<PAGE> 1
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
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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 1-9640
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MERCHANTS GROUP, INC.
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(Exact name of registrant as specified in its charter)
Delaware 16-1280763
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 Main Street, Buffalo, New York 14202
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (716) 849-3333
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Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
Name of each exchange on
Title of each class which registered
- ------------------- ----------------
<S> <C>
Common Stock, $.01 American Stock Exchange, Inc.
par value per share
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
NONE
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. X Yes 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
---
As of March 17, 1997, 2,999,602 shares of common stock were outstanding.
The aggregate market value of the common shares held by non-affiliates of
Merchants Group, Inc. on March 1, 1997 was $47,797,840.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 1997 Annual Meeting of
Stockholders are incorporated by reference into Part III.
<PAGE> 2
MERCHANTS GROUP, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 1996
<TABLE>
<CAPTION>
PART I PAGE
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<S> <C> <C>
ITEM 1. BUSINESS. 3
ITEM 2. PROPERTIES. 24
ITEM 3. LEGAL PROCEEDINGS. 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 26
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED 27
STOCKHOLDER MATTERS.
ITEM 6. SELECTED FINANCIAL DATA. 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 30
CONDITION AND RESULTS OF OPERATIONS.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 38
ACCOUNTING AND FINANCIAL DISCLOSURE.
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. 39
ITEM 11. EXECUTIVE COMPENSATION. 39
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 39
AND MANAGEMENT.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 39
PART IV
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ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 40
REPORTS ON FORM 8-K.
</TABLE>
2
<PAGE> 3
PART I
Item 1. BUSINESS.
General
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Merchants Group, Inc. (the "Company") was incorporated in August 1986 as a
Delaware holding company which, through its wholly owned subsidiary Merchants
Insurance Company of New Hampshire, Inc. ("MNH"), offers property and casualty
insurance to preferred risk individuals and small to medium size businesses in
the northeastern United States.
Administration
- --------------
The Company and MNH operate and manage their business in conjunction with
Merchants Mutual Insurance Company ("Mutual"), a New York domiciled mutual
property and casualty insurance company, under a management agreement (the
"Management Agreement"). The Company and MNH do not have any significant
operating assets and have no employees. Under the Management Agreement, Mutual
provides the Company and MNH with the facilities, management and personnel
required to operate their day-to-day business, including investment management.
All costs incurred by Mutual with respect to underwriting expenses are shared
pro rata between Mutual and MNH based upon their annual direct premiums written,
and unallocated loss adjustment expenses are allocated on the basis of the
number of claims outstanding each month that are attributable to each company.
All of Mutual's and MNH's investment expenses are shared pro rata based upon the
average book value of the invested assets of each company. MNH also pays Mutual
an annual management fee of $50,000. The Management Agreement requires that the
Company and MNH pay Mutual 110% of Mutual's costs of providing them with
non-insurance related services, and that the Company pay Mutual an annual fee of
one half of one percent (.5%) of the average book value of the Company's
invested assets exclusive of the Company's shares of MNH. Since the inception of
the Management Agreement, Mutual has not provided the Company or MNH with any
non-insurance related services.
The Management Agreement is designed to prevent conflicts of interest or to
deal with them on an equitable basis should they occur. Generally, business
opportunities which are presented to the common officers or employees of the
companies must be presented to each company's Board of Directors and approved
and determined to be fair to each company in the transaction by a majority of
the directors of each company who are not affiliated with any other company in
the transaction.
3
<PAGE> 4
Any amendment or modification of the Management Agreement must be approved
by the New York Insurance Department. The Management Agreement may be terminated
by any party to the agreement upon five years written notice to each of the
other parties. Mutual and MNH have jointly developed and paid for all
accounting, computer and insurance marketing systems used in their businesses.
In the event of termination of the Management Agreement, each company has a
right, at no cost, to obtain copies of all these systems, together with the
right to use these systems in perpetuity.
From 1975 through 1984, MNH and Mutual pooled their insurance businesses
pursuant to a pooling agreement (the "Pooling Agreement"). Prior to January 1,
1983, premiums and losses were allocated 10% to MNH and 90% to Mutual;
thereafter, pursuant to an amendment to the Pooling Agreement, the respective
pooling percentages were 25% for MNH and 75% for Mutual.
The Pooling Agreement was terminated effective December 31, 1984. The
termination provided for the runoff of unearned premiums, losses and expenses
associated with insurance contracts effective prior to January 1, 1985 according
to the pooling percentages set forth in the Pooling Agreement. For insurance
contracts effective subsequent to December 31, 1984, premiums written and
related premiums earned, losses and loss adjustment expenses ("LAE"),
commissions, premium taxes, and assessments are retained by the company which
issues the insurance policies.
Marketing
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The Company markets its products through approximately 660 independent
agents, which also represent Mutual. The Company primarily directs its marketing
efforts to its independent agents and believes the more closely it works with
those agents, the more likely it becomes that the agents will place business
with the Company. The Company believes the opportunity for growth exists through
further penetration of existing agents' new and renewal business, as well as
selective expansion of this group of agents in the future.
The Company believes that as a regional insurance company, it has certain
advantages, including a closer relationship with its agents and a better
knowledge of its operating territories, that enable it to compete effectively
against larger national carriers. The Company believes it distinguishes itself
from its competitors by providing its agents and policyholders with superior
service, products that target the preferred segment of the commercial and
personal insurance markets, and an agents' compensation program which, in
addition to standard commission rates, provides agents with a profit sharing
plan and bonus commissions for certain commercial lines of business.
4
<PAGE> 5
The Company services its agents from five Strategic Business Centers and
from its home office in Buffalo, New York. The Strategic Business Centers are
located in the Company's operating territories and focus primarily on policy
sales and underwriting. The manager of a Strategic Business Center appoints new
agents, agrees upon annual unit sales and premium objectives with the principal
of the agency, and ensures that the principal of the agency communicates these
objectives to the agency's sales staff. Strategic Business Center managers and
Agency Business Managers, or "ABM's," develop customized business plans for each
agent, which identify the opportunities to increase business and the actions
required to achieve the objectives agreed to by the agent and the Company.
In each of its Strategic Business Centers, the Company uses ABM's who are
trained underwriters with at least five years of underwriting experience. ABM's
meet with an agent's sales staff on a frequent basis to underwrite the Company's
renewal policies, as well as to solicit and underwrite policies new to the agent
and/or to the Company. ABM's are equipped with electronic technology to provide
prompt and efficient pricing and communication and can provide quotes for
substantially all lines of business at the agents' offices. The Company believes
personal contact between ABM's, who have underwriting authority, and an agent's
sales staff provides the Company with a competitive advantage compared to many
other property and casualty insurers, whose field representatives have no
underwriting authority. By placing its underwriting decision maker in the
agent's office, and thereby simplifying the underwriting process, the Company
believes it can improve the retention rate on its renewal policies, as well as
attract new policies.
Each Strategic Business Center has an Agents' Advisory Council that meets
at least twice a year. The Advisory Councils provide a forum for the Company and
its agents to discuss issues of mutual interest, and to assure that the agents'
business needs are being met. Additionally, the Chairmen of the Advisory
Councils from each Strategic Business Center meet twice a year with senior
officers of the Company.
In addition to standard commissions paid as a percentage of premiums
written, the Company's agents are eligible to participate in the Agents' Profit
Sharing Plan, which rewards agents based on premiums written and a two year loss
and allocated LAE ratio on business placed by the agent with the Company.
Payments under the Agents' Profit Sharing Plan for 1996 totalled $1,505,000 or
1.5% of direct premiums written, and increased participating agents' commissions
received from the Company by approximately 26%. The Company believes the terms
of its Agents' Profit Sharing Plan encourage its agents to increase the volume
of profitable business they place with the Company. In June 1994, the Company
instituted an Agent's Stock Option Program for MNH's agents which granted
options to purchase 22,500 shares of the Company's common stock to 54 agencies
based on their volume and profitability. The Company
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believes the Agent's Stock Option Program aligns the interests of its agents
more closely with the interests of the Company and its stockholders.
Unlike many of its competitors, the Company pays the same commission rate
on policies billed directly to the insured by the Company and on policies billed
to the agent and, in turn, re-billed to the insured by the agent. By offering to
bill the insured directly for both personal and commercial policies, the Company
helps its agents minimize their administrative costs without a reduction in
commission income. Approximately 75% of the voluntary premiums written by the
Company in 1995 and 1996 were billed directly to policyholders.
In order to assist its independent agents to compete more effectively with
insurance companies that have direct sales forces, and to strengthen its
relationship with those agents, the Company is providing advanced automation
services, such as download capability, to many of its agents. Download
capability, the electronic transmission of policy transactions from a company to
an agency database, is a significant step in helping agents and the Company
achieve the goal of single-entry, multiple company interface. The benefits to
agents are simplified client management, more time available for sales
activities, and fewer errors. Currently, the Company is downloading policy
transactions to approximately 80 agents for private passenger automobile and
homeowners' policies. The Company plans to offer download capability for
commercial insurance policies when the property and casualty insurance industry
adopts standards for downloading. The Company believes that developing
automation capabilities to facilitate the sharing of information with its agents
will improve its competitive position compared to other property and casualty
insurers that do not have such capabilities.
Insurance Underwriting
- ----------------------
The Company is licensed to issue insurance policies in 13 states, primarily
in the northeastern United States. In 1996, net premiums written totaled
$96,622,000, with 55% of the net premiums written derived from commercial lines
of insurance and 45% from personal lines of insurance.
6
<PAGE> 7
The following table sets forth the distribution of the Company's direct
premiums written by state for the years indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
New York 65% 64% 64%
New Jersey 11 14 15
New Hampshire 12 11 11
Rhode Island 4 4 3
Pennsylvania 3 3 3
Massachusetts 3 3 3
Other 2 1 1
--- --- ---
Total 100% 100% 100%
=== === ===
</TABLE>
The Company is licensed to underwrite most major lines of property and
casualty insurance. It issues policies primarily to preferred individuals and
small to medium size commercial risks. In general, the Company does not insure
risks that involve a high potential of loss or have a long-tail reporting
period. The types of risks insured in the Company's lines of business include:
* Personal automobile - full coverage of family-owned standard performance
automobiles, generally requiring drivers with no violations or at-fault
accidents in the last three years, and minimal youthful operator exposure.
* Homeowners' - properties generally with no losses in the last three years
that are less than 30 years old and valued between $75,000 and $300,000.
* Commercial automobile - primarily light and medium use vehicles operating
in a limited radius, with complete background information required of all
drivers.
* Commercial multi-peril - properties with medium to high construction
quality and low to moderate fire exposure, and occupancies with low to moderate
exposure to hazardous materials and processes.
* General liability - low hazard service, mercantile and light processing
businesses, generally with no losses in the last three years and with three
years of business experience.
* Workers' compensation - risks with low loss frequency and severity, low
to moderate exposure to hazardous materials and processes, and favorable
experience modification factors. Generally, workers' compensation insurance is
written in conjunction with other commercial insurance.
7
<PAGE> 8
The Company's underwriting strategy is to offer its insurance at rates
which are designed to cover its costs, including the costs of any involuntary
business associated with a particular line of insurance or a particular
territory. This pricing strategy makes the Company's rates non-competitive with
respect to certain lines of insurance or certain geographic regions. For
example, the Company's published rates for personal automobile insurance in the
New York City metropolitan area and other densely populated areas within its
region of operations are significantly higher than those of some of its
competitors. The Company believes that its pricing strategy allows the Company
to write the types of insurance for which the price charged reflects the cost of
providing coverage.
Agents of the Company are also agents of Mutual, which generally sells the
same lines of insurance as the Company to standard risk individuals and
businesses. Applicants that meet the Company's preferred risk criteria are
issued policies by the Company. Applicants that do not meet the Company's
underwriting criteria, but which meet the less restrictive criteria of Mutual,
are issued policies by Mutual, generally at higher premium rates. During the
years 1993 through 1995, under a quota share agreement with Mutual, the Company
assumed 10% of the standard risks insured by Mutual, which would not generally
meet the Company's more stringent underwriting guidelines. The terms of the
agreement allow Mutual to reduce its cessions to MNH to 0% of Mutual's direct
voluntary premiums written for any calendar year prior to the beginning of that
calendar year. Mutual did not cede any of its voluntary direct written premiums
to MNH under this agreement in 1996 and has informed the Company that it will
not cede any of its voluntary direct written premiums to MNH in 1997.
The Company establishes premium rates for most of its policies based on
loss experience, in some cases after considering prospective loss costs
suggested by the Insurance Services Office, Inc., an industry advisory group,
for the preferred individual and commercial classes of business that it insures.
The Company establishes rates independently for its personal automobile and
homeowners insurance policies and its specialty products, such as contractors
coverall and businessowners' policies.
8
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The following table shows, for each of the years in the three year period
ended December 31, 1996, (i) the amount of the Company's net premiums written
attributable to various personal lines and commercial lines and (ii)
underwriting results attributable to each such line as measured by the calendar
year loss ratio for such line. The loss ratio is the ratio of incurred losses to
net premiums earned for a given period.
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------------------------------
1994 1995 1996
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Premiums Premiums Premiums
Written Written Written
-------------------------------------------------------------------------------
Loss Loss Loss
Amount % Ratio Amount % Ratio Amount % Ratio
-------------------------------------------------------------------------------
(dollars in thousands
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Personal
Auto Liability $21,278 23.6% 79.2% $22,556 23.1% 78.2% $23,964 24.8% 80.9%
Auto Physical
Damage 10,603 11.8 53.0 11,546 11.8 52.1 12,241 12.7 60.3
Homeowners'
Multi-Peril 5,808 6.4 76.5 6,606 6.8 77.8 7,269 7.5 68.1
------- ---- ------- ---- ------- ----
Total 37,689 41.8 71.5 40,708 41.7 70.7 43,474 45.0 73.1
Commercial
Auto Liability 12,572 13.9 74.9 13,496 13.8 69.5 13,050 13.5 43.4
Auto Physical
Damage 2,918 3.2 41.1 3,047 3.1 51.8 3,225 3.3 51.7
Commercial
Multi-Peril 19,034 21.1 76.4 20,845 21.4 71.3 20,725 21.5 59.9
Workers'
Compensation 10,229 11.3 54.0 12,223 12.5 94.7 10,023 10.4 110.7
Other Lines 7,745 8.7 58.8 7,258 7.5 56.0 6,125 6.3 57.4
------- ---- ------- ---- ------- ----
Total 52,498 58.2 67.1 56,869 58.3 72.7 53,148 55.0 63.5
------- ---- ------- ---- ------- ----
Total Personal
and Commercial $90,187 100.0% 68.9% $97,577 100.0% 71.9% $96,622 100.0% 67.7%
======= ==== ======= ==== ======= ====
</TABLE>
Calendar year loss ratios set forth in the table above include an estimate
of losses for that accident year, as well as increases or decreases made in that
year for prior accident year losses. Depending on the size of the increase in
prior accident year losses, calendar year ratios may not be as indicative of the
profitability of policies in force in a particular year as accident year ratios,
which do not take into account increases in reserves for prior accident year
losses.
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The following table sets forth the composition of voluntary direct premiums
written for 1992 through 1996:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial 57% 60% 62% 62% 60%
Personal 43 40 38 38 40
--- --- --- --- ---
Total 100% 100% 100% 100% 100%
=== === === === ===
</TABLE>
Commercial Lines
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The Company's commercial business is primarily retail and mercantile in
nature and generally consists of small to medium size, low hazard commercial
risks which as a group have relatively stable loss ratios. The Company's
underwriting criteria exclude lines of business and classes of risks that are
considered by the Company to be high hazard or volatile, or which involve latent
injury potential or other long-tail liability exposures. Although the commercial
underwriting objectives of the Company and Mutual are similar, the Company has
refined its selection criteria to include specific classes of businesses,
occupancies, and operations with lower hazard ratings, which present a
relatively lower exposure to loss and are charged a correspondingly lower
premium. The Company offers specialized products within the commercial
multi-peril line such as the Contractors Coverall Plus for artisan and trade
contractors, and BusinessElite for specified retail, service and office risks.
Despite the lack of significant premium rate increases since 1988 in most
of its commercial lines and the increased competition in the lines of business
that the Company targets, the Company believes it can insure commercial business
profitably by selecting those classes of risks that offer better profit
potential. The Company competes for commercial business based upon the service
it provides to agents and policyholders, the compensation it pays to its agents,
and in certain instances, the price of its products. The Company establishes
prices after considering its costs, the exposures inherent in a particular class
of risk, potential investment income, projected future trends in loss frequency
and severity, and the degree of competition within a specific territory.
Accordingly, the relative prices of the Company's commercial products vary
considerably in relation to competitors' prices.
Personal Lines
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The Company offers personal automobile and homeowners' insurance to
preferred risk individuals, generally requiring experienced drivers with no
accidents or moving violations in the last three years for personal automobile
insurance, and medium to high value homes with systems that are less than thirty
years old in fire protected areas for homeowners' insurance. Personal
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automobile premium rates attempt to cover costs associated with required
participation in involuntary personal automobile programs, in addition to the
costs directly associated with the policies written voluntarily.
The Company and Mutual have developed automated underwriting procedures for
personal automobile and homeowners business, which perform an initial review of
policy applications based upon established underwriting guidelines. Applications
that do not meet the guidelines for automated acceptance are either referred to
personal lines underwriters who review the applications and assess exposure, or
rejected if the risk characteristics are such that neither the Company nor
Mutual would accept the insured.
As a condition to writing voluntary business in most states in which it
operates, the Company must participate in state-mandated programs which provide
insurance for individuals and businesses unable to obtain insurance voluntarily,
primarily for personal automobile insurance. The legislation creating these
programs usually allocates a pro rata portion of the risks attributable to such
insureds to each company writing voluntary business in the state on the basis of
its voluntary premiums written or the number of automobiles which it insures
voluntarily.
The Company's gross (direct and assumed) premiums written attributable to
involuntary policies were $9,274,000, $11,317,000 and $11,325,000 in 1994, 1995
and 1996, respectively, mostly in New York. The Company is unable to predict the
level of its annual involuntary business for 1997 or future years.
Claims
- ------
Insurance claims on policies written by the Company are investigated and
settled by claims adjustors employed by Mutual pursuant to the Management
Agreement. The Company and Mutual maintain several claims offices within their
operating territories. In areas where there is insufficient claim volume to
justify the cost of internal claims staff, the Company and Mutual use
independent appraisers and adjustors to investigate and settle claims. The
Company's claims policy emphasizes timely investigation of claims, settlement of
meritorious claims for equitable amounts, maintenance of adequate reserves for
claims and control of external claims adjustment expenses. In order to support
its claims policy, the Company has implemented a program designed to ensure that
claims are assigned an accurate value, based on available information, as soon
as practical. The program includes the centralization of certain branch claims
operations and an emphasis on the training of claims adjustors and supervisors
by senior claims staff. This claims policy is designed to support the Company's
marketing policy and provide agents and policyholders with prompt service and
support.
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Claims settlement authority levels are established for each adjustor,
supervisor and manager based on their expertise and experience. When the Company
receives notice of a claim, it is assigned to an adjustor based upon its type,
severity and line of business. The claims staff then reviews the claim, obtains
appropriate documentation and establishes a loss reserve. Claims that exceed
certain dollar amounts or that cannot be readily settled are assigned to senior
claims staff.
Loss and LAE Reserves
- ---------------------
The Company, like other insurance companies, establishes reserves for
losses and LAE. These reserves are estimates intended to cover the probable
ultimate cost of settling all losses incurred and unpaid, including those losses
not yet reported to the Company. An insurer's ultimate liability is likely to
differ from such estimates because during the life of a claim, which may be many
years, additional facts affecting an insurer's liability may become known. The
reserves of an insurer are frequently adjusted based on monitoring by the
insurer and periodic review by state insurance departments. Since 1989, the
Company has retained an independent actuarial firm to satisfy state insurance
departments' requirements with respect to the certification of reserves for
losses and LAE.
Loss reserves are established for known claims based on the type and
circumstance of the loss and the results of similar losses. For claims not yet
reported to the Company, loss reserves are based on statistical information from
previous experience periods, adjusted for inflation, trends in court decisions
and economic conditions. LAE reserves are intended to cover the ultimate cost of
investigating all losses that have occurred and defending lawsuits, if any,
arising from such losses. LAE reserves are evaluated periodically using
statistical techniques which compare current costs with historical data.
Inflation is implicitly reflected in the reserving process through analysis of
cost trends, and review of historical reserve results. With the exception of an
immaterial amount relating to workers' compensation claims, loss reserves are
not discounted for financial statement purposes.
The Company's reserving process is based on the assumption that past
experiences, adjusted for the effect of current developments and trends, are
relevant in predicting future events. In the absence of specific developments,
the process also assumes that the legal climate regarding the claims process and
underlying liabilities remains constant. Other assumptions employed by the
Company or its actuarial firm change from time to time as circumstances change.
In estimating loss and LAE reserves, the Company employs a number of actuarial
methods, depending on their applicability to each line of business, in order to
balance the advantages and disadvantages of each method. No single method is
used to estimate loss and LAE reserves. Although different actuarial methods may
give rise to different reserve estimates,
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which could be higher or lower than the reserves actually established by the
Company, the Company believes that those differences are not material.
The Company has recorded recent increases in reserves for prior accident
year losses in subsequent years. These increases were necessary because of
several factors, including inaccurate estimation of the extent of liability
associated with a number of claims involving serious injuries and claims
handling practices that did not produce accurate and timely reserve levels for a
broad range of claims. During 1996, the Company experienced greater than
anticipated severity (claim value) in liability claims primarily related to its
workers' compensation line of insurance.
13
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The following table sets forth the changes in the reserve for
losses and LAE for 1994, 1995 and 1996.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Reserve for losses and LAE
at beginning of year $ 93,896 $104,015 $119,722
Less reinsurance recoverables 3,957 6,401 6,004
-------- -------- --------
Net balance at beginning of
year 89,939 97,614 113,718
Provision for losses and LAE
for claims occurring in:
Current year 65,818 67,150 72,771
Prior years 4,982 11,045 6,832
-------- -------- --------
70,800 78,195 79,603
-------- -------- --------
Losses and LAE payments for
claims occurring in:
Current year 28,574 25,175 28,512
Prior years 34,551 36,916 38,549
-------- -------- --------
63,125 62,091 67,061
-------- -------- --------
Reserve for losses and LAE
at end of year, net 97,614 113,718 126,260
Plus reinsurance recoverables 6,401 6,004 7,219
-------- -------- --------
Balance at end of year $104,015 $119,722 $133,479
======== ======== ========
</TABLE>
In 1994, 1995 and 1996, the Company increased its reserves for prior years
by $4,982,000, $11,045,000 and $6,832,000, respectively. The increase in
reserves for prior years made in 1994 was primarily attributable to the
$3,135,000 settlement of the AIP matter discussed in Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" as
well as higher than anticipated severity of liability claims on auto, commercial
multi-peril and workers' compensation policies. The increase in reserves for
prior years made in 1995 was primarily attributable to higher than anticipated
severity of liability claims on homeowners, businessowners, workers'
compensation and commercial package lines of insurance. The increase in reserves
for prior years made in 1996 was primarily attributable to higher than
anticipated severity of claims on workers' compensation policies.
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<PAGE> 15
The first line of the following table presents, as of the end of the year
at the top of each column, the estimated amount of unpaid losses and LAE for
claims arising in that year and in all prior years, including claims that had
occurred but were not yet reported to the Company. For each column, the rows of
the table present, for the same group of claims, the amount of unpaid losses and
LAE as re-estimated as of the end of each succeeding year. The estimate is
modified as more information becomes known about the number and severity of
claims for each year. The "cumulative deficiency" represents the change in the
estimated amount of unpaid losses and LAE from the end of the year at the top of
each column through the end of 1996.
For each column in the table, the change from the liability for losses and
LAE shown on the first line to the liability as re-estimated as of the end of
the following year was included in operating results for the following year.
That change includes the change in the previous year's column from the liability
as re-estimated one year later to the liability as re-estimated two years later,
which, in turn, includes the change in the second preceding column from the
liability as re-estimated two years later to the liability as re-estimated three
years later, and so forth.
The rows of the lower portion of the table present, as of the end of each
succeeding year, the amount of paid losses and LAE for claims unpaid at the end
of the year at the top of each column.
