's September 30, 1997 Form 10-Q on file with the
Commission).
10.36 Fourth Amendment to the Term Credit Agreement and Guaranty,
dated November 17, 1997.
10.38 The ALLIED Group Marketing Agreement between the Company's
property-casualty subsidiaries and certain of its affiliated
companies dated August 25, 1993 and amendment thereto dated
November 1, 1993 (Incorporated by reference to Exhibit 10.39 to
the Companies September 30, 1993 Form 10-Q on file with the
Commission).
10.42 ALLIED Group, Inc. Long-Term Management Incentive Plan
(Incorporated by reference to Exhibit 10.42 to the Company's
March 31, 1994 Form 10-Q on file with the Commission).
10.44 Second Amendment to Amended and Restated ALLIED Group
Intercompany Operating Agreement dated May 16, 1994
(Incorporated by reference to Exhibit 10.42 to the Company's
June 30, 1994 Form 10-Q on file with the Commission).
10.45 Second Amendment to the ALLIED Group Marketing Agreement between
the Company's property-casualty subsidiaries and certain of its
affiliated companies, dated August 25, 1994 (Incorporated by
reference to Exhibit 10.45 to the Company's September 30, 1994
Form 10-Q on file with the Commission).
<PAGE>
64
10.46 Third Amendment to Amended and Restated ALLIED Group
Intercompany Operating Agreement (Incorporated by reference to
Exhibit 10.46 to the Company's December 31, 1994 Form 10-K on
file with the Commission).
10.47 Second Amendment to Amended and Restated Reinsurance Pooling
Agreement (Incorporated by reference to Exhibit 10.47 to the
Company's December 31, 1994 Form 10-K on file with the
Commission).
10.48 Consulting Agreement between John E. Evans and ALLIED Group,
Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial
Corporation (Incorporated by reference to Exhibit 10.48 to the
Company's December 31, 1994 Form 10-K on file with the
Commission).
10.49 ALLIED Group Short Term Management Incentive Plan for 1995
(Incorporated by reference to Exhibit 10.49 to the Company's
December 31, 1994 Form 10-K on file with the Commission).
10.50 Intercompany Cash Concentration Fund Agreement, dated April 24,
1995 (Incorporated by reference to Exhibit 10.52 to the
Company's June 30, 1995 Form 10-Q on file with the Commission).
10.51 Amendment to the Nonqualified Stock Option Plan, dated October
20, 1995 (Incorporated by reference to Exhibit 10.53 to the
Company's September 30, 1995 Form 10-Q on file with the
Commission).
10.52 ALLIED Group Short Term Management Incentive Plan for 1996
(Incorporated by reference to Exhibit 10.52 to the Company's
December 31, 1995 Form 10-K on file with the Commission).
10.54 Amendment to Consulting Agreement between John E. Evans, and
ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED
Life Financial Corporation (Incorporated by reference to Exhibit
10.54 to the Company's December 31, 1996 Form 10-K on file with
the Commission).
10.55 ALLIED Group Short Term Management Incentive Plan for 1997
(Incorporated by reference to Exhibit 10.55 to the Company's
December 31, 1996 Form 10-K on file with the Commission).
10.56 Amendment dated December 16, 1996, ALLIED Group, Inc. Long-Term
Management Incentive Plan (Incorporated by reference to Exhibit
10.56 to the Company's December 31, 1996 Form 10-K on file with
the Commission).
10.57 Amendment dated February 11, 1997, ALLIED Group, Inc. Outside
Director Stock Purchase Plan (Incorporated by reference to
Exhibit 10.57 to the Company's December 31, 1996 Form 10-K on
file with the Commission).
10.58 Amendment dated February 11, 1997, ALLIED Group, Inc.
Nonqualified Stock Option Plan (Incorporated by reference to
Exhibit 10.58 to the Company's December 31, 1996 Form 10-K on
file with the Commission).
10.59 Amendment dated February 11, 1997, ALLIED Group, Inc. Restated
and Amended Stock Option Plan (Incorporated by reference to
Exhibit 10.59 to the Company's December 31, 1996 Form 10-K on
file with the Commission).
10.60 Amendment dated February 11, 1997, ALLIED Group, Inc. Long-Term
Management Incentive Plan (Incorporated by reference to Exhibit
10.60 to the Company's December 31, 1996 Form 10-K on file with
the Commission).
10.61 ALLIED Mutual and General Re-insurance Corporation Property
Catastrophe Agreement (Incorporated by reference to Exhibit
10.61 to the Company's June 30, 1997 Form 10-Q on file with the
Commission).
<PAGE>
65
10.62 Second Amendment to Consulting Agreement between John E. Evans,
ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED
Life Financial Corporation (Incorporated by reference to Exhibit
10.62 to the Company's June 30, 1997 Form 10-Q on file with the
Commission).
10.63 ALLIED Group Short Term Management Incentive Plan for 1998.
21. Subsidiaries of the Registrant.
23. Consent of Independent Auditors.
27. Financial Data Schedule.
(d) Financial Statements required by Regulation S-X which are excluded from the
Annual Report to Stockholders by Rule 14a-3(b)(1).
None.
