UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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
(Address of principal executive offices)
50391-2000
(Zip Code)
515-280-4211
(Registrant's telephone number, including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of April 29, 1998:
30,634,052 shares of Common Stock.
<PAGE>
2
PART I
Item 1. Financial Statements
ALLIED Group, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
-------------- --------------
(in thousands)
<S> <C> <C>
Assets
Investments
Fixed maturities at fair value (amortized cost
$805,315 in 1998 and $791,945 in 1997) $ 830,624 $ 818,216
Equity securities at fair value
(cost $71,432 in 1998 and $69,452 in 1997) 86,174 79,182
Short-term investments at cost (note 2) 15,353 10,846
-------------- -------------
Total investments 932,151 908,244
Cash 4,899 2,168
Accrued investment income 12,032 11,634
Indebtness from affiliates (note 2) 1,425 3,035
Accounts receivable 100,340 91,596
Current income taxes recoverable --- 3,005
Reinsurance receivables for losses
and loss adjusting expenses 25,211 23,906
Mortgage loans held for sale (note 3) 80,416 29,521
Deferred policy acquisition costs 52,740 50,695
Prepaid reinsurance premiums 4,465 8,866
Mortgage servicing rights 37,963 35,931
Other assets 35,421 32,632
-------------- -------------
Total assets $ 1,287,063 $ 1,201,233
============== =============
.
</TABLE>
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
3
ALLIED Group, Inc. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
-------------- -------------
(in thousands)
<S> <C> <C>
Liabilities
Losses and loss adjusting expenses $ 382,641 $ 378,026
Unearned premiums 242,366 239,763
Current income taxes payable 2,041 ---
Notes payable to nonaffiliates (note 3) 108,046 51,038
Notes payable to affiliates (note 2) 9,260 5,900
Guarantee of ESOP obligations 22,380 22,380
Deferred income taxes 7,061 5,515
Other liabilities 65,853 68,527
-------------- -------------
Total liabilities 839,648 771,149
-------------- -------------
Stockholders' equity
Preferred stock, no par value, issuable in series,
authorized 7,500 shares
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 30,574 shares in
1998 and 30,532 shares in 1997 30,574 30,532
Additional paid-in capital 113,311 112,490
Retained earnings 257,382 244,079
Accumulated other comprehensive income 25,912 23,314
Unearned compensation related to ESOP (17,576) (18,143)
-------------- -------------
Total stockholders' equity 447,415 430,084
-------------- -------------
Total liabilities and stockholders' equity $ 1,287,063 $ 1,201,233
============== =============
</TABLE>
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
4
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------
1998 1997
---------------- ---------------
(in thousands, except per share data)
<S> <C> <C>
Revenues
Earned premiums $ 143,059 $ 131,867
Investment income 13,263 12,652
Realized investment gains (losses) 59 (7)
Income from affiliates (note 2) 1,366 1,141
Other income 15,978 13,092
---------------- ---------------
173,725 158,745
---------------- ---------------
Losses and expenses
Losses and loss adjusting expenses 95,243 87,891
Amortization of deferred
policy acquisition costs 31,657 28,938
Other underwriting expenses 6,859 5,518
Other expenses 14,423 13,426
Interest expense 639 395
---------------- ---------------
148,821 136,168
---------------- ---------------
Income before income taxes
and minority interest 24,904 22,577
---------------- ---------------
Income taxes
Current 6,769 7,614
Deferred 95 (1,081)
---------------- ---------------
6,864 6,533
---------------- ---------------
Income before minority interest 18,040 16,044
Minority interest in net income
of consolidated subsidiary 117 102
---------------- ---------------
Net income 17,923 15,942
Other comprehensive income (net of deferred taxes
of $1,452 in 1998 and $3,934 in 1997) 2,598 (7,318)
---------------- ---------------
Comprehensive Income $ 20,521 $ 8,624
================ ===============
Net income applicable to common stock (note 5) $ 17,044 $ 15,063
================ ===============
Earnings per share (note 5)
Basic $ 0.56 $ 0.49
================ ===============
Diluted $ 0.55 $ 0.49
================ ===============
</TABLE>
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
5
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------
1998 1997
---------------- ---------------
(in thousands)
<S> <C> <C>
Cash flows from operating activities
Net income $ 17,923 $ 15,942
Adjustments to reconcile net income to net cash