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<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for losses and LAE $32,137 $44,778 $55,412 $66,892 $71,222 $77,274 $86,159 $89,939 $97,614 $113,718
Liability re-estimated as of:
One year later 33,520 47,519 57,238 75,614 77,548 80,841 88,284 94,921 108,659 120,550
Two years later 33,873 47,112 61,534 76,310 75,987 81,743 91,224 100,607 113,091
Three years later 34,429 51,023 61,928 73,578 78,106 83,693 95,396 106,382
Four years later 39,086 52,104 61,014 75,672 79,563 87,105 99,779
Five years later 38,404 51,249 61,787 76,746 81,308 90,428
Six years later 38,049 51,764 62,201 77,026 84,530
Seven years later 38,411 52,141 62,332 79,690
Eight years later 38,368 52,035 64,388
Nine years later 38,283 53,836
Ten years later 40,155
Cumulative Deficiency - $ (8,018) (9,058) (8,976) (12,798) (13,308) (13,154) (13,620) (16,443) (15,477) (6,832)
- % (24.9) (20.2) (16.2) (19.1) (18.7) (17.0) (15.8) (18.3) (15.9) (6.0)
Paid (Cumulative) as of:
One year later 15,225 20,649 21,393 32,538 32,666 30,082 35,724 34,551 36,916 38,549
Two years later 21,907 28,049 37,459 47,816 47,339 50,490 56,003 56,965 60,074
Three years later 26,159 38,936 47,816 58,489 61,585 63,925 69,863 72,963
Four years later 31,943 44,819 52,758 66,466 70,219 72,917 80,156
Five years later 34,076 46,931 56,732 71,322 75,018 79,374
Six years later 35,356 48,985 59,162 73,558 78,398
Seven years later 36,644 50,547 59,994 75,822
Eight years later 37,495 50,815 61,546
Nine years later 37,525 51,795
Ten years later 38,432
</TABLE>
16
<PAGE> 17
The loss and LAE reserves reported in the Company's consolidated financial
statements prepared in accordance with generally accepted accounting principles
("GAAP") differ from those reported in the statements filed by MNH with the New
Hampshire Insurance Department in accordance with statutory accounting
principles ("STAT") as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Loss and LAE reserves on a
STAT basis $ 96,624 $113,059 $125,821
Adjustments:
Loss reserves ceded under a
quota share agreement with
an unrelated party 927 595 379
Ceded reinsurance balances
recoverable 6,401 6,004 7,219
Write-down of reinsurance
recoverable 63 64 60
-------- -------- --------
Loss and LAE reserves on a
GAAP basis $104,015 $119,722 $133,479
======== ======== ========
</TABLE>
Reinsurance
- -----------
The Company follows the customary industry practice of reinsuring a portion
of the exposure under its policies and as consideration pays to its reinsurers a
portion of the premium received on its policies. Insurance is ceded principally
to reduce an insurer's liability on individual risks and to protect against
catastrophic losses. Although reinsurance does not legally discharge an insurer
from its primary liability for the full amount of coverage provided by its
policies, it does make the assuming reinsurer liable to the insurer to the
extent of the reinsurance ceded.
The Company is a party to reinsurance contracts under which certain types
of policies are automatically reinsured without the need for approval by the
reinsurer with respect to the individual risks that are covered ("treaty"
reinsurance). The Company also is a party to reinsurance contracts which are
handled on an individual policy or per risk basis and require the specific
agreement of the reinsurer as to each risk insured ("facultative" reinsurance).
Occasionally, the Company may secure facultative reinsurance to supplement its
coverage under treaty reinsurance.
17
<PAGE> 18
Since 1980, most of the Company's treaty and facultative reinsurance has
been placed with a large United States domiciled reinsurer. The Company's excess
of loss arrangements for automobile liability, general liability and workers'
compensation insurance provide for recovery of losses over $500,000 up to a
maximum of $5,000,000 per occurrence. For claims occurring prior to 1993, the
$500,000 threshold is indexed for inflation for casualty lines other than
workers' compensation and New York State no-fault, and applies retroactively to
all occurrences until they are settled. There is no index provision for casualty
claims occurring after 1992. This coverage is supplemented by additional treaty
reinsurance covering losses up to $5,000,000 in excess of the first $5,000,000.
Property reinsurance agreements provide for recovery of property losses
over $500,000 up to $2,000,000 per occurrence without any index provision.
Property catastrophe coverage placed with many reinsurers worldwide provides for
recovery of 95% of up to $40,000,000 above aggregate retained losses of
$5,000,000 for each natural disaster. The property catastrophe coverage limits
are shared by the Company and Mutual on a pro rata basis based upon the gross
reported losses of the Company and Mutual for a covered event. The reinsurance
premium rate paid varies for each line of business.
As of December 31, 1996, the Company had $7,219,000 of reinsurance
recoverable on unpaid losses and paid losses, all of which it expects to
recover. The excess of loss reinsurance agreement has no definite term, but may
be renegotiated yearly. The property catastrophe reinsurance agreement expires
December 3l, 1997.
In 1987, the Company and its primary reinsurer agreed to limit the losses
which could be recovered by the Company under its excess of loss treaties for
the 1980 through 1986 accident years in exchange for a cap on retrospective
premiums due the reinsurer. At December 31, 1996, recoverable losses have
exceeded the cap by $528,000, and the excess losses have been retained by the
Company.
Effective January 1, 1993, Mutual and MNH entered into a quota share
reinsurance agreement under which MNH assumed 10% of Mutual's direct voluntary
written premiums and related losses and allocated LAE in exchange for a
reinsurance commission of 35%. The agreement also provides for MNH to pay a
contingent commission to Mutual equal to any underwriting profit on the premiums
assumed. Mutual pays the ceded premiums, net of commissions and paid losses, to
MNH on a monthly basis and MNH invests these funds and earns investment income.
To the extent commissions and paid losses exceed premiums, MNH is required to
pay the net monthly balance to Mutual. The agreement may be terminated by either
party effective as of any January 1 with the prior approval of the New York
Superintendent of Insurance and upon six months' notice to the other party. In
addition, the agreement may be terminated by MNH at any time if any amount
payable to MNH by
18
<PAGE> 19
Mutual becomes more than 90 days overdue or if there is a change in control of
Mutual approved by the New York Superintendent of Insurance. Further, the
agreement allows Mutual to reduce its cessions to MNH to 0% of Mutual's direct
voluntary premiums written for any calendar year prior to the beginning of that
calendar year. Mutual notified the Company that it will not cede any voluntary
direct written premiums to MNH in calendar year 1997.
Investments
- -----------
The primary source of funds for investment by the Company is premiums
collected. Although premiums, net of commissions and other underwriting costs,
are taken into income ratably over the terms of the policies, they provide funds
for investment from the date they are received. Similarly, although
establishment of and changes in reserves for losses and LAE are included in
results of operations immediately, the amounts so set aside may be invested
until the Company pays those claims.
The investments of the Company are regulated by New Hampshire insurance law
and are reviewed by the Board of Directors of the Company. Other than certain
short-term investments held to maintain liquidity, the Company primarily invests
in medium-term bonds, mortgage-backed and other asset-backed securities
including collateralized mortgage obligations, and tax-exempt securities. The
mortgage-backed securities he1d by the Company are typically purchased at
expected yields which are greater than comparable maturity Treasury securities
and are AAA or AA rated.
The Company had $46,818,000 of tax-exempt bonds in its investment portfolio
at December 31, 1996. The Company believes these tax-exempt bonds are of high
quality (rated A or better) and offer an after-tax total return greater than
comparable taxable securities.
At December 31, 1996, the Company had $8,248,000 of short-term investments
with maturities less than 30 days, and $3,329,000 of non-investment grade
securities. These non-investment grade securities represented 1.7% of its
investment portfolio.
19
<PAGE> 20
The table below gives information regarding the Company's investments as of
the dates indicated.
<TABLE>
<CAPTION>
As of December 31,
-----------------------------------------------------------
1994 1995 1996
---- ---- ----
Amount % Amount % Amount %
-------- ---- -------- ---- -------- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities (1):
U.S. Government
and Agencies $ 49,113 28.8% $ 58,421 30.4% $ 49,990 24.8%
Corporate Bonds 50,742 29.7 63,997 33.3 86,308 42.8
Tax-Exempt Bonds 62,050 36.3 60,837 31.7 46,818 23.2
-------- ---- -------- ---- -------- ----
Total Bonds 161,905 94.8 183,255 95.4 183,116 90.8
Short-Term Invest-
ments(2) 4,455 2.6 4,470 2.3 8,248 4.1
Other(3) 4,387 2.6 4,493 2.3 10,233 5.1
-------- ---- -------- ---- -------- ----
Total Invested
Assets $170,747 100.0% $192,218 100.0% $201,597 100.0%
======== ===== ======== ===== ======== =====
<FN>
(1) Fixed Maturities are shown at their carrying amounts in the respective
balance sheet. Held to Maturity fixed maturities are included at amortized
cost. Available for Sale fixed maturities are included at fair value.
(2) Shown at cost, which approximates fair value.
(3) Shown at estimated fair value or unpaid principal balance which
approximates estimated fair value.
</TABLE>
The table below sets forth the Company's net investment income and net
realized gains and losses, excluding the effect of income taxes, for the periods
shown:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1994 1995 1996
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Average investments (1) $176,791 $ 181,760 $194,677
Net investment income 9,849 10,368 11,724
Net investment income
as a percentage of average
investments (2) 5.6% 5.7% 6.0%
Net realized gains (losses)
on investments $ 20 $ (832) $ 996
<FN>
(1) At amortized cost.
(2) The tax equivalent yield for the years ended December 31, 1994, 1995 and
1996 were 6.4%, 6.6%, and 6.6%, respectively, assuming an effective tax
rate of 34%.
</TABLE>
20
<PAGE> 21
The table below sets forth the carrying value of bonds and percentage
distribution of various maturities at the dates indicated. Fixed Maturities are
shown at their carrying amounts in the respective balance sheet. Held to
Maturity fixed maturities are included at amortized cost. Available for Sale
fixed maturities are included at fair value. The estimated repayment date was
used instead of the ultimate repayment date for mortgage backed and other asset
backed securities.
<TABLE>
<CAPTION>
As of December 31,
--------------------------------------------------------
1994 1995 1996
--------------------------------------------------------
Amount % Amount % Amount %
-------- ----- -------- ----- -------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
1 year or less $ 10,560 6.5% $ 24,175 6.5% $ 15,518 8.5%
1 year through 5 years 94,697 58.5 114,823 58.5 123,856 67.6
5 years through 10 years 49,825 30.8 36,967 30.8 32,452 17.7
More than 10 years 6,823 4.2 7,290 4.2 11,290 6.2
-------- ----- -------- ----- -------- -----
Total $161,905 100.0% $183,255 100.0% $183,116 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
Competition
- -----------
The property and casualty insurance business is highly competitive. The
Company is in direct competition with many national and regional multiple-line
insurers, many of which are substantially larger than the Company and have
considerably greater financial resources. Competition is further intensified by
the independent agency system because each of the independent agents who sells
the Company's policies also represents one or more other insurers. Also, the
Company's agents compete with direct writing insurers and this indirectly
affects the Company.
Historically, the property and casualty industry has tended to be cyclical
in nature. During the "up" cycle, or "hard market," the industry is
characterized by price increases, strengthening of loss and LAE reserves,
surplus growth and improved underwriting results. Near the end of the "up"
cycle, an increase in capacity causes insurance companies to begin to compete
for market share on the basis of price. This price competition causes the
emergence of the "down" cycle, or "soft market," characterized by a reduction in
the premium growth rate and a general decline in profitability. Generally, the
down cycle is eventually accompanied by a decline in the adequacy of loss and
LAE reserves and a decrease in premium writing capacity. The property and
casualty insurance industry has experienced a cyclical downturn for the past ten
years due primarily to intense premium rate competition, which has resulted in
lower profitability. Many of the circumstances which led to the current cyclical
downturn in the property and casualty insurance
21
<PAGE> 22
industry continue to exist, and the Company cannot predict when or if market
conditions for the industry will improve.
Regulation
- ----------
General
-------
MNH is subject to regulation under applicable insurance statutes, including
insurance holding company statutes, of the various states in which it writes
insurance. Insurance regulation is intended to provide safeguards for
policyholders rather than to protect stockholders of insurance companies or
their holding companies. Insurance laws of the various states establish
regulatory agencies with broad administrative powers including, but not limited
to, the power to grant or revoke licenses to transact insurance business and to
regulate trade practices, investments, premium rates, the deposit of securities,
the form and content of financial statements and insurance policies, accounting
practices and the maintenance of specified reserves and capital. The regulatory
agencies of each state have statutory authority to enforce their laws and
regulations through various administrative orders, civil and criminal
enforcement proceedings, and the suspension or revocation of certificates of
authority. In extreme cases, including insolvency, impending insolvency and
other matters, a regulatory authority may take over the management and operation
of an insurer's business and assets.
Under insolvency or guaranty laws in the states in which MNH operates,
insurers doing business in those states can be assessed up to prescribed limits
for policyholder losses caused by other insurance companies that become
insolvent. The extent of any requirement for MNH to make any further payment
under these laws is not determinable. Most laws do provide, however, that an
assessment may be excused or deferred if it would threaten a solvent insurer's
financial strength. In addition, MNH is required to participate in various
mandatory pools or underwriting associations in certain states in which it
operates.
The property and casualty insurance industry has been the subject of new
regulations and legislative activity in various states attempting to address the
affordability and availability of different lines of insurance. The regulations
and legislation generally restrict the discretion an insurance company has in
operating its business. It is not possible to predict the effect, if any, that
new regulations and legislation would have on the Company and MNH.
The Company depends on cash dividends from MNH to pay cash dividends to its
stockholders and to meet its expenses. MNH is subject to New Hampshire state
insurance laws which restrict its ability to pay dividends without the prior
approval of state regulatory authorities. These restrictions limit dividends to
those that, when added to all other dividends paid within the preceding twelve
months, would not exceed 10% of the insurer's
22
<PAGE> 23
policyholders' surplus as of the preceding December 31st. The maximum amount of
dividends that MNH could pay during any twelve month period ending in 1997
without the prior approval of the New Hampshire Insurance Commissioner is
$4,391,000.
In certain states in which it operates, MNH is required to maintain
deposits with the appropriate regulatory authority to secure its obligations
under certain insurance policies written in the jurisdiction. At December 31,
1996, investments of MNH having a par value of $1,800,000 were on deposit with
regulatory authorities.
MNH and Mutual are required to file detailed annual reports with the
appropriate regulatory agency in each of the states in which they do business.
Their business and accounts are subject to examination by such agencies at any
time, and the laws of many states require periodic examination.
In 1993 the National Association of Insurance Commissioners ("NAIC")
adopted a risk-based capital measurement formula to be applied to all property
and casualty insurance companies. The formula calculates a minimum required
statutory net worth, based on the underwriting, investment, credit, loss reserve
and other business risks inherent in an individual company's operations. Any
insurance company that does not meet threshold risk-based capital measurement
standards could be forced to reduce the scope of its operations and ultimately
could become subject to statutory receivership proceedings. MNH's capital
substantially exceeds the statutory minimum as determined by the risk-based
capital measurement formula as of December 31, 1996.
The NAIC has established eleven financial ratios (the Insurance Regulatory
Information System, or "IRIS") to assist state insurance departments in their
oversight of the financial condition of insurance companies operating in their
respective states. The NAIC calculates these ratios based on information
submitted by insurers on an annual basis and shares the information with the
applicable state insurance departments. The ratios relate to leverage,
profitability, liquidity and loss reserve development. Two of the Company's
ratios as of December 31, 1996 relating to profitability and loss reserve
development fell outside of the acceptable range of ratios. Both of the ratios
were outside of the acceptable ranges due to the $6,832,000 increase in the
provision for losses and LAE recorded in 1996, for claims occurring in years
prior to 1996, as discussed in this Item under the heading "Loss and LAE
Reserves".
Rates
-----
Premium rate regulations vary greatly among states and lines of insurance,
but generally require approval of the regulatory authority or limited review by
the authority prior to changes in rates. However, in New York, insurers writing
in designated commercial risk, professional liability and public entity
23
<PAGE> 24
insurance markets may periodically revise rates within the limits of applicable
flexibility bands ("flex-bands") on a file and use basis, but must obtain the
Department's prior approval in order to implement rate increases or decreases
beyond these flex-bands.
Insurance Holding Companies
---------------------------
The Company is subject to statutes governing insurance holding company
systems. Typically, such statutes require the Company to file information
periodically concerning its capital structure, ownership, financial condition
and general business operations and material inter-company transactions not in
the ordinary course of business. Under the terms of applicable New Hampshire
statutes, any person or entity desiring to purchase shares which would result in
such person beneficially owning 10% or more of the Company's outstanding voting
securities would be required to obtain regulatory approval prior to the
purchase.
Involuntary Insurance
---------------------
As a condition to writing voluntary insurance in most of the states in
which it operates, the Company must participate in programs that provide
insurance for persons unable to obtain insurance voluntarily. Uncertainties as
to the size of the involuntary market population make it difficult to predict
the amount of involuntary business in a given year. Further complicating the
ability to predict assignments in New York is the Territorial Credit Program
("TCP") instituted by the Department in 1990. The TCP provides companies credits
against their NYAIP assignments based upon their voluntary automobile writings
in designated territories two years prior to the assignment year. Designated
territories are territories in which the ratio of NYAIP-insured car years to
total-insured car years exceeds the statewide average of the same ratio. The
designated territories are primarily in or near the New York City metropolitan
area, an area in which the Company does not have, or intend to develop, a
significant market presence. The Company's voluntary market share in the
designated territories is less than its statewide market share, which may result
in an increase in the Company's NYAIP assignments in 1997 and subsequent years.
Employees
- ---------
The Company has no employees. At December 31, 1996, Mutual had 382
full-time employees. The Company believes that Mutual's relationship with its
employees is satisfactory.
Item 2. PROPERTIES.
Although the Company has no facilities, it benefits from the facilities of
Mutual pursuant to the Management Agreement, under which the Company is charged
a proportionate share of the costs of such facilities.
24
<PAGE> 25
The Company's corporate headquarters are located in Buffalo, New York in a
building owned by Mutual that contains approximately 113,000 square feet of
office space. Mutual also has regional underwriting and/or claims office
facilities in Buffalo, Albany and Central Islip, New York; Bedford, New
Hampshire; and Moorestown, New Jersey. All of the offices except the Buffalo
office are leased.
Item 3. LEGAL PROCEEDINGS.
In 1995, a New York State trial court dismissed a purported class action
lawsuit which was filed in 1993 against the Company, Mutual, MNH and certain
directors of the Company and of Mutual (the "defendants") on behalf of the then
minority shareholders of the Company. The court, in granting the defendants'
motion, held that plaintiff's claims, to the extent they have any merit, are
derivative in nature. The complaint, which sought equitable relief and
unspecified money damages, alleged that the defendants breached their fiduciary
obligations to the minority shareholders of the Company, and defrauded the
minority shareholders, by causing MNH to purchase from the Federal Deposit
Insurance Corporation ("FDIC") a surplus note issued by Mutual and
simultaneously reducing the principal amount plus accrued return on such surplus
note to $1,350,000, which is the amount MNH paid to the FDIC for the note, and
by approving the public sale of the Company's common stock in July 1993 at what
the plaintiff alleges was an inadequate price. In November 1995, the plaintiff
filed an amended complaint which asserts the same claims as were asserted in his
class action lawsuit but in the form of a derivative suit. In June 1996, the
Company and the other defendants moved to dismiss the derivative complaint. The
court has not yet rendered its decision on those motions.
MNH, like many other property and casualty insurance companies, is subject
to environmental damage claims asserted by or against its insureds. Management
of the Company is of the opinion that based on various court decisions
throughout the country such claims should not be recoverable under the terms of
MNH's insurance policies because of either specific or general coverage
exclusions contained in the policies. However, there is no assurance that the
courts will agree with MNH's position in every case, nor can there be assurance
that material claims will not be asserted under policies which a court will find
do not explicitly or implicitly exclude claims for environmental damages.
Management, however, is not aware of any pending claim or group of claims which
would result in a liability that would have a material adverse effect on the
financial condition of the Company or MNH.
25
<PAGE> 26
In addition to the foregoing matters, MNH is a defendant in a number of
other legal proceedings in the ordinary course of its business. Management of
the Company is of the opinion that the ultimate aggregate liability, if any,
resulting from such proceedings will not materially affect the financial
condition of the Company or MNH.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
26
<PAGE> 27
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
The Company's common stock is traded on the American Stock Exchange (AMEX
symbol: MGP). The following table sets forth the high and low closing prices of
the common stock for the periods indicated as reported on the American Stock
Exchange.
<TABLE>
<CAPTION>
1996: High Low
- ----- ---- ---
<S> <C> <C>
Fourth Quarter $18.88 $18.00
Third Quarter 19.25 18.50
Second Quarter 19.50 17.00
First Quarter 18.75 17.50
1995:
Fourth Quarter $19.38 $16.75
Third Quarter 19.63 16.38
Second Quarter 18.88 14.75
First Quarter 15.75 14.50
</TABLE>
The number of stockholders of record of the Company's Common Stock as of
February 28, 1997 was 127. Securities held by nominees are counted as one
stockholder of record.
The Company has paid a quarterly cash dividend of $.05 per share to its
common stockholders since the third quarter of 1993. Continued payment of this
dividend and its amount will depend upon the Company's operating results,
financial condition, capital requirements and other relevant factors, including
legal restrictions applicable to the payment of dividends by its insurance
subsidiary, MNH.
As a holding company, the Company depends on dividends from its subsidiary,
MNH, to pay cash dividends to its stockholders. MNH is subject to New Hampshire
state insurance laws which restrict its ability to pay dividends without the
prior approval of state regulatory authorities. These restrictions limit
dividends to those that, when added to all other dividends paid within the
preceding twelve months, would not exceed 10% of the insurer's policyholders'
surplus as of the preceding December 31. The maximum amount of dividends that
MNH could pay during any twelve month period ending in 1997 without prior
approval of the New Hampshire Insurance Commissioner is $4,391,000.
27
<PAGE> 28
Item 6. SELECTED FINANCIAL DATA.
The selected financial data set forth in the following table for each of the
five years in the period ended December 31, 1996 have been derived from the
audited consolidated financial
statements of the Company.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net premiums written $84,341 $91,192 $ 90,187 $ 97,577 $ 96,622
======= ======= ========= ========= =========
Net premiums earned $87,912 $88,181 $ 90,845 $ 94,749 $ 95,752
Net investment income 9,003 9,155 9,849 10,368 11,724
Net realized investment
gains (losses) 1,066 1,467 20 (832) 996
Other revenues 615 693 638 259 172
------- ------- --------- --------- ---------
Total revenues 98,596 99,496 101,352 104,544 108,644
------- ------- --------- --------- ---------
Losses and loss
adjustment expenses 61,803 62,407 70,800 78,195 79,603
Amortization of deferred
policy acquisition costs 23,297 23,739 24,424 25,458 25,374
Other underwriting expenses 7,143 6,020 5,892 7,709 6,700
------- ------- --------- --------- ---------
Total expenses 92,243 92,166 101,116 111,362 111,677
------- ------- --------- --------- ---------
Income (loss) before
income taxes 6,353 7,330 236 (6,818) (3,033)
Provision (benefit)
for income taxes 1,238 1,727 (895) (2,999) (1,885)
------- ------- --------- --------- ---------
Income (loss) before
cumulative effect of change
in accounting for income
taxes 5,115 5,603 1,131 (3,819) (1,148)
Cumulative effect of change
in accounting for income
taxes -- 306 -- -- --
------- ------- --------- --------- ---------
Net income (loss) $ 5,115 $ 5,909 $ 1,131 $ (3,819) $ (1,148)
======= ======= ========= ========= =========
</TABLE>
28
<PAGE> 29
Merchants Group, Inc.
Selected Financial Data - continued
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Primary and fully diluted
earnings (loss) per share:
Before cumulative effect of
change in accounting for
income taxes $ 2.31 $ 2.12 $ .36 $ (1.19) $ (.36)
Cumulative effect of change
in accounting for income
taxes -- .12 -- -- --
-------- -------- -------- --------- ---------
Primary and fully diluted
earnings (loss) per share $ 2.31 $ 2.24 $ .36 $ (1.19) $ (.36)
======== ======== ======== ========= =========
Weighted average number of
shares outstanding:
Primary and fully diluted 2,109 2,641 3,177 3,220 3,182
BALANCE SHEET DATA:
(AT YEAR END)
Total investments $157,478 $175,762 $170,747 $ 192,218 $ 201,597
Total assets 193,202 219,188 227,750 252,808 262,123
Reserve for losses and
loss adjustment expenses 86,159 93,896 104,015 119,722 133,479
Unearned premiums 40,725 46,006 45,449 48,773 49,710
Stockholders' equity 53,265 75,083 67,279 69,970 65,029
DIVIDEND DATA:
Cash dividend per common
share $ -- $ .10 $ .20 $ .20 $ .20
</TABLE>
29
<PAGE> 30
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
1996 Compared to 1995.
- ----------------------
Total revenues for 1996 were $108,644,000, up 4% from $104,544,000 in 1995.