<PAGE>
66
REPORT OF INDEPENDENT AUDITORS ON SCHEDULES
The Board of Directors and Stockholders
ALLIED Group, Inc.:
Under date of February 3, 1998 we reported on the consolidated balance sheets of
ALLIED Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997, as contained in the 1997 Annual Report. In
connection with our audits of the aforementioned consolidated financial
statements, we also have audited the related consolidated financial statement
schedules listed in Part IV, Item 14(a)2. These financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Des Moines, Iowa
February 3, 1998
<PAGE>
67
ALLIED Group, Inc. and Subsidiaries
SCHEDULE I
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1997
<TABLE>
<CAPTION>
Amount at
Market which shown in
Type of investment Cost value the balance sheet
------------------ -------------- -------------- -----------------
<S> <C> <C> <C>
Fixed maturities - bonds
U.S. Government and government
agencies and authorities $ 205,403,262 $ 213,038,931 $ 213,038,931
States, municipalities, and
political subdivisions 385,977,158 400,490,494 400,490,494
All other corporate bonds 200,565,024 204,686,615 204,686,615
-------------- -------------- --------------
Total fixed maturities 791,945,444 $ 818,216,040 818,216,040
-------------- ============== --------------
Equity securities
Common stock
Public utilities 678,403 797,560 797,560
Banks, trust and insurance companies 5,939,548 7,533,558 7,533,558
Industrial, miscellaneous and all other 21,412,347 28,162,892 28,162,892
Nonredeemable preferred stocks 41,421,245 42,688,080 42,688,080
-------------- -------------- --------------
Total equity securities 69,451,543 $ 79,182,090 79,182,090
-------------- ============== --------------
Short-term investments 10,846,274 10,846,274
-------------- --------------
Total investments $ 872,243,261 $ 908,244,404
============== ==============
</TABLE>
<PAGE>
68
ALLIED Group, Inc. and Subsidiaries
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Assets 1997 1996
-------------- --------------
<S> <C> <C>
Indebtedness from affiliates $ 4,081,481 $ 2,067,575
Accrued investment income 10,075 6,078
Short-term investments 3,856,954 2,040,475
Fixed maturities at fair value (amortized cost
$74,788 in 1997 and $74,788 in 1996) 74,788 74,773
Equity securities at fair value (cost $2,920,040
in 1997 and $2,567,741 in 1996) 4,432,425 3,356,145
Investment in subsidiaries at equity (note 1) 448,440,840 390,149,644
Current income taxes recoverable 1,308,590 972,757
Deferred income taxes 431,080 246,677
Other assets 889,533 1,224,474
-------------- --------------
Total assets $ 463,525,766 $ 400,138,598
============== ==============
Liabilities
Guarantee of ESOP obligations $ 22,380,000 $ 24,370,000
Other liabilities 11,061,367 5,177,116
-------------- --------------
Total liabilities 33,441,367 29,547,116
-------------- --------------
Stockholders' Equity
Preferred stock, no par value, issuable in series, authorized
7,500,000 shares; issued and outstanding 1,827,222 shares
in 1997 and 1,827,222 in 1996 37,812,387 37,812,387
Common stock, no par value, $1 stated value, authorized
80,000,000 shares; issued and outstanding 30,532,074 in
1997 and 20,382,954 in 1996 30,532,074 20,382,954
Additional paid-in capital 112,489,977 126,078,569
Retained earnings 244,078,690 195,276,063
Accumulated other comprehensive income 23,314,537 12,698,554
Unearned compensation related to ESOP (18,143,266) (21,657,045)
-------------- --------------
Total stockholders' equity 430,084,399 370,591,482
-------------- --------------
Total liabilities and stockholders' equity $ 463,525,766 $ 400,138,598
============== ==============
</TABLE>
See accompanying Notes to Condensed Financial Statements
<PAGE>
69
ALLIED Group, Inc. and Subsidiaries
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
Revenues
<S> <C> <C> <C>
Equity in undistributed earnings of subsidiaries
(note 1) $ 49,097,371 $ 25,918,314 $ 38,478,651
Dividends received from subsidiaries (note 1) 17,059,064 24,631,481 12,985,307
Employee leasing income 116,671,728 99,771,562 93,265,042
Realized investment gains (losses) 298,039 (132,737) 405,654
Investment income 239,637 590,435 654,489
Other income 10,233 56,167 47,621
------------- ------------- -------------
183,376,072 150,835,222 145,836,764
------------- ------------- -------------
Expenses
Salaries, benefits, payroll taxes and other
employee leasing costs 116,150,599 98,322,653 91,929,248
Operating expenses 2,906,781 1,725,301 1,375,281
Interest expense 382,886 183,182 4,014
------------- ------------- -------------
119,440,266 100,231,136 93,308,543
------------- ------------- -------------
Income from operations before income taxes 63,935,806 50,604,086 52,528,221
Income tax (benefit) expense (1,499,791) (480,127) 151,392
------------- ------------- -------------
Net income 65,435,597 51,084,213 52,376,829
Other comprehensive income, net of deferred taxes
of $(5,779,787), $2,999,925, $(12,775,452) 10,615,983 (5,637,079) 23,576,516
------------- ------------- -------------
Comprehensive income $ 76,051,580 $ 45,447,134 $ 75,953,345
============= ============= =============
</TABLE>
See accompanying Notes to Condensed Financial Statements.
<PAGE>
70
ALLIED Group, Inc. and Subsidiaries
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------- -------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 65,435,597 $ 51,084,213 $ 52,376,829
Adjustments to reconcile net income to net
cash provided by operating activities
Equity in undistributed earnings (49,097,371) (25,918,314) (38,478,651)
Realized investment (gains) losses (298,039) 132,737 (405,654)
Indebtedness from affiliates (2,013,906) 2,701,195 (1,339,475)
Accrued investment income (3,997) 66,440 (6,665)
Cost of ESOP shares allocated 3,513,779 2,250,971 2,213,911
Current taxes (335,833) (893,628) 190,468
Deferred taxes (479,069) (292,999) (656,689)
Other, net 3,137,121 (4,336,578) 529,635
------------- -------------- ------------
Net cash provided by operating activities 19,858,282 24,794,037 14,423,709
------------- -------------- ------------
Cash flows from investing activities:
Investments in subsidiaries 992,828 (8,081,482) 539
Purchase of fixed maturities --- --- (3,276,014)
Purchase of equity securities (782,190) (854,643) (1,630,622)
Short-term investments, net (1,816,479) 3,980,545 (3,500,734)
Sale of fixed maturities --- 8,602,567 ---
Maturities, calls, and principal reductions
of fixed maturities --- 167,853 235,608
Sale of equity securities 727,930 83,220 2,045,080
------------- -------------- ------------
Net cash (used in) provided by investing activities (877,911) 3,898,060 (6,126,143)
------------- -------------- ------------
Cash flows from financing activities:
Issuance of preferred stock --- --- 699,559
Issuance of common stock 7,878,567 3,110,431 3,497,199
Repurchase of common stock (10,225,968) (16,524,753) ---
Dividends paid to stockholders, net of income tax benefit (16,632,970) (15,277,775) (12,659,236)
------------- -------------- -------------
Net cash used in financing activities (18,980,371) (28,692,097) (8,462,478)
------------- -------------- -------------
Net decrease in cash --- --- (164,912)
Cash beginning of year --- --- 164,912
------------- -------------- -------------
Cash end of year $ --- $ --- $ ---
============= ============== =============
</TABLE>
See accompanying Notes to Condensed Financial Statements.
<PAGE>
71
ALLIED Group, Inc. and Subsidiaries
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
NOTES TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in conjunction
with the consolidated financial statements and notes thereto of ALLIED Group,
Inc. and its subsidiaries.