provided by operating activities
Realized investment gains (59) 7
Depreciation and amortization 2,795 2,449
Indebtedness with affiliates 1,610 (862)
Accounts receivable, net (10,050) (10,025)
Accrued investment income (398) 123
Deferred policy acquisition costs (2,045) (660)
Mortgage loans held for sale, net 3,094 (2,738)
Other assets (4,728) 2,927
Losses and loss adjusting expenses 4,615 5,697
Unearned premiums, net 7,004 2,973
Cost of ESOP shares allocated 567 647
Current income taxes 5,046 5,935
Deferred income taxes 95 (1,081)
Other, net (5,676) (3,193)
---------------- ---------------
Net cash provided by operating activities 19,793 18,141
---------------- ---------------
Cash flows from investing activities
Purchase of fixed maturities (24,880) (29,641)
Purchase of equity securities (7,315) (14,901)
Purchase of equipment (2,887) (1,837)
Sale of fixed maturities --- 5,069
Maturities, calls, and principal reductions of fixed maturities 14,567 24,895
Sale of equity securities 5,337 52
Short-term investments, net (4,507) (689)
Sale of equipment --- 35
---------------- ---------------
Net cash used in investing activities (19,685) (17,017)
---------------- ---------------
Cash flows from financing activities
Notes payable to nonaffiliates, net 3,020 8,160
Notes payable to affiliates, net 3,360 3,150
Issuance of common stock 863 636
Repurchase of common stock --- (7,012)
Dividends paid to stockholders, net of income tax benefit (4,620) (4,087)
---------------- ---------------
Net cash provided by financing activities 2,623 847
---------------- ---------------
Net increase in cash 2,731 1,971
Cash at beginning of year 2,168 1,067
---------------- ---------------
Cash at end of quarter $ 4,899 $ 3,038
================ ===============
</TABLE>
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
6
ALLIED Group, Inc. and Subsidiaries
Notes to Interim Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The accompanying interim consolidated financial statements include the accounts
of ALLIED Group, Inc. (the Company) and its subsidiaries. The interim
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) and include all adjustments
which are, in the opinion of management, necessary for fair presentation of the
results for the interim periods. All such adjustments are of a normal and
recurring nature. All significant intercompany balances and transactions have
been eliminated. The accompanying interim consolidated financial statements
should be read in conjunction with the following notes and with the Notes to
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
At March 31, 1998, The ALLIED Group Employee Stock Ownership Trust (ESOP Trust)
owned 24.6% and ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated
property-casualty insurance company, controlled 18.2% of the outstanding voting
stock of the Company.
(2) Transactions with Affiliates
Pursuant to the terms of the Intercompany Operating Agreement, the Company
leases employees to 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 three months ended March 31, 1998 and 1997, the Company received
revenues of $729,000 and $651,000 for employees leased to affiliates,
respectively, which are included in income from affiliates.
Certain subsidiaries of the Company provide data processing and other services
for ALLIED Mutual and its subsidiaries. Included in income from affiliates are
revenues of $637,000 million and $490,000 relating to services performed for
ALLIED Mutual and its subsidiaries for the first three months of 1998 and 1997,
respectively.
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 fund administrator. At March 31, 1998, the
Company and its subsidiaries had $13.5 million invested in the fund and had
several short-term unsecured notes payable to the fund totaling $9.3 million.
The interest rates on the borrowings ranged from 5.8% to 8.8%.
The Company had interest income from affiliates of $180,000 and $125,000 in the
first three months of 1998 and 1997, respectively. Interest paid to affiliates
was $168,000 and $74,000 in the first three months of 1998 and 1997,
respectively.
(3) Reinsurance
Effective January 1, 1998, the Company's property-casualty subsidiaries entered
into a property catastrophe reinsurance agreement with a nonaffiliated
reinsurer. The agreement is an aggregate catastrophe excess of loss reinsurance
program that covers the property-casualty segment's share of pooled losses up to
$25 million in excess of $25 million in the aggregate for any one quarter or in
excess of $60 million in the aggregate for any one year.