Net premiums earned for 1996 were $95,752,000, an increase of $1,003,000,
or, 1% from $94,749,000 in 1995. Net premiums written for 1996 were $96,622,000,
an increase of 3% excluding the effect of the decision by Mutual to exercise its
option to not cede any of its direct voluntary premiums written to MNH for
calendar year 1996, under the quota share reinsurance agreement between Mutual
and MNH. In 1995, MNH assumed $2,110,000 of Mutual's direct voluntary premiums
written under this agreement. The increase in net premiums written resulted
primarily from a 2% increase in direct premiums written.
Direct premiums written for 1996 were $101,007,000, an increase of 2% from
$98,553,000 in 1995 due to a 9% increase in voluntary personal lines direct
written premiums, a 3% decrease in voluntary commercial lines direct written
premiums and a 16% increase in involuntary direct written premiums.
Voluntary personal lines direct premiums written for 1996 were $37,616,000,
an increase of 9% from $34,393,000 in 1995. Private passenger automobile direct
premiums written, which comprised 79% of total voluntary personal lines direct
premiums written in 1996 and 1995, increased 8% in 1996 compared to 1995. This
increase resulted from a 5% increase in policies in force and a 4% increase in
average premium per policy at December 31, 1996 compared to December 31, 1995.
Homeowners direct premiums written increased 14% in 1996 compared to 1995 due to
a 4% increase in policies in force and an 8% increase in average premium per
policy.
Voluntary commercial lines direct premiums written for 1996 were
$55,467,000, a decrease of 3% from $57,304,000 in 1995. This decrease resulted
primarily from a 10% decrease in commercial lines policies in force at December
31, 1996, partially offset by a 15% increase in average premium per policy
outstanding at December 31, 1996 compared to December 31, 1995.
In 1996 the Company continued the program initiated in 1995 to increase its
mandatory deductibles and its minimum premium levels on certain of its
commercial lines of business, primarily its businessowners and multi-peril
lines. In conjunction with these actions, the Company discounted its premium
rates 15% for its workers' compensation line of business. These discounted rates
combined with other refinements were designed to attract the entire insurance
business of preferred risk commercial accounts and to eliminate certain small
premium policies which were generally unprofitable. These actions contributed to
the decrease
30
<PAGE> 31
in commercial lines policies in force and the increase in average premium per
policy. Also affecting the average policy premium has been New York State
mandated reductions in workers' compensation premium rates of 12%, 9% and 18%,
respectively, in 1994, 1995 and 1996.
Involuntary direct premiums written, primarily involuntary private
passenger automobile insurance, which comprised 8% and 7% of total direct
premiums written during 1996 and 1995, respectively, were $7,923,000 for 1996
compared to $6,854,000 in 1995. This 16% increase resulted primarily from
additional policy premiums related to an increase in the legally required
minimum automobile policy limits in New York State, which became effective
January 1, 1996.
Net investment income was $11,724,000 in 1996, an increase of 13% from
$10,368,000 in 1995, primarily due to a 7% increase in average invested assets.
On a taxable equivalent basis, net investment income increased 10% in 1996
compared to 1995.
Realized investment gains were $996,000 in 1996 compared to a loss of
$832,000 in 1995. During 1996, the Company sold its investment in Signet Group
PLC ("Signet") cumulative auction rate preference shares and recognized a
realized gain of $900,000 before taxes. In 1995, the Company recorded an
$840,000 unrealized loss on its investment in Signet, which was included as a
component of realized investment gains and losses in the Company's 1995
consolidated statement of operations. In addition to the realized gain related
to its investment in Signet, the Company realized $96,000 of pre-tax gains on
the sale of other investments which were sold in 1996. The Company recorded
$8,000 of realized gains not related to Signet in 1995.
Losses and loss adjustment expenses ("LAE") were $79,603,000 for 1996, an
increase of 2% from $78,195,000 in 1995. The loss and LAE ratio increased to
83.1% in 1996 from 82.5% in 1995. In 1996, the Company increased its reserve for
losses that occurred prior to 1996 for its workers' compensation line of
business. In turn, the Company increased its estimates of losses related to
workers' compensation claims for accidents that occurred in 1996 based upon the
increase in prior year's workers' compensation reserves. Partly offsetting these
increases was a reduction in the Company's estimate of losses for automobile
insurance claims that occurred prior to 1996. The net increase in the reserve
for prior year losses and LAE was $6,896,000 and added 7.2 percentage points to
the loss and LAE ratio in 1996.
Losses and LAE in 1996 include $2,200,000 of higher than normal losses
related to unusually severe winter weather that affected the northeastern United
States during the first quarter of 1996. These higher than normal weather
related losses increased the 1996 loss and LAE ratio by 2.3 percentage points.
31
<PAGE> 32
Losses and LAE in 1995 included an $11,045,000 increase in reserves for
accidents that occurred prior to 1995 which added 11.6 percentage points to the
loss and LAE ratio in 1995.
Involuntary automobile insurance business increased the Company's calendar
year loss and LAE ratio by approximately .7 percentage points and decreased the
Company's calendar year loss and LAE ratio by approximately .6 percentage points
for the years ended December 31, 1996 and 1995, respectively. The combined ratio
on involuntary automobile business was greater than the combined ratio on
voluntary automobile business.
The ratio of policy acquisition costs and other underwriting expenses to
net premiums earned decreased to 33.5% in 1996 from 35.0% in 1995. In 1995,
other underwriting expenses included approximately $1,100,000 related to the
1995 resignation of the Company's former Chief Executive Officer. These expenses
added approximately 1.2 percentage points to the ratio of policy acquisition
costs and other underwriting expenses to net premiums earned in 1995.
Commissions, premium taxes and other state assessments that vary directly
with the Company's premium volume represented 22.0% and 20.6% of net premiums
earned in 1996 and 1995, respectively. Certain other underwriting expenses, such
as salaries, employee benefits, and other operating expenses vary indirectly
with volume and comprise the remainder of the Company's underwriting expenses.
The Company recorded an income tax benefit in 1996 and 1995. The benefits
recorded were larger than that calculated using the statutory federal income tax
rate due to tax exempt bond income.
1995 Compared to 1994.
- ----------------------
Total revenues increased 3% from $101,352,000 in 1994 to $104,544,000 in
1995. Of the $3,192,000 increase, $3,904,000 was attributable to a 4% increase
in net premiums earned and $519,000 was attributable to a 5% increase in net
investment income. These increases were partly offset by an $852,000 decrease in
net realized investment gains and a $379,000 decrease in other revenues.
Net premiums written increased 8% from $90,187,000 in 1994 to $97,577,000
in 1995, primarily due to a 10% increase in direct premiums written. This
increase in direct premiums written was partially offset by a 48% decrease in
premiums written assumed from Mutual in accordance with the quota share
reinsurance agreement between Mutual and MNH. In December 1995, Mutual informed
MNH that it would exercise its option to reduce its cessions to MNH under the
agreement to 0% of Mutual's direct voluntary premiums written effective for
calendar year 1996, including premiums written in 1995 which were unearned as of
December 31, 1995. As a result, premiums written assumed by the Company from
Mutual under this reinsurance agreement decreased
32
<PAGE> 33
from $4,086,000 in 1994 to $2,110,000 in 1995.
Voluntary personal lines direct premiums written increased 7% from
$32,101,000 in 1994 to $34,393,000 in 1995. Private passenger automobile direct
premiums written, which comprised 79% of total voluntary personal lines direct
premiums written in 1995, increased 5% in 1995 compared to 1994. Homeowners
direct premiums written increased 17% in 1995 compared to 1994 due to a 4%
increase in policies in force and a 13% increase in average premium per policy.
Voluntary commercial lines direct premiums written increased 11% from
$51,602,000 in 1994 to $57,304,000 in 1995. Commercial lines retention rates
held constant and commercial lines policies in force increased 1% in 1995
compared to 1994. Average premium per policy increased 10% in 1995 compared to
1994. Direct premiums written in each commercial line of business, except
contractors' coverall, increased in 1995 compared to 1994.
Net investment income increased 5% from $9,849,000 in 1994 to $10,368,000
in 1995, primarily due to a 3% increase in average invested assets. On a taxable
equivalent basis, net investment income increased 3% in 1995 compared to 1994.
The Company's investment in Signet included in other long-term investments
was carried at fair value. During 1995, the Company recorded an $840,000 loss on
its investment in Signet which is included as a component of realized investment
gains and losses in the consolidated statement of operations. There were no
material gains or losses realized from the sale of investments in 1994 or 1995.
Losses and LAE increased 10% from $70,800,000 in 1994 to $78,195,000 in
1995. The loss and LAE ratio increased from 77.9% in 1994 to 82.5% in 1995. As a
result of greater than expected reported loss experience during 1995, the
Company increased its estimate for claims that occurred in 1989 through 1994 for
the homeowners, businessowners, workers' compensation, and commercial package
lines of business. Partly offsetting these increases was a reduction in the
Company's estimate of automobile insurance claims that occurred in 1993 and
1994. The net increase in the reserve for prior year losses and LAE was
$11,045,000 and added 11.6 percentage points to the loss and LAE ratio in 1995.
Losses in 1994 included $3,135,000 paid to Mutual as a one time settlement
for losses relating to the 1985 through 1994 accident years on involuntary
automobile insurance policies issued by Mutual under automobile insurance plans
("AIP").
33
<PAGE> 34
In accordance with various states' AIP rules, Mutual historically received
the assignment of MNH's, as well as its own, AIP policies based on its and MNH's
combined voluntary automobile market share, issued the policies and settled the
claims associated with those polices. Mutual then allocated the results of the
involuntary AIP business to MNH based on MNH's share of the combined voluntary
automobile business of Mutual and MNH.
In July 1994, Mutual informed the Company that it had failed to identify
and bill to MNH during the period January 1, 1985 through June 30, 1994 for a
portion of MNH's share of AIP losses paid by Mutual in that period. The amount
of unbilled AIP losses was approximately $7,500,000. MNH paid Mutual $3,135,000
in full and complete settlement of the unbilled AIP paid losses for the period
noted above. This settlement increased the 1994 loss and LAE ratio by 3.5
percentage points.
Also included in losses in 1994 was approximately $2,400,000 of losses
related to severe winter weather that struck the northeastern United States. The
losses from these storms increased the loss and LAE ratio in 1994 by 2.6
percentage points.
In 1995, the Company increased its reserve for losses and LAE related to
prior years by $11,045,000, compared to an increase in reserve for losses and
LAE related to prior years of $4,982,000 recorded in 1994.
Involuntary automobile insurance business increased the Company's calendar
year loss and LAE ratio by approximately 3.1 percentage points and decreased the
Company's calendar year loss and LAE ratio by .6 percentage points for the years
ended December 31, 1994 and 1995, respectively.
The ratio of policy acquisition costs and other underwriting expenses to
net premiums earned increased from 33.4% in 1994 to 35.0% in 1995. In 1995,
other underwriting expenses included approximately $1,100,000 related to the
1995 resignation of the Company's former Chief Executive Officer. These expenses
added approximately 1.2 percentage points to the ratio of policy acquisition
costs and other underwriting expenses to net premiums earned in 1995.
Commissions, premium taxes and other state assessments that vary directly
with the Company's premium volume represented 20.6% of net premiums earned in
1995 and 1994. Certain other underwriting expenses, such as salaries, employee
benefits, and other operating expenses vary indirectly with volume and comprise
the remainder of the Company's underwriting expenses.
The Company recorded an income tax benefit in 1995 and 1994. The benefits
recorded were larger than that calculated using the statutory federal income tax
rate due to tax exempt bond income.
34
<PAGE> 35
Liquidity and Capital Resources
- -------------------------------
In developing its investment strategy, the Company determines a level of
cash and short-term investments which, when combined with expected cash flow, is
estimated to be adequate to meet expected cash obligations. Historically, the
excess of premiums collected over payments on claims, combined with cash income
from investments, has provided the Company with short-term funds in excess of
normal operating demands for cash.
Net cash provided by operations increased by $123,000 from $12,505,000 in
1995 to $12,628,000 in 1996. Increases in premiums collected of $3,504,000,
investment income received of $1,438,000 and income taxes recovered of
$2,792,000 were offset by increases in the payment of losses and LAE of
$4,954,000 and underwriting expenses of $2,408,000.
Net cash used in investing activities decreased $3,364,000 from $12,473,000
in 1995 to $9,109,000 in 1996. This decrease primarily resulted from a
$12,500,000 net decrease in the purchase of fixed maturities which was offset by
net increases in purchases of other long-term and short-term investments of
$4,944,000 and $3,763,000, respectively.
Net cash used in financing activities increased $3,536,000 from $11,000 in
1995 to $3,547,000 in 1996 primarily due to a $2,983,000 increase in cash used
by the Company to repurchase its common stock.
The Company has several objectives with respect to its investment
portfolio, which include maximizing total return while protecting policyholders'
surplus, maintaining flexibility and liquidity, and maintaining a reasonable
duration match between assets and liabilities. Like other property and casualty
insurers, the Company relies on premiums as a major source of cash, and
therefore liquidity. Cash flows from the Company's investment portfolio, either
in the form of interest or principal payments, are an additional source of
liquidity. Because the duration of the Company's investment portfolio and
liabilities are closely managed, increases or decreases in market interest rates
are not expected to have a material effect on the Company's liquidity, or its
results of operations.
The Company generally designates newly acquired fixed maturity investments
as available for sale and carries these investments at fair value. Unrealized
gains and losses related to these investments are recorded as a component of
stockholders' equity. At December 31, 1996, the Company had recorded $603,000 of
unrealized losses, net of tax, associated with its fixed maturity investments.
During 1996 the Company recorded a $246,000 increase in unrealized losses, net
of tax.
35
<PAGE> 36
At December 31, 1996, the Company's bond portfolio represented 90.8% of
invested assets. Management believes that this level of bond holdings is prudent
because it expects that cash receipts from net premiums written and investment
income will be sufficient to enable the Company to satisfy its cash obligations
in 1997. Furthermore, a portion of the Company's bond portfolio is invested in
mortgage-backed and other asset-backed securities which, in addition to interest
income, provide monthly paydowns of bond principal.
At December 31, 1996, $108,001,000, or 59.0%, of the Company's bond
portfolio was invested in mortgage-backed and other asset-backed securities. The
Company invests in a variety of collateralized mortagage obligations ("CMO")
products but has not invested in the derivative type of CMO products such as
interest only, principal only or inverse floating rate securities. All of the
Company's CMO investments have an active secondary market and their effect on
the Company's liquidity does not differ from that of other fixed maturity
investments. The Company does not own any other derivative financial
instruments.
At December 31, 1996, only $3,329,000, or 1.7%, of the Company's investment
portfolio was invested in non-investment grade securities.
Prior to 1996 in connection with the Company's stock option program for its
agents, the Company's Board of Directors approved a plan to purchase up to
25,000 shares of the Company's common stock. During 1996, the Company's Board of
Directors authorized the repurchase of up to 200,000 additional shares of the
Company's common stock in the open market. During 1996 the Company repurchased
160,700 shares of its common stock and is holding theses shares in treasury as
of December 31, 1996.
As a holding company, the Company is dependent upon cash dividends from MNH
to meet its obligations and pay any cash dividends. MNH is subject to New
Hampshire insurance laws which place certain restrictions on its ability to pay
dividends without the prior approval of state regulatory authorities. These
restrictions limit dividends to those that, when added to all other dividends
paid within the preceding twelve months, would not exceed 10% of the insurer's
policyholders' surplus as of the preceding December 31. The maximum amount of
dividends that MNH could pay during any twelve month period ending in 1997
without the prior approval of the New Hampshire Insurance Commissioner is
$4,391,000. The Company paid a $.05 per share quarterly cash dividend to its
common stockholders totalling $634,000 in 1996.
MNH, like many other property and casualty insurance companies, is subject
to environmental damage claims asserted by or against its insureds. Management
of the Company is of the opinion that based on various court decisions
throughout the country, such claims should not be recoverable under the terms of
MNH's insurance policies because of either specific or general
36
<PAGE> 37
coverage exclusions contained in the policies. However, there is no assurance
that the courts will agree with MNH's position in every case, nor can there be
assurance that material claims will not be asserted under policies which a court
will find do not explicitly or implicitly exclude claims for environmental
damages. Management, however, is not aware of any pending claim or group of
claims which would result in a liability that would have a material adverse
effect on the financial condition of the Company or MNH.
Industry and regulatory guidelines suggest that the ratio of a property and
casualty insurer's annual net premiums written to its statutory surplus should
not exceed 3 to 1. The Company has consistently followed a business strategy
that would allow it to meet this 3 to 1 regulatory guideline. MNH's ratio of net
premiums written to statutory surplus for 1996 was 2.2 to 1.
Inflation
- ---------
Inflation affects the Company, like other companies in the property and
casualty insurance industry, by contributing to higher losses, LAE and operating
costs, as well as greater investment income resulting from the higher interest
rates which can prevail in an inflationary period. Premium rates, however, may
not keep pace with inflation since competitive forces generally limit the
Company's ability to increase premium rates. The Company considers inflationary
trends in estimating its reserves for claims reported and for incurred but not
reported claims.
Federal Taxation
- ----------------
The Company and MNH are subject to federal income taxation under the
provisions of the Internal Revenue Code of 1986, as amended.
37
<PAGE> 38
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements required in response to
this Item are submitted as part of Item 14 (a) of this report.
Quarterly data for the two most recent fiscal years is set
forth below:
<TABLE>
<CAPTION>
Three months ended
------------------
3/31 6/30 9/30 12/31
---- ---- ---- -----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
1996
Net premiums earned $ 23,441 $ 24,432 $ 23,924 $ 23,955
Net investment income 2,800 2,807 2,921 3,196
Net realized investment
gains (losses) 7 935 58 (4)
Other revenues
(expenses), net 126 (68) 144 (30)
-------- -------- -------- --------
Total revenues 26,374 28,106 27,047 27,117
======== ======== ======== ========
Income (loss) before
income taxes (328) 2,651 239 (5,595)
Net income (loss)
as reported (261) 2,065 197 (3,262)
Net income (loss)
as adjusted (261) 2,065 310(a) (3,262)
Net income (loss) per
common share as reported (.08) .64 .06 (1.05)
Net income (loss) per
common share as adjusted (.08) .64 .10(a) (1.05)
1995
Net premiums earned $ 22,710 $ 23,392 $ 24,432 $ 24,215
Net investment income 2,523 2,588 2,559 2,698
Net realized investment
gains (losses) -- (832) -- --
Other revenues
(expenses), net 273 (224) 50 160
-------- -------- -------- --------
Total revenues 25,506 24,924 27,041 27,073
======== ======== ======== ========
Income (loss) before
income taxes 1,525 (7,899) (2,198) 1,754
Net income (loss) 1,111 (3,916) (1,996) 982
Net income (loss) per
common share .35 (1.23) (.62) .30
<FN>
(a) The Company incorrectly calculated and reported its income tax benefit and
its net income, for the the three months ended September 30, 1996.
</TABLE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
38
<PAGE> 39
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company's definitive proxy statement which will be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year is incorporated herein
by reference.
Item 11. EXECUTIVE COMPENSATION.
The Company's definitive proxy statement which will be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's fiscal year is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The Company's definitive proxy statement which will be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's fiscal year is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company's definitive proxy statement which will be filed with the
Commission pursuant to Regulation 14A within 120 days after the end of the
Company's fiscal year is incorporated herein by reference.
39
<PAGE> 40
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
(a) (1) The following financial statements of Merchants Group, Inc. are
included on pages F-1 to F-23:
Report of Independent Accountants
Consolidated Balance Sheet - December 31, 1995 and 1996.
Consolidated Statement of Income - Years ended December 31,
1994, 1995 and 1996.
Consolidated Statement of Changes in Stockholders' Equity -
Years ended December 31, 1994, 1995 and 1996.
Consolidated Statement of Cash Flows - Years ended December
31, 1994, 1995 and 1996.
Notes to Consolidated Financial Statements.
(2) The following financial statement schedules of Merchants Group, Inc.
are filed herewith pursuant to Item 8:
Schedule I -
Summary of Investments - Other Than Investments in Related
Parties.
Schedule II -
Amounts Receivable From Related Parties, and Underwriters,
Promoters and Employees Other Than Related Parties.
Schedule III -
Condensed Financial Information of Registrant.
Schedule V -
Supplemental Insurance Information (see Schedule X).
Schedule VI - Reinsurance
Schedule X -
Supplemental Insurance Information Concerning Property -
Casualty Subsidiaries
(b) Reports on Form 8-K.
There were no reports on Form 8-K filed for the quarter ended December 31,
1996.
(c) Exhibits required by Item 601 of Regulation S-K:
(3) (a) Restated Certificate of Incorporation (incorporated by
reference to Exhibit No. 3C to Amendment No. 1 to the Company's
Registration Statement (No. 33-9188) on Form S-1 filed on
November 7, 1986).
40
<PAGE> 41
(b) Restated By-laws (incorporated by reference to Exhibit No. 3D
to Amendment No. 1 to the Company's Registration Statement (No.
33-9188) on Form S-1 filed on November 7, 1986).
(10) (a) Management Agreement dated as of September 29, 1986 by and
among Merchants Mutual Insurance Company, Registrant and
Merchants Insurance Company of New Hampshire, Inc.
(incorporated by reference to Exhibit No. 10A to the Company's
Registration Statement (No. 33-9188) on Form S-1 filed on
September 30, 1986).
(b) Agreement of Reinsurance No. 6922 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation
(incorporated by reference to Exhibit No. 10E to the Company's
Registration Statement (No. 33-9188) on Form S-1 filed on
September 30, 1986).
(c) Agreement of Reinsurance No. 7299 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation,
(incorporated by reference to Exhibit No. 10o to the Company's
1987 Annual Report on Form 10-K (File No. 1-9640) filed on
March 19, 1988).
(d) Agreement of Reinsurance dated January 27, 1993, between
Merchants Mutual Insurance Company and Merchants Insurance
Company of New Hampshire, Inc. (incorporated by reference to
Exhibit (3) in the Company's Current Report on Form 8-K (File
No. 1-9640) filed on January 29, 1993).
(e) Agreement of Reinsurance No. 8009 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation,
(incorporated by reference to Exhibit 10e to the Company's 1995
Annual Report on Form 10-K filed on March 28, 1996)
(f) Property Catastrophe Reinsurance Agreement (HCI Agreement No.
439) between Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and General
Reinsurance Corporation, et. al., dated January 1, 1997, (filed
herewith).
41
<PAGE> 42
* (g) Merchants Mutual Capital Accumulation Plan (incorporated by
reference to Exhibit No. 10G to the Company's Registration
Statement (No. 33-9188) on Form S-1 filed on September 30,
1986).
* (h) Merchants Mutual Capital Accumulation Plan, fourth amendment,
effective January 1, 1996 (filed herewith).
* (i) Merchants Mutual Capital Accumulation Plan Trust Agreement
(restated as of January 1, 1996 filed herewith).
* (j) Merchants Mutual Supplemental Executive Retirement Plan dated
as of December 29, 1989 and Agreement of Trust dated as of
December 29, 1989 (incorporated by reference to Exhibit No. 10K
to the Company's 1989 Annual Report on Form 10-K (File No.
1-9640) filed on March 21, 1990).
* (k) Amendment dated June 10, 1992 to Agreement of Trust under
Merchants Mutual Supplemental Executive Retirement Plan dated
as of December 29, 1989 (incorporated by reference to Exhibit
No. 10R to the Company's 1992 Annual Report on Form 10-K (File
No. 1-9640) filed on March 31, 1993).
* (l) Merchants Group, Inc. 1986 Stock Option Plan As Amended Through
February 16, 1993 (incorporated by reference to Exhibit No. 10E
to the Company's 1992 Annual Report on Form 10-K (File No.
1-9640) filed on March 31, 1993).
(m) Form of Amended Indemnification Agreement entered into by
Registrant with each director and executive office of
Registrant (incorporated by reference to Exhibit No. 10N to
Amendment No. 1 to the Company's Registration Statement on (No.
33-9188) Form S-1 filed on November 7, 1986).
* (n) Merchants Mutual Insurance Company Incentive Compensation Plan,
as amended January 24, 1996 (filed herewith).
* (o) Employment Agreement between Robert M. Zak and Merchants Mutual
Insurance Company dated as of June 1, 1994 (incorporated by
reference to Exhibit No. 10O to the Company's 1994 Annual
Report on Form 10-K (File No. 1-9640) filed on
42
<PAGE> 43
March 31, 1995).
(11) (a) Statement re computation of per share earnings
(incorporated herein by reference to Note 1 to the Consolidated
Financial Statements included in Item 8).
(21) List of Subsidiaries of Registrant (incorporated by reference
to Exhibit No. 22 to the Company's Registration Statement ( No.
33-9188) on Form S-1 filed on September 30, 1986).
(23) Consent of Independent Accountants (filed herewith).
(27) Financial Data Schedule (filed herewith).
(28) (a) Schedule P furnished to state insurance regulatory
authorities by Merchants Insurance Company of New Hampshire,
Inc. for the year ended December 31, 1996 (filed herewith).
