<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
COMMISSION FILE NUMBER 1-9640
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MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
16-1280763
(I.R.S. Employer Identification No.)
250 MAIN STREET, BUFFALO, NEW YORK
(Address of principal executive offices)
14202
(Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [ x ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of October 28, 1997:
2,908,202 SHARES OF COMMON STOCK.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1996 1997
------ ------------ -------------
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$19,921 in 1996 and $20,218 in 1997) $ 19,549 $ 19,607
Available for sale at fair value (amortized cost
$163,500 in 1996 and $163,734 in 1997) 163,567 164,517
Preferred stock at fair value (cost $7,928
in 1996 and $10,025 in 1997) 7,928 10,624
Other long-term investments at fair value 2,305 1,591
Short-term investments 8,248 20,210
-------- --------
Total investments 201,597 216,549
Cash 11 7
Interest due and accrued 1,793 1,565
Premiums receivable, net of allowance for doubtful
accounts of $571 in 1996 and $560 in 1997 20,501 20,921
Deferred policy acquisition costs 12,396 12,628
Ceded reinsurance balances receivable 7,835 8,684
Prepaid reinsurance premiums 2,932 2,831
Receivable from affiliate 327 1,810
Federal income tax receivable 1,266 506
Deferred federal income tax benefit 6,645 6,002
Other assets 6,820 7,244
-------- --------
Total assets $262,123 $278,747
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
2
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MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $ 133,479 $ 136,079
Unearned premiums 49,710 50,485
Payable for securities -- 11,068
Other liabilities 13,905 14,988
--------- ---------
Total liabilities 197,094 212,620
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 3,220,352
shares issued at December 31, 1996 and 3,226,102
shares issued at September 30, 1997 32 32
Additional paid in capital 35,372 35,455
Treasury stock, 160,700 shares at December 31, 1996
and 317,500 shares at September 30, 1997 (2,983) (5,866)
Unrealized investment gains (losses), net of tax (603) 912
Accumulated earnings 33,211 35,594
--------- ---------
Total stockholders' equity 65,029 66,127
---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 262,123 $ 278,747
========= =========
</TABLE>
See Notes to Consolidated Financial Statements
3
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
1996 1997 1996 1997
---------------------- ---------------------
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $ 23,924 $23,764 $71,797 $70,922
Net investment income 2,921 3,223 8,528 9,442
Net realized investment gains 58 9 1,000 112
Other revenues 144 77 202 163
-------- ------- ------- -------
Total revenues 27,047 27,073 81,527 80,639
-------- ------- ------- -------
Expenses:
Net losses and loss adjustment
expenses 18,420 17,488 54,812 53,152
Amortization of deferred policy
acquisition costs 6,340 6,297 19,026 18,794
Other underwriting expenses 2,048 1,599 5,127 4,992
-------- ------- ------- -------
Total expenses 26,808 25,384 78,965 76,938
-------- ------- ------- -------
Income before income taxes 239 1,689 2,562 3,701
Provision (benefit) for income taxes (71) 400 448 872
-------- ------- ------- -------
Net income $ 310 $ 1,289 $ 2,114 $ 2,829
======== ======= ======= =======
Primary and fully diluted earnings per
share $ .10 $ .43 $ .66 $ .94
======== ======= ======= =======
Weighted average shares outstanding:
Primary and fully diluted 3,182 2,966 3,208 3,002
</TABLE>
See Notes to Consolidated Financial Statements
4
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1996 1997
-------------------
<S> <C> <C>
Common stock, beginning and end $ 32 $ 32
-------- --------
Additional paid in capital:
Beginning of period 35,302 35,372
Exercise of common stock options 38 83
-------- --------
End of period 35,340 35,455
-------- --------
Treasury stock:
Beginning of period -- (2,983)
Purchase of treasury shares (1,475) (2,883)
-------- --------
End of period (1,475) (5,866)
-------- --------
Unrealized investment gains (losses), net of tax:
Beginning of period (357) (603)
Appreciation (depreciation) (1,112) 1,515
-------- --------
End of period (1,469) 912
-------- --------
Accumulated earnings:
Beginning of period 34,993 33,211
Net income 2,114 2,829
Cash dividends (479) (446)
-------- --------
End of period 36,628 35,594
-------- --------
Total stockholders' equity $ 69,056 $ 66,127
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
5
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1996 1997
--------------------------------
<S> <C> <C>
Cash flows from operations:
Collection of premiums $ 71,909 $ 70,394
Payment of losses and loss adjustment expenses (49,737) (50,426)
Payment of other underwriting expenses (25,174) (23,246)
Investment income received 8,845 9,747
Investment expenses paid (180) (229)
Income taxes (paid) recovered 213 (250)
Other cash receipts 202 163
-------- --------
Net cash provided by operations 6,078 6,153
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 52,758 60,450
Purchase of fixed maturities (49,815) (59,523)