(1) The Company's investment in subsidiaries, undistributed earnings of
subsidiaries, and dividends received from subsidiaries are shown by segment
below:
<TABLE>
<CAPTION>
Property- Excess &
casualty Surplus Other Total
--------------- -------------- ------------- --------------
Year ended
December 31, 1997
<S> <C> <C> <C> <C>
Investment in subsidiaries $ 376,381,705 $ 49,852,582 $ 22,206,553 $ 448,440,840
Equity in undistributed
earnings of subsidiaries $ 42,148,797 $ 7,055,787 $ (107,213) $ 49,097,371
Dividends received from
subsidiaries $ 16,223,064 $ --- $ 836,000 $ 17,059,064
Year ended
December 31, 1996
Investment in subsidiaries $ 324,239,950 $ 42,083,857 $ 23,825,837 $ 390,149,644
Equity in undistributed
earnings of subsidiaries $ 19,074,658 $ 5,680,219 $ 1,163,437 $ 25,918,314
Dividends received from
subsidiaries $ 23,672,759 $ --- $ 958,722 $ 24,631,481
Year ended
December 31, 1995
Investment in subsidiaries $ 293,167,247 $ 37,291,129 $ 31,568,103 $ 362,026,479
Equity in undistributed
earnings of subsidiaries $ 33,655,150 $ 3,516,974 $ 1,306,527 $ 38,478,651
Dividends received from
subsidiaries $ 12,011,307 $ --- $ 974,000 $ 12,985,307
</TABLE>
<PAGE>
72
<TABLE>
<CAPTION>
ALLIED Group, Inc. and Subsidiaries
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
Years ended December 31, 1997, 1996, and 1995
Reserves for Amortization
Deferred losses and Losses of deferred Other
policy loss Net and loss policy under-
acquisition adjusting Unearned Earned investment adjusting acquisition writing Written
Segments costs expenses premiums premiums income expenses costs expenses premiums
-------- ----------- ------------ ---------- ---------- ---------- ---------- ------------ --------- ----------
(in thousands)
1997
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Property-casualty $ 47,504 $ 316,689 $ 220,327 $ 514,303 $ 44,258 $ 357,730 $ 113,147 $ 16,624 $ 531,679
Excess & Surplus 3,191 61,337 19,436 33,294 6,802 20,369 7,109 2,606 34,056
Other operations --- --- --- --- 383 --- --- --- ---
Eliminations --- --- --- --- (319) --- --- (53) ---
----------- ------------ ---------- ---------- ---------- ---------- ------------ --------- ----------
Consolidated $ 50,695 $ 378,026 $ 239,763 $ 547,597 $ 51,124 $ 378,099 $ 120,256 $ 19,177 $ 565,735
=========== ============ ========== ========== ========== ========== ============ ========= ==========
1996
Property-casualty $ 43,681 $ 303,014 $ 202,378 $ 466,211 $ 42,296 $ 335,511 $ 102,566 $ 18,193 $ 488,189
Excess & Surplus 2,990 59,177 18,218 27,314 6,241 17,484 5,749 2,272 28,417
Other operations --- --- --- --- 756 --- --- --- ---
Eliminations --- --- --- --- (71) --- --- (27) ---
----------- ------------ ---------- ---------- ---------- ---------- ------------ --------- ----------
Consolidated $ 46,671 $ 362,191 $ 220,596 $ 493,525 $ 49,222 $ 352,995 $ 108,315 $ 20,438 $ 516,606
=========== ============ ========== ========== ========== ========== ============ ========= ==========
1995
Property-casualty $ 38,846 $ 285,385 $ 180,217 $ 425,838 $ 39,110 $ 295,583 $ 93,684 $ 18,859 $ 440,838
Excess & Surplus 2,842 56,479 16,244 29,661 5,830 22,357 6,436 1,724 30,606
Other operations --- --- --- --- 2,302 --- --- --- ---
Eliminations --- --- --- --- --- --- --- --- ---
----------- ------------ ---------- ---------- ---------- ---------- ------------ --------- ----------
Consolidated $ 41,688 $ 341,864 $ 196,461 $ 455,499 $ 47,242 $ 317,940 $ 100,120 $ 20,583 $ 471,444
=========== ============ ========== ========== ========== ========== ============ ========= ==========
</TABLE>
<PAGE>
73
ALLIED Group, Inc. and Subsidiaries
SCHEDULE IV
REINSURANCE
Years ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Percentage
Ceded Assumed of amount
Gross to other from other Net assumed to
amount companies(1) companies amount net
------------- -------------- ----------------- -------------- ----------
(in thousands)
1997
Premiums:
<S> <C> <C> <C> <C> <C>
Property-casualty $ 568,160 $ 321,706 $ 267,849 $ 514,303 52.1%
Excess & surplus lines 43,254 9,960 --- 33,294 ---
------------- -------------- ----------------- --------------
Total premiums $ 611,414 $ 331,666 $ 267,849 $ 547,597 48.9%
============= ============== ================= ==============
1996
Premiums:
Property-casualty $ 497,099 $ 293,986 $ 263,098 $ 466,211 56.4%
Excess & surplus lines 37,639 10,325 --- 27,314 ---
------------- -------------- ----------------- --------------
Total premiums $ 534,738 $ 304,311 $ 263,098 $ 493,525 53.3%
============= ============== ================= ==============
1995
Premiums:
Property-casualty $ 435,223 $ 265,571 $ 256,186 $ 425,838 60.2%
Excess & surplus lines 37,184 7,523 --- 29,661 ---
------------- -------------- ----------------- --------------
Total premiums $ 472,407 $ 273,094 $ 256,186 $ 455,499 56.2%
============= ============== ================= ==============
</TABLE>
(1) See note 6 of Notes to Consolidated Financial Statements for additional
information on amounts ceded to ALLIED Mutual Insurance Company in
accordance with the affiliated reinsurance pooling agreement.