* Indicates a management contract or compensation plan or arrangement.
43
<PAGE> 44
MERCHANTS GROUP, INC.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1996
(in thousands)
<TABLE>
<CAPTION>
Amount at
which shown
Amortized Market in the
Type of Investment cost value balance sheet
------------------ ---- ----- -------------
<S> <C> <C> <C>
Fixed maturities:
United States Government
and government agencies
and authorities $ 26,276 $ 25,909 $ 25,949
Corporate bonds 3,086 3,239 3,239
Mortgage and asset backed
securities 107,003 107,522 107,110
Tax exempt bonds 46,684 46,818 46,818
-------- -------- --------
Total fixed maturities 183,049 $183,488 183,116
-------- ======== --------
Short-term investments 8,248 8,248
Other 10,233 10,233
-------- --------
$201,530 $201,597
======== ========
</TABLE>
44
<PAGE> 45
MERCHANTS GROUP, INC.
SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES,
AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER
THAN RELATED PARTIES
Years ended December 31, 1994, 1995 and 1996
(in thousands)
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Receivable from (payable to)
Merchants Mutual Insurance
Company(1):
Balance at beginning of period $(760) $ (397) $ 1,091
Increase (decrease) 363 1,488 (764)
----- ------- -------
Balance at end of period $(397) $ 1,091 $ 327
===== ======= =======
<FN>
(1) Under a Management Agreement, Merchants Mutual Insurance Company ("Mutual")
provides employees, services and facilities for Merchants Insurance Company
of New Hampshire, Inc. ("MNH") to carry on its insurance business on a cost
reimbursed basis. The balance in the intercompany receivable (payable)
account indicates the amount due from (to) Mutual for the excess
(deficiency) of premiums collected over (from) payments for losses,
employees, services and facilities provided to MNH.
</TABLE>
45
<PAGE> 46
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands except per share and share amounts)
BALANCE SHEET
- -------------
<TABLE>
<CAPTION>
December 31,
--------------------
1995 1996
---- ----
<S> <C> <C>
Assets
------
Investment in subsidiary $ 66,362 $ 63,764
Other assets 3,908 1,346
-------- --------
Total Assets $ 70,270 $ 65,110
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Other liabilities $ 300 $ 81
-------- --------
Total liabilities 300 81
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value,
authorized and unissued 3,000,000
shares -- --
Preferred stock, no par value, $424.30
stated value, no shares issued or
outstanding at December 31, 1995
or 1996 -- --
Common stock, $.01 par value,
authorized 10,000,000 shares;
issued and outstanding of
3,213,894 shares at December 31, 1995 and
3,059,652 shares at December 31, 1996 32 32
Additional paid in capital 35,302 35,372
Treasury stock, 160,700 shares at
December 31, 1996 -- (2,983)
Unrealized investment gains (losses),
net of tax (357) (603)
Accumulated earnings 34,993 33,211
-------- --------
Total stockholders' equity 69,970 65,029
-------- --------
Total liabilities and stockholders'
equity $ 70,270 $ 65,110
======== ========
</TABLE>
46
<PAGE> 47
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Continued
(in thousands except per share and share amounts)
INCOME STATEMENT
- ----------------
<TABLE>
<CAPTION>
Year ended
December 31,
-----------------------------
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Revenues:
Equity in net income (loss)
of subsidiary $ 1,307 $(2,856) $(1,570)
Investment income 69 73 133
Net realized investment gains
(losses) -- (840) 902
------- ------- -------
Total revenues 1,376 (3,623) (535)
Expenses:
General and administrative
expenses 336 246 281
------- ------- -------
Operating income before income taxes 1,040 (3,869) (816)
Income tax expense (benefit) (91) (50) 332
------- ------- -------
Net income $ 1,131 $(3,819) $(1,148)
======= ======= =======
</TABLE>
47
<PAGE> 48
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands)
STATEMENT OF CASH FLOWS
- -----------------------
Increase (Decrease) in Cash and Cash
Equivalents:
<TABLE>
<CAPTION>
Year ended
December 31,
-------------------------
1994 1995 1996
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities: $(129) $(311) $ 560
----- ----- -------
Cash flows from investing activities:
Receipt of subsidiary common
stock dividend 600 800 --
Sale (purchase) of other
investments, net 143 (480) 2,992
----- ----- -------
Cash flows from investing
activities 743 320 2,992
----- ----- -------
Cash flows from financing activities:
Purchase of treasury stock -- -- (2,983)
Cash dividend on common stock (631) (635) (634)
Exercise of common stock options 19 624 70
----- ----- -------
Cash flows from financing
activities (612) (11) (3,547)
----- ----- -------
Net increase (decrease) in cash and
cash equivalents 2 (2) 5
Cash and cash equivalents, beginning
of year 3 5 3
----- ----- -------
Cash and cash equivalents, end of year $ 5 $ 3 $ 8
===== ===== =======
</TABLE>
48
<PAGE> 49
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands)
STATEMENT OF CASH FLOWS - continued
<TABLE>
<CAPTION>
Year ended
December 31,
-----------------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Reconciliation of Net Income to Net
Cash Provided By Operations:
Net income (loss) $ 1,131 $(3,819) $(1,148)
Adjustments to reconcile net income
to net cash provided by operations:
Equity in (income) loss
of subsidiary (1,307) 2,856 1,570
Net realized investment
(gains) losses -- 840 (902)
Increase (decrease) in liabilities 136 98 (219)
(Increase) decrease in other
(non-investment) assets (292) 94 514
Other, net 203 (380) 745
------- ------- -------
Net cash provided by (used in)
operating activities $ (129) $ (311) $ 560
======= ======= =======
</TABLE>
NOTES TO CONDENSED FINANCIAL STATEMENTS
- ---------------------------------------
Cash dividends of $600,000 and $800,000 were paid to the Registrant by its
consolidated subsidiary in the years ended December 31, 1994, 1995,
respectively. No cash dividends were paid to the Registrant by its consolidated
subsidiary in 1996.
49
<PAGE> 50
MERCHANTS GROUP, INC.
SCHEDULE VI - REINSURANCE
YEARS ENDED DECEMBER 31, 1994, 1995, 1996
(in thousands)
<TABLE>
<CAPTION>
Percentage
Ceded Assumed of amount
Gross to other from other Net assumed
amount companies companies amount to net
-------- --------- ---------- ------- ---------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1994
Property and Casualty Premiums $ 89,808 $6,876 $7,255 $90,187 8.0%
Year ended December 31, 1995
Property and Casualty Premiums $ 98,553 $7,548 $6,572 $97,577 6.7%
Year ended December 31, 1996
Property and Casualty Premiums $101,007 $7,786 $3,401 $96,622 3.5%
</TABLE>
50
<PAGE> 51
MERCHANTS GROUP, INC.
SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING
PROPERTY - CASUALTY SUBSIDIARIES
Years ended December 31, 1994, 1995 and 1996
(in thousands)
<TABLE>
<CAPTION>
Reserves Losses & Loss Amortiza- Paid
for adjustment expenses tion of losses
Deferred losses Discount incurred related deferred and
policy & loss if any, Net to policy loss
acqui- adjust- deducted Net invest- (1) (2) acquisi- adjust- Direct
sition ment from Unearned earned ment Current Prior tion ment premiums
costs expenses reserves premiums premiums income years years costs expenses written
----- -------- -------- -------- -------- ------ ----- ----- ----- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended:
December 31, 1994 $11,587 $104,015 $ 242 $45,449 $90,845 $ 9,849 $65,818 $ 4,982 $24,424 $63,125 $ 89,808
December 31, 1995 $12,165 $119,722 $ 460 $48,773 $94,749 $10,368 $67,150 $11,045 $25,458 $62,091 $ 98,553
December 31, 1996 $12,396 $133,479 $1,113 $49,710 $95,752 $11,724 $72,771 $ 6,832 $25,374 $67,061 $101,007
</TABLE>
<PAGE> 52
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
With the exception of historical information, the matters and statements
discussed, made or incorporated by reference in this Annual Report on Form 10-K
constitute forward-looking statements and are discussed, made or incorporated by
reference, as the case may be, pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve certain assumptions, risks and uncertainties that could cause
actual results to differ materially from those included in or contemplated by
the statement. These assumptions, risks and uncertainties include, but are not
limited to, those associated with factors affecting the property and casualty
insurance industry generally, including price competition, size and frequency of
claims, increasing crime rates, escalating damage awards, natural disasters,
fluctuations in interest rates and general business conditions; the Company's
dependence on investment income; the geographic concentration of the Company's
business in the northeastern United States and in particular in New York, New
Hampshire, New Jersey, Rhode Island, Pennsylvania and Massachusetts; the
adequacy of the Company's loss reserves; government regulation of the insurance
industry; exposure to environmental claims; dependence of the Company on its
relationship with Mutual; and the other risks and uncertainties discussed or
indicated in all documents filed by the Company with the Commission. The Company
expressly disclaims any obligation to update any forward-looking statements as a
result of developments occurring after the filing of this report.
52
<PAGE> 53
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.
Merchants Group, Inc.
Date: March 25, 1997 BY: /s/Robert M. Zak, Senior Vice President
-------------------------------------
Robert M. Zak, Senior Vice President
and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/Richard E. Garman Director, Chairman March 25, 1997
- ----------------------- of the Board
Richard E. Garman
/s/Brent D. Baird Director, President March 25, 1997
- -----------------------
Brent D. Baird
/s/Robert M. Zak Director, Sr. VP & March 25, 1997
- ----------------------- Chief Operating
Robert M. Zak Officer
/s/Kenneth J. Wilson Vice President & CFO March 25, 1997
- ----------------------- (principal finance
Kenneth J. Wilson and accounting officer)
/s/Frank J. Colantuono Director March 25, 1997
- -----------------------
Frank J. Colantuono
/s/Henry P. Semmelhack Director March 25, 1997
- -----------------------
Henry P. Semmelhack
</TABLE>
53
<PAGE> 54
Report of Independent Accountants
---------------------------------
To the Board of Directors
and Stockholders of
Merchants Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 40 present fairly, in all material
respects, the financial position of Merchants Group, Inc. and its subsidiary at
December 31, 1996 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles. These 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
Price Waterhouse LLP
Buffalo, New York
February 27, 1997
F-1
<PAGE> 55
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED BALANCE SHEET
--------------------------
(in thousands)
<TABLE>
<CAPTION>
December 31,
-------------------
1995 1996
<S> <C> <C>
Assets
------
Investments:
Fixed maturities:
Held to maturity at amortized cost $ 19,477 $ 19,549
Available for sale at fair value 163,778 163,567
Other long-term investments at fair value 4,493 10,233
Short-term investments 4,470 8,248
-------- --------
Total investments 192,218 201,597
Cash 39 11
Interest due and accrued 1,886 1,793
Premiums receivable, net of allowance for doubtful accounts
of $416 in 1995 and $571 in 1996 20,360 20,501
Deferred policy acquisition costs 12,165 12,396
Ceded reinsurance balances receivable 7,014 7,835
Prepaid reinsurance premiums 2,866 2,932
Receivable from affiliate 1,091 327
Federal income taxes receivable 3,143 1,266
Deferred federal income tax benefit 5,491 6,645
Other assets 6,535 6,820
-------- --------
Total assets $252,808 $262,123
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
<PAGE> 56
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED BALANCE SHEET
--------------------------
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31,
-----------------------
1995 1996
---- ----
<S> <C> <C>
Liabilities and Stockholders' Equity
------------------------------------
Liabilities:
Reserve for losses and loss adjustment expenses $ 119,722 $ 133,479
Unearned premiums 48,773 49,710
Other liabilities 14,343 13,905
--------- ---------
Total liabilities 182,838 197,094
--------- ---------
Stockholders' equity:
Preferred stock -- --
Common stock, issued and outstanding 3,213,894
shares at December 31, 1995 and 3,059,652
shares at December 31, 1996 32 32
Additional paid in capital 35,302 35,372
Treasury stock, 160,700 shares at December 31, 1996 -- (2,983)
Unrealized investment losses, net of tax (357) (603)
Accumulated earnings 34,993 33,211
--------- ---------
Total stockholders' equity 69,970 65,029
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 252,808 $ 262,123
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 57
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF OPERATIONS
------------------------------------
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Revenues:
Net premiums earned $ 90,845 $ 94,749 $ 95,752
Net investment income 9,849 10,368 11,724
Net realized investment gains (losses) 20 (832) 996
Other revenues 638 259 172
--------- --------- ---------
Total revenues 101,352 104,544 108,644
--------- --------- ---------
Expenses:
Net losses and loss adjustment expenses 70,800 78,195 79,603
Amortization of deferred policy acquisition costs 24,424 25,458 25,374
Other underwriting expenses 5,892 7,709 6,700
--------- --------- ---------
Total expenses 101,116 111,362 111,677
--------- --------- ---------
Income (loss) before income taxes 236 (6,818) (3,033)
Income tax benefit (895) (2,999) (1,885)
--------- --------- ---------
Net income (loss) $ 1,131 $ (3,819) $ (1,148)
========= ========= =========
Primary and fully diluted earnings (loss) per share $ .36 $ (1.19) $ (.36)
========= ========= =========
Weighted average number of shares outstanding:
Primary 3,177 3,219 3,182
Fully diluted 3,177 3,220 3,182
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 58
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
---------------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Common stock:
Beginning and end of year $ 32 $ 32 $ 32
-------- -------- --------
Additional paid in capital:
Beginning of year 34,659 34,678 35,302
Exercise of common stock options 19 624 70
-------- -------- --------
End of year 34,678 35,302 35,372
-------- -------- --------
Treasury stock:
Beginning of year -- -- --
Purchase of treasury shares -- -- (2,983)
-------- -------- --------
End of year -- -- (2,983)
-------- -------- --------
Unrealized investment gains (losses), net of tax:
Beginning of year 1,445 (6,878) (357)
Appreciation (depreciation) (12,611) 9,880 (373)
Deferred income tax benefit (expense) 4,288 (3,359) 127
-------- -------- --------
End of year (6,878) (357) (603)
-------- -------- --------
Accumulated earnings:
Beginning of year 38,947 39,447 34,993
Net income (loss) 1,131 (3,819) (1,148)
Cash dividends (631) (635) (634)
-------- -------- --------
End of year 39,447 34,993 33,211
-------- -------- --------
Total stockholders' equity $ 67,279 $ 69,970 $ 65,029
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 59
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
INCREASE (DECREASE) IN CASH
---------------------------
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operations:
Collection of premiums $ 92,397 $ 93,944 $ 97,448
Payment of losses and loss adjustment expenses (63,125) (62,091) (67,061)
Payment of other underwriting expenses (30,444) (29,903) (32,311)
Investment income received 9,775 10,479 11,917
Investment expenses paid (166) (125) (287)
Income taxes (paid) recovered (760) (58) 2,734
Other cash receipts 638 259 188
-------- -------- --------
Net cash provided by operations 8,315 12,505 12,628
-------- -------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 21,696 15,321 55,899
Purchase of fixed maturities (25,851) (27,800) (55,910)
Net (increase) decrease in other long-term
investments (922) 164 (4,780)
Net increase in short-term investments (2,342) (15) (3,778)
Purchase of equipment, net (269) (143) (540)
-------- -------- --------
Net cash used in investing activities (7,688) (12,473) (9,109)
-------- -------- --------
Cash flows from financing activities:
Purchase of treasury stock -- -- (2,983)
Proceeds from exercise of common stock options -- 624 70
Cash dividends and other, net (613) (635) (634)
-------- -------- --------
Net cash used in financing activities (613) (11) (3,547)
-------- -------- --------
Increase (decrease) in cash 14 21 (28)
Cash, beginning of year 4 18 39
-------- -------- --------
Cash, end of year $ 18 $ 39 $ 11
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 60
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATIONS
---------------------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $ 1,131 $ (3,819) $ (1,148)
Adjustments:
Depreciation and amortization 22 100 33
Net realized investment (gains) losses (20) 832 (996)
(Increase) decrease in assets:
Interest due and accrued (88) 79 93
Premiums receivable (820) (2,309) (141)
Deferred policy acquisition costs 176 (578) (231)
Ceded reinsurance balances receivable 984 618 (821)
Prepaid reinsurance premiums (100) (496) (66)
Receivable from affiliate -- (1,091) 764
Federal income taxes receivable (1,197) (1,946) 1,877
Deferred federal income tax benefit (396) (1,111) (1,027)
Other assets (5,375) (141) 35
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 10,119 15,707 13,757
Unearned premiums (557) 3,324 937
Other liabilities 4,862 3,733 (438)
Payable to affiliate (363) (397) --
Federal income taxes payable (63) -- --
-------- -------- --------
Net cash provided by operations $ 8,315 $ 12,505 $ 12,628
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 61
MERCHANTS GROUP, INC.
---------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. Significant Accounting Policies
-------------------------------
Principles of consolidation and basis of presentation
-----------------------------------------------------
The consolidated financial statements of Merchants Group, Inc. (the
Company) include the accounts of the Company, its wholly owned subsidiary,
Merchants Insurance Company of New Hampshire, Inc. (MNH), and M.F.C. of New
York, Inc., an inactive premium finance company which is a wholly owned
subsidiary of MNH. MNH is a stock property and casualty insurance company
domiciled in the state of New Hampshire. MNH offers property and casualty
insurance to preferred risk individuals and small to medium sized
businesses in the northeast United States, primarily in the states of New
York, New Hampshire and New Jersey where a majority of its policies are
written. As a holding company, the Company has had no operations.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) which differ in some
respects from those followed in reports to insurance regulatory
authorities. In the 1996 Annual Statement filed with regulatory
authorities, MNH reported statutory capital of $31,458,000 and total
surplus of $43,908,000. MNH's net income (loss) as reported in its Annual
Statement was ($2,788,000) in 1996, ($4,490,000) in 1995 and $900,000 in
1994. All significant intercompany balances and transactions have been
eliminated.
The preparation of consolidated financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Investments
-----------
Fixed maturities consist primarily of debt securities. The Company has
classified its investments in fixed maturities as either held to maturity
or available for sale. Fixed maturities classified as held to maturity are
presented at amortized cost and consist of debt securities that management
intends and has the ability to hold until maturity.
Fixed maturities classified as available for sale are presented at fair
value and consist of debt securities that management may not hold until
maturity. The net aggregate unrealized gain or loss, net of applicable
income taxes, related to fixed maturities available for sale is included as
a component of stockholders' equity.
F-8
<PAGE> 62
In December 1995, the Company re-assessed the appropriateness of the
accounting classification of its fixed maturity investments as permitted by
the Financial Accounting Standards Board (FASB). As a result of this
reassessment the Company reclassified certain fixed maturity securities
with an amortized cost and fair value of $15,674,000 and $15,639,000,
respectively, from held to maturity to available for sale which resulted in
a $1,044,000 increase in stockholders' equity at December 31, 1995.
Other long-term investments include collateralized mortgage obligation
residuals, carried at unpaid principal balances which do not vary
significantly from fair value, preferred stocks carried at fair value and a
$1,350,000 capital advance carried at cost, which approximates fair value.
Short-term investments, consisting primarily of money market mutual funds,
have original maturities of three months or less, and are carried at cost,
which approximates fair value. Realized gains and losses on the sale of
investments are based on the cost of the specific investment sold.
Other financial instruments
---------------------------
The fair values of the Company's other financial instruments, principally
premiums receivable and certain non-insurance related liabilities, do not
vary significantly from the amounts assigned in these financial statements.
Premium revenue
---------------
Premiums are recorded as revenue ratably over the terms of the policies
written (principally one year). Unearned premiums are calculated using a
monthly pro rata method.
Deferred policy acquisition costs
---------------------------------
Policy acquisition costs, such as commissions (net of reinsurance
commissions), premium taxes and certain other underwriting expenses which
vary directly with premium volume, are deferred and amortized over the
terms of the related insurance policies. Deferred policy acquisition costs
do not exceed estimated recoverable amounts after allowing for anticipated
investment income.
Reserve for losses and loss adjustment expenses
-----------------------------------------------
Liabilities for unpaid losses and loss adjustment expenses (LAE) are
estimates of future payments to be made to settle all insurance claims for
reported losses and estimates of incurred but not reported losses based
upon past experience modified for current trends. With the exception of an
immaterial amount for workers' compensation losses, loss reserves are not
discounted. Estimated amounts of salvage and subrogation on paid and unpaid
losses are deducted from the liability for unpaid claims. The estimated
liabilities may be more or less than the amount ultimately paid when the
claims are settled. Management and the Company's independent consulting
actuaries regularly review the estimates of reserves needed and any changes
are reflected in current operating results.
F-9
<PAGE> 63
Structured settlements have been negotiated for claims on certain insurance
policies. Structured settlements are agreements to provide periodic
payments to claimants, and are funded by annuities purchased from various
life insurance companies. The Company remains primarily liable for payment
of these claims. Accordingly, a liability and a corresponding deposit in
the amount $5,382,000 and $5,333,000 at December 31, 1995 and 1996,
respectively, are recorded in the Company's consolidated balance sheet.
Reinsurance
-----------
Reinsurance assumed from business written through state reinsurance
facilities has been reflected in unearned premiums, loss reserves, premiums
earned and losses incurred based on reports received from such pools. Ceded
reinsurance premiums, losses and ceding commissions are netted against
earned premiums, losses and commission expense, respectively.
Income taxes
------------
The Company and its wholly owned subsidiary file a consolidated federal
income tax return. The Company uses the liability method to account for
income taxes. This approach requires the recognition of deferred tax
liabilities and assets for the expected future tax consequences of
temporary differences between the financial statement carrying amounts and
the tax bases of assets and liabilities.
Earnings per share
------------------
Primary and fully diluted earnings (loss) per share were computed by
dividing net income or loss by the weighted average number of shares of
common stock outstanding during each year. Primary and fully diluted
earnings per share for 1994, 1995 and 1996, assume the exercise of 65,164,
22,083 and 40,750 shares of common stock options, respectively.
2. Stockholders' Equity
--------------------
Preferred and common stock
--------------------------
Stockholders' equity is comprised of the following:
Preferred stock, no par value, $424.30 stated value, 10,000 shares
authorized; no shares issued or outstanding at December 31, 1995 or
December 31, 1996. The Company also has 3,000,000 shares of $.01 par value
preferred stock which is authorized and unissued.
Common stock, $.01 par value, authorized 10,000,000 shares; issued and
outstanding 3,213,894 shares at December 31, 1995 and 3,059,652 shares at
December 31, 1996.
F-10
<PAGE> 64
Dividends
---------
The Company may depend on dividends from its subsidiary, MNH, to pay cash
dividends to its stockholders and to meet its expenses. MNH is subject to
New Hampshire state insurance laws which restrict its ability to pay
dividends without the prior approval of state regulatory authorities. These
restrictions limit dividends to those that, when added to all other
dividends paid within the preceding twelve months, would not exceed 10% of
the insurer's policyholders' surplus as of the preceding December 31. The
maximum amount of dividends that MNH could pay during any twelve month
period ending in 1997, without the prior approval of the New Hampshire
Insurance Commissioner is $4,391,000. The Company paid a quarterly cash
dividend to its common stockholders in 1994, 1995 and 1996. Dividends paid
during 1996 totaled to $634,000.
Stock option plans
------------------
The Board of Directors had reserved 200,000 shares of common stock for
issuance to the Company's and MNH's officers and key employees of the
Company's affiliate Merchants Mutual Insurance Company (Mutual), under a
qualified and non-qualified stock option plan (the Plan). The Plan expired
in September 1996. Under the Plan, options may have been granted at any
amount which was not less than the fair market value of the Company's stock
on the date of grant. Options granted under the Plan have a 10 year life
and may be exercised in cumulative annual increments of 25% commencing one
year from the date of grant.
During 1996, 53,000 options were granted under the Plan at $21.00 per
share. No options were granted under the Plan in 1995 or in 1994. The
weighted average fair value of options granted in 1996 was $6.48 per
option.
In March 1994, the Company's Board of Directors approved a stock option
program providing for the issuance to certain of MNH's independent
insurance agents, options to purchase a total of 25,000 shares of the
Company's common stock. In June 1994, the Company issued options to
purchase 22,500 shares of common stock to certain of MNH's agents under the
option program at $16.38 per share. These options became exercisable on
June 1, 1996.
In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock Based
Compensation". In 1996, the Company adopted the disclosure provisions of
SFAS No. 123 but opted to remain under the expense recognition provisions
of APB Opinion No. 25 "Accounting for Stock Issued to Employees" in
accounting for its stock option plans. No compensation expense was
recognized for options granted under these plans in 1994, 1995 or 1996.