(4) Notes Payable to Nonaffiliates
At March 31, 1998, the mortgage banking subsidiary had borrowed $93 million
under the terms of three separate mortgage loan warehousing agreements with
different commercial banks. These notes payable are not guaranteed by the
Company. Under the terms of the agreements, the subsidiary can borrow up to the
lesser of $95 million or 98% of the mortgage credit borrowing base. The
outstanding borrowings were secured by $80 million of pledged mortgage loans
held for sale, mortgage servicing rights on loans with a principal balance of $3
billion, and foreclosure loans. Interest rates applicable to the mortgage loan
warehousing agreements vary with the level of investable deposits maintained at
the respective commercial banks.
<PAGE>
7
The mortgage banking subsidiary also had $10.5 million of 8.4% senior secured
notes outstanding as of March 31, 1998. The notes are payable to a nonaffiliated
life insurance company and are secured by pledged mortgage servicing rights. The
notes are payable in equal annual installments of $1.5 million each September 1,
with interest payable semi-annually. The final installment and interest is due
September 1, 2004.
The Federal Home Loan Bank of Des Moines provided a $5 million committed credit
facility through a line of credit agreement with AMCO Insurance Company (AMCO)
that expires February 26, 1999. 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 5.9% at March 31, 1998. AMCO had an outstanding
balance under this line of credit of $4.5 million at March 31, 1998. The
borrowings were secured by United States Government securities with a carrying
value of $16.3 million.
(5) Earnings per Share
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computation for the three months
ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
Basic earnings per share Diluted earnings per share
------------------------------------------------- -----------------------------------
Income
available to
Income Dilutive common
available to potential stockholders
Net Preferred common common and assumed
income dividends stockholders shares conversion
------------- ------------ -------------- ---------------- --------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
March 31, 1998
Income $ 17,923 $ (879) $ 17,044 $ --- $ 17,044
Weighted average
shares outstanding 30,542 --- 30,542 315 30,857
-------------- --------------
Earnings per share $ 0.56 $ 0.55
============== ==============
March 31, 1997
Income $ 15,942 $ (879) $ 15,063 $ --- $ 15,063
Weighted average
shares outstanding 30,540 --- 30,540 273 30,813
-------------- --------------
Earnings per share $ 0.49 $ 0.49
============== ==============
</TABLE>
Options to purchase 265,500 shares of common stock at a weighted average price
of $31.93 per share were outstanding at March 31, 1998, but not included in the
computation of diluted earnings per share. The options were excluded because the
exercise price was greater than the average market price per share for the first
quarter of 1998.
<PAGE>
8
(6) Segment Information
The Company has two reportable operating segments: property-casualty and excess
& surplus lines. For the three months ended March 31, 1998 and 1997, the
property-casualty and excess & surplus lines accounted for 85.6% and 5.8% of
consolidated revenues, respectively. Included in all other are mortgage banking,
data processing operations, and employee leasing services to affiliated
companies. All segments operated exclusively in the United States. The following
table presents a summary of the Company's operating segments for the three
months ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
Three months ended
March 31,
------------ ------------
1998 1997
------------ ------------
(in thousands)
<S> <C> <C>
Revenues from nonaffiliates *
Property-casualty $ 148,355 $ 135,595
Surplus & excess lines 10,130 9,615
All other 13,874 12,394
------------ ------------
Total $ 172,359 $ 157,604
============ ============
Revenues from affiliates
Property-casualty $ 319 $ 243
All other 30,537 26,842
Intersegment eliminations (29,490) (25,944)
------------ ------------
Total $ 1,366 $ 1,141
============ ============
Income before income taxes and minority interest *
Property-casualty $ 22,281 $ 21,041
Surplus & excess lines 2,445 2,065
All other 178 (529)
------------ ------------
Total $ 24,904 $ 22,577
============ ============
March 31, December 31,
1998 1997
------------ ------------
Segment assets
Property-casualty $ 1,041,277 $ 1,012,926
Surplus & excess lines 142,807 141,814
All other 634,881 560,270
Intersegment eliminations (531,902) (513,777)
------------ ------------
Total $ 1,287,063 $ 1,201,233
============ ============
</TABLE>
* includes realized investment gains or losses.
<PAGE>
9
Item 2. 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 ALLIED Group, Inc. (the Company) should be read in conjunction with
the Interim Consolidated Financial Statements and related footnotes included
elsewhere herein, and with the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 . 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 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 85.6% of consolidated revenues for each of the three
months ended March 31, 1998 and 1997.