<PAGE>
74
ALLIED Group, Inc. and Subsidiaries
SCHEDULE VI
SUPPLEMENTAL INFORMATION
Years ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
Losses and loss
adjusting expenses
incurred related to
--------------------------------
Discount
if any aid losses
deducted and loss
from Current Prior adjusting
Segment reserves year years expenses
------- --------------- -------------- ------------- --------------
(in thousands)
1997
<S> <C> <C> <C> <C>
Property-casualty $ --- $ 356,864 $ 866 $ 346,065
Excess & surplus lines --- 23,088 (2,719) 18,704
--------------- -------------- ------------- --------------
Total $ --- $ 379,952 $ (1,853) $ 364,769
=============== ============== ============= ==============
1996
Property-casualty $ --- $ 334,245 $ 1,266 $ 315,987
Excess & surplus lines --- 19,430 (1,946) 15,284
--------------- -------------- ------------- --------------
Total $ --- $ 353,675 $ (680) $ 331,271
=============== ============== ============= ==============
1995
Property-casualty $ --- $ 294,176 $ 1,407 $ 270,373
Excess & surplus lines --- 21,780 577 15,302
--------------- -------------- ------------- --------------
Total $ --- $ 315,956 $ 1,984 $ 285,675
=============== ============== ============= ==============
</TABLE>
<PAGE>
75
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ALLIED Group, Inc.
(Registrant)
Date: March 3, 1998 By /s/Jamie H. Shaffer
----------------------------------
Jamie H. Shaffer
(Principal Financial Officer and
Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
By: /s/ Douglas L. Andersen By: /s/ Jamie H. Shaffer By: /s/ John E. Evans
- ------------------------------------ ------------------------------------ -------------------------------
Douglas L. Andersen Jamie H. Shaffer John E. Evans
President, CEO, and Director Senior Vice President, CFO Chairman of the Board
March 3, 1998 and Treasurer and Director
March 3, 1998 March 3, 1998
By: /s/ James W. Callison By: /s/ Harold S. Carpenter By: /s/ Charles I. Colby
- ------------------------------------ ------------------------------------ --------------------------------
James W. Callison Harold S. Carpenter Charles I. Colby
Director Director Director
March 3, 1998 March 3, 1998 March 3, 1998
By: /s/ Harold S. Evans By: /s/ Richard O. Jacobson By: /s/ John P. Taylor
- ------------------------------------ ------------------------------------ --------------------------------
Harold S. Evans Richard O. Jacobson John P. Taylor
Director Director Director
March 3, 1998 March 3, 1998 March 3, 1998
By: /s/ William E. Timmons By: /s/ Donald S. Willis
- ------------------------------------ ------------------------------------
William E. Timmons Donald S. Willis
Director Director
March 3, 1998 March 3, 1998
</TABLE>
<PAGE>
76
ALLIED Group, Inc. and Subsidiaries
INDEX TO EXHIBITS
Exhibit
Number Item Page
10.17 ALLIED Group, Inc. Federal Income Tax Sharing Agreement. 77
10.36 Fourth Amendment to the Term Credit Agreement and Guaranty, 82
dated November 17, 1997.
10.63 ALLIED Group Short Term Management Incentive Plan for 1998. 83
21 Subsidiaries of the Registrant 91
23 Consent of Independent Auditors 92
27 Financial Data Schedule 93
<PAGE>
77
EXHIBIT 10.17
TAX SHARING AGREEMENT
Agreement effective January 1, 1997 by and among ALLIED Group, Inc. ("Parent")
and each of its undersigned subsidiaries.
WHEREAS, the parties hereto are members of an affiliated group ("Affiliated
Group") as defined in Section 1504(a) of the Internal Revenue Code of 1986 as
amended; and
WHEREAS, some of the parties hereto may be members of a unitary group ("Unitary
Group") as defined by various state laws; and
WHEREAS, the parties hereto may elect or be required to file their federal
income tax returns on a consolidated basis and file their various state income
tax returns on a consolidated, unitary or separate basis and desire to properly
account for the economic consequences of this arrangement,
WHEREAS, it is the intent and desire of the parties hereto that a method be
established for reimbursing the Parent for payment of tax liability, for
compensating any party for use of its losses or tax credits, and to provide for
the allocation and payment of any refund arising from a carryback of losses or
tax credits from subsequent taxable years,
NOW THEREFORE, in consideration of the mutual covenants and promises contained
herein, the parties hereto agree as follows:
1. Parent to Prepare and File Returns. A consolidated federal income tax
return and consolidated, unitary, or separate state tax income tax returns
shall be prepared and filed by the Parent for the taxable year ended
December 31, 1997 and for each subsequent taxable period in respect of
which this agreement is in effect. Each subsidiary shall execute and file
such consent, elections, and other documents that may be required or
appropriate for the proper filing of such returns.
2. Federal Tax Allocation. For each taxable period, each member of the
Affiliated Group shall compute its separate tax liability as if it had
filed a separate tax return and shall pay such amount to the Parent. The
separate return tax liability of each member shall be computed pursuant to
the provision of Regulations Section 1.1502-33(d)(3) in a manner provided
by Regulations Section 1.1502-33(d)(2)(ii) in conjunction with the method
described in Regulations Section 1.1552-1(a)(2).
3. State Tax Allocation.
(a) Separate Returns.
The Parent and each subsidiary shall be allocated its own separately
computed state income tax liability from those states requiring tax to
be computed on a separate return basis.
<PAGE>
78
(b) Unitary Group and Affiliated Group Returns.
The Unitary or Affiliated Group shall allocate to each member the
total state income tax liability from those states requiring a
consolidated or unitary return filing based on the following formula:
[each members separate company state taxable income or loss before
apportionment and net operating loss deduction] divided by [total sum
of all members separate state taxable income or loss before
apportionment and net operating loss deduction] multiplyed by [total
affiliated or unitary state income tax on taxable income before net
operating deduction and tax credits]
All prior tax year carryover tax credits and tax benefits of net
operating loss deductions shall be specifically allocated to those
members based on the allocation used in the tax year in which the net
operating loss or tax credit was originally created.
All tax credits except prior tax year carryover credits shall be
specifically allocated to the unitary members computed on a separate
return basis.
All tax credits and net operating losses carried forward from years
prior to a member joining the Affiliated or Unitary Group shall be
specially allocated to that member.
4. Payments. Each subsidiary shall pay to the Parent its allocation of quarterly
estimated, final or amended return taxes payable to the Internal Revenue Service
and any other state taxing authority within five days of receiving notice of
such payment from the Parent.
5. Refund of Overpayment. If for any taxable period the separate return
liability of each member of the Affiliated Group, including the Parent or
Unitary Group, exceeds the consolidated or unitary tax liability for such period
as a result of any excess losses or tax credits of one or more members, then the
Parent shall pay to each such member its allocable portion of such excess amount
within sixty days after the date of filing of the consolidated or unitary return
for such period. The excess federal tax amount to be reimbursed to such member
shall be computed in a manner consistent with the provisions of Regulation
Section 1.1502-33(d)(2)(ii). In utilization of this Regulation Section, the
percentage referred to in Regulation Section 1.1502-33(d)(2)(ii)(b) shall be 100
percent.