F-11
<PAGE> 65
Had compensation expense for stock options granted under the Company's
stock option plans been determined based on the fair value at the grant
date consistent with the method required by SFAS 123, the Company's net
loss and loss per share for the year ended December 31, 1996 would have
increased to the pro forma amounts shown below:
<TABLE>
<S> <C>
Net loss:
As reported ($1,148,000)
Pro forma ($1,316,000)
Loss per share:
As reported ($.36)
Pro forma ($.41)
</TABLE>
The fair value of each option granted in 1996 was estimated using a
binomial option pricing model which is a modification of the Black-Sholes
option pricing model, with the following assumptions for 1996: risk free
interest rate of 6.25%, volatility of 18.0%, expected dividend yield of
1.1% and expected life of 10 years.
A summary of the status of the Company's outstanding options as of December
31, 1996, 1995 and 1994, and changes during the years ending on those dates
is presented below:
<TABLE>
<CAPTION>
1994 1995 1996
--------------------- ------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Options Exercise Options Exercise
Outstanding Price Outstanding Price Outstanding Price
----------- -------- ----------- ------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Beginning
of year 84,491 $11.77 104,789 $12.74 49,083 $14.51
Granted 22,500 16.38 -- -- 53,000 21.00
Exercised (1,577) 12.03 (55,706) 11.20 (6,458) 12.01
Forfeited (625) 14.38 -- -- (4,875) 18.50
------- ------ ------
End of year 104,789 12.74 49,083 14.51 90,750 18.28
======= ====== ======
Options exer-
cisable at year-
end 65,164 10.98 22,083 12.61 40,750 14.93
======= ====== ======
</TABLE>
F-12
<PAGE> 66
The following table summarizes information about the Company's outstanding
stock options at December 31, 1996:
<TABLE>
<CAPTION>
Number Remaining Average Number
Exercise Outstanding Contractual Exercise Exercisable
Price at 12/31/96 Life in Years Price at 12/31/96
-------- ----------- ------------- -------- -----------
<S> <C> <C> <C> <C>
$ 9.38 4,000 2.2 $ 9.38 4,000
14.38 15,500 5.1 14.38 15,500
16.38 21,250 7.4 16.38 21,250
21.00 50,000 9.1 21.00 0
------ ------
90,750 40,750
====== ======
</TABLE>
Common stock repurchases
------------------------
Prior to 1996 in connection with the Company's stock option program for its
agents, the Company's Board of Directors approved a plan to purchase up to
25,000 shares of the Company's common stock. During 1996, the Company's
Board of Directors authorized the repurchase of up to 200,000 additional
shares of the Company's common stock in the open market. During 1996 the
Company repurchased 160,700 shares of its common stock and is holding these
shares in treasury as of December 31, 1996.
3. Related Party Transactions
--------------------------
The Company and MNH do not have any paid employees. Under a management
agreement Mutual, which owns 8.3% of the Company's outstanding common stock
at December 31, 1996, provides the Company and MNH with the facilities,
management and personnel required to manage their day-to-day business. All
underwriting, administrative, claims and investment expenses incurred on
behalf of Mutual and MNH are shared on an allocated cost basis, determined
as follows: for underwriting and administrative expenses, the respective
share of total direct premiums written for Mutual and MNH serves as the
basis of allocation; for claims expenses, the average number of outstanding
claims is used; investment expenses are shared based on each company's
share of total invested assets. Mutual also receives an annual management
fee of $50,000 from MNH. Management believes that the methods used to
allocate expenses to MNH and Mutual are reasonable and fair to both
companies. The management agreement may be terminated by either Mutual or
the Company upon five years written notice.
MNH's agents are also licensed to sell Mutual's products. The agents are
informed of the underwriting criteria of each company as well as the
classes of business that are acceptable to each company. Underwriters
review each application submitted by an agent to determine which company's
underwriting criteria the risk meets and then issue a policy in the
appropriate company. Involuntary automobile policies are shared in
accordance with the plan assignment ratios of the applicable governing
jurisdictions. The payable to or receivable from Mutual is non-interest
bearing and represents the net of premiums collected and loss and operating
F-13
<PAGE> 67
expense payments made by Mutual on behalf of MNH. This balance is settled
in cash on a monthly basis.
MNH owns an investment represented by a capital advance issued by Mutual in
the amount of $1,350,000. This investment carries a dividend of 4% per
annum. Mutual cannot repay the capital advance or pay dividends without the
prior approval of the Superintendent of the New York Insurance Department.
In December 1996, the Department granted Mutual permission to pay all
unpaid dividends through October 1996. MNH received $203,000 of such
dividends from Mutual in December 1996. This investment is included in
other long-term investments.
During 1994, Mutual filed an application with the New York Insurance
Department to convert from a mutual company to a stock corporation. The
Company had indicated to Mutual its willingness to consider sponsoring this
conversion. During 1996, Mutual advised the Company that it had withdrawn
its demutualization application with the Department.
Effective January 1, 1993, Mutual and MNH entered into a quota share
reinsurance agreement under which MNH assumes 10% of Mutual's direct
voluntary written premium and related losses in exchange for a reinsurance
commission of 35%. The agreement also provides for MNH to pay a contingent
commission to Mutual equal to any underwriting profit on the premiums
assumed. The agreement allows Mutual the option to reduce its cessions to
MNH to 0% for any calendar year. Mutual did not cede any portion of its
direct voluntary premiums written to MNH in 1996 and has informed MNH that
it will not cede any of its direct voluntary written premiums to MNH for
calendar year 1997.
In accordance with various states' automobile insurance plan (AIP) rules,
Mutual historically has received the assignment of AIP policies based upon
its and MNH's combined voluntary automobile market share, issued the
policies and settled the claims associated with those policies. Mutual then
allocated the results of the involuntary AIP business to MNH through a
series of accounting entries based on MNH's share of the combined voluntary
business of Mutual and MNH. During 1994, Mutual informed the Company that
it had failed to identify and bill to MNH during the period January 1, 1985
through June 30, 1994 a portion of MNH's share of AIP losses paid by Mutual
in that period. The amount of unbilled AIP losses was approximately
$7,500,000. MNH paid Mutual $3,135,000 in full and complete settlement of
the unbilled AIP paid losses for the period noted above. This amount is
included in loss and loss adjustment expenses for the year ended December
31, 1994.
F-14
<PAGE> 68
4. Reserve for Losses and Loss Adjustment Expenses
-----------------------------------------------
Activity in the reserve for losses and LAE is summarized as follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
(in thousands)
<S> <C> <C>
Reserve for losses and LAE at beginning of year $104,015 $119,722
Less reinsurance recoverables 6,401 6,004
-------- --------
Net balance at beginning of year 97,614 113,718
-------- --------
Provision for losses and LAE for claims occurring in:
Current year 67,150 72,771
Prior years 11,045 6,832
-------- --------
78,195 79,603
-------- --------
Losses and LAE payments for claims occurring in:
Current year 25,175 28,512
Prior years 36,916 38,549
-------- --------
62,091 67,061
-------- --------
Reserve for losses and LAE at end of year, net 113,718 126,260
Plus reinsurance recoverables 6,004 7,219
-------- --------
Balance at end of year $119,722 $133,479
======== ========
</TABLE>
In 1995 and 1996, the Company increased its reserves for prior years by
$11,045,000 and $6,896,000, respectively. The increase in reserves for
prior years made in 1995 was primarily attributable to higher than
anticipated severity of liability claims on homeowners, businessowners,
workers' compensation and commercial package lines of business. The
increase in reserves for prior years made in 1996 was primarily
attributable to higher than anticipated severity of claims on workers'
compensation policies.
F-15
<PAGE> 69
5. Investments
-----------
Investments in fixed maturities
-------------------------------
The amortized cost and estimated fair values of investments in fixed
maturities held to maturity and available for sale are as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1995
-----------------
Held to maturity
----------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 2,157 $ 15 $ 37 $ 2,135
Mortgage and asset backed
securities 17,320 902 9 18,213
-------- ------ ---- --------
Total $ 19,477 $ 917 $ 46 $ 20,348
======== ====== ==== ========
Available for sale
------------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 26,943 $ 30 $277 $ 26,696
Obligations of states and
political subdivisions 60,423 580 166 60,837
Corporate securities 12,037 4 73 11,968
Mortgage and asset backed
securities 63,846 502 71 64,277
-------- ------ ---- --------
Total $163,249 $1,116 $587 $163,778
======== ====== ==== ========
</TABLE>
F-16
<PAGE> 70
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1996
-----------------
Held to maturity
----------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 2,153 $ 7 $ 47 $ 2,113
Mortgage and asset backed
securities 17,396 412 -- 17,808
-------- ------ ---- --------
Total $ 19,549 $ 419 $ 47 $ 19,921
======== ====== ==== ========
Available for sale
------------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 24,123 $ 4 $331 $ 23,796
Obligations of states and
political subdivisions 46,684 336 202 46,818
Corporate securities 3,086 153 -- 3,239
Mortgage and asset backed
securities 89,607 532 425 89,714
-------- ------ ---- --------
Total $163,500 $1,025 $958 $163,567
======== ====== ==== ========
</TABLE>
F-17
<PAGE> 71
The amortized cost and fair value of fixed maturities by expected
maturity at December 31, 1996 are shown below. Mortgage and asset
backed securities are distributed in the table based upon management's
estimate of repayment periods. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Estimated Fair
Amortized Cost Value
-------------- --------------
(in thousands)
<S> <C> <C>
Held to maturity
----------------
Due in one year or less $ 2,080 $ 2,129
Due after one year through five years 11,386 11,565
Due after five years through ten years 4,251 4,352
Due after ten years 1,832 1,875
------- -------
Total $19,549 $19,921
======= =======
Available for sale
Due in one year or less $ 13,420 $ 13,438
Due after one year through five years 112,656 112,470
Due after five years through ten years 27,987 28,201
Due after ten years 9,437 9,458
-------- --------
Total $163,500 $163,567
======== ========
</TABLE>
Discount and premium pertaining to collateralized mortgage obligations
are amortized over the securities' estimated redemption periods using
the effective interest method. Yields used to calculate premium or
discount are adjusted for prepayments annually.
Fixed maturities with a par value of $1,800,000 were on deposit at
December 31, 1996 with various state insurance departments in
compliance with applicable insurance laws.
Proceeds from sales of available for sale fixed maturity securities and
gross realized gains and losses related to such sales are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Proceeds from sales $12,891 $1,797 $38,499
Gross realized gains 29 8 1,012
Gross realized losses 9 - 16
</TABLE>
F-18
<PAGE> 72
Net investment income
---------------------
Net investment income consists of:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Short-term investments $ 252 $ 238 $ 443
Fixed maturities 9,872 10,078 10,956
Other 188 177 612
------- ------- -------
Total investment income 10,312 10,493 12,011
Investment expenses 463 125 287
------- ------- -------
Net investment income $ 9,849 $10,368 $11,724
======= ======= =======
</TABLE>
Investment in auction rate preference shares
--------------------------------------------
During 1996, the Company sold its investment in Signet Group, PLC (Signet)
cumulative auction rate preference shares and recognized a realized gain of
$900,000. These shares were included in other long term investments at
December 31, 1995 and were carried at fair value.
During 1995, the Company recorded an $840,000 unrealized loss on its Signet
investment which was included as a component of realized gains and losses
in the Company's 1995 Consolidated Statement of Operations.
6. Reinsurance
-----------
MNH follows the customary practice of reinsuring a portion of the exposure
under its policies and as consideration pays to the reinsurer a portion of
the premium received on such policies. Insurance is ceded principally to
reduce net liability on individual risks and to protect against
catastrophic losses. Although reinsurance does not legally discharge an
insurer from its primary liability for the full amount of coverage provided
by its policies, it does make the assuming reinsurer liable to the insurer
to the extent of the reinsurance ceded.
MNH maintains a casualty excess of loss reinsurance agreement which
provides for recovery of losses over $500,000 up to $5,000,000 per
occurrence. This coverage is supplemented by a contingent casualty layer of
reinsurance of $5,000,000 in excess of the first $5,000,000. MNH also
maintains a property excess of loss reinsurance agreement which provides
for recovery of property losses over $500,000 up to $2,000,000 per
occurrence. Property catastrophe coverage provides for recovery of 95% of
$40,000,000 above aggregate retained losses of $5,000,000 per each natural
disaster. The limits of property catastrophe coverage are shared by MNH and
Mutual on a pro rata basis based upon the gross reported losses of MNH and
Mutual for a covered event.
F-19
<PAGE> 73
The effect of reinsurance on premiums written and earned for the years
ended December 31, 1995 and 1996 is as follows:
<TABLE>
<CAPTION>
1995 1996
-------------------- ---------------------
Premiums Premiums Premiums Premiums
Written Earned Written Earned
------- ------ ------- ------
(in thousands)
<S> <C> <C> <C> <C>
Direct $ 98,553 $ 93,502 $ 101,007 $ 99,858
Assumed 6,572 8,299 3,401 3,614
Ceded (7,548) (7,052) (7,786) (7,720)
-------- -------- --------- --------
Net premiums $ 97,577 $ 94,749 $ 96,622 $ 95,752
======== ======== ========= ========
</TABLE>
Reinsurance ceded transactions decreased losses and LAE by $1,527,000 and
$1,920,000 for the years ended December 31, 1995 and 1996, respectively.
As a result of the reinsurance agreements maintained by MNH, MNH is exposed
to certain credit risk if its primary reinsurer were to become financially
unstable. As of December 31, 1996, MNH has recognized amounts to be
recovered from its primary reinsurer related to ceded losses and ceded
unearned premiums totaling $9,009,000. MNH generally does not require
collateral for reinsurance recoverable.
7. Benefit Programs
----------------
Mutual maintains a capital accumulation plan which is a profit sharing plan
under Section 401(a) of the Internal Revenue Code that covers all full-time
employees who have completed one year of service. Mutual matches at least
15% and up to 100% of employee contributions, based on the combined net
operating profits of Mutual and MNH. Additional contributions may be made
at the discretion of the Board of Directors of Mutual. Under the terms of
the management agreement, the Company's portion of the total contribution
was $404,000, $186,000 and $ 238,000 for the years ended December 31, 1994,
1995 and 1996, respectively.
F-20
<PAGE> 74
8. Income Taxes
------------
The benefit for federal income taxes consists of:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Income tax benefit:
Current $(500) $(1,888) $(1,208)
Deferred (395) (1,111) (677)
----- ------- -------
Total income tax benefit $(895) $(2,999) $(1,885)
===== ======= =======
</TABLE>
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1995 1996
---- ----
(in thousands)
<S> <C> <C>
Deferred policy acquisition costs $ 4,136 $ 4,215
Other 462 400
--------- --------
Gross deferred tax liabilities 4,598 4,615
--------- --------
Discounting of reserve for losses and
loss adjustment expenses (6,004) (5,993)
Unearned premiums (3,122) (3,181)
Unrealized investment losses (674) (311)
Other (289) (466)
Minimum tax credit carryforward - (1,309)
--------- --------
Gross deferred tax assets (10,089) (11,260)
--------- --------
Net deferred federal income tax
benefit $ (5,491) $ (6,645)
========= ========
</TABLE>
Although realization is not assured, based upon the available evidence the
Company believes that it is more likely than not that the net deferred
federal income tax benefit will be realized. The amount of the deferred tax
benefit considered realizable, however, could be reduced in the near term
if estimates of future taxable income are not achieved.
F-21
<PAGE> 75
A reconciliation of the difference between the Company's total income tax
provision and that calculated using the federal statutory income tax rate
is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------
1994 1995 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Computed provision (benefit) at
statutory rate $ 80 $(2,318) $(1,031)
Adjustments:
Tax-exempt investment income (980) (878) (726)
Other items 5 197 (128)
--------- ------- -------
Total income tax benefit $ (895) $(2,999) $(1,885)
========= ======= =======
</TABLE>
9. Commitments and Contingencies
-----------------------------
In 1995, a New York State trial court dismissed a purported class action
lawsuit which was filed in 1993 against the Company, Mutual, MNH and
certain directors of the Company and of Mutual (the defendants) on behalf
of the then minority shareholders of the Company. The court, in granting
the defendants' motion, held that plaintiff's claims, to the extent they
have any merit, are derivative in nature. The complaint, which sought
equitable relief and unspecified money damages, alleged that the defendants
breached their fiduciary obligations to the minority shareholders of the
Company, and defrauded the minority shareholders, by causing MNH to
purchase from the Federal Deposit Insurance Corporation (the FDIC) a
surplus note issued by Mutual and simultaneously reducing the principal
amount plus accrued return on such surplus note to $1,350,000, which is the
amount MNH paid to the FDIC for the note, and by approving the public sale
of the Company's common stock in July 1993 at what the plaintiff alleges
was an inadequate price. In November 1995 the plaintiff filed an amended
complaint which asserts the same claims as were asserted in his class
action lawsuit but in the form of a derivative suit. In June 1996, the
Company and the other defendants moved to dismiss the derivative complaint.
The court has not yet rendered its decision on those motions.
MNH, like many other property-casualty insurance companies, is subject to
environmental damage claims asserted by or against its insureds. Management
is of the opinion that based on various court decisions throughout the
country, such claims should not be recoverable under the terms of MNH's
insurance policies because of either specific or general coverage
exclusions contained in the policies. However, there is no assurance that
the courts will agree with MNH's position in every case, nor can there be
assurance that material claims will not be asserted under policies which a
court will find do not explicitly or implicitly exclude claims for
environmental damages. Management, however, is not aware of any pending
claim or group of claims which would result in a liability that would have
a material adverse effect on the financial condition of MNH.
F-22
<PAGE> 76
In addition to the foregoing matters, MNH is a defendant in a number of
other legal proceedings in the ordinary course of its business. Management
of the Company is of the opinion that the ultimate aggregate liability, if
any, resulting from such proceedings will not materially affect the
financial condition of MNH or the Company.
F-23
<PAGE> 77
EXHIBIT INDEX
<PAGE> 1
EXHIBIT 10(f)
<PAGE> 2
HCI AGREEMENT NO. 439
PROPERTY CATASTROPHE EXCESS OF LOSS
REINSURANCE AGREEMENT
(hereinafter referred to as "Agreement")
between
MERCHANTS MUTUAL INSURANCE COMPANY
MERCHANTS INSURANCE COMPANY OF NEW HAMPSHIRE, INC.
Buffalo, New York
(hereinafter referred to as the "Company")
and
The Subscribing Reinsurers executing
the Interests and Liabilities Agreements attached to this Agreement
(hereinafter collectively referred to as the "Reinsurers")
------------------------------------------------------------------------
In consideration of the promises set forth in this Agreement, the parties agree
as follows:
ARTICLE I - SCOPE OF AGREEMENT
As a condition precedent to the Reinsurers' obligations under this
Agreement, the Company shall cede to the Reinsurers the property business
described in this Agreement, and the Reinsurers shall accept such business as
reinsurance from the Company.
This Agreement is comprised of Articles I through XXI and the Exhibits
listed below. The terms of the Articles and of the Exhibits shall determine the
rights and obligations of the parties. The terms of the Articles shall apply to
each Exhibit unless specifically amended therein.
EXHIBIT A - FIRST EXCESS OF LOSS REINSURANCE (Catastrophe)
of
PROPERTY BUSINESS
EXHIBIT B - SECOND EXCESS OF LOSS REINSURANCE (Catastrophe)
of
PROPERTY BUSINESS
EXHIBIT C - THIRD EXCESS OF LOSS REINSURANCE (Catastrophe)
of
PROPERTY BUSINESS
<PAGE> 3
ARTICLE II - PARTIES TO THE AGREEMENT
This Agreement is solely between the Company and the Reinsurers. When
more than one Company is named as a party to this Agreement, the first Company
named shall be the agent of the other companies as to all matters pertaining to
this Agreement. Performance of the obligations of each party under this
Agreement shall be rendered solely to the other party. However, if the Company
becomes insolvent, the liability of the Reinsurers shall be modified to the
extent set forth in the article entitled INSOLVENCY OF THE COMPANY. In no
instance shall any insured of the Company or any claimant against an insured of
the Company have any rights under this Agreement.
ARTICLE III - TERM
This Agreement shall apply to loss occurrences which commence during
the period from January 1, 1997 to December 31, 1997 both dates inclusive, at
the place of the loss occurrence.
This Agreement shall not apply to loss occurrences which commence prior
to the effective date of this Agreement and continue during any part of the term
of this Agreement. However, this Agreement shall apply to loss occurrences which
commence during and continue beyond the term of this Agreement and in the
computation of the liability of the Reinsurers the entire ultimate net loss
resulting from each such loss occurrence shall be included, subject to the
limitations set forth in paragraph (f) of the article entitled DEFINITIONS.
ARTICLE IV - DEFINITIONS
(a) PROPERTY BUSINESS
This term shall mean insurance which is classified in the NAIC
form of annual statement as fire, allied lines, farmowners
multiple peril (section I), homeowners multiple peril (section
I), commercial multiple peril (section I, including section I
of business owners), inland marine, (including Section 1 of
boatowners), Earthquake, and automobile physical damage
(excluding collision but including water damage, fleet
dealers' and garagekeepers' legal liability), except those
lines specifically excluded in the article entitled
EXCLUSIONS, on risks wherever located in the United States of
America, its territories and possessions, and in Canada.
-2-
<PAGE> 4
(b) COMPANY RETENTION
This term shall mean the amount the Company shall retain for
its own account; however, this requirement shall be satisfied
if this amount is retained by the Company or its affiliated
companies under common management or common ownership.
(c) ULTIMATE NET LOSS
This term shall mean all payments by the Company of claims and
losses, within the limits of liability or amounts of insurance
of the policies of the Company, and adjustment expense, after
deduction of salvage and after deduction of amounts due from
all other reinsurance, whether collectible or not. If the
Company becomes insolvent, this definition shall be modified
to the extent set forth in the article entitled INSOLVENCY OF
THE COMPANY.
(d) ADJUSTMENT EXPENSE
This term shall mean expenditures by the Company, other than
for office expenses and for the salaries and expenses of
employees of the Company or of any subsidiary or related or
wholly owned Company of the Company, made in connection with
the disposition of a claim, loss, or legal proceeding
including investigation, negotiation, and legal expenses;
court costs; prejudgment interest or delayed damages; and
interest on any judgment or award.
(e) PREJUDGMENT INTEREST OR DELAYED DAMAGES
This term shall mean interest or damages added to a
settlement, verdict, award, or judgment based on the amount of
time prior to the settlement, verdict, award, or judgment
whether or not made part of the settlement, verdict, award, or
judgment.
(f) LOSS OCCURRENCE
This term shall mean the sum of all individual losses directly
occasioned by any one disaster, accident or loss or series of
disasters, accidents or losses arising out of one event which
occurs within the territorial limits of this Agreement.
However, the duration and extent of any one loss occurrence
shall be limited to all individual losses sustained by the
Company occurring during any period of 168 consecutive hours
arising out of and directly occasioned by the same event,
except that the term "Loss Occurrence" shall be further
defined as follows:
-3-
<PAGE> 5
(l) As regards windstorm, hail, tornado, hurricane,
cyclone, including ensuing collapse and water damage,
all individual losses sustained by the Company
occurring during any period of 72 consecutive hours
arising out of and directly occasioned by the same
event. However, the event need not be limited to one
state or province or states or provinces contiguous
thereto;
(2) As regards riot, riot attending a strike, civil
commotion, vandalism and malicious mischief, all
individual losses sustained by the Company occurring
during any period of 72 consecutive hours within the
area of one municipality or county and the
municipalities or counties contiguous thereto arising
out of and directly occasioned by the same event. The
maximum duration of 72 consecutive hours may be
extended in respect of individual losses which occur
beyond such 72 consecutive hours during the continued
occupation of an assured's premises by strikers,
provided such occupation commenced during the
aforesaid period;
(3) As regards earthquake (the epicenter of which need
not necessarily be within the territorial confines
referred to in the opening paragraph of this
definition) and fire following directly occasioned by
earthquake, only those individual fire losses which
commence during the period of 168 consecutive hours
may be included in the Company's loss occurrence;
(4) As regards "Freeze", only individual losses directly
occasioned by collapse, breakage of glass and water
damage (caused by bursting of frozen pipes and tanks)
may be included in the Company's loss occurrence.
The Company may choose the date and time when any such period
of consecutive hours commences provided that it is not earlier
than the date and time of the occurrence of the first recorded
individual loss sustained by the Company arising out of that
disaster, accident or loss and provided that only one such
period of 168 consecutive hours (or in the case of paragraph
(1) and (2) above, 72 consecutive hours) shall apply with
respect to one event.
No individual losses occasioned by an event that would be
covered by 72 hours clauses may be included in any "Loss
Occurrence" claimed under the 168 hours provision.
-4-
<PAGE> 6
(g) SUBJECT NET EARNED PREMIUM
This term shall mean the direct premiums earned by the Company
during the term of this Agreement on the business reinsured
hereunder after deduction of return premiums and after
deduction of premiums paid for reinsurance which inures to the
benefit of the Reinsurers.