The property-casualty segment participates in a reinsurance pooling agreement
with ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated
property-casualty insurance company. The agreement generally provides that the
property-casualty insurance business is combined and then prorated among the
participants according to predetermined percentages. Participation percentages
are based on certain factors such as capitalization and business produced by the
respective companies. The segment's participation in the reinsurance pool has
been 64% since January 1, 1993.
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,
but not limited to, the effect of competition on pricing, the frequency and
severity of losses incurred in connection with weather-related and other
catastrophic events, adequacy of reserves, general economic and business
conditions, and other factors such as changes in tax laws and the regulatory
environment.
Results of Operations
Consolidated revenues for the first three months of 1998 were $173.7 million, up
9.4% over the $158.7 million reported for the same period of 1997. The increase
occurred primarily because of the growth in earned premiums for the three months
ended March 31, 1998.
Income before income taxes and minority interest for the first three months of
1998 was up 10.3% to $24.9 million from $22.6 million for the same period in
1997. The increase was due to higher revenues, that outpaced the increase in
expenses for the three months ending March 31, 1998.
<PAGE>
10
The Company's year-to-date effective income tax rate was 27.6% and 28.9% at
March 31, 1998 and 1997, respectively. The decrease is due to the tax benefit
attributed to the larger percentage of investment income generated from
tax-exempt securities and equity securities. The income tax expense for the
first three months of 1998 rose slightly on higher operating income up to $6.9
million from $6.5 million for the same period in 1997.
Net income was up 12.4% to $17.9 million, bringing diluted earnings per share to
$0.55 for the three months ended March 31, 1998, from $15.9 million ($0.49 per
share) for the corresponding period in 1997. Diluted earnings per share before
realized investment gains and losses were $0.55 for the first three months of
1998 compared with $0.49 for the same period of 1997.
Book value per share at March 31, 1998 increased to $13.97 compared to $13.44 at
December 31, 1997. Growth in the book value per share was primarily the result
of higher net income for the first three months of 1998. The fair value of
investments in fixed maturities was $25.3 million above cost at March 31, 1998
compared to $26.3 million above cost at December 31, 1997. If the investments in
fixed maturities were reported at amortized cost, the book value would have been
$13.43 at March 31, 1998 compared to $12.88 at December 31, 1997.
Investments and Investment Income
The investment policy for the Company's insurance segments require that the
fixed maturity portfolio be invested primarily in debt obligations rated "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 and Poor's
Corporation or Moody's. The Company's investment portfolio consisted primarily
of fixed income securities and equity securities; 89.1% and 9.2%, respectively.
The ratings on 99.6% of the fixed income securities at March 31, 1998 were
investment grade or higher. The investment portfolio contained no real estate or
mortgage loans at March 31, 1998.
Invested assets were up 2.6% to $932.2 million from $908.2 million at year-end
1997. Three-month consolidated investment income increased 4.8% to $13.3 million
from $12.7 million through March 31, 1997. The increase was due to a larger
average balance of invested assets. The Company's pretax rate of return on
invested assets was down to 5.8% from last year's 6.0%. The pretax yield was
down as a result of the low interest rate environment and due to a higher
proportional share of investment income from tax-exempt securities.
Property-casualty
Net written premiums for the pool (including ALLIED Mutual) totaled $216.4
million, an 8.5% increase over production in the first quarter months of 1997.
Growth was constrained by commercial lines that grew 3.3%, reflecting the highly
competitive environment in which the commercial lines are operating. The average
premium per policy for personal lines was up 3.2% from the first three months of
1997 to $623 while the policy count grew 6.2%. The average premium per policy
for commercial lines excluding crop-hail increased 2.7% from the first three
months of 1997 to $1,158 and the policy count was up 2.5%. Earned premiums for
the property-casualty segment were 69.6% personal lines and 30.4% commercial
lines in the first three months of 1998. The business mix for the first quarter
of 1997 was 67.9% personal lines and 32.1% commercial lines.
Revenues for the property-casualty segment increased 9.2% to $148.4 million from
$135.8 million for the three months ended March 31, 1998 and 1997, respectively.