6. Carryback or Forward of Unused Federal Loss or Tax Credit. If part of all of
an unused loss or tax credit is allocated to a member of the Affiliated Group
pursuant to Regulation Section 1.1502-79, and it is carried back or forward to a
year in which such member filed a separate return or a consolidated return with
another affiliated group, any refund or reduction in tax liability arising from
the carryback or carryover shall be retained by such member. Notwithstanding the
above, the Parent shall determine whether an election shall be made not to
carryback part or all of the consolidated net operating loss for any taxable
year in accordance with Section 172(b)(3)(c) of the Internal Revenue Code of
1986 as amended.
<PAGE>
79
7. Adjustment of Taxable Period. If the consolidated or unitary tax liability is
adjusted for any taxable period, whether by means of an amended return, claim
for refund or after a tax audit by the Internal Revenue Service or respective
states, the liability of each member shall be recomputed to give effect to such
adjustments, and in the case of a refund, the Parent shall make payment to each
member for its share of the refund, determined in the same manner as in
paragraph (5) above, within thirty days after the refund is received by the
Parent, and in the case of an increase in tax liability, each member shall pay
to the parent its allocable share of such increased tax liability within five
days after receiving notice of such liability from the Parent. In the event that
the taxing authority levies upon a member's assets in excess of its adjusted
portion of the consolidated tax liability, the member will be adequately
indemnified by the other members.
8. Acquisition through Organization or Additional Corporation. If during a
consolidated return period the Parent or any subsidiary acquires or organizes
another corporation that is required to be included in the consolidated return,
then such corporation shall join in and be bound by this agreement.
9. Term. This agreement shall apply to the taxable year ending December 31, 1997
and all subsequent taxable periods unless the Parent and the subsidiaries agree
to terminate the agreement. Notwithstanding such termination, this agreement
shall continue in effect with respect to any payment or refund for all taxable
periods prior to termination.
10. Application to Successors in Interest. This agreement shall be binding upon
and inure to the benefit of any successor, whether by statutory merger,
acquisition of assets or otherwise, to any parties hereto, to the same extent as
if the successor had been an original party to the agreement.
11. Arbitration. Any dispute arising out of or relating to this Tax Sharing
Agreement("Agreement") or the breach thereof between Parent and any of the
subsidiaries signatory hereto shall be settled by arbitration in accordance with
the Commercial Arbitration Rules of the American Arbitration Association.
Arbitration may be initiated by any party to a dispute, giving notice to each
other party two copies of such notice with the American Arbitration Association
and by complying with other applicable provisions of the Association's Rules.
12. Modification of Agreement. No party has the authority to change any
provisions of this Agreement or waive any of its provisions. No change in this
Agreement shall be binding, unless first expressed in writing and signed by each
party hereto.
13. Superseding Agreement. The parties hereto acknowledge that this agreement
shall supersede all other agreements, oral or written, between the parties.
14. Exchange of Information. The parties hereto acknowledge that the exchange
and flow of information is critical to the operation of this agreement. Having
acknowledged this fact, the parties hereby agree to grant free and unrestricted
access, at reasonable times, to those books and records necessary for the
operation of this agreement.
<PAGE>
80
IN WITNESS WHEREOF, the parties hereto have caused this agreement to be executed
by their duly authorized representatives.
ALLIED Group, Inc.
By /s/ Jamie H. Shaffer Date
--------------------------- --------------------------
Jamie H. Shaffer
Senior Vice President
Treasurer
Chief Financial Officer
AMCO Insurance Company
By /s/ Randall J. Covey Date
--------------------------- --------------------------
Randall J. Covey
Assistant Vice President
ALLIED Property and Casualty
Insurance Company
By /s/ Randall J. Covey Date
--------------------------- --------------------------
Randall J. Covey
Assistant Vice President
Depositors Insurance Company
By /s/ Randall J. Covey Date
--------------------------- --------------------------
Randall J. Covey
Assistant Vice President
Western Heritage Insurance Company
By /s/ Scott A. Wilson Date
--------------------------- --------------------------
Scott A. Wilson
Treasurer/Assistant Secretary
<PAGE>
81
ALLIED Group Mortgage Company
By /s/ Randall J. Covey Date
-------------------------- --------------------------
Randall J. Covey
Assistant Vice President
ALLIED General Agency Company
By /s/ Randall J. Covey Date
-------------------------- ---------------------------
Randall J. Covey
Assistant Vice President
ALLIED Group Information Systems, Inc.
By /s/ Randall J. Covey Date
-------------------------- ---------------------------
Randall J. Covey
Assistant Vice President
The Freedom Group, Inc.
By /s/ Randall J. Covey Date
-------------------------- ---------------------------
Randall J. Covey
Assistant Vice President
Midwest Printing Services, Ltd.
By /s/ Randall J. Covey Date
-------------------------- ---------------------------
Randall J. Covey
Assistant Vice President
<PAGE>
82
FOURTH AMENDMENT TO
TERM CREDIT AGREEMENT AND GUARANTY
THIS AMENDMENT dated as of November 17, 1997 is entered into by and
among ALLIED Group, Inc. ("Company"), State Street Bank and Trust Company, not
in its individual capacity but as trustee for The ALLIED Group Employee Stock
Ownership Trust ("ESOP Trustee"), Bank of Montreal, Chicago Branch ("BOM"), and
Norwest Bank Iowa, National Association ("Norwest") to amend the Term Credit
Agreement and Guaranty dated March 13, 1995, as amended October 12, 1995, March
5, 1996, and September 26, 1997 ("Agreement").
1. This Amendment shall be effective as of November 1, 1997.
2. Subsection (ii) of Section 6.1.25 of the Agreement is amended to
read as follows:
(ii) the sum of the Company's consolidated real estate, mortgages and
non-affiliated equity securities not to exceed 10% of the Company's
consolidated Total Assets.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed by their respective officers as of the day and year first above
written.
