SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
------------------ -----------------
Commission file number 0-14697
HARLEYSVILLE GROUP INC.
--------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 51-0241172
- ------------------------------------ ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
355 Maple Avenue, Harleysville, PA 19438-2297
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 256-5000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1 par value
--------------------------
(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
(or for such shorter period that the Registrant was required to
file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No
----- ----.
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 [X].
On March 9, 1999, the aggregate market value (based on the
closing sales price on that date) of the voting stock held by non-
affiliates of the Registrant was $268,775,234.
Indicate the number of shares outstanding of each of the
Registrant's classes of common stock, as of the latest
practicable date: 29,261,461 shares of Common Stock outstanding
on March 9, 1999.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's annual report to stockholders
for the fiscal year ended December 31, 1998 are incorporated
by reference in Parts I, II and IV of this report.
2. Portions of the Registrant's proxy statement relating to the
annual meeting of stockholders to be held April 28, 1999 are
incorporated by reference in Parts I and III of this report.
<PAGE>
HARLEYSVILLE GROUP INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 1998
PART I PAGE
------ ----
ITEM 1. BUSINESS 3
ITEM 2. PROPERTIES 25
ITEM 3. LEGAL PROCEEDINGS 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS 25
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS 28
ITEM 6. SELECTED FINANCIAL DATA 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 28
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT 29
ITEM 11. EXECUTIVE COMPENSATION 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT 29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS 29
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K 30
2
<PAGE>
PART I
ITEM 1. BUSINESS.
- ------- --------
(a) GENERAL DEVELOPMENT OF BUSINESS.
Harleysville Group Inc. (the "Company") is a regional
insurance holding company headquartered in Pennsylvania which
engages, through its subsidiaries, in the property and casualty
insurance business. As used herein, "Harleysville Group" refers
to Harleysville Group Inc. and its subsidiaries. Harleysville
Mutual Insurance Company (the "Mutual Company") owns
approximately 54% of the issued and outstanding common stock of
Harleysville Group.
Harleysville Group and the Mutual Company operate together
as a network of regional insurance companies that underwrite a
broad line of personal and commercial coverages. These insurance
coverages are marketed primarily in the eastern and midwestern
United States through approximately 22,600 independent insurance
agents associated with approximately 3,000 insurance agencies.
Regional offices are maintained in Georgia, Illinois, Indiana,
Maryland, Massachusetts, Michigan, Minnesota, New Jersey, New
York, North Carolina, Ohio, Pennsylvania, Tennessee, and
Virginia. The Company's property and casualty insurance
subsidiaries are: Great Oaks Insurance Company ("Great Oaks"),
Harleysville-Atlantic Insurance Company ("Atlantic"),
Harleysville Insurance Company of New Jersey ("HNJ"), Huron
Insurance Company ("Huron"), Lake States Insurance Company ("Lake
States"), Mid-America Insurance Company ("Mid-America"),
Minnesota Fire and Casualty Company ("Minnesota Fire"), New York
Casualty Insurance Company ("New York Casualty") and Worcester
Insurance Company ("Worcester").
The Company has followed a strategy of building a national
network of regional insurance companies. Management believes
that the Company's regional organization permits each regional
operation to benefit from economies of scale provided by
centralized support while encouraging local marketing autonomy
and managerial entrepreneurship. Services which directly involve
the insured or the agent (i.e., underwriting, claims and
marketing) generally are performed locally in accordance with
Company-wide standards to promote high quality service, while
actuarial, investment, legal, data processing and similar
services are performed centrally. The Company's network of
regional insurance companies has expanded significantly in the
last fifteen years. In 1983, the Company acquired Worcester, a
property and casualty insurer which has conducted business in New
England since 1823. In 1984, HNJ was formed by the Company and
began underwriting property and casualty insurance in New Jersey.
In 1987, the Company acquired Atlantic, a property and casualty
insurer which has conducted business in the southeastern United
States since 1905. In 1991, the Company acquired Mid-America,
(formerly named Connecticut Union Insurance Company) which
conducted business in
3
<PAGE>
Connecticut, and New York Casualty, which conducts business in
upstate New York. In 1993, the Company acquired Lake States,
which primarily conducts business in Michigan. In 1994, the
Company formed Great Oaks which began underwriting property and
casualty insurance in Ohio. In 1997, the Company acquired
Minnesota Fire, which primarily conducts business in Minnesota
and neighboring states.
The Company's property and casualty subsidiaries participate
in an intercompany pooling arrangement whereby these subsidiaries
cede to the Mutual Company all of their net premiums written and
assume from the Mutual Company a portion of the pooled business,
which included all of the Mutual Company's property and casualty
insurance business except for new and renewal Pennsylvania
personal automobile insurance insured after January 1, 1991 by a
subsidiary of the Mutual Company, Pennland Insurance Company
("Pennland") and new and renewal New Jersey personal automobile
insurance insured after January 1, 1992 by another subsidiary of
the Mutual Company, Harleysville-Garden State Insurance Company
("Garden State"). Beginning January 1, 1996, Harleysville
Group's participation in the pooling arrangement increased from
60% to 65% and Pennland became a participant in the pooling
arrangement. Beginning January 1, 1997, Harleysville Group's
participation in the pooling arrangement increased from 65% to
70% and Lake States became a participant in the pooling
arrangement. Beginning January 1, 1998, Harleysville Group's
participation in the pooling arrangement increased from 70% to
72% and Minnesota Fire became a participant in the pooling
arrangement. See "Business - Narrative Description of Business -
Pooling Arrangement."
The Company is a Delaware corporation formed in 1979 as a
wholly-owned subsidiary of the Mutual Company. In May 1986, the
Company completed an initial public offering of its common stock,
reducing the percentage of outstanding shares owned by the Mutual
Company to approximately 70%. In April 1992, the Mutual Company
completed a secondary public offering of a portion of the
Company's common stock then owned by it, further reducing the
percentage of outstanding shares owned by the Mutual Company to
approximately 54%.
(b) FINANCIAL INFORMATION ABOUT SEGMENTS.
Harleysville Group has three segments which consist of the
personal lines of insurance, the commercial lines of insurance
and the investment function. Financial information about these
segments is set forth in Note 13 of the Notes to Consolidated
Financial Statements.
4
<PAGE>
(c) Narrative Description of Business.
Property and Casualty Underwriting
Harleysville Group and the Mutual Company together
underwrite a broad line of personal and commercial property and
casualty coverages, including automobile, homeowners, commercial
multi-peril and workers compensation. The Mutual Company and the
Company's insurance subsidiaries participate in an intercompany
pooling arrangement under which such subsidiaries and the Mutual
Company combine their property and casualty business. Garden
State has not participated in the pooling arrangement. On
January 1, 1996, Pennland began participation in the pooling
arrangement and Harleysville Group's participation increased to
65%. Beginning January 1, 1997, Harleysville Group's
participation in the pooling arrangement increased from 65% to
70% and Lake States became a participant in the pooling
arrangement. Beginning January 1, 1998, Harleysville Group's
participation in the pooling arrangement increased from 70% to
72% and Minnesota Fire became a participant in the pooling
arrangement.
Harleysville Group and the Mutual Company have a pooled
rating of "A" (excellent) by A.M. Best Company, Inc. ("Best's")
based upon 1997 statutory results and operating performance.
Best's ratings are based upon factors relevant to policyholders
and are not directed toward the protection of investors.
Management believes that the Best's rating is an important factor
in marketing Harleysville Group's products to its agents and
customers.
The following table sets forth the premiums earned, by line
of insurance, for Harleysville Group for the periods indicated:
HARLEYSVILLE GROUP BUSINESS ONLY
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
PREMIUMS EARNED
- ---------------
Commercial:
Automobile $124,305 $110,128 $103,445
Workers compensation 105,918 113,832 128,563
Commercial multi-peril 138,931 127,247 123,393
Other 32,795 28,581 28,394
-------- -------- --------
Total commercial 401,949 379,788 383,795
-------- -------- --------
Personal:
Automobile 173,503 162,416 151,766
Homeowners 78,341 72,800 70,330
Other 10,811 9,901 9,306
-------- -------- --------
Total personal 262,655 245,117 231,402
-------- -------- --------
Total Harleysville
Group Business $664,604 $624,905 $615,197
======== ======== ========
5
<PAGE>
The following table sets forth ratios for the Company's
property and casualty subsidiaries, prepared in accordance with
generally accepted accounting principles ("GAAP") and with
statutory accounting practices ("SAP") prescribed or permitted by
state insurance authorities. The statutory combined ratio is a
standard measure of underwriting profitability. This ratio is
the sum of (i) the ratio of incurred losses and loss settlement
expenses to net earned premium ("loss ratio"); (ii) the ratio of
expenses incurred for commissions, premium taxes, administrative
and other underwriting expenses to net written premium ("expense
ratio"); and (iii) the ratio of dividends to policyholders to net
earned premium ("dividend ratio"). The GAAP combined ratio is
calculated in the same manner except that it is based on GAAP
amounts and the denominator for each component is net earned
premium. When the combined ratio is under 100%, underwriting
results are generally considered profitable. Conversely, when
the combined ratio is over 100%, underwriting results are
generally considered unprofitable. The combined ratio does not
reflect investment income, federal income taxes or other non-
operating income or expense. Harleysville Group's operating
income is a function of both underwriting results and investment
income.
HARLEYSVILLE GROUP BUSINESS ONLY
Year Ended December 31,
--------------------------
1998 1997 1996
------ ------ ------
GAAP combined ratio 103.6% 103.6% 108.4%
===== ===== =====
Statutory operating ratios:
Loss ratio 69.9% 70.3% 76.1%
Expense and dividend ratios 33.3% 33.2% 31.2%
----- ----- -----
Statutory combined ratio 103.2% 103.5% 107.3%
===== ===== =====
POOLING ARRANGEMENT
The Company's property and casualty subsidiaries participate
in an intercompany pooling arrangement with the Mutual Company.
The underwriting pool is intended to produce a more uniform and
stable underwriting result from year to year for all companies in
the pool than they would experience individually and to reduce
the risk of loss of any of the pool participants by spreading the
risk among all the participants. Each company participating in
the pool has at its disposal the capacity of the entire pool,
rather than being limited to policy exposures of a size
commensurate with its own capital and surplus. The additional
capacity exists because such policy exposures are spread among
all the pool participants which each have their own capital and
surplus. Regulation is applied to the individual companies rather
than to the pool.
6
<PAGE>
Pursuant to the terms of the pooling agreement with the
Mutual Company, each of the Company's subsidiary participants
cedes premiums, losses and expenses on all of its business to the
Mutual Company which, in turn, retrocedes to such subsidiaries a
specified portion of premiums, losses and expenses of the Mutual
Company and such subsidiaries. Under the terms of the
intercompany pooling agreement which became effective January 1,
1986, Huron and HNJ ceded to the Mutual Company all of their
insurance business written on or after January 1, 1986. All of
the Mutual Company's property and casualty insurance business
written or in force on or after January 1, 1986, was also
included in the pooled business. The pooling agreement provides,
however, that Harleysville Group is not liable for any losses
occurring prior to January 1, 1986. The pooling agreement does
not legally discharge Harleysville Group from its primary
liability for the full amount of the policies ceded. However, it
makes the Mutual Company liable to Harleysville Group to the
extent of the business ceded.
The following table sets forth a chronology of the changes
that have occurred in the pooling agreement since it became
effective on January 1, 1986.
CHRONOLOGY OF CHANGES IN POOLING AGREEMENT
HARLEYSVILLE MUTUAL
GROUP COMPANY
DATE PERCENTAGE PERCENTAGE EVENT
- --------------- ------------ ---------- ---------------------------------
January 1, 1986 30% 70% Current pooling agreement began
with Huron and HNJ as
participants with the Mutual
Company.
July 1, 1987 35% 65% Atlantic acquired and included
in the pool.
January 1, 1989 50% 50% Worcester included in the pool.
January 1, 1991 60% 40% New York Casualty and Mid-America
acquired and included in the
pool and the Mutual Company
formed Pennland (not a pool
participant) to write
Pennsylvania personal automobile
business.
January 1, 1996 65% 35% Pennland included in the pool.
January 1, 1997 70% 30% Lake States included in the pool.
January 1, 1998 72% 28% Minnesota Fire included in
the pool.
7
<PAGE>
Effective as of January 1, 1992, Garden State began insuring
new and renewal New Jersey personal automobile insurance policies
that had been included in the pooling arrangement. Garden State
is not a participant in the pooling arrangement.
When pool participation percentages increased as described
above, cash and investments equal to the net increase in
liabilities assumed less a ceding commission related to the net
increase in the liability for unearned premiums, was transferred
from the Mutual Company to Harleysville Group. See Note 3(a) of
the Notes to Consolidated Financial Statements.
All premiums, losses, loss settlement expenses and other
underwriting expenses are prorated among the parties to the
pooling arrangement on the basis of their participation in the
pool. The method of establishing reserves is set forth under
"Business - Reserves." The pooling agreement may be amended or
terminated by agreement of the parties. Termination may occur
only at the end of a calendar year. The Company and the Mutual
Company maintain a coordinating committee which reviews and
evaluates the pooling arrangements between the Company and the
Mutual Company. See "Business-Relationship with the Mutual
Company." In evaluating pool participation changes, the
coordinating committee considers current and proposed
acquisitions, the relative capital positions and revenue
contributions of the pool participants, and growth prospects and
ability to access capital markets to support that growth.
Harleysville Group does not intend to terminate its participation
in the pooling agreement.
8
<PAGE>
The following table sets forth the net written premiums and
combined ratios by line of insurance for the total pooled
business after elimination of management fees, prepared in
accordance with statutory accounting practices prescribed or
permitted by state insurance authorities, for the periods
indicated.
TOTAL POOLED BUSINESS
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
-------- --------- ---------
(dollars in thousands)
PREMIUMS WRITTEN
- ----------------
Commercial:
Automobile $182,972 $154,833 $146,987
Workers compensation 147,981 146,267 161,539
Commercial multi-peril 202,043 184,547 150,008
Other 47,469 37,924 39,503
-------- -------- --------
Total commercial 580,465 523,571 498,037
-------- -------- --------
Personal:
Automobile 245,786 228,689 178,166
Homeowners 111,195 102,791 93,513
Other 15,674 14,031 14,405
-------- -------- --------
Total personal 372,655 345,511 286,084
-------- -------- --------
Total pooled business $953,120 $869,082 $784,121
======== ======== ========
COMBINED RATIOS<F1>
- ---------------
Commercial:
Automobile 108.4% 109.7% 106.8%
Workers compensation 98.8% 93.2% 92.2%
Commercial multi-peril 119.2% 116.0% 118.1%
Other 97.3% 104.0% 108.2%
Total commercial 108.8% 106.7% 105.5%
Personal:
Automobile 98.1% 100.3% 107.5%
Homeowners 123.3% 100.8% 132.2%
Other 97.0% 69.5% 115.0%
Total personal 105.6% 99.2% 116.0%
Total pooled business 107.5% 103.8% 109.4%
- ---------------
[FN]
<F1>
See the definition of combined ratio in "Business-Property and
Casualty Underwriting".
9
<PAGE>
RESERVES. Loss reserves are estimates at a given point in
time of what the insurer expects to pay to claimants for claims
occurring on or before such point in time, including claims which
have not yet been reported to the insurer. These are estimates,
and it can be expected that the ultimate liability will exceed or
be less than such estimates. During the loss settlement period,
additional facts regarding individual claims may become known,
and consequently it often becomes necessary to refine and adjust
the estimates of liability.
Harleysville Group maintains reserves for the eventual
payment of losses and loss settlement expenses with respect to
both reported and unreported claims. Loss settlement expense
reserves are intended to cover the ultimate costs of settling all
claims, including investigation and litigation costs relating to
such claims. The amount of loss reserves for reported claims is
based primarily upon a case-by-case evaluation of the type of
risk involved and knowledge of the circumstances surrounding each
claim and the insurance policy provisions relating to the type of
loss. The amounts of loss reserves for unreported claims and loss
settlement expense reserves are determined on the basis of
historical information by line of insurance as adjusted to
current conditions. Inflation is implicitly provided for in the
reserving function through analysis of costs, trends and reviews
of historical reserving results. Reserves are closely monitored
and are recomputed periodically by Harleysville Group and the
Mutual Company using new information on reported claims and a
variety of statistical techniques. With the exception of
reserves relating to some workers compensation long-term
disability cases, loss reserves are not discounted.
10
<PAGE>
The following table sets forth a reconciliation of beginning
and ending net reserves for unpaid losses and loss settlement
expenses for the years indicated for the total pooled business on
a statutory basis.
TOTAL POOLED BUSINESS
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
(in thousands)
Reserves for losses
and loss settlement
expenses, beginning
of the year $1,124,910 $1,033,376 $ 900,336
---------- ---------- ----------
Adjustment to beginning
of the year reserves
for the addition of
Minnesota Fire (1998),
Lake States (1997) and
Pennland (1996) 33,353 71,544 78,205
---------- ---------- ----------
Incurred losses and loss
settlement expenses:
Provision for insured
events of the current
year 744,842 662,468 642,448
Decrease in provision
for insured events of
prior years (56,223) (37,720) (43,843)
---------- ---------- ----------
Total incurred
losses and loss
settlement expenses 688,619 624,748 598,605
---------- ---------- ----------
Payments:
Losses and loss
settlement expenses
attributable to
insured events of
the current year 335,841 276,067 270,026
Losses and loss
settlement expenses
attributable to
insured events of
prior years 338,377 328,691 273,744
---------- ---------- ----------
Total payments 674,218 604,758 543,770
---------- ---------- ----------
Reserves for losses and
loss settlement expenses,
end of the year $1,172,664 $1,124,910 $1,033,376
========== ========== ==========
11
<PAGE>
The following table sets forth the development of net
reserves for unpaid losses and loss settlement expenses from 1988
through 1998 for the pooled business of the Mutual Company and
Harleysville Group. "Reserve for losses and loss settlement
expenses" sets forth the estimated liability for unpaid losses
and loss settlement expenses recorded at the balance sheet date
for each of the indicated years. This liability represents the
estimated amount of losses and loss settlement expenses for
claims arising in the current and all prior years that are unpaid
at the balance sheet date, including losses incurred but not
reported.
The "Reserves reestimated" portion of the table shows the
reestimated amount of the previously recorded liability based on
experience of each succeeding year. The estimate is increased or
decreased as payments are made and more information becomes known
about the severity of remaining unpaid claims. For example, the
1990 liability has developed a deficiency after eight years, in
that reestimated losses and loss settlement expenses are expected
to exceed the initial estimated liability established in 1990 of
$676.5 million by $14.5 million, or 2.1%.
The "Cumulative amount of reserves paid" portion of the
table shows the cumulative losses and loss settlement expense
payments made in succeeding years for losses incurred prior to
the balance sheet date. For example, the 1990 column indicates
that as of December 31, 1998, payments of $615.2 million of the
currently reestimated ultimate liability for losses and loss
settlement expenses had been made.
The "Redundancy (deficiency)" portion of the table shows the
cumulative redundancy or deficiency at December 31, 1998 of the
reserve estimate shown on the top line of the corresponding
column. A redundancy in reserves means that reserves established
in prior years exceeded actual losses and loss settlement
expenses or were reevaluated at less than the original reserved
amount. A deficiency in reserves means that the reserves
established in prior years were less than actual losses and loss
settlement expenses or were reevaluated at more than the
originally reserved amount.