Direct earned premiums for the segment were $151.1 million for the first three
months of 1998 compared with $135.2 million one year earlier. Earned premiums
increased 8.7% for the first three months of 1998 to $134.7 million from $123.9
million. The increase resulted from growth in insurance exposure and increase in
average premium per policy.
Investment income for the first three months of 1998 was $11.5 million compared
to $10.9 million for the same period in 1997. The increase was the result of a
larger average balance in invested assets. The pretax yield on invested assets
was 5.8% and 6.1% for the three months ended March 31, 1998 and 1997,
respectively. The segment had realized investment gains of $57,000 in the first
three months of 1998 compared with realized losses of $6,000 in the same period
of 1997. Other income for the first three months of 1998 and 1997 was $2.1
million and $1 million, respectively.
Income before income taxes increased 5.9% to $22.3 million from $21 million in
the first quarter of 1997. Growth was slowed by higher wind and hail losses and
an increase in underwriting expenses. Wind and hail losses for the first three
months of 1998 were up to $5.9 million compared to $2.7 million for the same
period in 1997.
<PAGE>
11
The statutory combined ratio (after policyholder dividends) for the first three
months of 1998 was 94.1 compared to 92.5 reported in the first three months of
1997. The higher combined ratio was a result of the 1.7-point increase in the
three month underwriting expense ratio. The ratio was unfavorably impacted by
higher than expected contingency commissions for 1997, one-time costs associated
with setting up the new Central States Office, and legal expenses. The loss and
loss adjusting expense ratio also increased slightly (0.1-point). The impact of
wind and hail losses on the combined ratio was 4.4 points and 2.2 points for the
three months ended March 31, 1998 and 1997, respectively. The generally accepted
accounting principles (GAAP) underwriting gain was $8.6 million compared with a
gain of $9.1 million for the first three months of 1997. On a diluted basis, the
impact of wind and hail losses on the results of operations was $0.12 per share
versus $0.06 per share in the first three months of 1997.
The following table presents the property-casualty's statutory combined ratio by
line of business for the three and nine months ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------
1998 1997
------ ------
<S> <C> <C>
Personal automobile 94.8 95.4
Homeowners 94.4 90.1
Personal lines 94.6 93.9
Commercial automobile 101.9 105.3
Workers' compensation 98.9 85.8
Other property/liability 90.1 87.1
Other lines 70.1 61.3
Commercial lines 92.7 89.4
Total 94.1 92.5
</TABLE>
The personal auto statutory combined ratio improved to 94.8 for the first
quarter of 1998 from 95.4 for the same period in 1997. The improvement was
largely due to a 1.8-point decrease in the loss and loss adjusting expense
ratio; the underwriting expense ratio deteriorated 1.2-points. The impact of
wind and hail losses on the combined ratio for personal auto was down to 0.4
from 0.7 for the first quarter of 1997. The statutory combined ratio for the
homeowners line was 94.4 for the first three months of 1998 compared with 90.1
for the same period of 1997. The deterioration was primarily due to a 3.3-point
increase in the loss and loss adjusting expense ratio; the underwriting expense
ratio also increased 1 point. The impact of higher wind and hail losses on the
combined ratio for the homeowners line increased to 14.4-points from 5.7-points
for the first three months of 1997. Overall, the personal lines statutory
combined ratio increased to 94.6 in the first three months of 1998 from 93.9 in
the same period of 1997. The statutory combined ratio for commercial lines
increased to 92.7 in the first three months of 1998 from 89.4 for the first
three months of 1997. The deterioration of personal and commercial lines
combined ratio was primarily attributable to higher underwriting expenses in the
first quarter of 1998.
Excess & Surplus Lines
Earned premiums increased to $8.4 million for the first three months of 1998
from $7.9 million for the same period in 1997. Net written premiums increased to
$11.8 million for the three months ended March 31, 1998 from $7.9 million in the
same period of 1997. The increase is due to a change in reinsurance, effective
January 1, 1998, from the ceding of premiums on an unearned basis to an earned
basis. On January 1, 1998, the segment had $4.5 million of prepaid reinsurance
premiums that were retro-ceded back. For the three month period ended March 31,
1998, the segment's book of business was comprised of 3.9% personal lines and
96.1% commercial lines. The business mix for the first three months of 1997 was
2.7% personal lines and 97.3% commercial lines.