ALLIED Group, Inc. The ALLIED Group Employee Stock
Ownership Trust
By: /s/ Douglas L. Andersen By State Street Bank and Trust Company,
------------------------------ not individually, but solely in its
Douglas L. Andersen capacity as ESOP Trustee
------------------------------
Title: President
By: /s/ Kelly Driscoll
------------------------------------
Bank of Montreal, Chicago Branch Kelly Driscoll
Title: Vice President
By: /s/ K. Daniel Streiff ---------------------------------
------------------------------
K. Daniel Streiff
Title: Managing Director
---------------------------
Norwest Bank Iowa, National
Association
By: /s/ John D. Landry
-------------------------------
John D. Landry
Title: Assistant Vice President
----------------------------
<PAGE>
83
EXHIBIT 10.63
ALLIED GROUP
SHORT TERM MANAGEMENT
INCENTIVE PLAN
1. PURPOSE
This ALLIED Group Short Term Management Incentive Plan (the "Plan") is
effective January 1, 1998.
The purpose of this Plan is to encourage outstanding performance by
certain key employees of ALLIED Group, Inc. ("AGI") in the attainment of annual
financial and operating goals of AGI, ALLIED Mutual Insurance Company, and all
of their subsidiaries except for ALLIED Life Financial Corporation and its
subsidiaries (collectively, the "ALLIED Group").
2. DEFINITIONS
The capitalized terms used throughout the Plan have the following
meaning:
(a) "AGA" means ALLIED General Agency Company.
(b) "AGIMC" means ALLIED Group Insurance Marketing Company.
(c) "AGIS" means ALLIED Group Information Systems, Inc.
(d) "AGMC" means ALLIED Group Mortgage Company.
(e) "ALLIED Group Net Income" means net income after income taxes
(including net realized investment gains/losses) for the
consolidated group of companies comprising the ALLIED Group
(excluding crop-hail business) computed in conformity with
generally accepted accounting principles ("GAAP").
(f) "Base Award" is defined in Paragraph 5(c).
(g) "Base Salary" is the annualized weekly base pay of the Participant
in effect as of the last day in the position for which the bonus
is being calculated, which in no event shall be later than
December 31 of the Plan year.
(h) "Committee" shall mean the Compensation Committee of the Board of
Directors of AGI in consultation with the Joint Compensation
Committee of the Board of AGI and ALLIED Mutual Insurance Company.
(i) "Consolidated TFG" shall mean TFG and AGIS.
(j) "Discretionary Award" is defined in Paragraph 5(d).
(k) "Discretionary Tier Award" is defined in Paragraph 5(j).
<PAGE>
84
(l) "DPW" is direct premiums written, net of return premiums, as
reported in the 1998 Planning Package for a particular regional
office or company. For ALLIED Group, it includes all
property-casualty companies but excludes (i) Western Heritage
Insurance Company, (ii) crop-hail business, and (iii) flood
program. For AGIMC, DPW shall exclude any premiums generated from
business that is purchased by AGIMC from another entity, unless
the Committee determines otherwise.
(m) "Eligible Award Percentage" is defined in Paragraph 5(b).
(n) "Eligible Individual Award" is defined in Paragraph 5(c).
(o) "Eligible Tier Award" is defined in Paragraph 5(h).
(p) "Goal" is the expected level of performance used to establish
targeted awards as approved by the Committee.
(q) "Growth" is defined in Paragraph 4.
(r) "Maximum" is the level of performance at which the maximum
eligible award could be made.
(s) "Midwest Printing" is Midwest Printing Services, Ltd.
(t) "Operating Profit" is calculated on a GAAP basis, includes net
realized investment gains/losses, and is after income taxes.
(u) "Participant" is a key employee of AGI recommended by the
President of AGI and approved by the Committee to participate in
this Plan.
(v) "Persistency" for AGIMC is the year-end persistency percentage as
shown on the ALLIED Group AGIMC Production Report B, which shall
include any business that is purchased by AGIMC from another
entity.
(w) "Profit" is defined in Paragraph 4.
(x) "Regional Office Operating Profit" is the Regional Office
Operating Statement GAAP net income.
(y) "TFG" means The Freedom Group, Inc.
(z) "Threshold" is the minimum level of performance that will warrant
an award.
(aa) Total Award" is defined in Paragraph 5(e).
(bb) "WHIC" means Western Heritage Insurance Company.
3. PARTICIPATION AND TIERS
Participation in the Plan is tiered by responsibility level and the
short-term impact of the management position.
<PAGE>
85
General Responsibility Levels
Tier I President
Vice Presidents
Subsidiary Presidents and Officers
Tier II Regional Office Managers and Subsidiary Officers
Tier III Primary Corporate Staff Vice Presidents
Tier IV Subsidiary Officers and Managers
Corporate Staff Vice Presidents and Officers
Tier V Subsidiary Managers
Tier VI Subsidiary Managers
Regional Office Managers
A participation list specifying the Participants in each tier shall be
approved by the Committee prior to each fiscal year. The Committee may amend
such list from time to time to add or delete Participants.
Each tier level of participation will have varying award opportunity at
the Threshold, Goal, and Maximum performance levels for each of the performance
indicators.
4. PERFORMANCE INDICATORS
Two performance indicators, Profit and Growth, will be used to measure
the success of ALLIED Group and the level of bonus to be paid under this Plan.
"Profit" is defined as a performance indicator and shall be defined
based on the particular area for which a Participant provides services:
Regional Offices - "Regional Office Operating Profit"
Bonds - Bond Operating Profit"
AGIMC - "Persistency"
AGI subsidiaries - "Operating Profit"
Staff areas/all other areas - "ALLIED Group Net Income"
Consolidated TFG - net income after tax including subsidiaries
TFG - net income after tax excluding subsidiaries
AGIS - net income after tax
"Growth" is defined as a performance indicator and is the increase in
revenue from the prior year stated in terms of a percentage increase or dollar
target. Generally, revenue is expressed in DPW, except as follows:
Consolidated TFG - total revenues for TFG and AGIS
TFG - total revenues for TFG
AGIS - total revenues for AGIS
Midwest Printing - percentage increase in total revenues
The Threshold for Profit must be attained before any award will be made
based on Growth. However, with respect to AGIMC, the Threshold for Growth must
be attained before any award will be made based on Profit.
<PAGE>
86
Profit is the only indicator used to measure performance for AGMC,
WHIC, and AGA, and the total bonus amount is paid based upon results of Profit.
5. AWARDS
Individual Calculations
(a) A Participant may receive an Eligible Individual Award under the
Plan. "Eligible Individual Award" is defined as the award potential for a
Participant based on Profit and Growth results. Eligible Individual Award is the
sum of (i) the Eligible Award Percentage for Profit multiplied by the Base
Salary for the Participant and (ii) the Eligible Award Percentage for Growth
multiplied by the Base Salary for the Participant. The Eligible Individual Award
is the amount used to determine the Base Award and the Discretionary Award.