The following table includes all 1998 pool participants as
if they had participated in the pooling arrangement in all years
indicated except for acquired pool participant companies, which
are included from their date of acquisition. Under the terms of
the pooling arrangement, Harleysville Group is not responsible
for losses on the pooled business occurring prior to January 1,
1986.
12
<PAGE>
<TABLE>
<CAPTION>
TOTAL POOLED BUSINESS
YEAR ENDED DECEMBER 31,
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
------- ------- ------- ------- ------- -------- -------- -------- --------- --------- --------
(dollars in thousands)
Reserve for
losses and
loss
settlement
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
expenses $517,426 $610,128 $676,526 $742,989 $784,514 $825,028 $855,305 $900,336 $1,033,376 $1,124,910 $1,172,664
Reserves
reestimated:
One year
later 511,373 597,709 661,323 739,030 781,746 819,494 837,255 856,493 995,656 1,068,687
Two years
later 504,888 598,263 668,740 738,557 778,064 802,213 817,330 820,894 961,228
Three years
later 511,780 608,568 673,043 737,408 774,420 800,129 800,365 799,191
Four years
later 519,856 612,455 676,021 736,458 776,687 792,901 790,234
Five years
later 523,070 616,796 678,390 742,878 770,420 786,731
Six years
later 526,611 620,632 686,076 741,032 767,777
Seven years
later 531,760 627,462 689,367 741,941
Eight years
later 538,774 632,778 691,025
Nine years
later 544,191 634,248
Ten years
later 545,992
Cumulative
amount of
reserves paid:
One year
later 158,587 200,569 220,747 236,833 244,210 255,078 246,935 273,744 328,691 338,377
Two years
later 263,792 326,313 363,109 383,358 402,394 403,601 406,944 448,497 523,307
Three years
later 340,128 418,355 459,024 485,045 503,309 511,281 525,840 566,804
Four years
later 396,185 475,044 524,757 550,456 572,656 587,900 599,336
Five years
later 429,388 513,573 563,807 594,452 616,940 629,908
Six years
later 451,548 537,609 589,477 619,780 639,186
Seven years
later 465,664 552,083 605,440 633,771
Eight years
later 476,104 562,642 615,239
Nine years
later 484,047 569,841
Ten years
later 489,671
Redundancy
(defi-
ciency) (28,566) (24,120) (14,499) 1,048 16,737 38,297 65,071 101,145 72,148 56,223
Redundancy
(deficiency)
expressed as
a percent
of year end
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
reserves (5.5)% (4.0)% (2.1)% 0.1% 2.1% 4.6% 7.6% 11.2% 7.0% 5.0%
Cumulative
redundancy
excluding
pre-1986
reserve
develop-
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ment<F1> 6,344 3,867 10,784 22,296 35,109 55,642 80,755 113,288 79,546 58,710
<FN>
<F1> Excludes years not included in pooling arrangement with
Harleysville Group.
</TABLE>
13
<PAGE>
Harleysville Group's reserves primarily are derived from
those established for the total pooled business. The terms of
the pooling agreement provide that Harleysville Group is
responsible only for pooled losses incurred on or after the
effective date, January 1, 1986. The GAAP loss reserve
experience of Harleysville Group, as reflected in its financial
statements, is shown in the following table which sets forth a
reconciliation of beginning and ending net reserves for unpaid
losses and loss settlement expenses for the years indicated for
the business of Harleysville Group only.
HARLEYSVILLE GROUP BUSINESS ONLY
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- --------- --------
(in thousands)
Reserves for losses and
loss settlement expenses,
beginning of the year $793,563 $718,700 $576,653
-------- -------- --------
Reserves of acquired company 34,836
-------- -------- --------
Incurred losses and loss
settlement expenses:
Provision for insured
events of the current
year 507,087 469,216 503,489
Decrease in provision
for insured events of
prior years (42,607) (29,728) (34,999)
-------- -------- --------
Total incurred losses
and loss settlement
expenses 464,480 439,488 468,490
-------- -------- --------
Payments:
Losses and loss settlement
expenses attributable to
insured events of the
current year 215,902 198,554 220,669
Losses and loss settlement
expenses attributable to
insured events of prior
years 241,014 229,225 199,740
Adjustment to beginning of
the year reserves resulting
from the change in the pool
participation percentage (12,392) (28,318) (93,966)
-------- -------- --------
Total payments 444,524 399,461 326,443
-------- -------- --------
Reserves for losses and loss
settlement expenses, end
of the year $813,519 $793,563 $718,700
======== ======== ========
14
<PAGE>
Harleysville Group recognized a decrease in the provision
for insured events of prior years (favorable development) of
$42.6, $29.7 and $35.0 million in 1998, 1997 and 1996,
respectively. The favorable development primarily related to
lower than expected claim severity in the workers compensation
and automobile lines of business.
The following table sets forth the development of net reserves
for unpaid losses and loss settlement expenses for Harleysville
Group. The effect of changes to the pooling agreement
participation is reflected in this table. For example, the
January 1, 1989 increase in Harleysville Group's pooling
participation from 35% to 50% is reflected in the first line of
the 1989 column. Amounts of assets equal to increases in net
liabilities was transferred to Harleysville Group from the Mutual
Company in conjunction with each respective pooling change. The
amount of the assets transferred has been netted against and has
reduced the cumulative amounts paid for years prior to the
pooling changes. For example, the 1988 column of the "Cumulative
amount of reserves paid" portion of the table reflects the assets
transferred in conjunction with the 1989 increase in the pooling
percentage from 35% to 50% as a decrease netted in the "one year
later" line. The cumulative amounts paid are reflected in this
manner to maintain comparability. This is because when
Harleysville Group pays claims subsequent to the date of a pool
participation increase, the amounts paid are greater, however,
the prior year's reserve amounts are reflective of a lower pool
participation percentage. By reflecting pooling participation
increases in this manner, loss development is not obscured. Loss
development reflects Harleysville Group's share of the total
pooled business loss development since January 1, 1986 when
Harleysville Group began participation, plus loss development of
any subsidiary not participating in the pooling agreement.
Loss development information for the total pooled business is
presented on pages 11 to 13 to provide greater analysis of
underlying claims development.
15
<PAGE>
<TABLE>
<CAPTION>
HARLEYSVILLE GROUP BUSINESS
YEAR ENDED DECEMBER 31,
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(dollars in thousands)
Reserve for
losses
and loss
settlement
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
expenses $166,994 $259,522 $300,197 $406,619 $437,883 $499,272 $535,452 $576,653 $718,700 $793,563 $813,519
Reserves
reestimated:
One year
later 160,506 251,960 291,629 405,749 438,135 496,057 524,565 541,654 688,972 750,956
Two years
later 155,911 249,871 294,354 404,849 435,005 483,635 507,090 513,555 662,393
Three years
later 157,625 254,329 296,320 403,240 430,728 477,164 491,919 496,138
Four years
later 160,746 256,045 297,187 400,579 429,125 468,804 482,834
Five years
later 162,058 257,653 296,517 401,675 421,408 462,571
Six years
later 163,186 257,828 298,436 397,275 417,715
Seven years
later 164,149 259,184 297,598 396,139
Eight years
later 165,625 259,775 297,001
Nine years
later 166,299 259,043
Ten years
late 165,805
Cumulative amount
of reserves paid:
One year
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
later 29,100 90,964 67,570 135,067 144,465 161,557 164,849 105,774 200,907 228,622
Two years
later 72,381 126,668 145,954 219,233 234,991 254,840 219,225 204,030 330,158
Three years
later 92,887 174,860 199,754 276,451 292,381 290,667 283,816 281,546
Four years
later 119,488 205,124 235,650 312,539 314,848 329,830 330,705
Five years
later 135,660 224,882 255,921 328,682 335,411 355,338
Six years
later 145,701 236,145 265,062 338,515 347,731
Seven years
later 151,012 239,937 270,201 345,511
Eight years
later 153,221 242,514 274,703
Nine years
later 154,577 245,534
Ten years
later 156,751
Redundancy
(defi-
ciency) 1,189 479 3,196 10,480 20,168 36,701 52,618 80,515 56,307 42,607
Redundancy
(deficiency)
expressed as
a percent of
year end
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
reserves 0.7% 0.2% 1.1% 2.6% 4.6% 7.4% 9.8% 14.0% 7.8% 5.4%
Gross
<S> <C> <C> <C> <C> <C> <C> <C>
reserve $486,608 $560,811 $603,088 $645,941 $796,820 $868,393 $893,420
Ceded
reserve 48,725 61,539 67,636 69,288 78,120 74,830 79,901
-------- -------- -------- -------- -------- -------- --------
Net
reserve $437,883 $499,272 $535,452 $576,653 $718,700 $793,563 $813,519
======== ======== ======== ======== ======== ======== ========
Gross re-
estimated $469,622 $530,837 $554,637 $568,846 $743,281 $830,455
Ceded re-
estimated 51,907 68,266 71,803 72,708 80,888 79,499
-------- -------- -------- -------- -------- --------
Net re-
estimated $417,715 $462,571 $482,834 $496,138 $662,393 $750,956
======== ======== ======== ======== ======== ========
NOTE: The amount of cash and investments received equal to the
increase in liabilities for unpaid losses and loss settlement
expenses was $9,311,000, $35,582,000, $55,350,000, $93,966,000,
$28,318,000 and $12,392,000 for the changes in pool participation
in 1987, 1989, 1991, 1996, 1997 and 1998, respectively.
</TABLE>
16
<PAGE>
REINSURANCE. Harleysville Group follows the customary
industry practice of reinsuring a portion of its exposures and
paying to the reinsurers 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. Reinsurance does not legally discharge an insurer from
its primary liability for the full amount of the policies,
although it does make the assuming reinsurer liable to the
insurer to the extent of the reinsurance ceded. Therefore, a
ceding company is subject to credit risk with respect to its
reinsurers.
The reinsurance described below is maintained for the
Company's subsidiaries and the Mutual Company and its wholly-
owned subsidiaries. Reinsurance premiums and recoveries are
allocated to participants in the pooling agreement according to
pooling percentages.
Reinsurance for property and auto physical damage losses is
currently maintained under a per risk excess of loss treaty
affording recovery to $4,250,000, above a retention of $750,000.
Harleysville Group's 1998 pooling share of such recovery would be
$3,060,000 above a retention of $540,000. In addition, the
Company's subsidiaries and the Mutual Company and its wholly-
owned subsidiaries are reinsured under a catastrophe reinsurance
treaty effective for one year from July 1, 1998 which provides
coverage for 85.5% of up to $147 million in excess of a retention
of $20 million for any given catastrophe. Harleysville Group's
1998 pooling share of this coverage would be 85.5% of up to $106
million in excess of a retention of $14.4 million for any given
catastrophe. Pursuant to the terms of the treaty, the maximum
recovery would be $126 million for any catastrophe involving an
insured loss equal to or greater than $167 million. Harleysville
Group's pooling share of this maximum recovery would be $90
million for any catastrophe involving an insured loss of $120
million or greater. The treaty includes reinstatement provisions
providing for coverage for a second catastrophe and requiring
payment of an additional premium in the event of a first
catastrophe occurring. Harleysville Group has not purchased
funded catastrophe covers.
Casualty reinsurance (including liability and workers
compensation) is currently maintained under an excess of loss
treaty affording recovery to $19,000,000 above a retention of
$1,000,000 each loss occurrence. Harleysville Group's 1998
pooling share of such recovery would be $13,680,000 above a
retention of $720,000. In addition, there is reinsurance to
protect Harleysville Group from large workers compensation
losses. For umbrella liability coverages, reinsurance protection
up to $4,000,000 is provided over a retention of $1,000,000.
Harleysville Group's 1998 pooling share would provide for
recovery of $2,880,000 over a retention of $720,000.
17
<PAGE>
Harleysville Group has a reinsurance agreement with the
Mutual Company whereby, in 1999, the Mutual Company reinsures
accumulated catastrophe losses in a quarter up to $14,400,000 in
excess of $3,600,000 in return for a reinsurance premium. The
agreement excludes catastrophe losses resulting from earthquakes
or hurricanes.
The terms and charges for reinsurance coverage are typically
negotiated annually. The reinsurance market is subject to
conditions which are similar to those in the direct property and
casualty insurance market, and there can be no assurance that
reinsurance will remain available to Harleysville Group to the
same extent and at the same cost currently maintained.
Harleysville Group considers numerous factors in choosing
reinsurers, the most important of which is the financial
stability of the reinsurer. Harleysville Group has not
experienced any material collectibility problems for its
reinsurance recoverables.
COMPETITION. The property and casualty insurance industry
is highly competitive on the basis of both price and service.
There are numerous companies competing for this business in the
geographic areas where Harleysville Group operates, many of which
are substantially larger and have considerably greater financial
resources than Harleysville Group. In addition, because the
insurance products of Harleysville Group and the Mutual Company
are marketed exclusively through independent insurance agencies,
most of which represent more than one company, Harleysville Group
faces competition within each agency.
INVESTMENTS
An important element of the financial results of
Harleysville Group is the return on invested assets. An
investment objective of Harleysville Group is to maintain a
widely diversified fixed maturities portfolio structured to
maximize after-tax investment income while minimizing credit risk
through investments in high quality instruments. An objective
also is to provide adequate funds to pay claims without forced
sales of investments. Harleysville Group has invested in equity
securities with the objective of capital appreciation. At
December 31, 1998, the investment portfolio did not contain any
securities that were rated at less than investment grade, and it
did not contain any real estate or mortgage loans.
Harleysville Group has adopted and follows an investment
philosophy which precludes the purchase of non-investment grade
fixed income securities. However, due to uncertainties in the
economic environment, it is possible that the quality of
investments held in Harleysville Group's portfolio may change.
18
<PAGE>
The following table shows the composition of Harleysville
Group's fixed maturity investment portfolio at amortized cost,
excluding short-term investments, by rating as of December 31,
1998:
DECEMBER 31, 1998
-----------------------
AMOUNT PERCENT
---------- -------
(dollars in thousands)
RATING<F1>
- --------
U.S. Treasury and
U.S. agency bonds<F2> $ 222,145 16.4%
Aaa 399,520 29.5
Aa 449,122 33.2
A 237,282 17.5
Baa 46,575 3.4
---------- -----
Total $1,354,644 100.0%
========== =====
- --------------
[FN]
<F1>Ratings assigned by Moody's Investors Services, Inc.
<F2>Includes GNMA pass-through obligations and collateralized
mortgage obligations.
Harleysville Group invests in both taxable and tax-exempt
securities as part of its strategy to maximize after-tax income.
Such strategy considers, among other factors, the impact of the
alternative minimum tax. Tax-exempt bonds made up approximately
47%, 45% and 45% of the total investment portfolio at December
31, 1998, 1997 and 1996, respectively.
The following table shows the composition of Harleysville
Group's investment portfolio at carrying value, excluding short-
term investments, by type of security as of December 31, 1998:
DECEMBER 31, 1998
----------------------
AMOUNT PERCENT
---------- -------
(dollars in thousands)
Fixed maturities:
U.S. Treasury obligations $ 40,342 2.6%
U.S. agency obligations 49,122 3.1
Mortgage-backed securities 142,748 9.1
Obligations of states and
political subdivisions 735,406 47.0
Corporate securities 421,994 27.0
---------- -----
Total fixed maturities 1,389,612 88.8
---------- -----
Equity securities 174,932 11.2
---------- -----
Total $1,564,544 100.0%
========== =====
19
<PAGE>
Investment results of Harleysville Group's fixed maturity
investment portfolio for each of the three years ended December
31, 1998 are shown in the following table:
Year Ended December 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
(dollars in thousands)
Invested assets<F1> $1,321,061 $1,223,175 $1,133,640
Investment income<F2> $ 83,689 $ 79,765 $ 75,204
Average yield 6.3% 6.5% 6.6%
- --------------
[FN]
<F1>Average of the aggregate invested amounts at amortized cost
at the beginning and end of the period, adjusted for cash
transferred in connection with the 1998, 1997 and 1996 pooling
agreement amendments and the acquisition of Minnesota Fire.
<F2>Investment income does not include investment expenses,
realized investment gains or losses or provision for income
taxes.
The following table indicates the composition of
Harleysville Group's fixed maturity investment portfolio at
carrying value, excluding short-term investments, by time to
maturity as of December 31, 1998:
DECEMBER 31, 1998
------------------------
AMOUNT PERCENT
---------- --------
(dollars in thousands)
DUE IN<F1>
---------
1 year or less $ 56,039 4.0%
Over 1 year through 5 years 292,220 21.0
Over 5 years through 10 years 532,270 38.3
Over 10 years 366,335 26.4
---------- -----
1,246,864 89.7
Mortgage-backed securities 142,748 10.3
---------- -----
Total $1,389,612 100.0%
========== =====
- --------------
[FN]
<F1> Based on stated maturity dates with no prepayment
assumptions. Actual maturities may differ because borrowers
may have the right to call or prepay obligations with or
without call or prepayment penalties.
The average expected life of Harleysville Group's investment
portfolio as of December 31, 1998 was approximately 5.7 years.
20
<PAGE>
REGULATION
Insurance companies are subject to supervision and
regulation in the states in which they transact business. Such
supervision and regulation relate to numerous aspects of an
insurance company's business and financial condition. The
primary purpose of such supervision and regulation is the
protection of policyholders. The extent of such regulation
varies, but generally derives from state statutes which delegate
regulatory, supervisory and administrative authority to state
insurance departments. Accordingly, the authority of the state
insurance departments includes the establishment of standards of
solvency which must be met and maintained by insurers, the
licensing to do business of insurers and agents, the nature of
and limitations on investments, premium rates for property and
casualty insurance, the provisions which insurers must make for
current losses and future liabilities, the deposit of securities
for the benefit of policyholders and the approval of policy
forms. Such insurance departments also conduct periodic
examinations of the affairs of insurance companies and require
the filing of annual and other reports relating to the financial
condition of insurance companies.
All of the states in which Harleysville Group and the Mutual
Company do business have guaranty fund laws under which insurers
doing business in such states can be assessed up to 2% of annual
premiums written by the insurer in that state in order to fund
policyholder liabilities of insolvent insurance companies. Under
these laws in general, an insurer is subject to assessment,
depending upon its market share of a given line of business, to
assist in the payment of policyholder and third party claims
against insolvent insurers. During the five years ended December
31, 1998, the amount of such insolvency assessments paid by
Harleysville Group and the Mutual Company was not material.
State laws also require Harleysville Group to participate in
involuntary insurance programs for automobile insurance, as well
as other property and casualty lines, in states in which
Harleysville Group operates. These programs include joint
underwriting associations, assigned risk plans, fair access to
insurance requirements ("FAIR") plans, reinsurance facilities and
wind storm plans. These state laws generally require all
companies that write lines covered by these programs to provide
coverage (either directly or through reinsurance) for insureds
who cannot obtain insurance in the voluntary market. The
legislation creating these programs usually allocates a pro rata
portion of risks attributable to such insureds to each company on
the basis of direct written premiums or the number of automobiles
insured. Generally, state law requires participation in such
programs as a condition to doing business. The loss ratio on
insurance written under involuntary programs generally has been
greater than the loss ratio on insurance in the voluntary market.