Investment income for the first three months of 1998 increased 3.1% to $1.7
million from the same period in 1997. Investment income increased due to a
larger average balance in the investment portfolio. The pretax yield on those
assets was 6% in the first quarter of 1998 compared to 6.3% for the same period
in 1997. Invested assets increased 3.4% to $117.4 million at March 31, 1998 from
$113.5 million at year-end 1997.
<PAGE>
12
The statutory combined ratio (after policyholder dividends) was 94.3, which
produced a GAAP underwriting gain of $722,000 million for the first quarter of
1998. The combined ratio for the first three months of 1997 was 95.0 which
resulted in a GAAP underwriting gain of $396,000. The combined ratio improved
primarily because of a 2.8-point improvement in the loss and loss adjusting
expense ratio in the first three months of 1998, due to the growth in earned
premiums that outpaced losses and loss adjusting expenses. The underwriting
expense ratio deteriorated 2.1-points in the first three months of 1998 over the
same period in 1997. The deterioration was due to an increase in commission
expense as a result of the commission provision on the premiums retro-ceded back
to the segment.
Income before income taxes for the three months ended March 31, 1998 increased
to $2.4 million from $2.1 million. The segment had no realized gains or losses
for the first three months of 1998 and had realized losses of $2,000 in the same
period of 1997.
Noninsurance Operations
Revenues for the noninsurance operations (including mortgage banking, data
processing operations, and employee leasing to affiliates) after eliminations
increased 12.3% to $14.9 million for the first three months of 1998 from $13.3
million for the same period last year. The increase was primarily due to a $2.2
million increase in data processing revenues from outside consulting fees.
Income before income taxes was $178,000 for the first three months of 1998
compared to a loss before taxes of $529,000 for the same period in 1997. The
increase was due to revenue growth that outpaced the increase in operating
expenses in 1998. The mortgage banking servicing portfolio at March 31, 1998
increased slightly to $3 billion from $2.9 billion at year-end 1997.
New Accounting Pronouncement
In February of 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Statement (SFAS) 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits," effective for years beginning after
December 31, 1997. SFAS 132 revises the disclosure requirements but does not
change the measurement or recognition of those plans. SFAS 132 superseded SFAS
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions."
The adoption of SFAS 132 will result in revised and additional disclosures but
will have no effect on the financial position, results of operations, or
liquidity of the Company.
Liquidity and Capital Resources
Substantial cash inflows are generated from premiums, pool administration fees,
investment income, and proceeds from sales and maturities of investments. The
principal outflows of cash are payment of claims, commissions, premium taxes,
operating expenses, and income taxes and the purchase of fixed income and equity
securities. In developing its investment 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 the first three months of 1998 and 1997, operating activities generated cash
flows of $19.8 million and $18.1 million, respectively. For both quarters, the
primary source of funds was premium growth in the Company's property-casualty
insurance operations. The funds were used primarily to purchase fixed income and
equity securities. In the first quarter of 1997, funds were also used to
repurchase the Company's common stock.
Operating cash flows were also used to pay $4.9 million of dividends to
stockholders in the first three months of 1998. For the same period in 1997, the
Company paid dividends of $4.3 million to stockholders. Dividend payments to
common stockholders totaled $4 million for the three months ended March 31,
1998, up from $3.5 million for the same period in 1997. The increase in
dividends to common stock shareholders is due to a greater number of common
shares outstanding and from a higher dividend per share, 14.7% increase from
March 31, 1997. In the first three months of 1998 and 1997, the Company paid
dividends of $879,000 on the 6-3/4% Series preferred stock.
The Company relies primarily on dividend payments from its property-casualty
subsidiaries to pay preferred and common stock dividends to stockholders. During
the first three months of 1998, the Company received dividend payments of $4.2
million from the property-casualty subsidiaries and $19,000 from noninsurance
subsidiaries. During the same period of 1997, the Company received dividend
payments of $4.1 million from the property-casualty subsidiaries and $19,000
from noninsurance subsidiaries.
<PAGE>
13
During the first three months of 1997, the Company canceled 295,800 shares of
its common stock purchased on the open market at an average price per share of
$23.71. The first 85,500 shares were repurchased under a program approved by the
Board of Directors (Board) on July 16, 1996 and completed on March 13, 1997. An
additional 210,300 shares were repurchased under a program approved by the Board
on March 4, 1997, whereby an additional 375,000 shares of common stock were
authorized to be repurchased pursuant to SEC Rule 10b-18.