For purposes of this Agreement, subject net earned premium
shall be deemed to be:
(1) 100% of fire, allied lines and inland marine policy
premiums;
(2) 85% of the total homeowners and farmowners policy
premiums;
(3) 40% of the total commercial multiple peril and business
owners policy premiums;
(4) 100% of automobile physical damage premium excluding
collision; and
(5) 100% of all other policy premiums for the business
reinsured hereunder.
ARTICLE V - EXCLUSIONS
This Agreement shall not apply to:
(a) Reinsurance accepted by the Company other than:
(1) Facultative reinsurance on a share basis of risks accepted
individually and not forming part of any agreement, or
(2) Local agency reinsurance on a share basis accepted in the
normal course of business, or
(3) From its affiliates;
(b) Nuclear incident per the following clauses attached hereto:
(l) Nuclear Incident Exclusion Clause - Physical
Damage Reinsurance-U.S.A. NMA 1119;
-5-
<PAGE> 7
(2) Nuclear Incident Exclusion Clause - Physical Damage
Reinsurance-Canada NMA 1980;
(c) Any extra or non-contractual damages (including loss in excess
of policy limits) or legal fees and expense attendant to the
defense thereof, including but not limited to compensatory,
exemplary and punitive damages or fines or statutory penalties
which are awarded against the Company as a result of an act,
omission, or course of conduct committed by or on behalf of
the Company;
(d) Any loss or liability accruing to the Company directly or
indirectly from any insurance written by or through any pool
or association including pools or associations in which
membership by the Company is required under any statutes or
regulations; however, this exclusion shall not apply to:
(1) The Alabama Insurance Underwriting Association;
(2) The Florida Windstorm Underwriting Association;
(3) The Louisiana Insurance Underwriting Association;
(4) The Mississippi Windstorm Underwriting Association;
(5) The New York Coastal Market Assistance Program (CMAP);
(6) The North Carolina Insurance Underwriting Association;
(7) The South Carolina Windstorm and Hail Underwriting
Association;
(8) The Texas Catastrophe Property Insurance Association;
(9) All "Fair Plan" and "Rural Risk Plan" business;
(10) The Devco Mutual Association,
however, this Agreement shall not cover any increase in such
liability resulting from the inability of any other
participant in any such pool or plan to meet its liability;
(e) Any liability of the Company arising from its participation
or membership in any insolvency fund;
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<PAGE> 8
(f) Any loss or damage which is occasioned by war, invasion, hostilities,
acts of foreign enemies, civil war, rebellion, insurrection, military
or usurped power, or martial law or confiscation by order of any
government or public authority; however, this exclusion shall not apply
to any policy which contains a standard war exclusion;
(g) Risks written on a layered basis, whether primary or excess of loss, or
policies written with a deductible or franchise of more than $5,000;
however, this exclusion shall not apply to policies which provide a
percentage deductible or franchise in connection with windstorm;
(h) Insurance against earthquake, except when written in conjunction with
fire and otherwise eligible perils;
(i) Insurance on growing crops;
(j) Insurance against flood, surface water, waves, tidal water or tidal
wave, overflow of streams or other bodies of water or spray from any of
the foregoing, all whether driven by wind or not except when written in
conjunction with fire and otherwise eligible perils;
(k) Any loss in respect of overhead transmission and distribution lines and
their supporting structures other than those on or within 1000 feet of
the insured premises; however, this exclusion shall not apply to public
utilities extension and/or suppliers extension and/or contingent
business interruption coverages, provided that these are not part of a
transmitters' or distributors' policy;
(l) Business classified as fidelity;
(m) Liability under coverage afforded for loss or damage resulting from
failure to account or pay for any goods or merchandise sold on credit,
delivered under deferred payment agreements, consigned for sale, or
delivered under any trust or floor plan agreements, except under
standard accounts receivable policies;
(n) Any loss or damage caused by or resulting from explosion, rupture, or
bursting of steam boilers, steam pipes, steam turbines, steam engines,
or rotating parts of machinery caused by centrifugal force; if owned
by, leased by, or actually operated under the control of the insured.
This exclusion shall not apply to ensuing loss by fire not otherwise
excluded;
(o) Mortgage impairment insurance and similar kinds of insurance, howsoever
styled, providing coverage to an insured with respect to
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<PAGE> 9
its mortgagee interest in property or its owner interest in
foreclosed property;
(p) Difference in conditions insurance and similar kinds of insurance,
howsoever styled;
(q) Risks which have a total insurable value of more than $250,000,000;
however, this exclusion shall not apply if the Company writes 100% of
the risk;
(r) Any collection of fine arts with an insurable value of $5,000,000 or
more;
(s) Mobile homes;
(t) Inland marine business with respect to the following:
(l) All bridges and tunnels;
(2) Cargo insurance when written as such with respect to ocean,
lake, or inland waterways vessels;
(3) Commercial negative film insurance and cast insurance;
(4) Drilling rigs;
(5) Furriers' customers policies;
(6) Garment contractors policies;
(7) Insurance on livestock under so-called "mortality policies";
(8) Jewelers' block policies and furriers' block policies;
(9) Mining equipment while underground;
(10) Motor truck cargo insurance written for common carriers
operating beyond a radius of 300 miles;
(11) Radio and television broadcasting towers;
(12) Registered mail insurance when the limit of any one addressee
on any one day is more than $50,000;
(u) Watercraft, other than watercraft insured under a standard homeowners
policy;
-8-
<PAGE> 10
(v) Loss of, damage to, or failure of, or consequential loss resulting
therewith (including but not limited to earnings and extra expense) of
satellites, spacecraft, and launch vehicles, including cargo and
freight carried therein, in all phases of operation (including but not
limited to manufacturing, transit, pre-launch, launch, and in-orbit);
(w) Coverage afforded by ISO Pollutant Clean Up and Removal Additional
Aggregate Limit of Insurance Endorsement CP 04 07 (Ed. 4/86) or as
subsequently amended or by any similar endorsement affording such
coverage;
(x) Pollutant clean up or removal, including time element coverage
associated therewith, under any commercial property policy or any
inland marine policy written by the Company which does not contain ISO
Changes-Pollutants Endorsement CP 01 86 (Ed. 4/86) or as subsequently
amended; however, this exclusion does not apply to any risk located in
a jurisdiction which has not approved the Insurance Services Office
exclusion or where other regulatory constraints prohibit the Company
from attaching such endorsement. If the Company elects to file an
endorsement independent of ISO, such endorsement will be deemed a
suitable substitute provided the Company has submitted the wording to
the Reinsurers and received the Reinsurers' prior approval.
Article VI - MANAGEMENT OF CLAIMS AND LOSSES
The Company shall investigate and settle or defend all claims and
losses. When requested by the Reinsurers, the Company shall permit the
Reinsurers, at the expense of the Reinsurers, to be associated with the Company
in the defense or control of any claim, loss, or legal proceeding which involves
or is likely to involve the Reinsurers. All payments of claims or losses by the
Company within the limits of its policies which are within the limits set forth
in the applicable Exhibit shall be binding on the Reinsurers, subject to the
terms of this Agreement.
Article VII - RECOVERIES
The Company shall pay to or credit the Reinsurers with the Reinsurers'
portion of any recovery obtained from salvage, subrogation, or other insurance.
Adjustment expenses for recoveries shall be deducted from the amount recovered.
The Reinsurers shall be subrogated to the rights of the Company to the
extent of their loss payments to the Company. The Company agrees to enforce its
rights of salvage, subrogation, and its rights against insurers or to assign
these rights to the Reinsurers. Recoveries shall be distributed to the parties
in an order inverse to that in which their liabilities accrued.
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<PAGE> 11
Article VIII - AUTOMATIC REINSTATEMENT
The Limit of Liability of the Reinsurers under each Exhibit of this
Agreement with respect to each loss occurrence shall be reduced by an amount
equal to the amount of liability paid by the Reinsurers, but that part of the
liability of the Reinsurers that is so reduced shall be automatically reinstated
from the commencement of the loss occurrence for which payment is made; however,
the Limit of Liability of the Reinsurers with respect to all loss occurrences
commencing during the term of this Agreement shall not exceed the amount set
forth in the section entitled LIABILITY OF THE REINSURERS of each Exhibit of
this Agreement. In consideration of this automatic reinstatement, the Company
shall pay to the Reinsurers for each amount reinstated an additional reinsurance
premium that shall be the product of the reinsurance premium set forth in the
section entitled REINSURANCE PREMIUM of each Exhibit of this Agreement,
multiplied by the amount of the reinstated Limit of Liability of the Reinsurers
divided by the total Limit of Limit of Liability of the Reinsurers for each loss
occurrence irrespective of the time of the commencement of the loss occurrence.
The Company shall pay such additional premium at the same time that the
Reinsurers make each payment of ultimate net loss. If the Company requests any
such payment of ultimate net loss before the actual reinsurance premium is
determined, the additional reinsurance premium shall be provisionally calculated
on 100% of the deposit reinsurance premium stipulated in the each Exhibit of
this Agreement. Such additional reinsurance premium shall be recalculated and
adjusted until both the reinsurance premium and the ultimate net loss are
finally determined.
Article IX - REPORTS AND REMITTANCES
(a) Claims and Losses
The Company shall report to the Reinsurers as soon as possible
but within 45 days of each loss occurrence, which in the
Company's opinion, may involve the reinsurance afforded by
this Agreement. The Company shall advise the Reinsurers of the
estimated amount of ultimate net loss in connection with each
loss occurrence and of any subsequent changes in such
estimate.
As soon as possible but within 45 days after receipt of a
definitive statement of ultimate net loss from the Company,
the Reinsurers shall pay to the Company the Reinsurers'
portion of ultimate net loss. Any subsequent changes in the
amount of ultimate net loss shall be reported by the Company
to the Reinsurers and the amount due either party shall be
remitted as soon as possible but within 45 days after receipt
of such report
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<PAGE> 12
(b) P.C.S. CATASTROPHE BULLETINS
The Company shall furnish to the Reinsurers, upon request, the
following information with respect to each catastrophe set
forth in the Catastrophe Bulletins published by the Property
Claim Services:
(l) The preliminary estimate of the amount recoverable from
the Reinsurers;
(2) The Reinsurers' portion of claims, losses, and adjustment
expense paid less salvage recovered during each calendar
quarter;
(3) The Reinsurers' portion of reserves for claims, losses,
and adjustment expense at the end of each calendar
quarter.
(c) GENERAL
In addition to the reports required by (a) and (b) above and
by the Exhibits, the Company shall furnish such other
information as may be required by the Reinsurers for the
completion of the Reinsurers' quarterly and annual statements
and internal records.
All reports shall be rendered on forms acceptable to the
Company and the Reinsurers.
Article X - CURRENCY
Wherever the sign "$" is used in this Agreement it shall mean United
States Dollars. Premiums due the Reinsurers and loss payments due the Company
shall be remitted in United States Dollars.
Article XI - ERRORS AND OMISSIONS
The Reinsurers shall not be relieved of liability because of an error
or accidental omission of the Company in reporting any claim or loss or any
business reinsured under this Agreement, provided that the error or omission is
rectified promptly after discovery. The Reinsurers shall be obligated only for
the return of the premium paid for business reported but not reinsured under
this Agreement.
Article XII - SPECIAL ACCEPTANCES
Business not within the terms of this Agreement may be submitted to the
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<PAGE> 13
Reinsurers for special acceptance and, if accepted by the Reinsurers, shall be
subject to all of the terms of this Agreement except as modified by the special
acceptance.
Article XIII - RESERVES AND TAXES
The Reinsurers shall maintain the required reserves as to the
Reinsurers' portion of unearned premium, if any, claims, losses, and adjustment
expense.
The Company shall be liable for all premium taxes on premium ceded to
the Reinsurers under this Agreement. If the Reinsurers are obligated to pay any
premium taxes on this premium, the Company shall reimburse the Reinsurers;
however, the Company shall not be required to pay taxes twice on the same
premium.
Article XIV - OFFSET
The Company or the Reinsurers may offset any balance, whether on
account of premium, commission, claims or losses, adjustment expense, salvage,
or otherwise, due from one party to the other under this Agreement.
Article XV - INSPECTION OF RECORDS
The Company shall allow the Reinsurers to inspect, at reasonable times,
the records of the Company relevant to the business reinsured under this
Agreement, including Company files concerning claims, losses, or legal
proceedings which involve or are likely to involve the Reinsurers.
Article XVI - ARBITRATION
Any unresolved difference of opinion between any of the Reinsurers and
the Company shall be submitted to arbitration by three arbitrators. If more than
one Reinsurer is involved in the same dispute, all such Reinsurers shall
constitute and act as one party for purposes of this Article and communications
shall be made by the Company to each of the Reinsurers constituting the one
party; provided, however, that nothing herein shall impair the rights of such
Reinsurers to assert several, rather than joint, defenses of claims, nor be
construed as changing the liability of the Reinsurers under the terms of this
Agreement from several to joint.
One arbitrator shall be chosen by the Reinsurer(s), and one shall be
chosen by the Company. The third arbitrator shall be chosen by the other two
arbitrators within ten (10) days after they have been appointed. If the two
arbitrators cannot agree upon a third arbitrator, each arbitrator shall nominate
three persons of whom the other shall reject two. The third arbitrator shall
then be chosen by drawing lots. If either party fails to choose an arbitrator
within thirty (30) days after receiving the written request of the other party
to
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<PAGE> 14
do so, the latter shall choose both arbitrators, who shall choose the third
arbitrator. The arbitrators shall be impartial and shall be persons who are or
have been employed or engaged in a senior position in the insurance or
reinsurance business.
The party requesting arbitration (the "Petitioner") shall submit its
brief to the arbitrators within thirty (30) days after notice of the selection
of the third arbitrator. Upon receipt of the Petitioner's brief, the other party
(the "Respondent") shall have thirty (30) days to file a reply brief. On receipt
of the Respondent's brief, the Petitioner shall have twenty (20) days to file a
rebuttal brief. Respondent shall have twenty (20) days from the receipt of
Petitioner's rebuttal brief to file its rebuttal brief. The arbitrators may
extend the time for filing of briefs at the request of either party.
The arbitrators are relieved from judicial formalities and, in addition
to considering the rules of law and the customs and practices of the insurance
and reinsurance business, shall make their award with a view to effecting the
intent of this Agreement. The decision of the majority shall be final and
binding upon the parties. The costs of arbitration, including the fees of the
arbitrators, shall be shared equally unless the arbitrators decide otherwise.
The arbitration shall be held at the times and places agreed upon by the
arbitrators.
Article XVII - INSOLVENCY OF THE COMPANY
In the event of the insolvency of the Company, the reinsurance proceeds
will be paid to the Company or the liquidator on the basis of the amount of the
claim allowed in the insolvency proceeding without diminution by reason of the
inability of the Company to pay all or part of the claim.
The Reinsurers shall be given written notice of the pendency of each
claim against the Company on the policy(ies) reinsured hereunder within a
reasonable time after such claim is filed in the insolvency proceedings. The
Reinsurers shall have the right to investigate each such claim and to interpose,
at their own expense, in the proceeding where such claim is to be adjudicated,
any defenses which they may deem available to the Company or its liquidator. The
expense thus incurred by the Reinsurers shall be chargeable, subject to court
approval, against the insolvent Company as part of the expense of liquidation to
the extent of a proportionate share of the benefit which may accrue to the
Company solely as a result of the defense undertaken by the Reinsurers.
Article XVIII - LOSS RESERVES (U.S. Dollar Reinsurance Letters of Credit)
(This Article applies only to those Reinsurers who do not quality for
credit in any state or any other governmental authority having
jurisdiction over the Company's loss reserves.)
As regards all business coming within the scope of this Agreement, the
Company agrees that when it files with the Insurance Department or establishes
reserves for business
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<PAGE> 15
covered hereunder, as required by law, it will forward to the Reinsurers a
statement showing the proportion of such reserves which is applicable to them.
These reserves will consist of known outstanding losses that have been reported
to the Reinsurers, allocated loss adjustment expenses and unearned premiums.
Each such Reinsurer hereby agrees to apply for and secure delivery to the
Company of a clean, unconditional and irrevocable Letter of Credit, with a
minimum term of one year, that is in a format, and is issued or confirmed, and
presentable and payable in the United States by a bank that is a member of the
Federal Reserve and approved by the NAIC Securities Valuation Office or, at the
option of such Reinsurer, provide a cash advance in an amount equal to such
Reinsurer's proportion of said reserves. No reserves established in accordance
with the foregoing shall include or be applied towards security for losses
incurred but not reported.
The Company and the Reinsurers agree that the Letter of Credit provided
by the Reinsurers under this provision may be drawn upon at any time,
notwithstanding any other provisions in this Agreement, and be utilized by the
Company or any successor by operation of law of the Company, including, without
limitation, any liquidator, rehabilitator, receiver or conservator of such
Company for the following purposes:
(a) to reimburse the Company for the Reinsurers' share of premiums
returned to the owners of policies reinsured under this
Agreement on account of cancellations of such policies.
(b) to reimburse the Company for the Reinsurers' share of benefits
or losses paid by the Company under the terms and provisions
of the policies reinsured under this Agreement;
(c) to fund an account with the Company in an amount at least
equal to the deduction, for reinsurance ceded, from the
Company's liabilities for policies ceded under this Agreement.
Such amount shall include, but not be limited to, all case
reserves and loss adjustment expense, and unearned premiums;
(d) to pay any other amounts the Company claims are due under this
Agreement; and
(e) to return any amounts drawn down on Letters of Credit in
excess of the actual amounts required for (a), (b) and (d)
above, or in the case of (c) above, any amounts which are
subsequently determined not to be due.
All of the foregoing should be applied without diminution because of
insolvency on the part of the Company or Reinsurers.
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<PAGE> 16
Article XIX - SERVICE OF SUIT
(This Article applies only to those Reinsurers who are domiciled
outside the United States of America and also to Reinsurers
unauthorized in the State of New York.)
In the event of the failure of the Reinsurers to whom this Article
applies, or any one of them, to pay any amount claimed to be due hereunder, such
Reinsurers, at the request of the Company, will submit to the jurisdiction of
any court of competent jurisdiction within the United States, and will comply
with all requirements necessary to give such court jurisdiction, and all matters
arising hereunder shall be determined in accordance with the law and practice of
such court.
Service of process in such suit may be made upon Messrs. Mendes and
Mount, 750 Seventh Avenue, New York, New York 10019-6829, and in any suit
instituted against any one of them upon this Agreement, the Reinsurers will
abide by the final decision of such court or any appellate court in the event of
an appeal.
The above named are authorized and directed to accept service of
process on behalf of the Reinsurers in any such suit and/or upon the request of
the Company to give a written undertaking to the Company that they will enter a
general appearance on behalf of Reinsurers or any one of them in the event such
a suit shall be instituted.
Further, pursuant to any statute of any state, territory, or district
of the United States which makes provisions therefor, the Reinsurers to whom
this Article applies hereby designate the Superintendent, Commissioner or
Director of Insurance or other officer specified for that purpose in the
statute, or his successor or successors in office, as their true and lawful
attorney upon whom may be served any lawful process in any action, suit, or
proceeding instituted by or on behalf of the Company or any beneficiary
hereunder arising out of this Agreement, and hereby designate the above named
Mendes and Mount as the firm to whom the said officer is authorized to mail such
process or a true copy thereof.
Article XX - FEDERAL EXCISE TAX
(This Article applies only to those Reinsurers domiciled outside the
United States of America, excepting Reinsurers exempt from the Federal
Excise Tax.)
The Reinsurers have agreed to allow for the purpose of paying Federal
Excise Tax 1% of the premium payable hereon to the extent such premium is
subject to Federal Excise Tax.
In the event of any return of premium becoming due hereon the
Reinsurers will deduct 1% from the amount of the return and the Company or its
Agent should take steps to recover the tax from the United States Government.
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<PAGE> 17
Article XXI - INTERMEDIARY
Herbert Clough Inc. is hereby recognized as the Intermediary
negotiating this Agreement for all business hereunder. All communications
(including but not limited to notices, statements, premiums, return premiums,
commissions, taxes, losses, loss adjustment expense, salvages, and loss
settlements) relating thereto shall be transmitted to the Company or the
Reinsurers through Herbert Clough Inc., Financial Centre, P.O. Box 10216,
Stamford, Connecticut 06904-2216. Payments by the Company to the Intermediary
shall be deemed to constitute payment to the Reinsurers. Payments by the
Reinsurers to the Intermediary shall be deemed only to constitute payment to the
Company to the extent that such payments are actually received by the Company.
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<PAGE> 18
Effective: January 1, 1997
EXHIBIT A
Attached to and made a part of
HCI Agreement No. 439
PROPERTY CATASTROPHE EXCESS OF LOSS
REINSURANCE AGREEMENT
FIRST EXCESS OF LOSS REINSURANCE (CATASTROPHE)
of
PROPERTY BUSINESS
------------------------------------------------------------------------
SECTION 1 - LIABILITY OF THE REINSURERS
The Reinsurers shall pay to the Company, with respect to each loss
occurrence, 95% of the amount of ultimate net loss in excess of the Company
Retention of $5,000,000 but not exceeding the Limit of Liability of the
Reinsurer of 95% of the next $5,000,000 of ultimate net loss with respect to
such loss occurrence nor 95% of $10,000,000 with respect to all loss occurrences
commencing during the term of this Agreement.
The Company shall retain net for its own account, with respect to each
loss occurrence, the remaining 5% of such ultimate net loss.
Section 2 - REINSURANCE PREMIUM
As a condition precedent to the Reinsurers' obligations hereunder, the
Company shall pay to the Reinsurers 1.499% of the Company's subject net earned
premium during the term of the Agreement, subject to a minimum reinsurance
premium of $425,800 and a deposit reinsurance premium of $532,000.
Section 3 - REINSURANCE PREMIUM REPORTS AND REMITTANCES
The Company shall pay to the Reinsurers the deposit reinsurance premium
stipulated in the section entitled REINSURANCE PREMIUM in equal quarterly
installments of $133,000 each on or before the beginning of each calendar
quarter during the term of this Agreement.
Within 60 days after the expiration of this Agreement, the Company
shall render to the Reinsurers a report of the Company's subject net earned
premium during the term of the Agreement. The Company shall calculate the
reinsurance premium thereon, shall balance such amount against the deposit
reinsurance premium previously paid, and the amount due either party, subject to
the minimum reinsurance premium, shall be remitted within 60 days.
<PAGE> 19
Effective: January 1, 1997
EXHIBIT B
Attached to and made a part of
HCI Agreement No. 439
PROPERTY CATASTROPHE EXCESS OF LOSS
REINSURANCE AGREEMENT
SECOND EXCESS OF LOSS REINSURANCE (CATASTROPHE)
of
PROPERTY BUSINESS
------------------------------------------------------------------------
SECTION 1 - LIABILITY OF THE REINSURERS
The Reinsurers shall pay to the Company, with respect to each loss
occurrence, 95% of the amount of ultimate net loss in excess of the sum of:
(a) The Company Retention of $5,000,000; and
(b) The First Excess Cover of $5,000,000,
but not exceeding the Limit of Liability of the Reinsurer of 95% of the next
$10,000,000 of ultimate net loss with respect to such loss occurrence nor 95% of
$20,000,000 with respect to all loss occurrences commencing during the term of
this Agreement.
The Company shall retain net for its own account, with respect to each
loss occurrence, the remaining 5% of such ultimate net loss.
SECTION 2 - REINSURANCE PREMIUM
As a condition precedent to the Reinsurers' obligations hereunder, the
Company shall pay to the Reinsurers 1.861% of the Company's subject net earned
premium during the term of the Agreement, subject to a minimum reinsurance
premium of $528,000 and a deposit reinsurance premium of $660,000.
SECTION 3 - REINSURANCE PREMIUM REPORTS AND REMITTANCES
The Company shall pay to the Reinsurers the deposit reinsurance premium
stipulated in the section entitled REINSURANCE PREMIUM in equal quarterly
installments of $165,000 each on or before the beginning of each calendar
quarter during the term of this Agreement.
Within 60 days after the expiration of this Agreement, the Company
shall render to the Reinsurers a report of the Company's subject net earned
premium during the term of the
<PAGE> 20
Agreement. The Company shall calculate the reinsurance premium thereon, shall
balance such amount against the deposit reinsurance premium previously paid, and
the amount due either party, subject to the minimum reinsurance premium, shall
be remitted within 60 days.
<PAGE> 21
Effective: January 1, 1997
EXHIBIT C
Attached to and made a part of
HCI Agreement No. 439
PROPERTY CATASTROPHE EXCESS OF LOSS
REINSURANCE AGREEMENT
THIRD EXCESS OF LOSS REINSURANCE (CATASTROPHE)
of
PROPERTY BUSINESS
------------------------------------------------------------------------
Section 1 - LIABILITY OF THE REINSURERS
The Reinsurers shall pay to the Company, with respect to each loss
occurrence, 95% of the amount of ultimate net loss in excess of the sum of:
(a) The Company Retention of $5,000,000;
(b) The First Excess Cover of $5,000,000; and
(c) The Second Excess Cover of $10,000,000.
but not exceeding the Limit of Liability of the Reinsurer of 95% of the next
$20,000,000 of ultimate net loss with respect to such loss occurrence nor 95% of
$40,000,000 with respect to all loss occurrences commencing during the term of
this Agreement.