21
<PAGE>
State insurance holding company acts regulate insurance
holding company systems. Each insurance company in the holding
company system is required to register with the insurance
supervisory agency of its state of domicile and furnish certain
information concerning transactions between companies within the
holding company system that may materially affect the operations,
management or financial condition of the insurer within the
system including the payment of "extraordinary dividends" from
the insurance subsidiaries to the Company.
Insurance holding company acts require that all transactions
within the holding company system affecting the Mutual Company
and the Company's insurance subsidiaries must be fair and
equitable. Further, approval of the applicable insurance
commissioner is required prior to the consummation of
transactions affecting the control of an insurer.
The property and casualty insurance industry has been
subject to significant public scrutiny and comment primarily due
to concerns regarding solvency issues, rising insurance costs,
and the industry's methods of operations. Accordingly,
regulations and legislation may be proposed to bring the
insurance industry under federal control; to strengthen state
oversight, particularly in the field of solvency and investments;
to further restrict an insurer's ability to underwrite and price
risks; and to impose new taxes and assessments. It is not
possible to predict whether, in what form or in what
jurisdictions any of these proposals might be adopted or the
effect, if any, on the Company.
The Company's insurance subsidiaries are restricted by the
insurance laws of their respective states of domicile as to the
amount of dividends they may pay to the Company without the prior
approval of the respective state regulatory authorities.
Generally, the maximum dividend that may be paid by an insurance
subsidiary during any year without prior regulatory approval is
limited to a stated percentage of that subsidiary's statutory
surplus as of a certain date, or adjusted net income of the
subsidiary, for the preceding year. Applying current regulatory
restrictions as of December 31, 1998, $57,000,000 would be
available for distribution to Harleysville Group Inc. without
prior approval during 1999. The Company's insurance subsidiaries
paid dividends of $10.0 million in 1998 and $31.7 million in 1997
to Harleysville Group Inc. No dividends were paid in 1996.
The National Association of Insurance Commissioners has
adopted risk-based capital (RBC) standards that require insurance
companies to calculate and report statutory capital and surplus
needs based on a formula measuring underwriting, investment and
other business risks inherent in an individual company's
operations. These RBC standards have not affected the operations
of Harleysville Group since each of the Company's insurance
subsidiaries has statutory capital and surplus in excess of RBC
requirements.
22
<PAGE>
Harleysville Group is required to file financial statements
for its subsidiaries, prepared by using statutory accounting
practices, with state regulatory authorities. SAP differs from
GAAP primarily in the recognition of revenue and expense. The
adjustments necessary to reconcile net income and shareholders'
equity determined by using SAP to net income and shareholders'
equity determined in accordance with GAAP are as follows:
NET INCOME SHAREHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------
1998 1997 1996 1998 1997
------- ------- ------- --------- --------
(in thousands)
SAP amounts $62,133 $59,658 $15,332 $489,665 $398,468
Adjustments:
Deferred
policy
acquisition
costs 6,908 (841) 9,670 78,984 72,076
Deferred
income
taxes (32) 507 7,118 5,373 20,338
Unrealized
investment
gains 34,980 28,833
Other, net (4,925) (4,520) (3,505) 7,546 14,724
Holding
company<F1> (671) (732) 65 (86,890) (87,924)
------- ------- ------- -------- --------
GAAP amounts $63,413 $54,072 $28,680 $529,658 $446,515
======= ======= ======= ======== ========
[FN]
<F1> Represents the GAAP income and equity amounts for
Harleysville Group Inc., excluding the earnings of and
investment in subsidiaries.
RELATIONSHIP WITH THE MUTUAL COMPANY
Harleysville Group's operations are interrelated with the
operations of the Mutual Company due to the pooling arrangement
and other factors. The Mutual Company owns approximately 54% of
the issued and outstanding common stock of Harleysville Group.
Harleysville Group employees provide a variety of services to the
Mutual Company and its wholly-owned subsidiaries. The cost of
facilities and employees required to conduct the business of both
companies is charged on a cost-allocated basis. Harleysville
Group also manages the operations of the Mutual Company and its
wholly-owned subsidiaries pursuant to a management agreement
which commenced January 1, 1993 under which Harleysville Group
receives a management fee. Harleysville Group also manages the
operations
23
<PAGE>
of Berkshire Mutual Insurance Company, a small property and
casualty insurance company, pursuant to a management services
agreement. Harleysville Group received $6.3 million, $6.0
million and $6.6 million for the years ended December 31, 1998,
1997 and 1996, respectively, for all such management services.
All of the Company's officers are officers of the Mutual
Company, and five of the Company's seven directors are directors
of the Mutual Company. A coordinating committee exists to review
and evaluate the pooling agreement and is responsible for matters
involving actual or potential conflicts of interest between the
two companies. The decisions of the coordinating committee are
binding on the two companies. No intercompany transaction can be
authorized by the coordinating committee unless the Company's
committee members conclude that such transaction is fair and
equitable to Harleysville Group. The coordinating committee
consists of six non-employee directors, two from Harleysville
Group Inc. and three from the Mutual Company all of whom are not
members of both Boards and one, the Chairman, who is a member of
both Boards. For information concerning the members of the
coordinating committee, see "Board and Committee Meetings"
section on pages 8 to 9 of the Company's proxy statement relating
to the annual meeting of the shareholders to be held April 28,
1999 which is incorporated by reference in this Form 10-K Report.
The Mutual Company leases the home office from Harleysville
Group with which it shares most of the facility. Rental income
under the lease was $2,754,000 for 1998, 1997 and 1996.
Harleysville Group believes that the lease terms are no less
favorable to it than if the property were leased to a non-
affiliate.
In connection with the acquisition of Mid-America and New
York Casualty, the Company borrowed approximately $18.5 million
from the Mutual Company. See Note 8 of the Notes to Consolidated
Financial Statements. For additional information with respect to
transactions with the Mutual Company, see Note 3 of the Notes to
Consolidated Financial Statements.
EMPLOYEES
All employees are paid by Harleysville Group and,
accordingly, are considered to be employees of Harleysville
Group. As of December 31, 1998, there were 2,788 employees. They
provide a variety of services to the Mutual Company and its
wholly-owned subsidiaries. See "Business-Relationship with the
Mutual Company" and Note 3(c) of the Notes to Consolidated
Financial Statements.
24
<PAGE>
ITEM 2. PROPERTIES.
- ------- -----------
The buildings which house the headquarters of Harleysville
Group and the Mutual Company are leased by the Mutual Company
from a subsidiary of Harleysville Group. See "Business-
Relationship with the Mutual Company." The Mutual Company
charges Harleysville Group for an appropriate portion of the rent
under an intercompany allocation agreement. The buildings
containing the headquarters of Harleysville Group and the Mutual
Company have approximately 220,000 square feet of office space.
Harleysville Group also rents office facilities in certain of the
states in which it does business.
ITEM 3. LEGAL PROCEEDINGS.
- ------- ------------------
Harleysville Group is a party to numerous lawsuits arising
in the ordinary course of its insurance business. Harleysville
Group believes that the resolution of these lawsuits will not
have a material adverse effect on its financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ----------------------------------------------------
No matter was submitted during the fourth quarter of 1998 to
a vote of holders of the Company's Common Stock.
25
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY
All of the persons listed below are executive officers of
Harleysville Group or its affiliates. There are no family
relationships between any of the Company's executive officers and
directors, and there are no arrangements or understandings
between any of these officers and any other person pursuant to
which the officer was selected as an officer.
Name Age Position
- ---------------------- --- --------------------------------
Walter R. Bateman, II 51 Chairman of the Board, President,
Chief Executive Officer and
Director
Mark R. Cummins 42 Executive Vice President, Chief
Investment Officer and Treasurer
Spencer M. Roman 50 Executive Vice President
Roger A. Brown 50 Senior Vice President, Secretary
and General Counsel
Dennis M. Hyland 55 Senior Vice President
Bruce J. Magee 44 Senior Vice President and
Chief Financial Officer
E. Wayne Ratz 53 Senior Vice President and Chief
Information Officer
Thomas E. Roden 63 Senior Vice President
Catherine B. Strauss 51 Senior Vice President
Robert G. Whitlock, Jr. 42 Senior Vice President and Chief
Actuary
Roger J. Beekley 56 Vice President and Controller
Walter R. Bateman, II has been Chairman of the Board since
August 1998 and has been Chief Executive Officer since January 1,
1994. He has been President and Director of Harleysville Group
and the Mutual Company since 1992.
Mark R. Cummins is Executive Vice President, Chief
Investment Officer and Treasurer of Harleysville Group and the
Mutual Company, and has been in charge of the investment and
treasury function, since 1992. Since January 1, 1996, he also
has been in charge of corporate administration.
26
<PAGE>
Spencer M. Roman has been Executive Vice President in charge
of the field and subsidiary operations of Harleysville Group and
the Mutual Company since August 1998. From 1996 to August 1998,
he was in charge of marketing, claims and underwriting. He was
in charge of marketing for the three preceding years.
Roger A. Brown has been Senior Vice President, Secretary and
General Counsel of Harleysville Group and the Mutual Company
since April 1995. He was Assistant General Counsel from 1986
until assuming his present position.
Dennis M. Hyland has been Senior Vice President since 1993.
Since August 1998, he has been in charge of marketing, claims and
underwriting. From 1991 to 1998 he was in charge of commercial
lines underwriting.
Bruce J. Magee has been Senior Vice President and Chief
Financial Officer of Harleysville Group and the Mutual Company
since January 1, 1994. From 1986 to 1993 he was Vice President
and Controller of Harleysville Group.
E. Wayne Ratz has been Senior Vice President and Chief
Information Officer of Harleysville Group and the Mutual Company
since February 1997. From 1967 to 1997 he was employed by
General Accident Insurance Company, most recently as Vice
President of Information Services/Application Services.
Thomas E. Roden has been Senior Vice President of
Harleysville Group and the Mutual Company since 1998. He is in
charge of government affairs. From 1992 to 1998 he was in charge
of field and subsidiary operations for both companies.
Catherine B. Strauss has been Senior Vice President since
April 1998 and has been in charge of human resources since 1996.
From 1979 to 1996 she was employed by Penn Mutual Insurance
Company, most recently as Vice President of human resources.
Robert G. Whitlock, Jr. has been Senior Vice President and
Chief Actuary of Harleysville Group and the Mutual Company since
February 1995. He was Vice President and Actuary before assuming
his present position and was in charge of various actuarial
functions since 1991.
Roger J. Beekley has been Vice President and Controller of
Harleysville Group since January 1, 1994 and is Vice President
and Controller of the Mutual Company, a position he has held
since 1982.
27
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
- ------ ----------------------------------------------------
STOCKHOLDER MATTERS.
- -------------------
The "Market for Common Stock and Related Security Holder
Matters" section from the Company's annual report to stockholders
for the year ended December 31, 1998, which is included as
Exhibit (13)(E) to this Form 10-K Report, is incorporated herein
by reference.
ITEM 6. SELECTED FINANCIAL DATA.
- ------- ------------------------
The "Selected Consolidated Financial Data" section from the
Company's annual report to stockholders for the year ended
December 31, 1998, which is included as Exhibit (13)(A) to this
Form 10-K Report, is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ------ -------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS.
- -----------------------------------
The "Management's Discussion and Analysis of Results of
Operations and Financial Condition" section from the Company's
annual report to stockholders for the year ended December 31,
1998, which is included as Exhibit (13)(B) to this Form 10-K
Report, is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
- ------- -----------------------------------------------------
RISK.
- ----
The "Quantitative and Qualitative Disclosures About Market
Risk" section from the Company's annual report to stockholders
for the year ended December 31, 1998, which is included as
Exhibit (13)(C) to this Form 10-K Report, is incorporated herein
by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
- ------- --------------------------------------------
The consolidated financial statements from the Company's
annual report to stockholders for the year ended December 31,
1998, which is included as Exhibit (13)(D) to this Form 10-K
Report, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
- ---------------------------------------------------------
ACCOUNTING AND FINANCIAL DISCLOSURE.
- -----------------------------------
None.
28
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------- ---------------------------------------------------
The "Election of Directors" section, which provides
information regarding the Company's directors, on pages to
and the "Section 16(a) Beneficial Ownership Reporting Compliance"
section on page of the Company's proxy statement relating to
the annual meeting of stockholders to be held April 28, 1999, are
incorporated herein by reference.
The information concerning executive officers called for by
Item 10 of Form 10-K is set forth in Part I of this Annual Report
on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
- -------- -----------------------
The information set forth on pages 25 to 31 and the
"Compensation of Directors" section on pages 9 to 11 of the
Company's proxy statement relating to the annual meeting of
stockholders to be held April 28, 1999, are incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
- -------- ---------------------------------------------------
MANAGEMENT.
- -----------
The "Ownership of Common Stock" section on pages 15 and 16
of the Company's proxy statement relating to the annual meeting
of stockholders to be held April 28, 1999, is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- -------- -----------------------------------------------
The "Transactions with Harleysville Mutual" section on pages
32 and 33 of the Company's proxy statement relating to the annual
meeting of stockholders to be held April 28, 1999, is
incorporated herein by reference.
29
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
- -------- ------------------------------------------------------
FORM 8-K.
- ---------
(a) (1) The following consolidated financial
statements are filed as a part of this report:
Consolidated Financial Statements Page
-----
Consolidated Balance Sheets as of
December 31, 1998 and 1997 27*
Consolidated Statements of Income for
Each of the Years in the Three-year
Period Ended December 31, 1998 28*
Consolidated Statements of Shareholders'
Equity for Each of the Years in the Three-
year Period Ended December 31, 1998 29*
Consolidated Statements of Cash Flows
for Each of the Years in the Three-year
Period Ended December 31, 1998 30*
Notes to Consolidated Financial Statements 31*
Independent Auditors' Report 43*
(2) The following consolidated financial statement
schedules for the years 1998, 1997 and 1996
are submitted herewith:
Financial Statement Schedules
Schedule I. Summary of Investments - Other
Than Investments in Related
Parties 38
Schedule II. Condensed Financial Information
of Parent Company 39
Schedule III. Supplementary Insurance
Information 42
Schedule IV. Reinsurance 43
Schedule VI. Supplemental Insurance Information
Concerning Property and Casualty
Subsidiaries 44
Independent Auditors' Consent and Report on Schedules
(filed as Exhibit 23)
All other schedules are omitted because they are not
applicable or the required information is included in the
financial statements or notes thereto.
- -------------------
*Refers to the respective page of Harleysville Group Inc.'s
1998 Annual Report to Stockholders. The Consolidated Financial
Statements and Independent Auditors' Report, which are included
as Exhibit (13)(D), are incorporated herein by reference. With
the exception of the portions of such Annual Report specifically
incorporated by reference in this Item and Items 5, 6, 7 and 8,
such Annual Report shall not be deemed filed as part of this Form
10-K or otherwise subject to the liabilities of Section 18 of the
Securities Exchange Act of 1934.
30
<PAGE>
(3) Exhibits
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- ----------------------------------------------
( 3)(A) Amended and restated Certificate of Incor-
poration of Registrant - incorporated herein
by reference to Exhibit (4)(A) to the
Registrant's Form S-8 Registration Statement
No. 333-03127 filed May 3, 1996.
( 3)(B) Amended and Restated By-laws of Registrant -
incorporated herein by reference to Exhibit
4(B) to the Post-Effective Amendment No. 12 of
Registrant's Form S-3 Registration Statement
No. 33-90810 filed October 10, 1995.
( 4) Indenture between the Registrant and
CoreStates Bank, N.A., dated as of November
15, 1993 - incorporated herein by reference to
Exhibit (4) to the Registrant's Annual Report
on Form 10-K for the year ended December 31,
1993.
*(10)(A) Deferred Compensation Plan, as amended, for
Directors of Harleysville Mutual Insurance
Company, Harleysville Group Inc. and
Harleysville Life Insurance Company -
incorporated herein by reference to Exhibit
10(A) to the Registrant's Form S-3
Registration Statement No. 33-28948 filed May
25, 1989.
*(10)(B) Harleysville Insurance Companies Director
Deferred Compensation Plan Approved by the
Board of Directors November 25, 1987 -
incorporated herein by reference to Exhibit
10(B) to the Registrant's Form S-3
Registration Statement No. 33-28948 filed May
25, 1989.
*(10)(C) Harleysville Group Inc. Non-qualified Deferred
Compensation Plan - incorporated herein by
reference to Exhibit 10(C) to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1993.
*(10)(D) Pension Plan of Harleysville Group Inc. and
Associated Employers dated December 1, 1994
and amendment dated February 6, 1995 -
incorporated herein by reference to Exhibit
10(D) to the Registrant's Annual Report on
Form 10-K for the year ended December 31,
1994.
31
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -----------------------------------------------
*(10)(E) Harleysville Insurance Companies Senior
Executive Supplemental Retirement Plan dated
May 25, 1982 - incorporated herein by
reference to Exhibit 10(E) to the Registrant's
Form S-1 Registration Statement No. 33-4885
declared effective May 23, 1986.
*(10)(F) Harleysville Mutual Insurance Company/
Harleysville Group Inc. Senior Management
Incentive Bonus Plan As Amended and Restated
November 20, 1996 - incorporated herein by
reference to Exhibit (10)(F) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996.
(10)(G) Proportional Reinsurance Agreement effective
as of January 1, 1986 among Harleysville
Mutual Insurance Company, Huron Insurance
Company and Harleysville Insurance Company of
New Jersey -incorporated herein by reference
to Exhibit 10(N) to the Registrant's Form S-1
Registration Statement No. 33-4885 declared
effective May 23, 1986.
*(10)(H) Equity Incentive Plan of Registrant, as
amended - incorporated herein by reference to
Exhibit (4)(C) to the Registrant's Form S-8
Registration Statement No. 333-25817 filed
April 25, 1997.
(10)(I) Tax Allocation Agreement dated December 24,
1986 among Harleysville Insurance Company of
New Jersey, Huron Insurance Company, Worcester
Insurance Company, McAlear Associates, Inc.
and the Registrant - incorporated herein by
reference to Exhibit 10(Q) to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1986.
(10)(J) Amended and Restated Financial Tax Sharing
Agreement dated March 20, 1995 among Huron
Insurance Company, Harleysville Insurance
Company of New Jersey, Worcester Insurance
Company, Harleysville-Atlantic Insurance
Company, New York Casualty Insurance Company,
Connecticut Union Insurance Company, Great
Oaks Insurance Company, Lakes States Insurance
Company and the Registrant - incorporated
herein by reference to Exhibit (10)(L) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1994.
32
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -----------------------------------------------
(10)(K) Amendment, effective July 1, 1987, to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey
and Atlantic Insurance Company of Savannah -
incorporated herein by reference to the
Registrant's Form 8-K Report dated July 1,
1987.
(10)(L) Amendment, effective January 1, 1989, to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey,
Atlantic Insurance Company of Savannah and
Worcester Insurance Company - incorporated
herein by reference to Exhibit 10(U) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1988.
(10)(M) Amendment, effective January 1, 1991, to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey,
Atlantic Insurance Company of Savannah,
Worcester Insurance Company, Phoenix General
Insurance Company and New York Casualty
Insurance Company - incorporated herein by
reference to Exhibit (10)(O) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1990.