(b) "Eligible Award Percentage" is defined as the percentage amount
used to determine the potential Eligible Tier Awards and Eligible Individual
Award. The amount of the Eligible Award Percentage is tied to tier and
performance level attained (Threshold, Goal, or Maximum), as set forth in
Exhibit B.
Example for Eligible Award Percentage for Profit for a Participant
Step 1: Compare actual profit results for the fiscal year to the
goals specified in Exhibit A. If the actual Profit results for the
fiscal year do not meet the Threshold, then the Eligible Award
Percentage is 0, and no further calculations are necessary.
Step 2: Determine the percent by which the profit results exceeded
the Threshold value (or the goal value as the case may be). There
is no need for a calculation if the Maximum results were achieved
or exceeded.
Step 3: Identify the Eligible Award Percentage for the Profit
indicator in the tier at the Threshold level, as shown in Exhibit
B. Multiply the Eligible Award Percentage by the percent
calculated in Step 2. This will calculate the actual Eligible
Award Percentage available based on the profit results attained.
Repeat Steps 1 through 3 using Growth to compute the Eligible
Award Percentage for Growth.
(c) Upon meeting the Threshold for Profit, a Participant will receive
a Base Award. "Base Award" is defined as the award to a Participant when a
minimum performance level is met. The Base Award is 60% of the Eligible
Individual Award.
(d) Depending on the determination of the Committee, a Participant may
or may not receive a Discretionary Award. "Discretionary Award" is defined as an
amount separate from the Base Award which is awarded to a Participant based on
the discretion of the Committee. The Discretionary Award is calculated as a
percentage of the Eligible Tier Award.
<PAGE>
87
(e) A Participant's Total Award" is defined as the sum of the Base
Award and the Discretionary Award. The Discretionary Award combined with the
Base Award cannot exceed 150% of the Participant's Eligible Individual Award.
(f) In addition to the requirements in the foregoing paragraph, a
pre-Threshold requirement will be applicable to Staff employees. "Staff
employees" are defined to include those employees with overall corporate
responsibilities, each of whom shall be identified as "Staff" on the
participation list approved by the Committee. Staff employees must attain a 14%
return on average equity based on AGI financial statements before they are
eligible to meet the Threshold goal. "Return on equity" is defined as the
"Return on Average Book Value per Diluted Share" as calculated for and as
disclosed in the ALLIED Group, Inc. Annual Report to Stockholders.
(g) In the event a Participant does not meet the Threshold for Profit,
the Committee may, in unusual or extraordinary circumstances, award the
Participant a special award under the Plan. This paragraph may only be invoked
by the Committee in rare and extreme situations.
Tier Calculations
(h) "Eligible Tier Award" is defined as the award potential for a tier
based on Profit and Growth results. Eligible Tier Award is the sum of the
Eligible Individual Awards for all of the Participants in a particular tier.
Total awards made to all of the Participants in a particular tier shall not
exceed 100% of the Eligible Tier Award, but the total awards for a particular
tier may be less than the Eligible Tier Award.
(i) Notwithstanding the foregoing, if the Committee determines that a
Participant has shown extraordinary performance in a calendar year, the
Committee may exceed the Eligible Tier Award in order to increase the
Discretionary Award for the Participant showing such extraordinary performance.
(j) Discretionary Tier Award" is defined as the portion of the tier
award potential that is not guaranteed to payout but may be awarded based on
contribution and performance. This portion may equal up to 40% of the Eligible
Tier Award. A Participant may receive a portion, all, or none of the
Discretionary Tier Award.
6. PRORATED AWARDS
Employees who become eligible for participation in this Plan after the
beginning of the Plan year may receive a prorated award based on the time the
employee was a Participant and based on active time employed during the Plan
year. Prorated awards will be calculated by determining the number of calendar
days that a Participant has been eligible for a tier and dividing that number by
the calendar days in that Plan year.
7. DEATH, DISABILITY, OR RETIREMENT
In the event that a Participant dies, becomes disabled, or retires due
to age in accordance with AGI policy, a prorated award will be made based on
active time employed as a Participant during the Plan year.
<PAGE>
88
8. PLAN YEAR
The Plan year will be AGI's fiscal year.
9. TRANSFERABILITY
A Participant may not sell, pledge, donate, or otherwise assign any
interest in this Plan.
10. EMPLOYMENT
Nothing in this Plan confers upon a Participant any right to continued
employment or interferes with or limits in any way ALLIED Group's right to
terminate the employment of a Participant at any time.
11. TERMINATION OF EMPLOYMENT
If a Participant terminates employment or is terminated by ALLIED Group
for any reason other than death, disability, or retirement due to age in
accordance with AGI policy, and if such termination date is prior to the payment
date of an award under this Plan, any right to an award under this Plan is
forfeited.
12. PLAN AMENDMENT OR TERMINATION
The Committee may amend or terminate the Plan at any time. Participants
will be notified of such action as soon as it is practical to do so.
In the event of any change in the corporate structure of AGI affecting
the goals set forth in Exhibit A or the eligible award percentages set forth in
Exhibit B, and where such change in corporate structure would adversely affect a
Participant, the Committee may adjust or amend the Plan so as not to
disadvantage a Participant. In the event that a change in accounting rules or
procedures would affect the goals set forth in Exhibit A or the eligible award
percentages set forth in Exhibit B, and where such change in accounting rules or
procedures would adversely affect or create a windfall for a Participant, the
Committee may adjust or amend the Plan.
13. ADMINISTRATION
All matters pertaining to the administration of this Plan will be the
responsibility of the Committee, and any decisions of the Committee shall be
conclusive and binding. This includes all matters of interpretation, areas not
specified in the Plan, and any other issues that may affect the Plan.
14. GOVERNING LAW
The Plan will be administered, enforced, construed, and interpreted in
accordance with the laws of the State of Iowa.