The Company shall retain net for its own account, with respect to each
loss occurrence, the remaining 5% of such ultimate net loss.
Section 2 - REINSURANCE PREMIUM
As a condition precedent to the Reinsurers' obligations hereunder, the
Company shall pay to the Reinsurers 2.115% of the Company's subject net earned
premium during the term of the Agreement, subject to a minimum reinsurance
premium of $599,000 and a deposit reinsurance premium of $748,000.
Section 3 - REINSURANCE PREMIUM REPORTS AND REMITTANCES
The Company shall pay to the Reinsurers the deposit reinsurance premium
stipulated in the section entitled REINSURANCE PREMIUM in equal quarterly
installments of $187,000 each on or before the beginning of each calendar
quarter during the term of this Agreement.
<PAGE> 22
Within 60 days after the expiration of this Agreement, the Company
shall render to the Reinsurers a report of the Company's subject net earned
premium during the term of the Agreement. The Company shall calculate the
reinsurance premium thereon, shall balance such amount against the deposit
reinsurance premium previously paid, and the amount due either party, subject to
the minimum reinsurance premium, shall be remitted within 60 days.
<PAGE> 23
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE - USA
(1) This Agreement does not cover any loss or liability accruing to the
Company directly or indirectly and whether as Insurer or Reinsurer, from any
Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or
Nuclear Energy risks.
(2) Without in any way restricting the operation of paragraph (1) of this
Clause, this Agreement does not cover any loss or liability accruing to the
Company, directly or indirectly and whether as Insurer or Reinsurer, from any
insurance against Physical Damage (including business interruption or
consequential loss arising out of such Physical Damage) to:
(i) Nuclear reactor power plants including all auxiliary property on the
site, or
(ii) Any other nuclear reactor installation, including laboratories
handling radioactive materials in connection with reactor
installations, and "critical facilities" as such, or
(iii) Installations for fabricating complete fuel elements or for
processing substantial quantities of "special nuclear material", and
for reprocessing, salvaging, chemically separating, storing or
disposing of "spent" nuclear fuel or waste materials, or
(iv) Installations other than those listed in paragraph (2) (iii) above
using substantial quantities of radioactive isotopes or other
products of nuclear fission.
(3) Without in any way restricting the operations of paragraphs (1) and (2)
hereof, this Agreement does not cover any loss or liability by radioactive
contamination accruing to the Company, directly or indirectly, and whether as
Insurer or Reinsurer, from any insurance on property which is on the same site
as a nuclear reactor power plant or other nuclear installation and which
normally would be insured therewith except that this paragraph (3) shall not
operate:
(a) where the Company does not have knowledge of such nuclear reactor
power plant or nuclear installation, or
(b) where said insurance contains a provision excluding coverage for
damage to property caused by or resulting from radioactive
contamination, however caused. However on and after 1st January 1960
this sub-paragraph (b) shall only apply provided the said radioactive
contamination exclusion provision has been approved by the
Governmental Authority having jurisdiction thereof.
(4) Without in any way restricting the operations of paragraphs (1),(2) and
(3) hereof, this Agreement does not cover any loss or liability by radioactive
contamination accruing to the Company, directly or indirectly, and whether as
Insurer or Reinsurer, when such radioactive contamination is a named hazard
specifically insured against.
(5) It is understood and agreed that this Clause shall not extend to
risks using radioactive isotopes in any form where the nuclear exposure is not
considered by the Company to be the primary hazard.
(6) The term "special nuclear material" shall have the meaning given it
in the Atomic Energy Act of 1954 or by any law amendatory thereof.
(7) The Company to be sole judge of what constitutes:
(a) substantial quantities, and
(b) the extent of installation, plant or site.
Note: Without in any way restricting the operation of paragraph (1) hereof,
it is understood and agreed that:
(a) all policies issued by the Company on or before 31st December
1957 shall be free from the application of the other provisions
of this Clause until expiry date or 31st December 1960 whichever
first occurs whereupon all the provisions of this Clause shall
apply.
(b) with respect to any risk located in Canada policies issued by the
Company on or before 31st December 1958 shall be free from the
application of the other provisions of this Clause until expiry
date or 31st December 1960 whichever first occurs whereupon all
the provisions of this Clause shall apply.
<PAGE> 24
NUCLEAR INCIDENT EXCLUSION CLAUSE-PHYSICAL DAMAGE-REINSURANCE-CANADA
(1) This Agreement does not cover any loss or liability accruing to the
Company directly or indirectly and whether as Insurer or Reinsurer, from any
Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or
Nuclear Energy risks.
(2) Without in any way restricting the operation of paragraph (1) of
this Clause, this Agreement does not cover any loss or liability accruing to the
Company, directly or indirectly and whether as Insurer or Reinsurer, from any
insurance against Physical Damage (including business interruption or
consequential loss arising out of such Physical Damage) to:
(i) Nuclear reactor power plants including all auxiliary property on
the site, or
(ii) Any other nuclear reactor installation, including laboratories
handling radioactive materials in connection with reactor
installations, and "critical facilities" as such, or
(iii) Installations for fabricating complete fuel elements or for
processing substantial quantities of "prescribed substances",
and for reprocessing, salvaging, chemically separating, storing
or disposing of "spent" nuclear fuel or waste materials, or
(iv) Installations other than those listed in (2)(iii) above using
substantial quantities of radioactive isotopes or other products
of nuclear fission.
(3) Without in any way restricting the operation of paragraphs (1) and
(2) of this Clause, this Agreement does not cover any loss or liability by
radioactive contamination accruing to the Company, directly or indirectly, and
whether as Insurer or Reinsurer, from any insurance on property which is on the
same site as a nuclear reactor power plant or other nuclear installation and
which normally would be insured therewith, except that this paragraph (3) shall
not operate:
(a) where the Company does not have knowledge of such nuclear
reactor power plant or nuclear installation, or
(b) where the said insurance contains a provision excluding
coverage for damage to property caused by or resulting from
radioactive contamination, however caused.
(4) Without in any way restricting the operation of paragraphs (1), (2)
and (3) of this Clause, this Agreement does not cover any loss or liability by
radioactive contamination accruing to the Company, directly or indirectly, and
whether as Insurer or Reinsurer, when such radioactive contamination is a named
hazard specifically insured against.
(5) This Clause shall not extend to risks using radioactive isotopes in
any form where the nuclear exposure is not considered by the Company to be the
primary hazard.
(6) The term "prescribed substances" shall have the meaning given it by
the Atomic Energy Control Act or by any law amendatory thereof.
(7) The Company to be sole judge of what constitutes:
(a) substantial quantities, and
(b) the extent of installation, plant or site.
(8) Without in any way restricting the operation of paragraphs (1), (2),
(3) and (4) of this Clause, this Agreement does not cover any loss or liability
accruing to the Company, directly or indirectly, and whether as Insurer or
Reinsurer, caused:
(a) by any nuclear incident as defined in the Nuclear Liability
Act or any other nuclear liability act, law or statute, or any
law amendatory thereof or nuclear explosion, except for
ensuing loss or damage which results directly from fire,
lightning or explosion of natural, coal or manufactured gas;
(b) by contamination by radioactive material.
Note: Without in any way restricting the operation of paragraphs (1), (2), (3)
and (4) of this Clause, paragraph (8) of this Clause shall only apply to
all original contracts of the Company whether new, renewal or replacement
which become effective on or after December 31, 1992.
<PAGE> 25
POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE
- ---------------------------------------------------
SECTION A
- ---------
Excluding:
(a) All Business derived directly or indirectly from any Pool,
Association or Syndicate which maintains its own reinsurance
facilities.
(b) Any Pool or Scheme (whether voluntary or mandatory) formed
after March 1, 1968 for the purpose of insuring Property
whether on a country-wide basis or in the respect of
designated areas. This exclusion shall not apply to so-called
Automobile Insurance Plans or other pools formed to provide
coverage for Automobile Physical damage.
SECTION B
- ---------
It is agreed that business written by the Company for the same perils, which is
known at the time to be insured by, or in excess of underlying amounts placed in
the following Pools, Associations or Syndicates, whether by way of insurance or
reinsurance, is excluded hereunder:
Industrial Risk Insurers (formerly Factory Insurance Association
and Oil Insurance Association), including Underwriters Grain Division.
Associated Factory Mutual.
Improved Risk Mutuals.
Any Pool, Association or Syndicate formed for the purpose of writing
Oil, Gas or Petro-Chemical Plants and/or Oil or Gas Drilling Rigs.
Nuclear Energy Property Insurance Association.
Nuclear Energy Liability Insurance Association.
Mutual Atomic Energy Reinsurance Pool.
Mutual Atomic Energy Liability Underwriters.
United States Aircraft Insurance Group.
Canadian Aircraft Insurance Group.
Associated Aviation Underwriters.
American Aviation Underwriters.
Section B does not apply:
(a) Where the Total Insured value over all interests of the risk in
question is less than $250,000,000.
(b) To interests traditionally underwritten as Inland Marine or Stock
and/or Contents written on a Blanket basis.
-1-
<PAGE> 26
(c) To Contingent Business Interruption, except when the Company is
aware that the key location is known at the time to be insured in
any Pool, Association or Syndicate named above, other than as
provided for under Section B (a).
(d) To risks as follows: Offices, Hotels, Apartments, Hospitals,
Educational Establishments, Public Utilities (other than Railroad
Schedules) and Builders Risks on the classes of risks specified in
this subsection (d) only.
Where this Clause attaches to Catastrophe Excesses, the following
SECTIONS C and D are added:
SECTION C
- ---------
NEVERTHELESS the Reinsurers specifically agree that liability accruing to the
Company from its participation in residual market mechanisms including but not
limited to:
(1) The following so-called "Coastal Pools"
ALABAMA INSURANCE UNDERWRITING ASSOCIATION
FLORIDA WINDSTORM UNDERWRITING ASSOCIATION
LOUISIANA INSURANCE UNDERWRITING ASSOCIATION
MISSISSIPPI WINDSTORM UNDERWRITING ASSOCIATION
NORTH CAROLINA INSURANCE UNDERWRITING ASSOCIATION
SOUTH CAROLINA WINDSTORM AND HAIL UNDERWRITING ASSOCIATION
TEXAS CATASTROPHE PROPERTY INSURANCE ASSOCIATION
and
(2) All "Fair Plan" and "Rural Risk Plan" Business, including but
not limited to:
Florida Windstorm Underwriting Association (FWUA)
Florida Property and Casualty Joint Underwriting Association
(FPCJUA)
Residential Property and Casualty Joint Underwriting
Association (RPCJUA)
for all perils otherwise protected hereunder shall not be excluded,
except that this reinsurance does not include any increase in such
liability resulting from:
(i) The inability of any other participant in such Residual Market
Mechanism including but not limited to "Coastal Pool" and/or
"Fair Plan" and/or "Rural Risk Plan" to meet its liability.
-2-
<PAGE> 27
(ii) Any claim against such Residual Market Mechanism including but
not limited to "Coastal Pool" and/or "Fair Plan" and/or "Rural
Risk Plan" or any participant therein, including the Company,
whether by way of subrogation or otherwise, brought by or on
behalf of any insolvency fund.
SECTION D
- ---------
NOTWITHSTANDING Section C above, in respect of the FWUA, FPCJUA, and RPCJUA,
where an assessment is made against the Company by the FWUA, the FPCJUA, the
RPCJUA, or any combination thereof, the maximum loss that the Company may
include in the Ultimate Net Loss in respect of any loss occurrence hereunder
shall nor exceed the lesser of:
1. The Company's assessment from the relevant entity (FWUA, FPCJUA and/
or RPCJUA) for the accounting year in which the loss occurrence
commenced, or
2. The product of the following:
a) The Company's percentage participation in the relevant entity
for the accounting year in which the loss occurrence
commenced, and
b) The relevant entity's total losses in such loss occurrence.
Any assessments for accounting years subsequent to that in which the
loss occurrence commenced may not be included in the Ultimate Net Loss
hereunder. Moreover, notwithstanding Section C above, in respect of the FWUA,
the FPCJUA and/or the RPCJUA, the Ultimate Net Loss hereunder shall not include
any monies expended to purchase or retire bonds as a consequence of being a
member of the FWUA, the FPCJUA and/or the RPCJUA. For the purposes of this
Agreement, the Company may not include in the Ultimate Net Loss any assessment
or any percentage assessment levied by the FWUA, the FPCJUA and/or the RPCJUA to
meet the obligations of any insolvent insurer member or other party, or to meet
any obligations arising from the deferment by the FWUA, FPCJUA and/or RPCJUA of
the collection of monies.
- --------------------------------------------------------------------------------
NOTES: Wherever used herein the terms:
"Company" shall be understood to mean "Reinsured", "Reassured" or
whatever other term is used in the attached reinsurance
document to designate the reinsured company or companies.
"Contract" shall be understood to mean "Agreement", "Policy" or
whatever other term is used to designate the attached
reinsurance document.
-3-
<PAGE> 28
"Reinsurers" shall be understood to mean "Underwriters" or whatever
other term is used in the attached reinsurance document to
designate the reinsurer or reinsurers.
-4-
<PAGE> 1
EXHIBIT 10(h)
<PAGE> 2
FOURTH AMENDMENT
TO THE
MERCHANTS MUTUAL
CAPITAL ACCUMULATION PLAN
(AS AMENDED AND RESTATED AS OF JANUARY 1, 1993)
WHEREAS, Merchants Mutual Insurance Company ("Merchants Mutual") has
reserved the right to amend the Merchants Mutual Capital Accumulation Plan as
amended and restated as of January 1, 1993 (the "Plan") at any time or from time
to time; and
WHEREAS, this amendment to the Plan has been authorized by the Board of
Directors of Merchants Mutual;
NOW, THEREFORE, Merchants Mutual hereby amends the Plan as follows:
1. Section 1.38 is amended by deleting "the Bankers Trust Company" and
substituting therefor "SEI Trust Company", effective as of August 1, 1996.
2. Section 5.2 is amended to read as follows, effective as of January 1,
1996:
"5.2 INVESTMENT FUNDS. The following Investment Funds shall be
maintained within the Trust Fund, subject to the further provisions of this
Section:
(a) FIXED INCOME FUND. This fund shall be invested exclusively in
interests in the Capital Preservation Trust, a fund established by Bankers Trust
Company within the BT Pyramid Trust (previously called the General Employee
Benefit Trust) under a declaration of trust dated May 28, 1956 and amended April
1, 1967, January 21, 1983, and June 28, 1990.
(b) TWENTIETH CENTURY BALANCED INVESTORS FUND. This fund shall be
invested exclusively in shares of Twentieth Century Balanced Investors Fund, a
mutual fund maintained by Twentieth Century Investors, Inc., which is invested
principally in common stocks and fixed income securities with the objective of
capital growth and current income.
(c) TWENTIETH CENTURY SELECT INVESTORS FUND. This fund shall be
invested exclusively in shares of Twentieth Century Select Investors Fund, a
mutual fund maintained by Twentieth Century Investors, Inc., which is invested
principally in equity securities with the objective of long-term capital growth.
- 1 -
<PAGE> 3
(d) TWENTIETH CENTURY ULTRA INVESTORS FUND. This fund shall be
invested exclusively in shares of Twentieth Century Ultra Investors Fund, a
mutual fund maintained by Twentieth Century Investors, Inc., which is invested
principally in equity securities with the objective of aggressive long-term
capital growth.
(e) TWENTIETH CENTURY INTERNATIONAL EQUITY FUND. This fund shall be
invested exclusively in shares of Twentieth Century International Equity Fund, a
mutual fund maintained by Twentieth Century World Investors, Inc., which is
invested principally in foreign equity securities with the objective of long
term capital growth.
(f) TWENTIETH CENTURY VALUE FUND. This fund shall be invested
exclusively in shares of the Twentieth Century Value Fund, a mutual fund
maintained by Twentieth Century Capital Portfolios, Inc., which is invested
principally in equity securities with the primary objective of long-term capital
growth and a secondary objective of income.
The Company may from time to time cause one or more additional
Investment Funds to be established and maintained within the Trust Fund in
accordance with the provisions of the Trust Agreement.
The Company may at any time cause one or more of the Investment
Funds maintained under the Plan to be discontinued.
The name of any Investment Fund may be changed by the Company at
any time by written notice to the Trustee."
3. Section 5.2 is further amended by revising subsection (a)
thereof to read as follows, effective as of August 1, 1996:
"(a) BENHAM PRESERVATION FUND. This fund shall be invested
exclusively in the following investments:
(1) interests in the Benham Preservation Fund, a collective trust
fund established by SEI Trust Company under a Declaration of Trust dated June
10, 1996 which is invested principally in guaranteed investment contracts, bank
investment contracts, similar fixed-income investments, and units of other
collective trust funds which are invested principally in such investments.
(2) interests in any other collective trust fund or pooled
investment fund designated by the Company from time to time by written notice to
the Trustee, specifically including, but not limited to, the Benham Stable Asset
Fund, a
- 2 -
<PAGE> 4
collective trust fund also established by SEI Trust Company under a Declaration
of Trust dated June 10, 1996, provided that any such collective trust fund or
pooled investment fund is invested principally in guaranteed investment
contracts, bank investment contracts, and similar fixed-income investments.
The Benham Preservation Fund shall also be known as the 'Fixed-Income Fund'."
4. Section 5.4 is amended by revising the second paragraph of
subsection (a) thereof to read as follows, effective as of August 1, 1996:
"The interests of Participants' Accounts in the Fixed Income Fund
shall be valued in accordance with the standard procedure used by Twentieth
Century Services, Inc. to value interests in the Benham Preservation Fund or any
other collective trust fund or pooled investment fund in which the Fixed Income
Fund may be invested in accordance with subsection (a) of Section 5.2."
5. Section 5.4 is further amended by revising the first sentence of
subsection (b) thereof to read as follows, effective as of January 1, 1996:
"...The provisions of this subsection (b) shall govern the
valuation of interests of Participants' Accounts in the Twentieth Century Ultra
Investors Fund, the Twentieth Century Select Investors Fund, the Twentieth
Century Balanced Investors Fund, the Twentieth Century International Equity
Fund, and the Twentieth Century Value Fund. ..."
6. Section 5.5 is amended by revising the second paragraph thereof
to read as follows, effective as of August 1, 1996:
"A withdrawal under Section 7.4 from a Participant's Rollover
Account, Employee Contribution Account, Matching Account, or 401(k) Account, a
loan under Article VIII from a Participant's 401(k) Account or a distribution of
excess contributions under Section 4.5(f) from a Participant's 401(k) Account or
Matching Account shall be effected by the withdrawal of funds from each
Investment Fund in which the applicable subaccount is invested in the proportion
that the balance of the subaccount in the Investment Fund bears to the total
balance of the subaccount in all Investment Funds."
7. Section 7.1 is amended by adding the following sentence at the
end of paragraph (2) of subsection (b) thereof, effective as of January 1, 1996:
"...If the Participant elects to receive a distribution over a
period equal to his life expectancy or the joint life and survivor expectancy of
the Participant and his
- 3 -
<PAGE> 5
beneficiary, the Participant's life expectancy, or if the beneficiary is the
Participant's Spouse, the joint life and survivor expectancy of the Participant
and his Spouse, shall not be recalculated under the permissive recalculation
rule of section 401(a)(9)(D) of the Code."
8. Section 7.4 is amended by revising (iii) of the second paragraph
of paragraph (2) of subsection (d) to read as follows, effective as of
January 1, 1996:
"(iii) payment of tuition, related educational fees, and room and
board expenses for the next twelve months of post-secondary education for the
Participant, the Spouse of the Participant, or his children or dependents."
IN WITNESS WHEREOF, Merchants Mutual has caused this document to be
executed this day of July, 1996.
MERCHANTS MUTUAL INSURANCE COMPANY
[SEAL]
By s/ Robert M. Zak
-----------------------------------
ATTEST
s/ Christine M. Kanowski
- --------------------------------
- 4 -
<PAGE> 1
EXHIBIT 10(i)
<PAGE> 2
MERCHANTS MUTUAL CAPITAL ACCUMULATION PLAN
TRUST AGREEMENT
(As Restated as of January 1, 1996)
<PAGE> 3
MERCHANTS MUTUAL CAPITAL ACCUMULATION PLAN
TRUST AGREEMENT
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Article Page
<S> <C>
I Establishment and Acceptance of Trust............................... 3
II Investment and Administration of Trust Fund......................... 4
III Investment Funds.................................................... 9
IV Payments from Trust Fund............................................ 11
V Liabilities and Immunities of Trustee............................... 13
VI Accounting of the Trustee........................................... 15
VII Removal and Resignation of the Trustee.............................. 16
VIII Amendment and Termination........................................... 17
IX Miscellaneous....................................................... 18
</TABLE>
<PAGE> 4
MERCHANTS MUTUAL CAPITAL ACCUMULATION PLAN
TRUST AGREEMENT
THIS AGREEMENT, made and entered into effective as of January
1, 1996, by and between Merchants Mutual Insurance Company (the "Company"), a
corporation organized under the New York Insurance Law, having its principal
office at 250 Main Street, Buffalo, New York 14202, and The Chase Manhattan
Bank, N.A. (the "Trustee"), a corporation organized and existing under the laws
of the State of New York having its principal place of business at 770 Broadway,
New York, New York 10003-9598.
WHEREAS, the Company maintains the Merchants Mutual Capital
Accumulation Plan (the "Plan"), a qualified profit sharing plan under section
401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), in which
certain of the employees of the Company participate; and
WHEREAS, the Company established a trust (the
"Trust Fund" or the "Fund") with United States Trust Company of
New York ("U.S. Trust") under a trust agreement (the "Trust
Agreement") effective as of September 30, 1992 to hold all of the
assets of the Plan; and
WHEREAS, U.S. Trust was merged into the Trustee on
September 5, 1995; and
WHEREAS, the Company and the Trustee wish to restate
the Trust Agreement as set forth herein; and
NOW, THEREFORE, the Company and the Trustee amend and restate
the Trust Agreement as follows, effective as of January 1, 1996:
<PAGE> 5
ARTICLE I.
Continuance and Acceptance of Trust Fund
----------------------------------------
1.01 The Company shall continue to maintain a Trust Fund for
the funding of the Plan in accordance with the terms of this Agreement. This
Agreement shall be a part of the Plan, and the Trust Fund shall be administered
for the exclusive purpose of providing benefits to participants in the Plan and
their beneficiaries.
1.02 The Trustee accepts the Trust maintained under this
Agreement and agrees to be bound by the terms of this Agreement. The Trustee
shall accept such cash and other property contributed or transferred to it under
this Agreement.
- 2 -
<PAGE> 6
ARTICLE II.