(10)(N) Amendments, effective January 1, 1995 and
1993, respectively, to the Proportional
Reinsurance Agreement effective January 1,
1986 among Harleysville Mutual Insurance
Company, Huron Insurance Company, Harleysville
Insurance Company of New Jersey, Harleysville-
Atlantic Insurance Company, Worcester
Insurance Company, Connecticut Union Insurance
Company, New York Casualty Insurance Company
and Great Oaks Insurance Company -
incorporated herein by reference to Exhibit
(10)(P) to the Registrant's Annual Report on
Form 10-K for the year ended December 31,
1994.
33
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -----------------------------------------------
(10)(O) Amendment, effective January 1, 1996 to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey,
Harleysville-Atlantic Insurance Company,
Worcester Insurance Company, Connecticut Union
Insurance Company, New York Casualty Insurance
Company, Great Oaks Insurance Company and
Pennland Insurance Company - incorporated
herein by reference to Exhibit (10)(O) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1995.
(10)(P) Amendment, effective January 1, 1997 to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey,
Harleysville-Atlantic Insurance Company,
Worcester Insurance Company, Mid-America
Insurance Company, New York Casualty Insurance
Company, Great Oaks Insurance Company,
Pennland Insurance Company and Lake States
Insurance Company - incorporated herein by
reference to Exhibit (10)(P) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996.
(10)(Q) Amendment, effective January 1, 1998 to the
Proportional Reinsurance Agreement effective
January 1, 1986 among Harleysville Mutual
Insurance Company, Huron Insurance Company,
Harleysville Insurance Company of New Jersey,
Harleysville-Atlantic Insurance Company,
Worcester Insurance Company, Mid-America
Insurance Company, New York Casualty Insurance
Company, Great Oaks Insurance Company,
Pennland Insurance Company, Lake States
Insurance Company and Minnesota Fire and
Casualty Company - incorporated herein by
reference to Exhibit (10)(Q) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997.
34
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -------------------------------------------------------
*(10)(R) Long-Term Incentive Plan for senior officers
of Harleysville Mutual Insurance Company and
Registrant - incorporated herein by reference
to Exhibit 10(V) to the Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1988.
(10)(S) Lease effective January 1, 1995 between
Harleysville, Ltd. and Harleysville Mutual
Insurance Company - incorporated herein by
reference to Exhibit (10)(R) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1994.
*(10)(T) 1990 Directors' Stock Option Program of
Registrant - incorporated herein by reference
to Exhibit (10)(R) to the Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1990.
*(10)(U) 1995 Directors' Stock Option Program of
Registrant - incorporated herein by
reference to Exhibit (10)(S) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1993.
(10)(V) Loan Agreement dated as of March 19, 1998 by
and between Harleysville Group Inc. and
Harleysville Mutual Insurance Company -
incorporated herein by reference to Exhibit
(10)(V) to the Registrant's Annual Report on
Form 10-K for the year ended December 31,
1997.
(10)(W) Form of Management Agreements dated January
1, 1994 between Harleysville Group Inc. and
Harleysville Mutual Insurance Company,
Harleysville-Garden State Insurance Company,
Mainland Insurance Company, Pennland
Insurance Company, Berkshire Mutual Insurance
Company and Harleysville Life Insurance
Company - incorporated herein by reference to
Exhibit (10)(U) to the Registrant's Annual
Statement on Form 10-K for the year ended
December 31, 1993.
35
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -----------------------------------------------
(10)(X) Form of Salary Allocation Agreements dated
January 1, 1993 between Harleysville Group
Inc. and Harleysville Mutual Insurance
Company, Harleysville-Garden State Insurance
Company, Mainland Insurance Company, Pennland
Insurance Company, Berkshire Mutual Insurance
Company and Harleysville Life Insurance
Company - incorporated herein by reference to
Exhibit (10)(U) to the Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1992.
(10)(Y) Equipment and Supplies Allocation Agreement
dated January 1, 1993 between Harleysville
Mutual Insurance Company and Harleysville
Group Inc. - incorporated herein by reference
to Exhibit (10)(V) to the Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1992.
*(10)(Z) 1992 Incentive Stock Option Plan for
Employees Amended and Restated August 26,
1992 - incorporated herein by reference to
Exhibit (10)(W) to the Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1992.
*(10)(AA) Harleysville Group Inc. Supplemental Pension
Plan dated May 25, 1994 - incorporated herein
by reference to Exhibit (10)(AA) to the
Registrant's Annual Report on Form 10-K for
the year ended December 31, 1994.
*(10)(AB) 1996 Directors' Stock Purchase Plan of
Registrant - incorporated herein by reference
to Exhibit (4)(C) to the Registrant's From S-
8 Registration Statement No. 333-03127 filed
May 3, 1996.
*(10)(AC) Directors Equity Award Program of Registrant
- incorporated herein by reference to Exhibit
(4)(C) to the Registrant's Form S-8
Registration Statement No. 333-09701 filed
August 7, 1996.
(13)(A) Selected Consolidated Financial Data from the
Company's 1998 annual report to stockholders.
(13)(B) Management's Discussion and Analysis of
Results of Operations and Financial Condition
from the Company's 1998 annual report to
stockholders.
36
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- -----------------------------------------------
(13)(C) Quantitative and Qualitative Disclosures
About Market Risk from the Company's 1998
annual report to stockholders.
(13)(D) Consolidated financial statements from the
Company's 1998 annual report to stockholders.
(13)(E) Market for Common Stock and Related Security
Holder Matters from the Company's 1998 annual
report to stockholders.
(21) Subsidiaries of Registrant.
(23)
Independent Auditors' Consent and Report on
Schedules.
(27)
Financial Data Schedule
(99)
Form 11-K Annual Report for the Harleysville
Group Inc. Employee Stock Purchase Plan for
the year ended December 31, 1998.
- --------------
* A management contract, compensatory plan or arrangement
required to be separately identified by reason of the provision
of Item 14(a)(3).
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the
last quarter of the period covered by this report.
37
<PAGE>
HARLEYSVILLE GROUP
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
(in thousands)
AMOUNT
AT WHICH
SHOWN IN
THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ------------------------ ------------ ----------- -----------
Fixed maturities:
United States
government and
government agencies
and authorities $ 85,364 $ 90,193 $ 89,464
States, municipalities
and political
subdivisions 714,571 757,533 735,406
Mortgage-backed
securities 136,903 142,748 142,748
All other corporate
bonds 417,806 441,190 421,994
---------- ---------- ----------
Total fixed
maturities 1,354,644 1,431,664 1,389,612
---------- ---------- ----------
Equity securities:
Common stocks
Banks, trust and
insurance companies 18,860 26,862 26,862
Industrial,
miscellaneous and
all other 76,937 148,070 148,070
---------- ---------- ----------
Total equities 95,797 174,932 174,932
---------- ---------- ----------
Short-term
investments 15,022 15,022
---------- ----------
Total investments $1,465,463 $1,579,566
========== ==========
38
<PAGE>
HARLEYSVILLE GROUP INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31,
-------------------------
1998 1997
-------- --------
ASSETS
Short-term investments $ 5,362 $ 1,921
Fixed maturities:
Available for sale, at fair
value (cost $11 and $1,843) 11 1,911
Investments in common
stock of subsidiaries
(equity method) 616,548 534,439
Accrued investment income 39 33
Due from affiliate 5,883 3,872
Other assets 5,200 4,831
-------- --------
Total assets $633,043 $547,007
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Debt $ 93,500 $ 93,500
Accounts payable and
accrued expenses 6,884 5,895
Federal income taxes payable 3,001 1,097
-------- --------
Total liabilities 103,385 100,492
-------- --------
Shareholders' equity:
Preferred stock, $1 par value;
authorized 1,000,000 shares,
none issued
Common stock, $1 par value;
authorized 80,000,000 shares;
shares issued and outstanding
1998, 29,150,518 and 1997,
28,821,973 29,151 28,822
Additional paid-in capital 119,302 113,646
Accumulated other
comprehensive income 74,167 46,478
Retained earnings 307,038 257,569
-------- --------
Total shareholders' equity 529,658 446,515
-------- --------
Total liabilities and
shareholders' equity $633,043 $547,007
======== ========
39
<PAGE>
HARLEYSVILLE GROUP INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF INCOME
(in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Revenues $ 6,756 $ 6,747 $ 7,603
Expenses:
Interest 6,322 6,441 6,378
Expenses other than interest 1,474 1,435 1,116
------- ------- -------
(1,040) (1,129) 109
Income tax expense (benefit) (369) (397) 44
------- ------- -------
Income (loss) before equity in
income of subsidiaries (671) (732) 65
Equity in income of subsidiaries 64,084 54,804 28,615
------- ------- -------
Net income $63,413 $54,072 $28,680
======= ======= =======
40
<PAGE>
HARLEYSVILLE GROUP INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
Cash flows from operating
activities:
Net income $ 63,413 $ 54,072 $ 28,680
Adjustments to reconcile
net income to net cash
used by operating activities:
Equity in undistributed
earnings of subsidiaries (64,084) (54,804) (28,615)
(Increase) decrease in
accrued investment income (6) 86 46
Increase (decrease) in
accrued income taxes 1,927 684 (896)
Gain on sale of
investments (76) (62)
Other, net (1,707) (983) (464)
-------- -------- --------
Net cash used by
operating activities (533) (1,007) (1,249)
-------- -------- --------
Cash flows from investing activities:
Sales of fixed maturity
investments 1,908 9,043 1,500
Net sales (purchases) or
maturities of short-term
investments (3,441) (481) 420
Acquisition (33,986)
-------- -------- --------
Net cash provided (used)
by investing activities (1,533) (25,424) 1,920
-------- -------- --------
Cash flows from financing activities:
Issuance of common stock 5,985 7,295 9,936
Dividends from subsidiaries 10,025 31,729 23
Dividends paid (13,944) (12,593) (11,155)
-------- -------- --------
Net cash provided (used)
by financing activities 2,066 26,431 (1,196)
-------- -------- --------
Change in cash - - (525)
Cash at beginning of year 525
-------- -------- --------
Cash at end of year $ - $ - $ -
======== ======== ========
41
<PAGE>
<TABLE>
HARLEYSVILLE GROUP
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(in thousands)
<CAPTION>
LIABILITY
FOR UNPAID AMORTIZATION
DEFERRED LOSSES AND LOSSES OF DEFERRED
POLICY LOSS NET AND LOSS POLICY OTHER
ACQUISITION SETTLEMENT UNEARNED EARNED INVESTMENT SETTLEMENT ACQUISITION UNDERWRITING PREMIUMS
COSTS<F1> EXPENSES PREMIUMS PREMIUMS INCOME EXPENSES COSTS<F1> EXPENSES WRITTEN
----------- ---------- --------- --------- ---------- ---------- ------------ ------------ ---------
Year ended
December 31,
1998
Commercial
<S> <C> <C> <C> <C> <C>
lines $ 898,086 $ 272,599 $ 560,551 $ 411,560 $ 580,465
Personal
lines 274,579 151,934 366,712 277,058 372,655
Elimina-
tions<F2> (279,245) (106,761) (262,659) (224,138) (266,974)
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total $78,984 $ 893,420 $ 317,772 $ 664,604 $ 464,480 $169,567 $54,154 $ 686,146
======= ========= ========= ========= ========= ======== ======= =========
Net investment
<S> <C>
income $86,025
=======
Year ended
December 31,
1997
Commercial
lines $ 875,231 $ 252,685 $ 542,632 $ 387,776 $ 528,467
Personal
lines 283,032 145,991 349,701 244,188 350,897
Elimina-
tions<F2> (289,870) (100,051) (267,428) (192,476) (262,427)
--------- --------- --------- --------- ---------
Total $72,076 $ 868,393 $ 298,625 $ 624,905 $ 439,488 $157,591 $50,108 $ 616,937
======= ========= ========= ========= ========= ======== ======= =========
Net investment
income $81,783
=======
Year ended
December 31,
1996
Commercial
lines $ 821,537 $ 244,327 $ 555,750 $ 396,077 $ 570,224
Personal
lines 283,383 131,552 331,866 285,002 336,993
Elimina-
tions<F2> (308,100) (94,513) (272,419) (212,589) (246,474)
--------- --------- --------- --------- ---------
Total $68,779 $ 796,820 $ 281,366 $ 615,197 $ 468,490 $154,320 $43,965 $ 660,743
======= ========= ========= ========= ========= ======== ======= =========
Net investment
income $78,008
=======
</TABLE>
[FN]
<F1> Deferred policy acquisition costs and other
underwriting expenses are not determined separately for
commercial and personal lines.
See Note 13 of the Notes to Consolidated Financial Statements.
<F2> See Note 13 of the Notes to Consolidated Financial Statements.
42
<PAGE>
HARLEYSVILLE GROUP
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(in thousands)
ASSUMED PERCENTAGE
CEDED FROM OF AMOUNT
GROSS TO OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- --------- -------- -----------
Year ended
December 31, 1998
Property and
casualty
premiums $589,956 $619,230 $693,878 $664,604 104.4%
======== ======== ======== ======== ======
Year ended
December 31, 1997
Property and
casualty
premiums $542,887 $566,440 $648,458 $624,905 103.8%
======== ======== ======== ======== ======
Year ended
December 31, 1996
Property and
casualty
premiums $494,215 $422,623 $543,605 $615,197 88.4%
======== ======== ======== ======= ======
Note: The amounts ceded and assumed include the amounts ceded
and assumed under the terms of the pooling arrangement.
43
<PAGE>
HARLEYSVILLE GROUP
SCHEDULE VI - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING
PROPERTY AND CASUALTY SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(in thousands)
LIABILITY LOSSES AND LOSS
FOR UNPAID DISCOUNT, (BENEFITS) INCURRED
LOSSES AND IF ANY, RELATED TO PAID LOSSES
LOSS DEDUCTED -------------------- AND LOSS
SETTLEMENT FROM CURRENT PRIOR SETTLEMENT
EXPENSES RESERVES<F1> YEAR YEARS EXPENSES
---------- ----------- -------- -------- -----------
Year ended:
December 31,
1998 $893,420 $10,272 $507,087 $(42,607) $444,524
======== ======= ======== ======== ========
December 31,
1997 $868,393 $ 9,433 $469,216 $(29,728) $399,461
======== ======= ======== ======== ========
December 31,
1996 $796,820 $ 9,185 $503,489 $(34,999) $326,443
======== ======= ======== ======== ========
[FN]
Notes:<F1> The amount of discount relates to certain long-term
disability workers' compensation cases. A discount
rate of 3.5% (5% on New Jersey cases) was used.
(2) Information required by remaining columns is contained
in Schedule III.
44
<PAGE>
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.
HARLEYSVILLE GROUP INC.
Date: March 25, 1999 By: /s/WALTER R. BATEMAN
-----------------------------
Walter R. Bateman
Chairman of the Board,
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed by the following
persons on behalf of the Registrant in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
- -------------------- ------------------------- --------------
Chairman of the Board,
President,
Chief Executive Officer
/s/WALTER R. BATEMAN and a Director March 25, 1999
- ---------------------
Walter R. Bateman
Senior Vice President
and Chief Financial
Officer (principal financial
officer and principal
/s/BRUCE J. MAGEE accounting officer) March 25, 1999
- --------------------
Bruce J. Magee
45
<PAGE>
SIGNATURES
(Continued)
SIGNATURE TITLE DATE
- --------------------- ----------------- --------------
/s/LOWELL R. BECK Director March 25, 1999
- ---------------------
Lowell R. Beck
/s/MICHAEL L. BROWNE Director March 25, 1999
- -----------------------
Michael L. Browne
/s/ROBERT D. BUZZELL Director March 25, 1999
- -----------------------
Robert D. Buzzell
/s/JOSEPH E. MCMENAMIN Director March 25, 1999
- -----------------------
Joseph E. McMenamin
/s/FRANK E. REED Director March 25, 1999
- -----------------------
Frank E. Reed
/s/WILLIAM E. STRASBERG Director March 25, 1999
- -----------------------
William E. Strasburg
46
<PAGE>
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
- -------- ---------------------------------------------------
(13)(A) Selected Consolidated Financial Data from
the Company's 1998 annual report to
stockholders.
(13)(B) Management's Discussion and Analysis of
Results of Operations and Financial
Condition from the Company's 1998 annual
report to stockholders.
(13)(C) Quantitative and Qualitative Disclosures
About Market Risk from the Company's 1998
annual report to stockholders.
(13)(D) Consolidated financial statements from the
Company's 1998 annual report to
stockholders.
(13)(E) Market for Common Stock and Related
Security Holder Matters from the Company's
1998 annual report to stockholders.
(21) Subsidiaries of Registrant.
(23) Independent Auditors' Consent and Report on
Schedules.
(27) Financial Data Schedule
(99) Form 11-K Annual Report for the Harleysville Group Inc.
Employee Stock Purchase Plan for the year ended December 31,
1998.
<PAGE>
EXHIBIT 13(A)
SELECTED CONSOLIDATED FINANCIAL DATA
Harleysville Group Inc. (Company) is 54% owned by
Harleysville Mutual Insurance Company (Mutual). Harleysville
Group Inc. and its wholly-owned subsidiaries (Harleysville Group)
are engaged in property and casualty insurance. These
subsidiaries are: Great Oaks Insurance Company (Great Oaks),
Harleysville-Atlantic Insurance Company (Atlantic), Harleysville
Insurance Company of New Jersey (HNJ), Huron Insurance Company
(Huron), Lake States Insurance Company (Lake States), Mid-America
Insurance Company (Mid-America), Minnesota Fire and Casualty
Company (Minnesota Fire), New York Casualty Insurance Company
(New York Casualty), and Worcester Insurance Company (Worcester),
and Harleysville Ltd., a real estate partnership that owns the
home office.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
---------- --------- ---------- --------- ----------
(in thousands, except per share data)
INCOME STATEMENT DATA <F1>:
- -------------------------
Premiums earned $ 664,604 $ 624,905 $ 615,197 $ 477,042 $ 447,731
Investment income,
net 86,025 81,783 78,008 68,445 64,366
Realized investment
gains 16,085 6,541 3,182 2,245 3,367
Total revenues 779,311 724,179 707,425 558,549 525,458
Income before
income taxes 80,441 67,281 31,375 52,642 16,832
Income taxes
(benefit) 17,028 13,209 2,695 11,311 (1,622)
Net income 63,413 54,072 28,680 41,331 18,454
Basic earnings
per share $ 2.18 $ 1.89 $ 1.03 $ 1.53 $ .70
Diluted earnings
per share $ 2.15 $ 1.86 $ 1.02 $ 1.51 $ .69
Cash dividends
per share $ .48 $ .44 $ .40 $ .36 $ .33
BALANCE SHEET DATA AT YEAR END:
- ------------------------------
Total investments $1,579,566 $1,451,590 $1,291,279 $1,085,151 $ 956,316
Total assets 1,934,497 1,801,195 1,622,612 1,378,341 1,241,072
Debt and lease
obligations 97,140 97,440 97,715 97,965 100,195
Shareholders'
equity 529,658 446,515 370,245 345,009 276,924
Shareholders'
equity
per share $ 18.17 $ 15.49 $ 13.09 $ 12.57 $ 10.36
- ------------------------
[FN]
<F1> The Company's insurance subsidiaries participate in an
underwriting pooling arrangement with Mutual. Harleysville
Group's participation was 60% from January 1, 1994 to
December 31, 1995 and 65% for 1996. Lake States was acquired
as of November 1, 1993, and was not a participant in the
pool through 1996. As of January 1, 1997, Harleysville
Group's participation increased to 70% and Lake States
became a participant in the pool. Minnesota Fire was
acquired as of October 1, 1997 and became a participant in
the pool as of January 1, 1998, at which time Harleysville
Group's participation increased to 72%. See "Management's
Discussion and Analysis of Results of Operations and
Financial Condition" and Note 3(a) of the Notes to
Consolidated Financial Statements.