The mortgage banking subsidiary has separate credit arrangements to support its
operations. Short-term and long-term notes payable to nonaffiliated companies
are used to finance its mortgage loans held for sale and to purchase mortgage
servicing rights. The level of short-term borrowings fluctuates daily depending
on the level of inventory being financed. At March 31, 1998, short-term
borrowings amounted to $93 million to be repaid through the subsequent sale of
mortgage loans held for sale and long-term borrowings amounted to $10.5 million
to be repaid over the next seven years. These notes payable are not guaranteed
by the Company. In the normal course of its business, the subsidiary 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.
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 March 31, 1998, the Company and its
subsidiaries 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.
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
determined. Management of the Company continues to believe that 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>
14
PART II
Item 6. Exhibits and Reports on Form 8-K
(a) 10.64 Third Amendment to Consulting Agreement between John E. Evans,
ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED
Life Financial Corporation, dated March 24, 1998
27 Financial Data Schedule
(b) The Company filed two reports on Form 8-K during the first quarter
ended March 31, 1998.
Items Financial Date
Reported Statements Filed
-------- ---------- -----
Item 5 -- Other None January 05, 1998
Item 5 -- Other None January 15, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLIED Group, Inc.
(Registrant)
Date: May 1, 1998 /s/ Jamie H. Shaffer
----------------------------------------
Jamie H. Shaffer, Senior Vice President,
Chief Financial Officer, and Treasurer
<PAGE>
15
ALLIED Group, Inc. and Subsidiaries
INDEX TO EXHIBITS
EXHIBIT
NUMBER ITEM PAGE
10.64 Third Amendment to Consulting Agreement between
John E. Evans, ALLIED Group, Inc., ALLIED Mutual
Insurance Company, and ALLIED Life Financial
Corporation, dated March 24, 1998 16
27 Financial Data Schedule 17
<PAGE>
16
EXHIBIT 10.64
THIRD AMENDMENT
TO CONSULTING AGREEMENT
THIS AMENDMENT is made this 24th day of March, 1998, by and between
John E. Evans ("Evans") and ALLIED Group, Inc. ("AGI"), ALLIED Mutual Insurance
Company ("Mutual"), and ALLIED Life Financial Corporation ("ALFC"). AGI, Mutual,
and ALFC shall be known collectively as "ALLIED".
WHEREAS, on December 14, 1994, ALLIED and Evans entered into a
Consulting Agreement setting forth the services which Evans was to render to
ALLIED following retirement;
WHEREAS, on December 18, 1996 and May 13, 1997, ALLIED and Evans
amended the Consulting Agreement;
WHEREAS, the parties desire to amend the Consulting Agreement as set
forth herein;
NOW, THEREFORE, in consideration of the foregoing, and of the mutual
covenants set forth below and other valuable consideration, the receipt of which
is hereby acknowledged, the parties agree as follows:
1. Effective March 1, 1998, Section III of the Consulting Agreement is
amended by deleting "$180,000" and replacing it with "$120,000".
2. All other terms and conditions remain in full force and effect.
IN WITNESS WHEREOF, the parties hereto have caused this agreement to
be executed as of the day and year above first written.
ALLIED Mutual Insurance Company
/s/ John E. Evans By:/s/ Douglas L. Andersen
- --------------------------------- ------------------------------
John E. Evans Douglas L. Andersen, President
ALLIED Group, Inc. ALLIED Life Financial Corporation
By:/s/ Douglas L. Andersen By:/s/ Samuel J. Wells
------------------------------ ------------------------------
Douglas L. Andersen, President Samuel J. Wells, President
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLIED
GROUP, INC.'S MARCH 31, 1998 FORM 10-Q 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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> MAR-31-1998
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<TOTAL-INVEST> 932,151
<CASH> 4,899
<RECOVER-REINSURE> 25,211
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<TOTAL-ASSETS> 1,287,063
<POLICY-LOSSES> 382,641
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<NOTES-PAYABLE> 117,306
0
37,812
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<INCOME-TAX> 6,864
<INCOME-CONTINUING> 18,040
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<EXTRAORDINARY> 0
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