Investment and Administration of the Trust Fund
-----------------------------------------------
2.01 Subject to the succeeding provisions of this Article II
and to Article III, the Trustee shall invest and reinvest the Trust Fund,
without distinction between principal and income, as it in its sole discretion
shall determine proper. The Trustee shall have and exercise the following powers
and authority in the investment and administration of the Fund:
(a) to invest and reinvest the Fund in
securities and other property of any kind, subject to the Employee Retirement
Income Security Act ("ERISA") but without regard to any other law prescribing or
limiting the investment powers of fiduciaries;
(b) to purchase, receive, or subscribe for any
securities or other property and to retain such securities or
other property;
(c) to sell, exchange for securities or other
property, redeem, transfer, dispose of, and grant options with respect to any
assets of the Fund by private agreement or public auction, for cash, securities,
other property, or credit; to write call options against any securities or other
property or other forms of options directly related to any such call options
outstanding, or to enter into stand-by agreements for future investment, either
with or without a stand-by fee;
(d) to exercise voting rights, either in
person, by limited or general power of attorney, or by proxy, with respect to
all stocks, securities, or other property, to participate in or consent to any
voting trust, and generally to exercise with respect to the Fund's assets all
rights, powers, and privileges as may be lawfully exercised by any person owning
similar property in his or her own right;
(e) to exercise any options, conversion rights,
or rights to subscribe for additional stocks, bonds, or other securities held in
the Fund and to cause to be made any necessary payments in connection with such
exercise; to join in, dissent from, and oppose the reorganization,
consolidation, recapitalization, liquidation, merger, or sale, mortgage, pledge,
or lease of property, with respect to any corporation or property in which the
Fund may be interested; to cause to be deposited any property with any
protective, reorganization, or similar committee, and to cause to be paid or
agree to pay part of the expenses and compensation levied with respect to
property so deposited;
- 3 -
<PAGE> 7
(f) to compromise, compound, submit to
arbitration or settle any debt obligation owing to or from the Fund; to reduce
or increase the rate of interest on extension, or otherwise modify, foreclose
upon default, or otherwise enforce any such obligation; to sue or defend suits
or legal proceedings to protect or enforce any interest in trusts and to
represent the Trust Fund in all suits or legal proceedings in any court or
before any other administrative agency, body, or tribunal;
(g) to retain, manage, administer, develop,
operate, repair, alter, demolish, improve, lease, mortgage, and otherwise deal
with any real or tangible personal property; to renew or extend or participate
in the renewal or extension of any mortgage, upon such terms as may be deemed
advisable, and to agree to a reduction in the rate of interest on any mortgage
or to any other modification or change in the terms of any mortgage, upon such
terms as may be deemed advisable; to waive any default whether in the
performance of any covenant or condition of any mortgage, or to enforce such
default in such manner and to the extent as may be deemed advisable; to exercise
and enforce any and all rights of foreclosure, to bid in property on
foreclosures, to take a deed in lieu of foreclosure with or without paying a
consideration therefor and in connection therewith to release the obligation on
the bond secured by such mortgage, and to exercise and enforce in any action,
suit or proceeding at or in equity any rights or remedies in respect to any such
mortgage;
(h) to organize corporations or partnerships or
establish ancillary or subsidiary trusts under the laws of any
jurisdiction to acquire and hold title to any property held in
the Fund;
(i) with regard to the cash requirements of the
Plan as indicated by the Company, to hold part or all of the Fund
uninvested in cash balances and not be required to pay interest
on it;
(j) to make, sign, acknowledge, and deliver
deeds, leases, assignments, and other instruments;
(k) to hold any property at any place, except
that it shall not maintain the indicia of ownership of any assets of the Fund
outside the jurisdiction of the district courts of the United States except as
permitted by regulations issued under section 404(b) of ERISA;
(l) to retain and compensate from the Fund
professional management personnel to administer any real or
tangible personal property;
- 4 -
<PAGE> 8
(m) to acquire, hold or dispose of property in
unregistered form, or in its name without designation of fiduciary capacity, or
in the name of its nominee or any custodian, and, to the extent permitted by
ERISA, to combine certificates representing investments with certificates
representing investments on the same issue held by the Trustee in other
fiduciary capacities, and to deposit property in a depository or clearing
corporation or with the federal reserve bank in its district;
(n) to employ legal counsel, including counsel
to the Company or the Trustee in its individual capacity, brokers, and other
advisors, agents, or employees to perform services for the Fund or to advise it
with respect to its duties and obligations under this Agreement and in
connection with the Trust, and to pay to them from the Fund such reasonable
compensation as it determines appropriate;
(o) at the direction of the Company to accept
as part of the Trust Fund such property as is acceptable to the Trustee that
represents a participant's retirement benefits transferred from another plan
qualified under section 401(a) of the Code or transferred from the participant
or an individual retirement account as a permissible rollover under section
402(a)(5) or 408(d)(3) of the Code;
(p) to make distributions in cash or at the
direction of the Company in specific property, real or personal, or an undivided
interest in such property or partly in cash and partly in such property;
(q) to invest all or a portion of the fund in
mutual funds including mutual funds maintained by Twentieth Century Investors,
Inc. or any affiliate thereof, or through any common, collective, commingled, or
group trust fund, including (i) the BT Pyramid Trust, which was established by
Bankers Trust Company on May 28, 1956, under a declaration of trust dated May
28, 1956, that has been amended April 1, 1967, January 21, 1983, and June 28,
1990, and was previously called the General Employees Benefit Trust; and (ii)
the Benham Preservation Fund and the Benham Stable Asset Fund, both of which
were established by SEI Trust Company under declarations of trust dated June 10,
1996; and
(r) generally, to do all acts, whether or not
expressly authorized, that the Trustee may find necessary or
desirable for the protection of the Fund.
2.02 Wherever used in this Agreement, the term "securities"
shall include bonds, mortgages, notes, obligations, warrants and stocks of any
class, options, futures contracts, mutual fund shares, interests in general or
limited partnerships
- 5 -
<PAGE> 9
or trusts, repurchase agreements, and such other evidence of indebtedness and
certificates of interest as are usually referred to by the term "securities";
and the term "property" shall include real, personal, and mixed property,
tangible or intangible, of any kind and wherever located, including, without
limitation, (i) securities, (ii) interests in insurance contracts, specifically
including group annuity contracts, guaranteed investment contracts, and
interests in any separate account maintained under any group annuity contract;
(iii) interests in pooled investment funds maintained by an insurance company;
and (iv) interests in any common, collective, commingled, or group trust fund
maintained by a bank or trust company (which may be an investment manager or a
custodian for the Fund) supervised by a federal or state agency, that is a
qualified trust exempt from federal income tax under section 501(a) of the
Internal Revenue Code that permits separate pension or profit sharing trusts
qualified under section 401(a) of the Internal Revenue Code to pool some or all
of their funds for investment purposes. To the extent that property of the Trust
Fund is invested in any common, collective, commingled, or group trust fund
maintained by a bank or trust company as described above, the declaration of
trust pertaining to such fund and the trust created by such declaration shall be
a part of this Agreement.
2.03 In carrying out the powers and duties specified in
Section 2.01 regarding the investment and reinvestment of assets of the Trust
Fund, the Trustee shall consider any general investment guidelines that may be
communicated to the Trustee from time to time by the Company, provided that the
Trustee shall not be required or obligated to follow any such general
guidelines. Subject to the provisions of Article III, all investment decisions
with respect to the assets of the Trust Fund contemplated by this Agreement
shall be the sole responsibility of the Trustee.
2.04 The Company may appoint an investment manager, as defined
in section 3(38) of ERISA, with respect to all or a specified portion of the
Trust Fund. Any investment manager so appointed shall be (i) an investment
adviser registered as such under the Investment Advisers Act of 1940 (the
"Act"), (ii) a bank (as defined in the Act) or (iii) an insurance company
qualified to perform investment management services under the laws of more than
one state of the United States. The Company shall notify the Trustee of any such
appointment by delivering to the Trustee an executed copy of the instrument
under which the investment manager is appointed and of the investment manager's
acceptance of such appointment, an acknowledgement by the investment manager
that it is a fiduciary of the Plan, and evidence of the investment manager's
current registration under the Investment Advisers Act of 1940 or other
appropriate qualification. The Company shall specify to the Trustee the
- 6 -
<PAGE> 10
portion of the Trust Fund that shall be subject to such investment management.
The Trustee shall invest and reinvest the portion of the Trust Fund subject to
such investment management only to the extent and in the manner directed by the
investment manager in writing. During the term of such appointment, the Trustee
shall have no liability for the acts or omissions of such investment manager,
and, except as provided in the preceding sentence, shall be under no obligation
to invest or otherwise manage the portion of the Trust Fund subject to such
investment management. The Trustee may maintain separate accounts within the
Trust Fund for the assets of the Trust Fund subject to such investment
management. The Company may terminate the appointment of an investment manager
at any time and shall notify the Trustee in writing of such termination. The
Trustee shall be protected in assuming that the appointment of an investment
manager remains in effect until it is otherwise notified.
If an investment manager appointed under this
Agreement is a bank or a trust company or an affiliate of a bank or a trust
company, the Trustee shall, upon the direction of the Company, transfer funds to
such bank, trust company, or affiliate for investment through the medium of any
fund described in Section 2.02(iv) that has been created and is administered by
such bank, trust company, or affiliate, as trustee. In order to implement the
provisions of this paragraph, the Trustee is authorized to enter into any
required ancillary trust, agency, or other type of agreement with an investment
manager, or its affiliate.
2.05 The Company shall certify to the Trustee the names of the
persons who from time to time shall be authorized to act on its behalf. All
directions to the Trustee by the Company shall be in writing.
2.06 The Company may from time to time delegate any of its
specific duties under the Plan or this Trust Agreement to the Committee which
may be established under the Plan or to other persons pursuant to the provisions
of this Plan. The Trustee shall be furnished with a certified copy of any
resolution adopted by the Board of Directors effecting such delegation. In the
event of any such delegation, the provisions of this Agreement pertaining to
such delegated duty shall be deemed to refer to the delegate of the Company
rather than the Company itself while such delegation remains in effect.
- 7 -
<PAGE> 11
ARTICLE III.
Investment Funds
----------------
3.01 The Trustee shall establish and maintain within the Trust
Fund the separate investment funds described in Section 3.02 (the "Investment
Funds"). The Trustee shall invest and reinvest the Trust Fund in one or more of
the Investment Funds, and make transfers between such Investment Funds, in
accordance with the directions of the Company.
With respect to each Investment Fund, the Trustee shall maintain
accounts for such Investment Fund in a manner that accurately reflects the
market value of such fund at such times as are necessary for the administration
of the Plan. All net income from, and appreciation and addition allocable to,
each such fund shall be credited by the Trustee to the account of such fund, and
any payments made from such fund by the Trustee as authorized in this Agreement
and attributable to such fund and any depreciation or net losses allocable to
such fund shall be charged by the Trustee to the account of such fund.
3.02 The Trustee shall establish the following
Investment Funds upon the establishment of this Trust:
(a) FIXED INCOME FUND. This fund shall be
invested exclusively in the following investments:
(1) prior to August 1, 1996, interests
in the Capital Preservation Trust,
a fund established by Bankers
Trust Company within the BT
Pyramid Trust (previously called
the General Employee Benefit
Trust) under a declaration of
trust dated May 28, 1956 and
amended April 1, 1967, January 21,
1983, and June 28, 1990;
(2) on and after August 1, 1996, (i)
interests in the Benham
Preservation Fund, a collective
trust fund established by SEI
Trust Company under a Declaration
of Trust dated June 10, 1996 which
is invested principally in
guaranteed investment contracts,
bank investment contracts, similar
fixed-income investments, and
units of other collective trust
funds which are invested
principally in such
- 8 -
<PAGE> 12
investments; and (ii) interests in
any other collective trust fund or
pooled investment fund designated
by the Company from time to time
by written notice to the Trustee,
specifically including, but not
limited to, the Benham Stable
Asset Fund, a collective trust
fund also established by SEI Trust
Company under a Declaration of
Trust dated June 10, 1996,
provided that any such collective
trust fund or pooled investment
fund is invested principally in
guaranteed investment contracts,
bank investment contracts, and
similar fixed-income investments.
The Fixed Income Fund shall also
be known on and after August 1,
1996 as the "Benham Preservation
Fund".
(b) TWENTIETH CENTURY BALANCED INVESTORS FUND.
This fund shall be invested exclusively in shares of Twentieth Century Balanced
Investors Fund, a mutual fund maintained by Twentieth Century Investors, Inc.,
which is invested principally in common stocks and fixed income securities with
the objective of capital growth and current income.
(c) TWENTIETH CENTURY SELECT INVESTORS FUND.
This fund shall be invested exclusively in shares of Twentieth Century Select
Investors Fund, a mutual fund maintained by Twentieth Century Investors, Inc.,
which is invested principally in equity securities with the objective of
long-term capital growth.
(d) TWENTIETH CENTURY ULTRA INVESTORS FUND.
This fund shall be invested exclusively in shares of Twentieth Century Ultra
Investors Fund, a mutual fund maintained by Twentieth Century Investors, Inc.,
which is invested principally in equity securities with the objective of
aggressive long-term capital growth.
(e) TWENTIETH CENTURY INTERNATIONAL EQUITY FUND.
This fund shall be invested exclusively in shares of Twentieth Century
International Equity Fund, a mutual fund maintained by Twentieth Century World
Investors, Inc., which is invested principally in foreign equity securities with
the objective of long term capital growth.
(f) TWENTIETH CENTURY VALUE FUND. This fund
shall be invested exclusively in shares of the Twentieth Century Value Fund, a
mutual fund maintained by Twentieth Century Capital Portfolios, Inc., which is
invested principally in equity
- 9 -
<PAGE> 13
securities with the primary objective of long-term capital growth and a
secondary objective of income.
Notwithstanding the foregoing, each such
Investment Fund may hold cash or be invested in short-term fixed income
securities or obligations or interests in any collective trust fund maintained
by the Trustee invested principally in such securities and obligations, provided
that the portion of each such Investment Fund held in cash or invested in such
other investments shall not exceed such limit or limits as the Company may
establish from time to time for such Investment Fund.
As directed by the Company, the Trustee shall
establish and maintain such additional Investment Funds as the Company
determines necessary or appropriate for the investment of the assets of the Plan
or discontinue such Investment Fund as the Company determines necessary or
appropriate. The power conferred upon the Company by the preceding sentence
shall be exercised by a written notice to the Trustee specifying the nature of
the additional Investment Fund to be established and maintained or the identity
of the Investment Fund to be discontinued and all other terms and conditions
pertaining to the fund. Any such notice by the Company shall have the same force
and effect as if incorporated as part of this Section 3.02.
The name of any Investment Fund may be changed by the Company at
any time by written notice to the Trustee.
- 10 -
<PAGE> 14
ARTICLE IV.
Payments from Trust Fund
------------------------
4.01 As directed by the Company, the Trustee shall pay
benefits and administrative expenses under the Plan. The Trustee need not
inquire into whether any payment the Company instructs it to make is consistent
with the terms of the Plan or applicable law or otherwise proper. Any payment
made by the Trustee in accordance with such instructions shall be a complete
discharge and acquittance to the Trustee. The Trustee shall not pay benefits
from the Fund without such instructions, even though it may be informed from
other sources, including, without limitation, a participant or beneficiary, that
benefits are payable under the Plan. The Trustee shall have no responsibility to
determine when, to whom, or in what amount benefits and expenses are payable
under the Plan.
4.02 The Trustee may pay any benefit or expense under the Plan
by mailing a check for the amount of the payment to the person designated by the
Company as entitled to receive such payment to such address as may have last
been furnished to the Trustee by the Company. If no such address has been so
furnished, benefits or expenses may be mailed by the Trustee to such person in
care of the Company.
4.03 All taxes that may be levied or assessed upon or in
respect of the Fund shall be paid from the Fund. The Trustee shall notify the
Company of any proposed or final assessments of taxes and may assume that any
such taxes are lawfully levied or assessed unless the Company advises the
Trustee in writing to the contrary within fifteen days after receiving such
notice from the Trustee. The Trustee, if requested by the Company in writing,
shall contest the validity of such taxes in any manner deemed appropriate by the
Company; the Company may itself contest the validity of any such taxes, in which
case it shall so notify the Trustee and the Trustee shall have no responsibility
or liability respecting such contest. If either party to this Agreement contests
any such proposed levy or assessment, the other party shall provide such
information and cooperation as the party conducting the contest shall reasonably
request.
4.04 At no time before the satisfaction of all liabilities
with respect to participants in the Plan and their beneficiaries shall any part
of the Trust Fund be used for, or diverted to, purposes other than for the
exclusive benefit of such participants and their beneficiaries. The assets of
the Trust Fund shall never inure to the benefit of the Company and shall be held
for the exclusive purpose of providing benefits to
- 11 -
<PAGE> 15
participants in the Plan and their beneficiaries and defraying the reasonable
expenses of administering the Plan, except as otherwise permitted by the Plan in
the case of a contribution made by mistake of fact or conditioned on the
qualification of the Plan under section 401(a) of the Internal Revenue Code or
the deductibility of the contribution under section 404 of the Code.
4.05 The Trustee shall be entitled to receive such reasonable
compensation for its services as may be agreed upon from time to time by the
Company and the Trustee. Unless paid by the Company, such compensation and such
other reasonable expenses as are incurred in the administration of the Trust
Fund shall be paid from the Trust Fund.
4.06 At the direction of the Company, the Trustee shall
transfer all of the property representing a participant's vested interest in the
Plan to the trustee or custodian of any other plan qualified under section
401(a) of the Code or to an individual retirement account or annuity described
in section 408 of the Code.
- 12 -
<PAGE> 16
ARTICLE V.
Liabilities and Immunities of the Trustee
-----------------------------------------
5.01 The Trustee shall discharge its duties under this
Agreement with the care, skill, prudence, and diligence under the circumstances
then prevailing that a prudent man acting in a like capacity and familiar with
such matters would use in the conduct of an enterprise of a like character and
with like aims; subject to the provisions of Article III, to the extent required
by ERISA diversify the investments of the Trust so as to minimize the risk of
large losses, unless under the circumstances it is clearly prudent not to do so;
and discharge its duties in accordance with the provisions of the Plan and this
Agreement insofar as such provisions are consistent with ERISA.
The Trustee shall not engage in any transaction
that it knows or should know violates section 406 of ERISA. Notwithstanding the
foregoing, the Trustee may, in accordance with any appropriate exemption
provided under ERISA or upon the approval of the Secretary of the Department of
Labor, enter into any transaction otherwise prohibited under section 406 of
ERISA.
5.02 The Trustee shall not be responsible for computing or
collecting contributions due under the Plan.
5.03 The Trustee in its corporate capacity shall not be liable
for claims of any persons in any matter regarding the Plan unless such claim
results from a breach of the Trustee's fiduciary liability. The Trustee shall
not be liable to make distributions or payments of any kind unless sufficient
funds are available in the Fund. The Trustee shall be responsible only for such
money and other property as are received by it as Trustee under this Agreement.
5.04 Except for its own negligence, willful misconduct, or
other breach of fiduciary duty, the Trustee shall not be liable to anyone at any
time interested in the Plan, the Trust, or the Fund, for any act or omission in
the administration of this Agreement.
5.05 The Trustee shall not be liable for any act or omission
in compliance with any written direction executed by or on behalf of the
Company. The Trustee may rely upon any written instrument it reasonably believes
to be genuine and to have been presented and signed by the proper party or
parties.
5.06 The Company shall indemnify and hold the Trustee
harmless against any liability arising from or in connection with
- 13 -
<PAGE> 17
the acceptance or administration of the Trust, the investment and administration
of the Fund, any action or omission in compliance with any written direction
executed by or on behalf of the Company, and any action or omission in
compliance with instructions or lack of instructions from an investment manager,
and against the reasonable expense of defending itself against such liability,
unless such liability results from the Trustee's own negligence, willful
misconduct, or other breach of fiduciary duty.
5.07 Whenever the Trustee shall determine it desirable for a
matter to be proved or established before taking, permitting, or omitting any
act, the matter (unless other evidence is specifically prescribed in this
Agreement) may be considered to be conclusively established by a certification
signed by an officer of the Company and delivered to the Trustee, and the
Trustee shall be fully protected in relying on such an instrument.
5.08 If a dispute arises as to the payment of any funds or
delivery of any assets by the Trustee, the Trustee may withhold such payment or
delivery until the dispute is determined by a court of competent jurisdiction or
finally settled in writing by the parties concerned.
- 14 -
<PAGE> 18
ARTICLE VI.
Accounting of the Trustee
-------------------------
6.01 The Trustee shall keep records of all transactions
relating to the Trust Fund. These records shall be open to inspection at
reasonable times by the Company or any person or persons designated by the
Company in a written instrument filed with the Trustee.
6.02 Within ninety days after the close of each fiscal year of
the Plan or the termination of the Plan or this Agreement, or at such other
intervals as may be mutually agreeable to the Trustee and the Company, the
Trustee shall file with the Company an account setting forth all transactions
(including all receipts and disbursements) during a stated period. If the
Company has not communicated an objection or exception to an account in writing
to the Trustee within sixty days after its filing, the Trustee shall, to the
extent permitted by law, be discharged from any liability or accountability to
the Company with respect to the transactions reflected in the account. If an
objection or exception is timely raised by the Company and is not settled
between the Company and the Trustee, the Trustee may commence a proceeding for a
judicial settlement of the account in any court of competent jurisdiction. No
party other than the Company shall be entitled to an accounting by the Trustee,
except as may be required by law.
6.03 Nothing in this Agreement shall prevent the Trustee from
having its accounts settled by a court of competent jurisdiction at any time.
The only parties that need be joined in any such proceeding are the Company, the
Trustee, and such other parties whose participation is required by law.
- 15 -
<PAGE> 19
ARTICLE VII.
Removal and Resignation of the Trustee
--------------------------------------
7.01 The Trustee shall serve until resignation or removal. The
Trustee may resign as Trustee under this Agreement at any time by a written
instrument delivered to the Company giving notice of such resignation, which
shall be effective thirty days after receipt or at such other time as is
agreeable to the Company and the Trustee. The Trustee may be removed at any time
by the Company by a written resolution, certified by the Secretary or Assistant
Secretary of the Company and delivered to the Trustee, which shall be effective
thirty days after receipt or at such other time as is agreeable to the Company
and the Trustee.
7.02 If the Trustee resigns or is removed, the Board of
Directors of the Company shall appoint a successor trustee. Any successor
trustee shall have all the powers and duties of the original Trustee.
7.03 Upon the resignation or removal of the Trustee and the
appointment of a successor trustee, the Trustee shall account for the
administration of the Trust Fund up to the date of its resignation or removal in
the manner provided in Article VI and shall transfer to the successor trustee
all of the assets then constituting the Trust Fund. The term "Trustee" as used
in this Agreement shall include any successor trustee.
- 16 -
<PAGE> 20
ARTICLE VIII.
Amendment and Termination
-------------------------
8.01 This Agreement may be amended at any time and from time
to time by a written instrument signed by the Company and the Trustee. The
instrument of amendment shall be approved by the Board of Directors of the
Company. No amendment shall permit any part of the Fund to be used for or
diverted to purposes other than the exclusive benefit of participants and their
beneficiaries or the payment of reasonable expenses of administering the Plan
and Trust, subject to Section 4.04. The instrument of amendment shall specify
its effective date; amendments may be made effective retroactively.
8.02 If the Company certifies to the Trustee that the Plan is
or has been terminated, the Trustee shall hold or dispose of the Fund in
accordance with the Company's written instructions, subject to the Trustee's
right to receive a written or judicial settlement of its account. The Trustee
may reserve such sum of money as it determines necessary for payment of its
expenses in connection with its administration of the Trust or the settlement of
its account or for payment of taxes that may be assessed on or in respect of the
Fund or the income of the Fund.
- 17 -
<PAGE> 21
ARTICLE IX.
Miscellaneous
9.01 No right or claim in or to the Fund or any Fund assets
shall be assignable or subject to garnishment, attachment, execution, or levy of
any kind; any attempt to transfer, assign, or pledge the same shall be void and
shall not be recognized by the Trustee except to such extent as may be legally
required or is pursuant to a qualified domestic relations order in accordance
with section 414(p) of the Code.
9.02 This Agreement shall be administered, construed, and
enforced in accordance with ERISA and the laws of the State of New York to the
extent applicable.
9.03 Headings of Articles are inserted for convenience
of reference. They are not part of this Agreement and shall not
be considered in construing it.
9.04 This Agreement may be executed in any number of
counterparts, each of which shall be considered an original even though no
others are produced.
IN WITNESS WHEREOF, the Company and the Trustee have each
caused this Agreement to be executed as of the day and year first above written.
MERCHANTS MUTUAL INSURANCE COMPANY
Attest:
_______________________ By _______________________________
THE CHASE MANHATTAN BANK, N.A.
Attest:
_________________________ By _______________________________
-18 -
<PAGE> 22
STATE OF NEW YORK )
COUNTY OF ERIE ) SS.:
On this _____ day of _________________________, 1996, before
me personally came ____________________________________________________________,
to me known, who, being by me duly sworn, did depose and say that he/she resides
at _______________________________________________; that he/she is
________________________________________ of MERCHANTS MUTUAL INSURANCE COMPANY,
the corporation described in and which executed the foregoing instrument; that
he/she knows the seal of said corporation; that the seal affixed to said
instrument is such corporate seal; that it was so affixed by order of the Board
of Directors of said corporation, and that he/she signed his/her name hereto by
like order.
----------------------------------
Notary Public
- 19 -
<PAGE> 23
STATE OF __________________)
COUNTY OF ERIE ____________) SS.:
On this _____ day of _________________________, 1996, before
me personally came ____________________________________________________________,
to me known, who, being by me duly sworn, did depose and say that he/she resides
at _______________________________________________; that he/she is
___________________________________________ of THE CHASE MANHATTAN BANK, N.A.,
the corporation described in and which executed the foregoing instrument; that
he/she knows the seal of said corporation; that the seal affixed to said
instrument is such corporate seal; that it was so affixed by order of the Board
of Directors of said corporation, and that he/she signed his/her name hereto by
like order.
----------------------------------
Notary Public
- 20 -
<PAGE> 1
EXHIBIT 23
<PAGE> 2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-47014) and in the Prospectus constituting part of
the Registration Statement on Form S-3 (No. 333-08951) of Merchants Group, Inc.
of our report dated February 27, 1997 appearing on page F-1 of this Form 10-K.
/s/ Price Waterhouse LLP
Buffalo, New York
March 31, 1997
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<INCOME-TAX> (1,885,000)
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