1
<PAGE>
EXHIBIT 13(B)
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
Harleysville Group underwrites property and casualty
insurance in both the personal and commercial lines of insurance.
The personal lines of insurance include both auto and homeowners,
and the commercial lines include auto, commercial multi-peril and
workers compensation. The business is marketed primarily in the
eastern and midwestern United States through independent agents.
The Company's property and casualty subsidiaries participate in a
pooling agreement with Mutual. The pooling agreement provides
for the allocation of premiums, losses, loss settlement expenses
and underwriting expenses between Harleysville Group and Mutual.
Harleysville Group is not liable for any pooled losses occurring
prior to January 1, 1986, the date the pooling agreement became
effective. Beginning January 1, 1996, Harleysville Group's
participation in the pooling agreement increased from 60% to 65%
and Pennland Insurance Company (Pennland), a wholly owned
subsidiary of Mutual that writes Pennsylvania personal automobile
policies, became a participant in the pooling agreement. Lake
States was not a participant in the pooling agreement in 1996.
Beginning January 1, 1997, Harleysville Group's participation
increased to 70% and Lake States became a participant in the
pooling agreement. Minnesota Fire was acquired as of October 1,
1997 and became a participant in the pooling agreement as of
January 1, 1998, at which time Harleysville Group's participation
increased to 72%.
When the Company's subsidiaries' pooling participation
increases, there is a larger retrocession of this pooled business
from Mutual. Through this retrocession, Harleysville Group is
assuming a larger share of premiums, losses and expenses for
current and future periods originating both from its subsidiaries
and Mutual. An increase in Harleysville Group's pooling
participation results in a larger share of the pooled liabilities
being assumed by Harleysville Group. Cash and investments are
received by Harleysville Group equal to this greater share of
loss reserves, unearned premiums and other insurance liabilities
(primarily commissions and premium taxes) less a ceding
commission based on acquisition costs related to unearned
premiums. An increase in pool participation also increases
Harleysville Group's leverage and exposure to adverse
development. Only balance sheet entries have been made as of the
date of changes in pool participation and no gain or loss has
been recognized on the transactions.
Harleysville Group is reducing the potential impact of
future catastrophes by achieving greater geographic distribution
of risks, reducing exposure in catastrophe-prone areas and
through reinsurance. Effective January 1, 1997, Harleysville
Group entered into a reinsurance agreement with Mutual whereby
Mutual,
2
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
RESULTS OF OPERATIONS (continued)
in return for a reinsurance premium, reinsured accumulated
catastrophe losses in a quarter up to $16.2 million and $15.8
million for 1998 and 1997, respectively. This reinsurance
coverage was in excess of a retention of $1.8 million. The
agreement excludes catastrophe losses resulting from earthquakes
or hurricanes, and supplements the existing external catastrophe
reinsurance program. Under this agreement, Harleysville Group
ceded to Mutual premiums earned of $3.0 million and $2.6 million
and losses incurred of $29.5 million and $1.6 million for 1998
and 1997, respectively. Beginning January 1, 1999, Harleysville
Group's retention increased to $3.6 million per quarter and the
reinsurance premium rate increased by a factor of 2.2 times.
Effective for one year from July 1, 1998, the Company's
subsidiaries, and Mutual and its wholly owned subsidiaries are
reinsured under a catastrophe reinsurance treaty that provides
coverage for 85.5% of up to $147 million in excess of a retention
of $20 million for any given catastrophe. Harleysville Group's
1999 pooling share of this coverage would be 85.5% of up to
$105.8 million in excess of a retention of $14.4 million for any
given catastrophe. Accordingly, pursuant to the terms of the
treaty, the maximum recovery would be $126 million for any
catastrophe involving an insured loss of $167 million or greater.
Harleysville Group's 1999 pooling share of this maximum recovery
would be $90 million for any catastrophe involving an insured
loss of $120 million or greater. The treaty includes
reinstatement provisions for coverage for a second catastrophe
and payment of an additional premium in the event of a first
catastrophe occurring.
Historically, Harleysville Group's results of operations
have been influenced by factors affecting the property and
casualty insurance industry in general. The operating results of
the U.S. property and casualty insurance industry have been
subject to significant variations due to competition, weather,
catastrophic events, regulation, general economic conditions,
judicial trends, fluctuations in interest rates and other changes
in the investment environment.
Harleysville Group's premium growth and underwriting results
have been, and continue to be, influenced by market conditions.
Insurance industry price competition has made it more difficult
to attract and retain properly priced personal and commercial
lines business. It is management's policy to maintain its
underwriting standards, even at the expense of premium growth.
3
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(continued)
1998 COMPARED TO 1997
Premiums earned increased $39.7 million for the year ended
December 31, 1998. The increase is primarily due to the
acquisition of Minnesota Fire on October 1, 1997 and its
inclusion in the pooling agreement on January 1, 1998.
Investment income increased $4.2 million for the year ended
December 31, 1998 resulting from an increase in invested assets
provided by operating cash flow including a $15.0 million cash
transfer received for various insurance liabilities assumed
January 1, 1998 in connection with the increase in Harleysville
Group's pool participation.
Realized investment gains increased $9.5 million for the
year ended December 31, 1998 due to sales of equity securities at
greater gains.
Income before income taxes increased $13.2 million for the
year ended December 31, 1998 primarily due to the higher
investment income and realized investment gains. Harleysville
Group's statutory combined ratio decreased to 103.2% for the year
ended December 31, 1998 from 103.5% for the year ended December
31, 1997 primarily due to improved results in the personal and
commercial automobile lines of business, partially offset by the
effect of Hurricane Bonnie. Hurricane Bonnie struck North and
South Carolina and Virginia during the third quarter of 1998 and
caused losses of $3.0 million ($.07 per basic share after taxes)
and adversely affected Harleysville Group's combined ratio by 0.4
points. Hurricane losses are not covered under the aggregate
catastrophe reinsurance agreement with Mutual.
Losses ceded under the aggregate catastrophe reinsurance
agreement with Mutual increased by $27.9 million for the year
ended December 31, 1998 primarily due to several spring and
summer storms and a first quarter ice storm in upstate New York.
Harleysville Group recognized favorable development in the
provision for insured events of prior years of $42.6 million and
$29.7 million in 1998 and 1997, respectively. The increased
favorable development primarily related to a greater variance
from expected claim severity in the automobile lines of business.
The 1998 effective tax expense rate increased to 21.2%
compared to 19.6% in 1997 primarily due to tax-exempt investment
income comprising a lower proportion of income before income
taxes in 1998.
4
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
1997 COMPARED TO 1996
Premiums earned increased $9.7 million for the year ended
December 31, 1997. Of such increase, $9.6 million was due to the
acquisition of Minnesota Fire. The change in pool participation
did not materially affect premiums earned. However, effective
January 1, 1997, 30% of Lake States' business was ceded to and
retained by Mutual and an additional 5% of the pooled business
was assumed from Mutual.
Investment income increased $3.8 million for the year ended
December 31, 1997 primarily resulting from an increase in
invested assets provided by operating cash flow including $29.0
million from a cash transfer received for various insurance
liabilities assumed January 1, 1997 in connection with the
increase in Harleysville Group's pool participation. Also,
invested assets increased by $26.4 million due to the October 1,
1997 acquisition of Minnesota Fire.
Realized investment gains increased $3.4 million for the
year ended December 31, 1997 primarily resulting from sales of
equity securities at greater gains.
Income before income taxes increased $35.9 million for the
year ended December 31, 1997 primarily due to improved
underwriting results and the higher investment income and
realized investment gains. Harleysville Group's combined ratio,
determined under generally accepted accounting principles (GAAP),
decreased to 103.6% for the year ended December 31, 1997 from
108.4% for the year ended December 31, 1996. The 1996 results
were adversely affected by two hurricanes that struck the North
Carolina coast and a blizzard which, together, resulted in losses
of $28.2 million ($0.66 per basic share after taxes) and
adversely affected Harleysville Group's 1996 combined ratio by
4.6 points. Excluding this impact, the GAAP combined ratio
improved 0.2 points primarily due to improved results in the
personal automobile line of business.
Harleysville Group recognized favorable development in the
provision for insured events of prior years of $29.7 million and
$35.0 million in 1997 and 1996, respectively. The decreased
favorable development primarily related to a smaller variance
from expected claim severity in the automobile lines of business.
The 1997 effective tax expense rate increased to 19.6%
compared to 8.6% in 1996 primarily due to tax-exempt investment
income comprising a lower proportion of income before income
taxes in 1997.
5
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
YEAR 2000
Harleysville Group began assessing its information
technology (IT) systems in 1996 and developed plans to ensure
their functionality with respect to the year 2000 millennium
change. These plans contain four major phases: remediation,
certification testing, enterprise testing and street testing.
The major part of the remediation phase involved modifying
our basic transaction processing systems that include the policy
issuance, billing and claims systems. The remediation phase was
completed during the fourth quarter of 1998.
The certification testing phase began in the third quarter
of 1998 and is expected to be completed in the first quarter of
1999. This phase involves testing each system using aged data and
critical future dates in a separate year 2000 compliant
environment and remediating any problems that arise.
Harleysville Group has not encountered any significant problems
during certification testing and all problems identified have
been remediated.
The enterprise testing phase is scheduled to begin in the
second quarter of 1999 and involves testing hardware and
operating system software running in concert with each other
using critical future dates. It is expected to be essentially
completed during the second quarter of 1999.
The street testing phase involves testing Harleysville
Group's IT systems with third parties and is scheduled for the
second quarter of 1999, but the exact timing is dependent upon
the readiness of the third parties. Harleysville Group has
identified and communicated with all of the third parties
identified.
Harleysville Group has non-IT systems that include embedded
technology such as office equipment and building systems.
Harleysville Group has inventoried the non-IT systems and has
either tested or communicated with vendors and landlords
regarding year 2000 readiness for essentially all of the non-IT
systems. Harleysville Group currently does not expect any
material impact to its business, results of operations or
financial condition from the failure of non-IT systems.
Harleysville Group's expenses since 1996 to address year
2000 issues were approximately $3.0 million as of December 31,
1998 and consisted primarily of costs of internal resources.
Estimated remaining costs to complete the year 2000 work are
currently $0.4 million.
6
<PAGE>
HARLEYSVILLE GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
YEAR 2000 (Continued)
Harleysville Group's year 2000 plans provide for time to
correct problems encountered in the testing phases. Harleysville
Group is continually assessing the most reasonably likely worst
case year 2000 scenario, which is currently believed to be that
problems encountered in the remaining testing are worse than
expected and systems readiness is delayed. Under such a
scenario, the contingency plan is to devote more internal
resources to solving such problems in a timely manner so that
delays in processing transactions are avoided or minimized.
Harleysville Group has risk that third parties will suffer
year 2000 problems. As most of Harleysville Group's computer
systems have been internally developed, Harleysville Group is not
significantly dependent on third party vendors for year 2000
compliance. Of the independent agents that interface
electronically with Harleysville Group, almost all either
utilize, or have access to, a system for which the remediation
and certification testing phases are complete. Some information
used in underwriting policies and adjusting claims, such as motor
vehicle reports, rating information and crime data bases, is
generally obtained electronically. Investment portfolio pricing
information and bank statement information is obtained
electronically. Harleysville Group is communicating with and
monitoring the year 2000 progress of such third parties and will
decide on contingency plans in mid-1999. Harleysville Group is
also communicating with and monitoring the year 2000 readiness of
other third parties it does business with but with which it does
not exchange data electronically. To the extent that any of
these third parties appear not to be year 2000 ready,
Harleysville Group will make contingency plans dependent upon the
facts and circumstances of each third party.
Harleysville Group has risk that claims related to year 2000
issues will be made under insurance policies that it underwrites.
Harleysville Group has concluded that its policies do not
generally provide coverage for losses relating to year 2000
issues and has issued endorsements further clarifying this
exclusion. However, due in part to the potential for judicial
decisions which expand policies to cover risks that were not
contemplated by the policy, which in turn may produce
unanticipated claims, and because there is no prior history of
such claims at this point in time, the amount of any potential
year 2000 coverage liabilities is not determinable.
This year 2000 disclosure contains statements which are
forward-looking statements that involve risks and uncertainties
and qualify for the statutory safe harbor under the Private
Securities Litigation Reform Act of 1995. Future year 2000
7
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
YEAR 2000 (Continued)
readiness activities may not adhere to the anticipated schedule
and cost estimations because: more problems may be encountered
than anticipated in the various stages of testing and trained
personnel may not be available to work on internal systems in the
time required; or there may be unexpected problems with the
readiness of third party business partners and vendors who cannot
produce services; or utility companies may not be able to provide
the vital services required to maintain operations.
NEW ACCOUNTING STANDARDS
In 1997, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-
Related Assessments," which provides guidance for determining
when to recognize, and how to determine, a liability for guaranty-
fund and other insurance-related assessments. SOP 97-3 is
effective for financial statements issued for fiscal years
beginning after December 15, 1998. Harleysville Group, which
expects to adopt this SOP on January 1, 1999, currently expects
the cumulative effect of this change in accounting principle to
be approximately $3 million. This effect is primarily related to
other insurance-related assessments involving workers
compensation regulatory bodies and second-injury funds.
In March 1998, the AICPA issued SOP 98-1, "Accounting for
Costs of Computer Software Developed or Obtained for Internal
Use." This SOP requires that certain costs related to the
development or purchase of internal-use software be capitalized
and amortized over the estimated useful life of the software.
This SOP also requires that costs related to the preliminary
project stage and the post implementation/operations stage in an
internal-use computer software development project be expensed as
incurred. SOP 98-1 is effective for financial statements issued
for fiscal years beginning after December 15, 1998. Harleysville
Group, which expects to adopt this SOP on January 1, 1999, is
currently assessing its impact on the Company's financial
reporting.
In June 1998, Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued and established standards for
accounting and reporting of derivative instruments and hedging
activities. The statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. Harleysville Group
is in the process of determining the effect, if any, of this
statement on its financial statements. Harleysville Group has
not held or issued derivative financial instruments.
8
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of the ability to generate sufficient
cash to meet cash obligations as they come due. Harleysville
Group's primary sources of cash are premium income, investment
income and maturing investments. Cash outflows can be variable
because of uncertainties regarding settlement dates for
liabilities for unpaid losses and because of the potential for
large losses either individually or in the aggregate.
Accordingly, Harleysville Group maintains investment and
reinsurance programs generally intended to provide adequate funds
to pay claims without forced sales of investments. Harleysville
Group models its exposure to catastrophes and has the ability to
pay claims without selling held to maturity securities even for
events having a low (less than 1%) probability. Even in years of
greater catastrophe frequency, Harleysville Group has been able
to pay claims without liquidating any investments. Harleysville
Group has also considered scenarios of declines in revenue and
increases in loss payments and has the ability to meet cash
requirements under such scenarios without selling held to
maturity securities. Harleysville Group's policy with respect to
fixed maturity investments is to purchase only those that are of
investment grade quality.
Net cash provided by operating activities was $81.9 million
and $89.8 million for 1998 and 1997, respectively. The decrease
in net cash provided by operating activities in 1998 primarily
reflects the effect of amendments to the pooling agreement with
Mutual. Cash transfers of $15.0 million and $29.0 million were
received effective January 1, 1998 and 1997, respectively, by
Harleysville Group related to the various liabilities assumed in
connection with such amendments.
Net cash used by investing activities was $71.3 million and
$84.9 million for 1998 and 1997, respectively. The lower amount
in 1998 reflects the investment of the cash provided by operating
activities.
Financing activities used net cash of $8.3 million in 1998
compared to $5.6 million in 1997. The change was primarily due
to an increase in dividend payments and a decrease in the
issuance of common stock.
The Company maintained $5.4 million of cash and marketable
securities at the holding company level at December 31, 1998,
which is available for general corporate purposes including
dividends, debt service, capital contributions to subsidiaries
and acquisitions. Harleysville Group has no material commitments
for capital expenditures as of December 31, 1998.
9
<PAGE>
HARLEYSVILLE GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
LIQUIDITY AND CAPITAL RESOURCES (Continued)
As a holding company, the Company's principal source of cash
for the payment of dividends is dividends from its subsidiaries.
The Company's insurance subsidiaries are subject to state laws
that restrict their ability to pay dividends.
Applying the current regulatory restrictions as of December
31, 1998, $57.0 million would be available for distribution to
the Company by its subsidiaries without prior regulatory approval
during 1999. In 1997, the Company's insurance subsidiaries paid
dividends of $31.7 million to the Company that were used to
purchase Minnesota Fire. See the Business-Regulation section of
the Company's 1998 Form 10-K, which includes a reconciliation of
net income and shareholders' equity as determined under statutory
accounting practices to net income and shareholders' equity as
determined in accordance with generally accepted accounting
principles. Also, see Note 9 of the Notes to Consolidated
Financial Statements.
The National Association of Insurance Commissioners has
adopted risk-based capital (RBC) standards that require insurance
companies to calculate and report statutory capital and surplus
needs based on a formula measuring underwriting, investment and
other business risks inherent in an individual company's
operations. These RBC standards have not affected the operations
of Harleysville Group since each of the Company's insurance
subsidiaries has statutory capital and surplus in excess of RBC
requirements.
Harleysville Group had off-balance-sheet credit risk related
to $62.0 million of premium balances due to Mutual from agents at
December 31, 1998.
IMPACT OF INFLATION
Property and casualty insurance premiums are established
before the amount of losses and loss settlement expenses, or the
extent to which inflation may affect such expenses, are known.
Consequently, Harleysville Group attempts, in establishing rates,
to anticipate the potential impact of inflation. In the past,
inflation has contributed to increased losses and loss settlement
expenses.
10
<PAGE>
EXHIBIT 13(C)
HARLEYSVILLE GROUP
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
Harleysville Group's exposure to market risk for changes in
interest rates is concentrated in the investment portfolio and,
to a lesser extent, the debt obligations. Harleysville Group
monitors this exposure through periodic reviews of asset and
liability positions. Estimates of cash flows and the impact of
interest rate fluctuations relating to the investment portfolio
are modeled regularly.
Principal cash flows and related weighted-average interest
rates by expected maturity dates for financial instruments
sensitive to interest rates are as follows:
DECEMBER 31, 1998
----------------------------------
PRINCIPAL WEIGHTED-AVERAGE
CASH FLOWS INTEREST RATE
---------- -----------------
Fixed maturities and short-
term investments:
1999 $ 123,965 6.89%
2000 85,299 7.32%
2001 131,727 7.07%
2002 96,420 6.58%
2003 209,012 5.92%
Thereafter 728,474 5.82%
----------
Total $1,374,897
==========
Market value $1,446,686
==========
Debt
1999 $ 330 3.25%
2000 360 3.25%
2001 395 3.25%
2002 435 3.25%
2003 75,475 6.73%
Thereafter 20,145 4.96%
----------
Total $ 97,140
==========
Fair value $ 98,332
==========
Actual cash flows may differ from those stated as a result
of calls and prepayments.