<PAGE>
89
EXHIBIT A GOALS
Threshold Goal Maximum
--------- ---- -------
PROFIT
Regional Offices:
DMRO $16,000,000 $18,500,000 $21,000,000
LRO $11,500,000 $13,000,000 $14,500,000
RMRO $6,500,000 $7,500,000 $8,500,000
PCRO $17,000,000 $19,500,000 $22,000,000
CSRO $11,500,000 $13,000,000 $14,500,000
Bonds $450,000 $675,000 $800,000
Staff1 $70,000,000 $81,000,000 $92,000,000
AGMC $2,700,000 $3,100,000 $3,500,000
WHIC $6,000,000 $7,000,000 $8,000,000
ALLIED General Agency $30,000 $34,000 $50,000
TFG (2) $825,000 $900,000 $975,000
AGIS (2) $175,000 $250,000 $325,000
Consolidated TFG (2) $1,000,000 $1,150,000 $1,300,000
Midwest Printing Services $250,000 $325,000 $400,000
AGIMC 87.5% 89% 90.5%
GROWTH
Staff DPW 10% 12.5% 15%
DMRO DPW 8.0% 10.0% 12.0%
LRO DPW 8.0% 10.0% 12.0%
RMRO DPW 17.0% 21.0% 25.0%
PCRO DPW 10.0% 12.5% 15.0%
CSRO DPW 14.0% 17.0% 20.0%
Bonds DPW 12.0% 16.0% 20.0%
AGIMC DPW 18% 23% 28%
Midwest Printing Services 10% 14% 18%
TFG (2) $10,000,000 $12,000,000 $14,000,000
AGIS (2) $16,000,000 $18,000,000 $20,000,000
Consolidated TFG (2) $26,000,000 $30,000,000 $34,000,000
- --------------------
(1) A pre-Threshold requirement will be applicable to Staff employees. Staff
employees must attain a 14% return on equity based on ALLIED Group, Inc.
financial statements before they are eligible to meet the Threshold goal.
(2) In the event that either TFG or AGIS receives a capital contribution in
the Plan year, the Threshold, Goal, and Maximum shall each be adjusted
upwards by the addition of the dollar amount derived from the following
formula:
Dollar Amount of x 14% x Remaining / Total Number
Capital Contribution Days in of Days in
Plan Year Plan Year
<PAGE>
90
EXHIBIT B
ELIGIBLE AWARD PERCENTAGES
Threshold Goal Maximum Weight
--------- ---- ------- ------
Tier I: (1)
Profit 19% 38% 56% 75%
Growth 6% 12% 19% 25%
Total 25% 50% 75%
Tier II: (2)
Profit 15% 30% 45% 75%
Growth 5% 10% 15% 25%
Total 20% 40% 60%
Tier III:
Profit 13% 27% 40% 75%
Growth 5% 9% 14% 25%
Total 18% 36% 54%
Tier IV: (1,2,3)
Profit 12% 24% 36% 75%
Growth 4% 8% 12% 25%
Total 16% 32% 48%
Tier V: (4)
Profit 9% 18% 27% 75%
Growth 3% 6% 9% 25%
Total 12% 24% 36%
Tier VI: (5)
Profit 6% 12% 18% 75%
Growth 2% 4% 6% 25%
Total 8% 16% 24%
- -------------------
(1) AGMC and WHIC award percentages are weighted 100% Profit.
(2) AGIMC award percentage is weighted 25% Persistency and 75% Growth.
(3) TFG, AGIS, and Consolidated TFG award percentages are weighted 50%
Profit and 50% Growth.
(4) WHIC award percentage is weighted 100% Profit.
(5) AGA award percentage is weighted 100% Profit.
<PAGE>
91
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
State of
Name of subsidiary incorporation
- ------------------------------------------------------------ -------------
I. AMCO Insurance Company Iowa
A. Western Heritage Insurance Company Arizona
B. ALLIED General Agency Company Iowa
II. ALLIED Property and Casualty Insurance Company Iowa
III. Depositors Insurance Company Iowa
IV. ALLIED Group Mortgage Company Iowa
V. The Freedom Group, Inc. Iowa
A. ALLIED Group Information Systems, Inc. Iowa
VI. Midwest Printing Services, Ltd. Iowa
VII. Premier Agency Incorporated Iowa
<PAGE>
92
Exhibit 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
ALLIED Group, Inc.
We consent to incorporation by reference in Registration Statement Nos.
33-48235, 33-6643, 33-6644, 33-48206, 33-24543, 33-28907, 33-48234, 33-76876,
and 33-65037 on Form S-8 and Registration Statement Nos. 33-48233, 33-61090, and
333-19163 on Form S-3 of ALLIED Group, Inc. of our reports dated February 3,
1998, relating to the accompanying consolidated balance sheets of ALLIED Group,
Inc. and subsidiaries as of December 31, 1997 and 1996, and related consolidated
statements of income and comprehensive income, stockholders' equity, and cash
flows and related schedules for each of the years in the three-year period ended
December 31, 1997, which appear in the December 31, 1997 annual report on Form
10-K of ALLIED Group, Inc.
KPMG Peat Marwick LLP
Des Moines, Iowa
March 10, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLIED
GROUP, INC.'S DECEMBER 31, 1997 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY
BY SUCH FINANCIAL STATEMENTS
</LEGEND>
<CIK> 0000774624
<NAME> ALLIED GROUP, INC
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 818,216
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 79,182
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 908,244
<CASH> 2,168
<RECOVER-REINSURE> 23,906
<DEFERRED-ACQUISITION> 50,695
<TOTAL-ASSETS> 1,201,233
<POLICY-LOSSES> 378,026
<UNEARNED-PREMIUMS> 239,763
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 56,938
0
37,812
<COMMON> 30,532<F1>
<OTHER-SE> 361,740
<TOTAL-LIABILITY-AND-EQUITY> 1,201,233
547,597
<INVESTMENT-INCOME> 51,124
<INVESTMENT-GAINS> 391
<OTHER-INCOME> 65,570
<BENEFITS> 378,099
<UNDERWRITING-AMORTIZATION> 120,256
<UNDERWRITING-OTHER> 19,177
<INCOME-PRETAX> 91,912
<INCOME-TAX> 25,973
<INCOME-CONTINUING> 65,939
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 65,436
<EPS-PRIMARY> 2.030
<EPS-DILUTED> 2.010
<RESERVE-OPEN> 346,663
<PROVISION-CURRENT> 379,952
<PROVISION-PRIOR> (1,853)
<PAYMENTS-CURRENT> 216,920
<PAYMENTS-PRIOR> 147,849
<RESERVE-CLOSE> 359,993
<CUMULATIVE-DEFICIENCY> 1,284
<FN>
<F1> The Board of Directors authorized a 3-for-2 stock split issuable
November 28, 1997 to shareholders of record on November 14, 1997.
</FN>
</TABLE>