11
<PAGE>
HARLEYSVILLE GROUP
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
(Continued)
EQUITY PRICE RISK
Harleysville Group's portfolio of equity securities, which
is carried on the balance sheet at market value, has exposure to
price risk. Price risk is defined as the potential loss in
market value resulting from an adverse change in prices.
Portfolio characteristics are analyzed regularly and market risk
is actively managed through a variety of techniques. The
portfolio is diversified across industries, and concentrations in
any one company or industry are limited by parameters established
by senior management.
The combined total of realized and unrealized equity
investment gains and losses were $51.5 million, $33.4 million and
$13.5 million in 1998, 1997 and 1996, respectively. During these
three years, the largest total equity investment gain and loss in
a quarter was $32.6 million and $10.2 million, respectively.
12
<PAGE>
EXHIBIT 13(D)
HARLEYSVILLE GROUP
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31,
-----------------------------
1998 1997
---------- ----------
ASSETS
------
Investments:
Fixed maturities:
Held to maturity, at amortized
cost (fair value $680,371
and $643,951) $ 638,319 $ 611,604
Available for sale, at fair value
(cost $716,325 and $660,911) 751,293 689,806
Equity securities, at fair value
(cost $95,797 and $79,221) 174,932 121,830
Short-term investments, at cost,
which approximates fair value 15,022 28,350
----------- ---------
Total investments 1,579,566 1,451,590
Cash 3,799 1,460
Receivables:
Premiums 91,256 83,948
Reinsurance 84,179 78,750
Accrued investment income 22,134 21,253
----------- ---------
Total receivables 197,569 183,951
Deferred policy acquisition costs 78,984 72,076
Prepaid reinsurance premiums 12,108 14,504
Property and equipment, net 25,051 24,778
Deferred income taxes 3,604 18,906
Other assets 33,816 33,930
----------- ---------
Total assets $1,934,497 $1,801,195
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Liabilities:
Unpaid losses and loss
settlement expenses $ 893,420 $ 868,393
Unearned premiums 317,772 298,625
Accounts payable and
accrued expenses 83,735 72,427
Debt 97,140 97,440
Due to affiliate 12,772 17,795
----------- ---------
Total liabilities 1,404,839 1,354,680
----------- ---------
Shareholders' equity:
Preferred stock, $1 par value,
authorized 1,000,000 shares;
none issued
Common stock, $1 par value,
authorized 80,000,000 shares;
shares issued and outstanding
1998, 29,150,518 and
1997, 28,821,973 29,151 28,822
Additional paid-in capital 119,302 113,646
Accumulated other comprehensive
income 74,167 46,478
Retained earnings 307,038 257,569
---------- ---------
Total shareholders' equity 529,658 446,515
---------- ---------
Total liabilities and
shareholders' equity $1,934,497 $1,801,195
========== ==========
See accompanying notes to consolidated financial statements.
13
<PAGE>
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- --------- --------
Revenues:
Premiums earned $664,604 $624,905 $615,197
Investment income, net
of investment expense 86,025 81,783 78,008
Realized investment gains 16,085 6,541 3,182
Other income 12,597 10,950 11,038
-------- -------- --------
Total revenues 779,311 724,179 707,425
-------- -------- --------
Losses and expenses:
Losses and loss settlement
expenses 464,480 439,488 468,490
Amortization of deferred
policy acquisition costs 169,567 157,591 154,320
Other underwriting expenses 54,154 50,108 43,965
Interest expense 6,470 6,597 6,548
Other expenses 4,199 3,114 2,727
-------- -------- --------
Total expenses 698,870 656,898 676,050
-------- -------- --------
Income before income
taxes 80,441 67,281 31,375
Income taxes 17,028 13,209 2,695
-------- -------- --------
Net income $ 63,413 $ 54,072 $ 28,680
======== ======== ========
Per common share:
Basic earnings $ 2.18 $ 1.89 $ 1.03
======== ======== ========
Diluted earnings $ 2.15 $ 1.86 $ 1.02
======== ======== ========
Cash dividends $ .48 $ .44 $ .40
======== ======== ========
See accompanying notes to consolidated financial statements.
14
<PAGE>
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(dollars in thousands)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN COMPREHENSIVE RETAINED
SHARES AMOUNT CAPITAL INCOME (LOSS) EARNINGS TOTAL
----------- -------- ---------- -------------- -------- --------
Balance at
December 31,
<S> <C> <C> <C> <C> <C> <C>
1995 13,718,086 $13,718 $111,519 $21,207 $198,565 $345,009
Net income 28,680 28,680
Other compre-
hensive
income,
net of tax:
Unrealized
investment
losses, net
of reclassi-
fication
adjustment (2,225) (2,225)
--------
Comprehensive
income 26,455
--------
Issuance of
common stock:
Incentive
plans 234,470 235 4,249 4,484
Dividend
Reinvestment
Plan 187,306 187 4,776 4,963
Tax benefit
from
stock options
exercised 489 489
Cash dividends
paid (11,155) (11,155)
---------- ------- -------- ------- -------- --------
Balance at
December 31,
1996 14,139,862 14,140 121,033 18,982 216,090 370,245
Net income 54,072 54,072
Other compre-
hensive
income,
net of tax:
Unrealized
investment
gains, net
of reclassi-
fication
adjustment 27,496 27,496
--------
Comprehensive
income 81,568
--------
Issuance of
common stock:
Incentive
plans 303,682 304 5,161 5,465
Dividend
Reinvestment
Plan 15,984 16 500 516
</TABLE>
(continued)
15
<PAGE>
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Continued)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(dollars in thousands)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN COMPREHENSIVE RETAINED
SHARES AMOUNT CAPITAL INCOME (LOSS) EARNINGS TOTAL
---------- -------- ---------- ------------- -------- ---------
Tax benefit
from stock
options
<S> <C> <C> <C> <C> <C> <C>
exercised 1,314 1,314
Cash dividends
paid (12,593) (12,593)
Two-for-one
stock
split 14,362,445 14,362 (14,362)
---------- ------- -------- ------- -------- --------
Balance at
December 31,
1997 28,821,973 28,822 113,646 46,478 257,569 446,515
Net income 63,413 63,413
Other compre-
hensive
income,
net of tax:
Unrealized
investment
gains, net
of reclassi-
fication
adjustment 27,689 27,689
--------
Comprehensive
income 91,102
--------
Issuance of
common stock:
Incentive
plans 303,912 304 4,445 4,749
Dividend
Reinvestment
Plan 24,633 25 541 566
Tax benefit
from stock
options
exercised 670 670
Cash dividends
paid (13,944) (13,944)
---------- ------- -------- ------- -------- --------
Balance at
December 31,
1998 29,150,518 $29,151 $119,302 $74,167 $307,038 $529,658
========== ======= ======== ======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Cash flows from operating
activities:
Net income $ 63,413 $ 54,072 $ 28,680
Adjustments to reconcile net
income to net cash provided
by operating activities:
Change in receivables,
unearned premiums, prepaid
reinsurance and due to
affiliate (23) (132) 6,282
Increase in unpaid losses
and loss settlement
expenses 12,635 2,502 56,914
Deferred income taxes 392 (159) (6,655)
(Increase) decrease in deferred
policy acquisition costs (6,908) 841 (9,670)
Amortization and depreciation 2,598 1,794 1,430
Gain on sale of investments (16,085) (6,541) (3,182)
Other, net 10,874 8,430 15,380
Cash from change in pooling
agreement 14,962 29,002 117,800
--------- --------- ---------
Net cash provided by
operating activities 81,858 89,809 206,979
--------- --------- ---------
Cash flows from investing activities:
Held to maturity investments:
Purchases (49,037) (36,419) (97,062)
Maturities 22,432 28,630 19,279
Available for sale investments:
Purchases (183,793) (139,859) (244,185)
Maturities 69,001 28,970 69,829
Sales 59,334 57,427 37,724
Net sales or maturities of
short-term investments 13,328 11,042 8,951
Acquisition, net of cash (32,920)
Purchases of property and
equipment (2,525) (1,767) (1,182)
--------- --------- ---------
Net cash used by
investing activities (71,260) (84,896) (206,646)
--------- --------- ---------
Cash flows from financing
activities:
Issuance of common stock 5,985 7,295 9,936
Repayment of debt (300) (275) (250)
Dividends paid (13,944) (12,593) (11,155)
--------- --------- ---------
Net cash used by financing
activities (8,259) (5,573) (1,469)
--------- --------- ---------
Increase (decrease) in cash 2,339 (660) (1,136)
Cash at beginning of year 1,460 2,120 3,256
--------- --------- ---------
Cash at end of year $ 3,799 $ 1,460 $ 2,120
========= ========= =========
See accompanying notes to consolidated financial statements.
17
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 - Description of Business and Summary of Significant
Accounting Policies
Description of Business
Harleysville Group consists of Harleysville Group Inc. and
its subsidiaries (all wholly owned). Those subsidiaries are:
- Great Oaks Insurance Company (Great Oaks)
- Harleysville-Atlantic Insurance Company (Atlantic)
- Harleysville Insurance Company of New Jersey (HNJ)
- Huron Insurance Company (Huron)
- Lake States Insurance Company (Lake States)
- Mid-America Insurance Company (Mid-America)
- Minnesota Fire and Casualty Company (Minnesota Fire)
- New York Casualty Insurance Company (New York Casualty)
- Worcester Insurance Company (Worcester)
- Harleysville Ltd., a real estate partnership that owns
the home office
Harleysville Group is approximately 54% owned by
Harleysville Mutual Insurance Company (Mutual).
Harleysville Group underwrites property and casualty
insurance in both the personal and commercial lines of insurance.
The personal lines of insurance include both auto and homeowners,
and the commercial lines include auto, commercial multi-peril and
workers compensation. The business is marketed primarily in the
eastern and midwestern United States through independent agents.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying financial statements include the accounts
of Harleysville Group prepared in conformity with generally
accepted accounting principles, which differ in some respects
from those followed in reports to insurance regulatory
authorities. All significant intercompany balances and
transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from these estimates.
18
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
Investments
Accounting for fixed maturities depends on their
classification as held to maturity, available for sale or
trading. Fixed maturities classified as available for sale are
carried at fair value, with unrealized gains or losses credited
or charged directly to a separate component of shareholders'
equity.
Investments in fixed maturities that are classified as held
to maturity are carried at amortized cost. Equity securities are
carried at fair value. There were no investments classified as
trading. Short-term investments are recorded at cost, which
approximates fair value.
Realized gains and losses on sales of investments are
recognized in net income on the specific identification basis.
Unrealized investment gains or losses, net of applicable income
taxes, are reflected directly in shareholders' equity and,
accordingly, have no effect on net income.
PREMIUMS
Premiums are recognized as revenue ratably over the terms of
the respective policies. Unearned premiums are calculated on the
monthly pro rata basis.
POLICY ACQUISITION COSTS
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, are
deferred and amortized over the effective period of the related
insurance policies. The method followed in computing deferred
policy acquisition 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
settlement expenses, and certain other costs expected to be
incurred as the premium is earned.
19
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
LOSSES AND LOSS SETTLEMENT EXPENSES
The liability for losses and loss settlement expenses
represents estimates of the ultimate unpaid cost of all losses
incurred which includes the gross liabilities to Harleysville
Group's policyholders plus the net liability to Mutual under the
pooling agreement. See Note 3(a). Such estimates may be more or
less than the amounts ultimately paid when the claims are
settled. These estimates are periodically reviewed and adjusted
as necessary; such adjustments are reflected in current
operations.
STOCK-BASED COMPENSATION
Stock-based compensation plans are accounted for under the
provisions of Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense would be recorded
on the date of a stock option grant only if the current market
price of the underlying stock exceeded the exercise price. For
disclosure purposes, pro forma net income and earnings per share
are provided in accordance with Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation."
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated
depreciation. Depreciation is calculated primarily on the
straight-line basis over the estimated useful lives of the assets
(40 years for buildings and three to 15 years for equipment).
INCOME TAXES
Deferred income tax assets and liabilities are recognized
for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases.
EARNINGS PER SHARE
Basic earnings per share are computed by dividing earnings
by the weighted-average number of common shares outstanding
during the year. Diluted earnings per share includes the
dilutive effect of the stock option and stock purchase plans
described in Note 11.
20
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
COMPREHENSIVE INCOME
In 1998, Harleysville Group adopted SFAS No. 130,
"Comprehensive Income," which established standards for the
reporting and disclosure of comprehensive income and its
components. Comprehensive income consists of net income and net
unrealized investment gains or losses and is presented in the
Consolidated Statements of Shareholders' Equity. The adoption of
SFAS No. 130 had no impact on total shareholders' equity. Prior
year financial statements have been reclassified to conform to
these requirements.
2 - ACQUISITION
On October 1, 1997, Harleysville Group Inc. acquired
Minnesota Fire, a property and casualty insurance company
conducting business primarily in Minnesota and neighboring
states, for $33,986,000 in cash. The acquisition was accounted
for as a purchase and resulted in goodwill of $7,028,000, which
is being amortized over 40 years on the straight-line basis. The
consolidated financial statements include the results of
operations of Minnesota Fire from the date of acquisition. Pro
forma consolidated results of operations are not presented
because the amounts are not materially different from
Harleysville Group's historical results. Supplemental cash flow
information for the acquisition is as follows:
(in thousands)
Fair value of assets $112,795
Liabilities assumed 78,809
--------
Cash paid 33,986
Less cash acquired 1,066
--------
$ 32,920
========
3 - TRANSACTIONS WITH AFFILIATES
(a) UNDERWRITING
The insurance subsidiaries participate in a reinsurance
pooling agreement with Mutual whereby such subsidiaries cede to
Mutual all of their insurance business and assume from Mutual an
amount equal to their participation in the pooling agreement.
All losses and loss settlement expenses and other
underwriting
21
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - TRANSACTIONS WITH AFFILIATES (Continued)
(a) UNDERWRITING (Continued)
expenses are prorated among the parties on the basis of
participation in the pooling agreement. The agreement pertains
to all insurance business written or earned on or after January
1, 1986. Beginning January 1, 1996, Harleysville Group's
participation in the pooling agreement increased from 60% to 65%
and Pennland Insurance Company, a subsidiary of Mutual, became a
participant in the pooling agreement. Lake States was not a
participant in the pooling agreement in 1996. Beginning January
1, 1997, Harleysville Group's participation increased to 70% and
Lake States became a participant in the pooling arrangement.
Minnesota Fire was acquired as of October 1, 1997, and became a
participant in the pool as of January 1, 1998, at which time
Harleysville Group's participation increased to 72%. In
connection with these changes in pool participation, Harleysville
Group received cash and investments from Mutual of $14,962,000,
$29,002,000 and $117,800,000, which related to the various
insurance liabilities assumed on January 1, 1998, 1997 and 1996,
respectively. These liabilities consist of the following at
January 1:
1998 1997 1996
-------- -------- --------
(in thousands)
Unpaid losses and loss
settlement expenses $12,392 $28,318 $ 93,966
Unearned premiums 2,271 441 22,225
Other liabilities 299 243 1,609
------- ------- --------
$14,962 $29,002 $117,800
======= ======= ========
Because this agreement does not relieve Harleysville Group of
primary liability as the originating insurer, there is a
concentration of credit risk arising from business ceded to
Mutual. However, the reinsurance pooling agreement provides for
the right of offset and the net balance with Mutual is a
liability at December 31, 1998 and 1997. Mutual has an A. M.
Best rating of "A" (Excellent) and, in accordance with certain
state regulatory requirements, maintained $342.1 million (fair
value) of investments in a trust account to secure liabilities
under the reinsurance pooling agreement at December 31, 1998.
22
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - TRANSACTIONS WITH AFFILIATES (Continued)
(a) UNDERWRITING (Continued)
The following amounts represent reinsurance transactions
between Harleysville Group and Mutual under the pooling
arrangement:
1998 1997 1996
-------- -------- --------
(in thousands)
Ceded:
Premiums written $604,196 $533,311 $394,787
======== ======== ========
Premiums earned $587,980 $532,456 $383,593
======== ======== ========
Losses incurred $471,155 $381,650 $280,421
======== ======== ========
Assumed:
Premiums written $689,171 $609,270 $537,648
======== ======== ========
Premiums earned $667,629 $617,899 $505,921
======== ======== ========
Losses incurred $494,015 $433,886 $386,009
======== ======== ========
Net assumed from Mutual:
Unearned premiums $ 30,780 $ 25,453 $ 34,937
======== ======== ========
Unpaid losses and loss
settlement expenses $173,951 $205,756 $205,790
======== ======== ========
Effective January 1, 1997, Harleysville Group entered into a
reinsurance agreement with Mutual whereby Mutual, in return for a
reinsurance premium, reinsured accumulated catastrophe losses in
a quarter up to $16,200,000 and $15,750,000 for 1998 and 1997,
respectively. This reinsurance coverage was in excess of a
retention of $1,800,000 and $1,750,000 for 1998 and 1997,
respectively. The agreement excludes catastrophe losses
resulting from earthquakes or hurricanes and supplements the
existing external catastrophe reinsurance program. Under this
agreement, Harleysville Group ceded to Mutual premiums earned of
$3,025,000 and $2,615,000, and losses incurred of $29,535,000 and
$1,616,000 for 1998 and 1997, respectively. Beginning January 1,
1999, Harleysville Group's retention increased to $3,600,000 per
quarter and the reinsurance premium rate increased by a factor of
2.2 times.
23
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - TRANSACTIONS WITH AFFILIATES (Continued)
(b) PROPERTY
Harleysville Ltd. leases the home office to Mutual, which
shares most of the facility with Harleysville Group. Rental
income under the lease was $2,754,000 for 1998, 1997 and 1996,
and is included in other income after elimination of intercompany
amounts of $1,685,000, $1,639,000 and $1,552,000 in 1998, 1997
and 1996, respectively.
(c) MANAGEMENT AGREEMENTS
Harleysville Group Inc. received $6,293,000, $5,992,000 and
$6,628,000 of management fee income in 1998, 1997 and 1996,
respectively, under agreements whereby Harleysville Group Inc.
provides management services to Mutual and other affiliates.
(d) INTERCOMPANY BALANCES
Intercompany balances are created primarily from the pooling
arrangement (settled quarterly), allocation of common expenses,
collection of premium balances and payment of claims (settled
monthly). No interest is charged or received on intercompany
balances due to the timely settlement terms and nature of the
items. Interest expense on the loan from Mutual described in
Note 8 was $1,157,000, $1,275,000 and $1,212,000 in 1998, 1997
and 1996, respectively.
Harleysville Group had off-balance-sheet credit risk related
to approximately $62,000,000 and $59,000,000 of premium balances
due to Mutual from agents and insureds at December 31, 1998 and
1997, respectively.
24
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - INVESTMENTS
The amortized cost and estimated fair value of investments
in fixed maturity and equity securities are as follows:
DECEMBER 31, 1998
-----------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- ---------
(in thousands)
Held to maturity:
US Treasury securities
and obligations of
US government corpora-
tions and agencies $ 9,949 $ 729 $ $ 10,678
Obligations of states
and political
subdivisions 354,046 22,216 (89) 376,173
Corporate securities 274,221 19,200 (4) 293,417
Mortgage-backed
securities 103 103
---------- ------- ------- ----------
Total held to maturity 638,319 42,145 (93) 680,371
---------- ------- ------- ----------
Available for sale:
US Treasury securities
and obligations of
US government corpora-
tions and agencies 75,415 4,179 (79) 79,515
Obligations of states
and political
subdivisions 360,525 20,951 (116) 381,360
Corporate securities 143,585 4,486 (298) 147,773
Mortgage-backed
securities 136,800 6,206 (361) 142,645
---------- ------- ------- ----------
Total available for sale 716,325 35,822 (854) 751,293
---------- ------- ------- ----------
Total fixed maturities $1,354,644 $77,967 $ (947) $1,431,664
========== ======= ======= ==========
Total equity securities $ 95,797 $80,161 $(1,026) $ 174,932
========== ======= ======= ==========
25
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - INVESTMENTS (Continued)
DECEMBER 31, 1997
------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ----------- -----------
(in thousands)
Held to maturity:
US Treasury securities
and obligations of
US government corpora-
tions and agencies $ 10,295 $ 527 $ (14) $ 10,808
Obligations of states
and political
subdivisions 333,946 19,250 353,196
Corporate securities 267,194 13,081 (497) 279,778
Mortgage-backed
securities 169 169
---------- ------- ------- ----------
Total held to maturity 611,604 32,858 (511) 643,951
---------- ------- ------- ----------
Available for sale:
US Treasury securities
and obligations of
US government corpora-
tions and agencies 92,742 2,655 (84) 95,313
Obligations of states
and political
subdivisions 287,507 16,667 (113) 304,061
Corporate securities 141,750 2,705 (71) 144,384
Mortgage-backed
securities 138,912 7,137 (1) 146,048
---------- ------- ------- ----------
Total available for sale 660,911 29,164 (269) 689,806
---------- ------- ------- ----------
Total fixed maturities $1,272,515 $62,022 $ (780) $1,333,757
========== ======= ======= ==========
Total equity securities $ 79,221 $43,049 $ (440) $ 121,830
========== ======= ======= ==========
The amortized cost and estimated fair value of fixed
maturity securities at December 31, 1998, by contractual
maturity, are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment
penalties.
26
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - INVESTMENTS (Continued)
ESTIMATED
AMORTIZED FAIR
COST VALUE
---------- -----------
(in thousands)
Held to maturity:
Due in one year or less $ 25,864 $ 26,279
Due after one year
through five years 153,449 162,688
Due after five years
through ten years 309,884 331,840
Due after ten years 149,019 159,461
---------- ----------
638,216 680,268
Mortgage-backed
securities 103 103
---------- ----------
638,319 680,371
---------- ----------
Available for sale:
Due in one year or less 29,688 30,175
Due after one year
through five years 133,138 138,771
Due after five years
through ten years 210,160 222,386
Due after ten years 206,539 217,316
---------- ----------
579,525 608,648
Mortgage-backed
securities 136,800 142,645
---------- ----------
716,325 751,293
---------- ----------
Total fixed maturities $1,354,644 $1,431,664
========== ==========
The amortized cost of fixed maturities on deposit with
various regulatory authorities at December 31, 1998 and 1997
amounted to $19,848,000 and $17,665,000, respectively.
27
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - Investments (Continued)
A summary of net investment income is as follows:
1998 1997 1996
-------- -------- --------
(in thousands)
Interest on fixed maturities $83,689 $79,765 $75,204
Dividends on equity securities 1,560 1,345 776
Interest on short-term
investments 1,780 1,626 2,917
------- ------- -------
Total investment income 87,029 82,736 78,897
Investment expense 1,004 953 889
------- ------- -------
Net investment income $86,025 $81,783 $78,008
======= ======= =======
Realized gross gains (losses) from investment sales and
redemptions and the change in difference between fair value and
cost of investments, before applicable income taxes, are as
follows:
1998 1997 1996
--------- -------- ---------
(in thousands)
Fixed maturity securities:
Held to maturity:
Gross gains $ 273 $ 255 $ 178
Gross losses (17) (3) (2)
Available for sale:
Gross gains 1,109 1,263 69
Gross losses (240) (223) (323)
Equity securities:
Gross gains 16,483 6,934 4,716
Gross losses (1,523) (1,685) (1,456)
------- ------- --------
Net realized
investment gains $16,085 $ 6,541 $ 3,182
======= ======= ========
Change in difference between
fair value and cost of
investments<F1>:
Fixed maturity securities $15,778 $27,707 $(27,903)
Equity securities 36,526 28,150 10,222
------- ------- --------
Total $52,304 $55,857 $(17,681)
======= ======= ========
[FN]
<F1> Parentheses indicate a net unrealized decline in fair value.
28
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - INVESTMENTS (Continued)
Income taxes on realized investment gains were $5,630,000,
$2,289,000 and $1,114,000 for 1998, 1997 and 1996, respectively.
Deferred income taxes applicable to net unrealized investment
gains included in shareholders' equity were $39,936,000 and
$25,026,000 at December 31, 1998 and 1997, respectively.
Harleysville Group has not held or issued derivative
financial instruments.
5 - REINSURANCE
In the ordinary course of business, Harleysville Group cedes
insurance to, and assumes insurance from, insurers to limit its
maximum loss exposure through diversification of its risks. See
Note 3(a) for discussion of reinsurance with Mutual. Reinsurance
contracts do not relieve Harleysville Group of primary liability
as the originating insurer. After excluding reinsurance
transactions with Mutual under the pooling arrangement, the
effect of Harleysville Group's share of other reinsurance on
premiums written and earned is as follows:
1998 1997 1996
---------- ---------- ---------
(in thousands)
Premiums written:
Direct $689,865 $620,330 $659,053
Assumed 25,136 28,871 37,369
Ceded (28,855) (32,264) (35,679)
-------- -------- --------
Net premiums written $686,146 $616,937 $660,743
======== ======== ========
Premiums earned:
Direct $669,605 $628,330 $616,543
Assumed 26,249 30,559 37,684
Ceded (31,250) (33,984) (39,030)
-------- -------- --------
Net premiums earned $664,604 $624,905 $615,197
======== ======== ========
Losses and loss settlement expenses are net of reinsurance
recoveries of $59,474,000, $18,401,000 and $26,907,000 for 1998,
1997 and 1996, respectively.
29
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6 - PROPERTY AND EQUIPMENT
Property and equipment consisted of land and buildings with
a cost of $28,219,000 and $28,060,000, and equipment with a cost
of $9,318,000 and $7,281,000 at December 31, 1998 and 1997,
respectively. Accumulated depreciation related to such assets
was $12,486,000 and $10,563,000 at December 31, 1998 and 1997,
respectively.
Rental expense under leases with non-affiliates amounted to
$3,770,000, $2,941,000 and $2,497,000 for 1998, 1997 and 1996,
respectively. Operating lease commitments were not material at
December 31, 1998.
7 - LIABILITY FOR UNPAID LOSSES AND LOSS SETTLEMENT EXPENSES
Activity in the liability for unpaid losses and loss
settlement expenses is summarized as follows:
1998 1997 1996
--------- --------- ---------
(in thousands)
Liability at January 1 $868,393 $796,820 $645,941
Less reinsurance recoverables 74,830 78,120 69,288
-------- -------- --------
Net liability at January 1 793,563 718,700 576,653
-------- -------- --------
Net liability of
acquired company 34,836
--------
Incurred related to:
Current year 507,087 469,216 503,489
Prior years (42,607) (29,728) (34,999)
-------- -------- --------
Total incurred 464,480 439,488 468,490
-------- -------- --------
Paid related to:
Current year 215,902 198,554 220,669
Prior years 241,014 229,225 199,740
Adjustments to beginning
reserves resulting from
change in pool
participation percentage (12,392) (28,318) (93,966)
-------- -------- --------
Total paid 444,524 399,461 326,443
-------- -------- --------
Net liability at December 31 813,519 793,563 718,700
Plus reinsurance recoverables 79,901 74,830 78,120
-------- -------- --------
Liability at December 31 $893,420 $868,393 $796,820
======== ======== ========
30
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7 - LIABILITY FOR UNPAID LOSSES AND LOSS SETTLEMENT EXPENSES
(Continued)
Harleysville Group recognized favorable development in the
provision for insured events of prior years of $42,607,000,
$29,728,000 and $34,999,000 in 1998, 1997 and 1996, respectively.
The favorable development relates to lower-than-expected claim
severity in the workers compensation and automobile lines of
business.
In establishing the liability for unpaid losses and loss
settlement expenses, management considers facts currently known
and the current state of the law and coverage litigation.
Liabilities are recognized for known losses (including the cost
of related litigation) when sufficient information has been
developed to indicate the involvement of a specific insurance
policy, and management can reasonably estimate its liability. In
addition, liabilities have been established to cover additional
exposures on both known and unasserted losses. Estimates of the
liabilities are reviewed and updated continually.
The property and casualty insurance industry has received
significant publicity about environmental-related losses from
exposures insured many years ago. Since the intercompany pooling
agreement pertains to insurance business written or earned on or
after January 1, 1986, Harleysville Group has not incurred
significant environmental-related losses.
8 - DEBT
Debt is as follows:
DECEMBER 31,
--------------------
1998 1997
-------- --------
(in thousands)
Notes, 6.75%, due 2003 $75,000 $75,000
Demand term-loan payable
to Mutual, LIBOR plus
0.65%, due 2005 18,500 18,500
Economic Development
Corporation (EDC)
Revenue Bond obligation 3,640 3,940
------- -------
$97,140 $97,440
======= =======
31
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8 - DEBT (Continued)
The fair value of the notes was $76,192,000 and $75,517,000
at December 31, 1998 and 1997, respectively, based on quoted
market prices for the same or similar debt. The carrying value
of the remaining debt approximates fair value.
The EDC obligation is secured by Lake States' building.
Interest is payable semiannually at a variable rate (3.25% at
December 31, 1998) equal to the market interest rate that would
allow the bonds to be remarketed at par value. The bonds are
subject to redemption prior to maturity in 2006 at levels
dependent upon the occurrence of certain events.
Interest paid was $6,379,000, $6,493,000 and $6,446,000 in
1998, 1997 and 1996, respectively.
9 - SHAREHOLDERS' EQUITY
Comprehensive income consisted of the following:
1998 1997 1996
-------- -------- --------
(in thousands)
Net income $ 63,413 $54,072 $28,680
-------- ------- -------
Other comprehensive
income:
Unrealized investment
holding gains (losses)
arising during period,
net of taxes of $20,450,
$17,006 and $(147) 37,978 31,584 (271)
Less:
Reclassification
adjustment for gains
included in net income,
net of taxes of $5,540,
$2,201 and $1,052 (10,289) (4,088) (1,954)
-------- ------- -------
Net unrealized
investment gains (losses) 27,689 27,496 (2,225)
-------- ------- -------
Comprehensive income $ 91,102 $81,568 $26,455
======== ======= =======
32
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9 - SHAREHOLDERS' EQUITY (Continued)
A source of cash for the payment of dividends is dividends
from subsidiaries. Harleysville Group Inc.'s insurance
subsidiaries are required by law to maintain certain minimum
surplus on a statutory basis, and are subject to risk-based
capital requirements and to regulations under which payment of a
dividend from statutory surplus is restricted and may require
prior approval of regulatory authorities. Applying the current
regulatory restrictions as of December 31, 1998, $57,000,000
would be available for distribution to Harleysville Group Inc.
during 1999 without prior approval.
The following table contains selected information for
Harleysville Group Inc.'s property and casualty insurance
subsidiaries, as determined in accordance with prescribed
statutory accounting practices:
DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Statutory capital and surplus $489,665 $398,468 $326,455
======== ======== ========
Statutory unassigned surplus $355,396 $264,199 $209,199
======== ======== ========
Statutory net income $ 62,133 $ 59,658 $ 15,332
======== ======== ========
33
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10 - INCOME TAXES
The components of income tax expense (benefit) are as
follows:
1998 1997 1996
-------- -------- --------
(in thousands)
Current $16,636 $13,368 $ 9,350
Deferred 392 (159) (6,655)
------- ------- -------
$17,028 $13,209 $ 2,695
======= ======= =======
Cash paid for federal income taxes in 1998, 1997 and 1996
was $14,350,000, $11,564,000 and $10,100,000, respectively.
The actual income tax rate differed from the statutory
federal income tax rate applicable to income before income taxes
as follows:
1998 1997 1996
-------- -------- --------
Statutory federal income
tax rate 35.0 % 35.0 % 35.0 %
Tax-exempt interest (14.0) (15.6) (26.8)
Other, net 0.2 0.2 0.4
------ ------ ------
21.2 % 19.6 % 8.6 %
====== ====== ======
34
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10 - INCOME TAXES (Continued)
The tax effects of the significant temporary differences
that give rise to deferred tax liabilities and assets are as
follows:
DECEMBER 31,
-----------------------
1998 1997
-------- --------
(in thousands)
Deferred tax liabilities:
Deferred policy acquisition
costs $27,644 $25,226
Unrealized investment gains 39,936 25,026
Other 4,229 3,755
------- -------
Total deferred tax
liabilities 71,809 54,007
------- -------
Deferred tax assets:
Unearned premiums 21,396 19,889
Losses incurred 44,879 44,788
Tax credit carryforward 96
Other 9,138 8,140
------- -------
Total deferred tax
assets 75,413 72,913
------- -------
Net deferred tax asset $ 3,604 $18,906
======= =======
A valuation allowance is required to be established for any
portion of the deferred tax asset that management believes will
not be realized. In the opinion of management, it is more likely
than not that the benefit of the deferred tax asset will be
realized and, therefore, no such valuation allowance has been
established.
35
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11 - INCENTIVE PLANS
Harleysville Group applies APB Opinion No. 25 in accounting
for its stock-based compensation plans. Accordingly, no
compensation cost has been recognized for its fixed stock option
plans and certain of its stock purchase plans. Had compensation
cost for these stock-based compensation plans been determined
under SFAS No. 123, Harleysville Group's net income and earnings
per share would have been reduced to the pro forma amounts
indicated below:
1998 1997 1996
-------- -------- --------
(in thousands, except per share data)
Net income:
As reported $63,413 $54,072 $28,680
Pro forma $61,843 $52,726 $27,691
Basic earnings
per share:
As reported $ 2.18 $ 1.89 $ 1.03
Pro forma $ 2.13 $ 1.85 $ .99
Diluted earnings
per share:
As reported $ 2.15 $ 1.86 $ 1.02
Pro forma $ 2.10 $ 1.82 $ .99
The per share weighted-average fair value of options granted
during 1998, 1997 and 1996 was $7.23, $5.36 and $3.83,
respectively. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions used for grants
in 1998, 1997 and 1996, respectively: dividend yield of 1.88%,
2.34% and 2.87%; expected volatility of 27.53%, 26.06% and
26.13%; risk-free interest rate of 5.62%, 6.65% and 6.4%; and an
expected life of 5.32 years, 5.75 years and 6.5 years.
Fixed Stock Option Plans
- ------------------------
Harleysville Group has an Equity Incentive Plan (EIP) for
key employees. Awards may be made in the form of stock options,
stock appreciation rights (SARs), restricted stock or any
combination of the above. The EIP was amended in 1997 and
limited future awards to an aggregate of 4,260,946 shares of
Harleysville Group Inc.'s common stock. The plan provides that
stock options may become exercisable from six months to 10 years
from the date of grant with an option price not less than fair
market value on the date of grant. The options normally vest 50%
at the end of one year and 50% at the end of two years from the
date of grant. SARs have not been material.
The income tax benefit related to the difference between the
market price at the date of exercise and the option price for non-
qualified stock options was credited to additional paid-in
capital.
36
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11 - INCENTIVE PLANS (continued)
The Harleysville Group Inc. 1995 Directors' Stock Option
Program provides for the granting of options to eligible
directors to purchase a maximum of 130,000 shares of common
stock. Options are granted at exercise prices equal to fair
market value on the date of grant. The options vest and become
exercisable as follows: 20% six months after the date of grant
and thereafter 20% per year of active service. The options have
a term of 10 years.
Harleysville Group maintains stock option plans for
substantially all employees and certain designated agents. The
plans provide for the granting of options to purchase a maximum
of 850,000 shares of common stock. The plans provide that the
options become exercisable from three to 10 years from the date
of grant with an option price not less than fair market value on
the date of grant.
Information regarding activity in Harleysville Group's fixed
stock option plans is presented below:
WEIGHTED-AVERAGE
NUMBER EXERCISE PRICE
OF SHARES PER SHARE
---------- ----------------
Outstanding at
December 31, 1995 1,883,524 $11.17
Granted--1996 313,520 13.27
Exercised--1996 (259,478) 7.16
Forfeited--1996 (40,200) 13.43
--------- ------
Outstanding at
December 31, 1996 1,897,366 12.01
Granted--1997 318,212 17.94
Exercised--1997 (377,622) 10.03
Forfeited--1997 (49,744) 13.43
--------- ------
Outstanding at
December 31, 1997 1,788,212 13.45
Granted--1998 334,870 24.49
Exercised--1998 (147,557) 11.86
Forfeited--1998 (25,296) 16.25
--------- ------
Outstanding at
December 31, 1998 1,950,229 $15.42
========= ======
Exercisable at:
December 31, 1996 1,397,906 $11.67
========= ======
December 31, 1997 1,292,018 $12.39
========= ======
December 31, 1998 1,445,877 $13.10
========= ======
37
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11 - INCENTIVE PLANS (continued)
The following table summarizes information about fixed stock
options at December 31, 1998:
Range of Exercise Prices
-----------------------------------------
$7.07-10.25 $11.13-13.75 $14.00-24.50
----------- ------------ ------------
Options outstanding at
December 31, 1998:
Number of options 144,426 1,099,875 705,928
========== ========== ==========
Weighted-average
remaining contractual
life 2.3 years 5.5 years 8.5 years
========== ========== ==========
Weighted-average
exercise price $8.71 $12.95 $20.65
========== ========== ==========
Options exercisable at
December 31, 1998:
Number of options 144,426 1,082,127 219,324
========== ========== ==========
Weighted-average
exercise price $8.71 $12.96 $16.69
========== ========== ==========
Other Stock Purchase and Incentive Plans
- ----------------------------------------
Harleysville Group Inc. is authorized to issue up to 1,000,000
shares of common stock under the terms of the 1995 Employee Stock
Purchase Plan. Virtually all employees are eligible to
participate in the plan, under which a participant may elect to
have up to a maximum of 15% of base pay withheld to purchase
shares. The purchase price of the stock is 85% of the lower of
the beginning-of-the-subscription period or end-of-the-
subscription period fair market value. Each subscription period
runs from January 15 through July 14, or July 15 through
January 14. Under the plan, Harleysville Group Inc. issued
93,991, 97,424 and 99,790 shares to employees in 1998, 1997 and
1996, respectively.
38
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11 - INCENTIVE PLANS (continued)
Under Harleysville Group Inc.'s 1995 Agency Stock Purchase
Plan, eligible independent insurance agencies may invest up to
$12,500 in shares of common stock at 90% of the fair market value
at the end of each six-month subscription period. There are
1,000,000 shares of common stock available under the plan.
There were 53,706, 38,671 and 73,864 shares issued under the plan
for which $84,000, $45,000 and $69,000 of expense was recognized
in 1998, 1997 and 1996, respectively.
The 1996 Directors' Stock Purchase Plan provides for the
issuance of up to 200,000 shares of Harleysville Group Inc.
common stock to outside directors of Harleysville Group Inc. and
Mutual. The purchase price of the stock is 85% of the lower of
the beginning-of-the-subscription period or end-of-the-
subscription period fair market value. In 1998 and 1997
respectively, there were 17,880 and 32,538 shares issued under
the plan for which $67,000 and $126,000 of expense was
recognized. There were no shares issued prior to 1997.
The Harleysville Group Inc. Directors' Equity Award Program,
which was adopted in 1996, granted directors a one-time award
totaling 45,168 shares of restricted common stock with a fair
value of $13.25 per share. Under the terms of the program, the
shares may not be transferred until the director retires after
attaining age 72, dies or becomes disabled. The director has
the right to receive dividends and the right to vote the shares
during the restriction period. Compensation expense of $41,000,
$56,000 and $31,000 associated with this award program was
recognized in 1998, 1997 and 1996, respectively.
Harleysville Group has incentive bonus plans. Cash bonuses
are earned on a formula basis depending upon the performance of
Harleysville Group and Mutual in relation to certain targets.
Harleysville Group's expense for such plans was $1,230,000,
$842,000 and $627,000 for 1998, 1997 and 1996, respectively.
12 - PENSION AND OTHER BENEFIT PLANS
Harleysville Group Inc. has a pension plan that covers
substantially all full-time employees. Retirement benefits are a
function of both the years of service and level of compensation.
Harleysville Group Inc.'s funding policy is to contribute
annually an amount equal to at least the minimum required
contribution in accordance with minimum funding standards
established by ERISA. Contributions are intended to provide not
only for benefits attributed to service to date, but also for
those expected to be earned in the future.
39
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - PENSION AND OTHER BENEFIT PLANS (Continued)
The following table sets forth the year-end status of the
plan including Mutual:
1998 1997
-------- --------
(in thousands)
Change in benefit obligation
Benefit obligation at January 1 $ 86,648 $ 69,133
Service cost 4,325 3,913
Interest cost 6,277 5,465
Amendments 1,907
Net actuarial loss 3,722 5,710
Acquisition 4,191
Benefits paid (2,768) (2,219)
Release of liability due to
annuity purchase (1,452)
-------- --------
Benefit obligation at
December 31 $ 98,204 $ 86,648
======== ========
Change in plan assets
Fair value of plan assets at
January 1 $ 87,154 $ 63,161
Actual return on plan assets 27,781 20,866
Employer contributions 925 3,253
Acquisition 3,353
Benefits paid (2,603) (2,027)
Annuity purchase (1,452)
-------- --------
Fair value of plan assets
at December 31 $113,257 $ 87,154
======== ========
Funded status $ 15,053 $ 506
Unrecognized net actuarial
gain (32,073) (13,438)
Unrecognized prior service cost 3,438 4,075
Unrecognized transition obligation
(asset) 51 (66)
-------- --------
Accrued pension cost $(13,531) $ (8,923)
======== ========
40
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - PENSION AND OTHER BENEFIT PLANS (Continued)
The net periodic pension cost for the plan including Mutual
includes the following components:
1998 1997 1996
-------- -------- --------
(in thousands)
Components of net periodic
pension cost:
Service cost $ 4,325 $ 3,913 $ 3,772
Interest cost 6,277 5,465 4,728
Expected return on
plan assets (5,683) (4,464) (3,826)
Recognized net
actuarial loss 257 346 612
Amortization of prior
service cost 637 457 457
Amortization of
transition asset (117) (117) (117)
------- ------- -------
Net periodic pension cost:
Entire plan $ 5,696 $ 5,600 $ 5,626
======= ======= =======
Harleysville Group
portion $ 3,754 $ 3,601 $ 3,504
======= ======= =======
1998 1997 1996
--------- -------- --------
Weighted-average assumptions
as of December 31
Discount rate 7.00% 7.25% 7.75%
Expected long-term rate
of return on plan
assets 9.00% 8.50% 8.50%
Rate of compensation
increase 4.50% 4.50% 5.00%
Harleysville Group has profit-sharing plans covering
qualified employees. Harleysville Group's expense under the
plans was $2,869,000, $2,450,000 and $1,526,000 for 1998, 1997
and 1996, respectively.
41
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13 - SEGMENT INFORMATION
In 1998, Harleysville Group adopted SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related
Information," which establishes standards for reporting
information about operating segments. As an underwriter of
property and casualty insurance, Harleysville Group has three
reportable segments, which consist of the investment function,
the personal lines of insurance and the commercial lines of
insurance. Using independent agents, Harleysville Group markets
personal lines of insurance to individuals and commercial lines
of insurance to small and medium-sized businesses.
Harleysville Group evaluates the performance of the personal
lines and commercial lines primarily based upon underwriting
results as determined under statutory accounting practices (SAP)
for the total pooled business of Harleysville Group and Mutual.
The following tables reflect the total pooled business plus the
business of Minnesota Fire and Lake States before they began
participation in the pool on January 1, 1998 and 1997,
respectively. The eliminations reflect the share of the total
pooled business not retained by Harleysville Group and the effect
of the catastrophe reinsurance agreement between Harleysville
Group and Mutual. Assets are not allocated to the personal and
commercial lines, and are reviewed in total by management for
purposes of decision making. Harleysville Group operates only in
the United States, and no single customer or agent provides 10
percent or more of revenues.
Financial data by segment is as follows:
1998 1997 1996
--------- --------- ---------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $ 560,551 $ 542,632 $ 555,750
Personal lines 366,712 349,701 331,866
Eliminations (262,659) (267,428) (272,419)
--------- --------- ---------
Total premiums earned 664,604 624,905 615,197
Net investment income 86,025 81,783 78,008
Realized investment
gains 16,085 6,541 3,182
Other 12,597 10,950 11,038
--------- --------- ---------
Total revenues $ 779,311 $ 724,179 $ 707,425
========= ========= =========
Income before income taxes:
Underwriting income (loss):
Commercial lines $ (55,873) $ (32,088) $ (28,709)
Personal lines (22,424) 2,132 (53,893)
Eliminations 49,750 10,793 23,697
--------- --------- ---------
SAP underwriting
loss (28,547) (19,163) (58,905)
GAAP adjustments 4,950 (3,119) 7,327
--------- --------- ---------
GAAP underwriting
loss (23,597) (22,282) (51,578)
Net investment income 86,025 81,783 78,008
Realized investment
gains 16,085 6,541 3,182
Other 1,928 1,239 1,763
--------- --------- ---------
Income before income taxes $ 80,441 $ 67,281 $ 31,375
========= ========= =========
42
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
14 - EARNINGS PER SHARE
The computation of basic and diluted earnings per share is
as follows:
1998 1997 1996
--------- -------- --------
(dollars in thousands, except per share data)
Numerator for basic
and diluted earnings
per share:
Net income $ 63,413 $ 54,072 $ 28,680
======== ======== ========
Denominator for basic
earnings per share --
weighted-average
shares outstanding 29,029,410 28,573,192 27,844,116
Effect of stock
incentive plans 490,545 458,846 236,330
-------- -------- --------
Denominator for
diluted earnings
per share 29,519,955 29,032,038 28,080,446
========== ========== ==========
Basic earnings
per share $ 2.18 $ 1.89 $ 1.03
======== ======== ========
Diluted earnings
per share $ 2.15 $ 1.86 $ 1.02
======== ======== ========
43
<PAGE>
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
15 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
1998
-------------------------------------------------
(in thousands, except per share data)
FIRST SECOND THIRD FOURTH TOTAL
--------- -------- -------- -------- ---------
Revenues $190,505 $194,022 $192,645 $202,139 $779,311
Losses and
expenses 173,226 172,810 175,201 177,633 698,870
Net income 13,902 16,552 14,153 18,806 63,413
Earnings per
common share:
Basic $ .48 $ .57 $ .49 $ .65 $ 2.18
Diluted $ .47 $ .56 $ .48 $ .64 $ 2.15
1997
-------------------------------------------------
(in thousands, except per share data)
FIRST SECOND THIRD FOURTH TOTAL
--------- -------- -------- -------- ---------
Revenues $180,182 $178,754 $179,893 $185,350 $724,179
Losses ab=nd
expenses 167,368 162,491 159,583 167,456 656,898
Net income 10,832 13,164 15,830 14,246 54,072
Earnings per
common share:
Basic $ .38 $ .46 $ .55 $ .50 $ 1.89
Diluted $ .38 $ .46 $ .54 $ .49 $ 1.86
44
<PAGE>
Independent Auditors' Report
The Board of Directors
and Shareholders
Harleysville Group Inc.:
We have audited the accompanying consolidated balance sheets of
Harleysville Group as of December 31, 1998 and 1997, and the
related consolidated statements of income, shareholders' equity,
and cash flows for each of the years in the three-year period
ended December 31, 1998. These consolidated financial statements
are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on 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 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 Harleysville Group as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/KPMG LLP
Philadelphia, Pennsylvania
February 15, 1999
45
<PAGE>
EXHIBIT 13(E)
MARKET FOR COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The stock of Harleysville Group Inc. is quoted on the NASDAQ
National Market System, and assigned the symbol HGIC. At the
close of business on March 2, 1999, the approximate number of
holders of record of Harleysville Group Inc.'s common stock was
2,171 (counting all shares held in single nominee registration as
one shareholder).
The payment of dividends is subject to the discretion of
Harleysville Group Inc.'s Board of Directors which each quarter
considers, among other factors, Harleysville Group's operating
results, overall financial condition, capital requirements and
general business conditions. The present quarterly dividend of
$0.125 per share paid in each of the third and fourth quarters of
1998 is expected to continue during 1999. As a holding company,
one of Harleysville Group Inc.'s sources of cash with which to
pay dividends is dividends from its subsidiaries. Harleysville
Group Inc.'s insurance company subsidiaries are subject to state
laws that restrict their ability to pay dividends. See Note 9 of
the Notes to Consolidated Financial Statements.
The following table sets forth the amount of cash dividends
declared per share, and the high and low bid quotations as
reported by NASDAQ for Harleysville Group Inc.'s common stock for
each quarter during the past two years.
CASH
DIVIDENDS
1998 HIGH LOW DECLARED
-----------------------------------------------------
First Quarter $26.88 $21.13 $.115
Second Quarter 28.13 20.38 .115
Third Quarter 27.00 19.00 .125
Fourth Quarter 25.81 17.25 .125
-----------------------------------------------------
CASH
DIVIDENDS
1997 HIGH LOW DECLARED
-----------------------------------------------------
First Quarter $15.90 $14.65 $.105
Second Quarter 17.98 16.52 .105
Third Quarter 20.98 19.10 .115
Fourth Quarter 26.52 22.00 .115
-----------------------------------------------------
46
<PAGE>
EXHIBIT (21)
SUBSIDIARIES OF REGISTRANT
Registrant owns 100% of the outstanding stock of each of the following
corporations:
NAME STATE OF INCORPORATION
--------------------------------------- ----------------------
Great Oaks Insurance Company Ohio
Harleysville-Atlantic Insurance Company Georgia
Harleysville Insurance Company
of New Jersey New Jersey
Huron Insurance Company Pennsylvania
Lake States Insurance Company Michigan
Mid-America Insurance Company Connecticut
Minnesota Fire and Casualty Company Minnesota
New York Casualty Insurance Company New York
Worcester Insurance Company Massachusetts
1
<PAGE>
EXHIBIT (23)
INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES
The Board of Directors
Harleysville Group Inc.
The audits referred to in our report dated February 15, 1999
include the related financial statement schedules as of December
31, 1998, and for each of the years in the three-year period
ended December 31, 1998, included in the annual report on Form 10-
K. 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.
We consent to incorporation by reference in the registration
statements (Nos. 333-03127, 33-84348, 33-43494, 33-91718, 33-
91726, 33-43532) on Form S-8 and registration statements (Nos. 33-
78372, 33-90810, 33-91720) on Form S-3 of Harleysville Group Inc.
of our report dated February 15, 1999, relating to the
consolidated balance sheets of Harleysville Group Inc. as of
December 31, 1998 and 1997, and the related consolidated
statements of income, shareholders' equity and cash flows and
related financial statement schedules for each of the years in
the three-year period ended December 31, 1998, which report
appears in the December 31, 1998 annual report on Form 10-K of
Harleysville Group Inc., and of our report dated March , 1999
relating to the statements of financial condition of the
Harleysville Group Inc. Employee Stock Purchase Plan as of
December 31, 1998 and 1997, and the related statements of income
and changes in plan equity for each of the years in the three-
year period ended December 31, 1998, which report appears in the
Harleysville Group Inc. Employee Stock Purchase Plan annual
report on Form 11-K.
/s/KPMG LLP
Philadelphia, Pennsylvania
March 25, 1999
<PAGE>
EXHIBIT (99)
FORM 11-K
FOR ANNUAL REPORTS OF EMPLOYEE STOCK PURCHASE, SAVINGS
AND SIMILAR PLANS PURSUANT TO SECTION 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1998
-------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
-------------- ---------------
Commission file number 0-14697
------------------
A. Full title of the plan and the address of the
plan, if different from that of the issuer named below:
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
B. Name of issuer of the securities held pursuant to
the plan and the address of its principal executive
office:
Harleysville Group Inc.
355 Maple Avenue
Harleysville, Pennsylvania 19438-2297
<PAGE>
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
FORM 11-K
DECEMBER 31, 1998
Financial Statements
- --------------------
Page
----
Independent Auditors' Report 3
Statements of Financial Condition
as of December 31, 1998 and
1997 4
Statements of Income and Changes in
Plan Equity for each of the years
in the three-year period ended
December 31, 1998 5
Notes to Financial Statements 6
Schedules -
Schedules I, II and III have been
omitted because they are not
required, are not applicable,
or the required information is
shown in the financial statements
or notes thereto.
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Administrative Committee
Harleysville Group Inc.
Employee Stock Purchase Plan:
We have audited the accompanying statements of financial
condition of Harleysville Group Inc. Employee Stock Purchase Plan
as of December 31, 1998 and 1997, and the related statements of
income and changes in plan equity for each of the years in the
three-year period ended December 31, 1998. These financial
statements are the responsibility of the Plan's management. Our
responsibility is to express an opinion on these financial
statements based on 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 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 financial statements referred to above
present fairly, in all material respects, the financial condition
of the Harleysville Group Inc. Employee Stock Purchase Plan as of
December 31, 1998 and 1997, and the income and changes in its
plan equity for each of the years in the three-year period ended
December 31, 1998 in conformity with generally accepted
accounting principles.
/s/KPMG LLP
Philadelphia, Pennsylvania
March 16, 1999
3
<PAGE>
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
STATEMENTS OF FINANCIAL CONDITION
AS OF
DECEMBER 31,
-------------------------
1998 1997
-------- --------
Assets
- ------
Receivable from affiliate $946,560 $676,722
======== ========
Plan Equity
- -----------
Net assets available for
plan participants $946,560 $676,722
======== ========
See accompanying notes to financial statements.
4
<PAGE>
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
STATEMENTS OF INCOME AND CHANGES IN PLAN EQUITY
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
----------- ----------- ----------
Contributions - Employees $ 1,942,663 $ 1,355,248 $ 1,179,486
Purchase and distribution
of Harleysville Group Inc.
stock to employees (1,616,818) (1,174,483) (1,102,646)
Employee withdrawals and
terminations (56,007) (46,810) (28,108)
----------- ----------- -----------
Net increase 269,838 133,955 48,732
Plan equity beginning
of year 676,722 542,767 494,035
----------- ----------- -----------
Plan equity end of year $ 946,560 $ 676,722 $ 542,767
=========== =========== ===========
See accompanying notes to financial statements.
5
<PAGE>
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounts of the plan are maintained on the accrual
basis. The receivable from affiliate represents the biweekly
contributions from employees which are made in the form of
regular payroll deductions and are recorded by the plan after
each biweekly pay period.
2. Description of the Plan
All regular full-time employees and regular part-time
employees who work at least twenty hours a week are eligible to
participate in the plan.
Eligible employees must authorize a payroll deduction equal
to no more than 15 percent of their base pay during the
enrollment periods to participate in the plan. The enrollment
periods are the 1st through 14th day of January and July of each
plan year. Once enrolled, an eligible employee will continue to
participate in the plan for each succeeding subscription period
until the employee terminates participation or ceases to be an
eligible employee.
Each subscription period will run from January 15 through
July 14 or from July 15 through January 14. At the close of each
pay period, the amount to be deducted from each participant's
base pay will be credited to such participant's plan account. On
the last day of each subscription period, the amount credited to
each participant's plan account will be divided by the
subscription price for that subscription period and the
participant's account will be credited with the number of the
whole and fractional shares which results. Participants may
request such shares to be issued in certificate form.
If a participant desires to change the rate of contribution
the participant may do so effective for the next subscription
period by filing a new subscription agreement during the
applicable enrollment period. At any time, a participant may
withdraw from the plan and receive cash for the amount deducted
from the participant's base pay during that subscription period
by giving written notice to the Company. Separation from
employment for any reason including death, disability or
retirement shall be treated as an automatic withdrawal from the
plan.
At December 31, 1998, there were 940 participants in the
plan.
6
<PAGE>
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
NOTES TO FINANCIAL STATEMENTS
(Continued)
3. INVESTMENT
The contributions credited to the participant's account are
used to purchase shares of Harleysville Group Inc. common stock
at a specified subscription price. The subscription price for
each share of common stock shall be the lesser of 85 percent of
the fair market value of such shares on the last trading day
before the first day of the subscription period or 85 percent of
the fair market value of such share on the last day of the
subscription period. The fair market value of a share shall be
the closing price as reported on the NASDAQ National Market
System on the applicable date. The total number of shares to be
made available under the plan is 1,000,000 shares of common stock
of the Company.
4. TAX STATUS
The plan is intended to qualify under the provisions of
Section 423 of the Internal Revenue Code. No income will be
realized for federal income tax purposes by a participant upon
the purchase of shares under the plan. Tax consequences to the
Company and to plan participants upon disposition of shares under
the plan vary depending on the length of time held and fair
market value at time of disposition.
5. PLAN TERMINATION
The plan will be in effect until the earlier of July 31,
2005 or the date on which plan participants have subscribed for
the total number of shares available for purchase under the plan.
At December 31, 1998, there are approximately 595,585 shares that
remain available for issuance under the plan. During the
effective duration of the plan, there will be twenty subscription
periods.
6. SUBSEQUENT EVENT
On January 15, 1999, 55,593 shares of stock were purchased
at a subscription price of $18.38 per share on behalf of the plan
participants for the subscription period ended January 14, 1999.
7
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the trustees (or other persons who administer the plan)
have duly caused this annual report to be signed by the
undersigned hereunto duly authorized.
HARLEYSVILLE GROUP INC.
EMPLOYEE STOCK PURCHASE PLAN
Date: March 25, 1999 By: /s/BRUCE J. MAGEE
------------------- -----------------------------
Bruce J. Magee, Member,
Administrative Committee for
Harleysville Group Inc.
Employee Stock Purchase Plan
8
<PAGE>
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<NAME> HARLEYSVILLE GROUP INC.
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<PERIOD-END> DEC-31-1998
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0
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<UNDERWRITING-AMORTIZATION> 169,567
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<INCOME-PRETAX> 80,441
<INCOME-TAX> 17,028
<INCOME-CONTINUING> 63,413
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<RESERVE-OPEN> 793,563
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