Purchase of preferred stock (3,924) (2,067)
Net decrease in other long-term investments 2,221 714
Net increase in short-term investments (11,993) (11,962)
Purchase of equipment, net (413) (108)
-------- --------
Net cash used in investing activities (11,166) (12,496)
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances (1,726) (1,483)
Exercise of common stock options 38 83
Cash borrowed to purchase securities 8,946 11,068
Purchase of treasury stock (1,475) (2,883)
Cash dividends on common stock (479) (446)
-------- --------
Net cash provided by financing activities 5,304 6,339
-------- --------
Increase (decrease) in cash and cash equivalents 216 (4)
Cash:
Beginning of period 39 11
-------- --------
End of period $ 255 $ 7
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
6
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1996 1997
---------------------
<S> <C> <C>
Net income $ 2,114 $ 2,829
Adjustments:
Depreciation and amortization 2 17
Realized investment gains (1,000) (112)
(Increase) decrease in assets:
Interest due and accrued 290 228
Premiums receivable (373) (420)
Deferred policy acquisition costs (127) (232)
Ceded reinsurance balances receivable (1,285) (849)
Prepaid reinsurance premiums 1 101
Federal income tax receivable 38 760
Deferred federal income tax benefit 624 (138)
Other assets (52) (489)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 6,543 2,600
Unearned premiums 476 775
Other liabilities (1,173) 1,083
------- -------
Net cash provided by operations $ 6,078 $ 6,153
======= =======
</TABLE>
See Notes to Consolidated Financial Statements
7
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MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
-----------------------------------------------------------
The consolidated balance sheet as of September 30, 1997 and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows for the nine months ended September 30, 1996 and 1997 are unaudited.
In the opinion of management, the interim financial statements reflect all
adjustments necessary for a fair presentation of financial position and results
of operations. Such adjustments consist only of normal recurring items. Interim
results are not necessarily indicative of results for a full year.
The consolidated financial statements include the accounts of Merchants Group,
Inc. (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. The
accompanying consolidated financial statements should be read in conjunction
with the following notes and the Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1996.
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. All
significant intercompany balances and transactions have been eliminated. Certain
1996 amounts have been reclassified to conform with 1997 presentation.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share", which prescribes standards for computing and presenting earnings per
share ("EPS"). SFAS No. 128 simplifies current standards for computing EPS and
makes such presentation consistent with international EPS standards. The Company
is required to adopt the requirements of SFAS No. 128 at the end of 1997.
Earlier adoption is not permitted. The Company does not expect SFAS No. 128 to
have a material impact on EPS.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income".
SFAS No. 130 establishes standards for the reporting of comprehensive income in
a full set of general-purpose financial statements. Comprehensive income, as
described in SFAS No. 130, includes net income as well as items under existing
accounting standards that are reported as adjustments to stockholders' equity.
Such adjustments to stockholders' equity include unrealized gains and losses on
certain investments in debt and equity securities.
The Company is required to adopt SFAS No. 130 in the first quarter of 1998
Earlier application is permitted. The Company is currently in the process of
determining the presentation of comprehensive income and its components within
the guidelines established by SFAS No. 130.
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2. RELATED PARTY TRANSACTIONS
--------------------------
The Company and MNH do not have any paid employees. Under a management
agreement, Merchants Mutual Insurance Company ("Mutual"), which owns 8.8% of the
Company's common stock outstanding at September 30, 1997, 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.
3. EARNINGS PER SHARE
--------------------
Primary and fully diluted earnings per share were computed by dividing net
income by the weighted average number of shares of common stock outstanding
during each period, increased by the assumed exercise of 34,250 and 45,708
shares of common stock options in 1997 and 1996, respectively, which would have
resulted in 6,879 and 9,785 additional shares outstanding, respectively,
assuming the proceeds to the Company from exercise were used to purchase shares
of the Company's common stock at its average market value per share during the
quarter.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AS COMPARED
- ------------------------------------------------------------------------------
TO THE NINE MONTHS ENDED SEPTEMBER 30, 1996
- -------------------------------------------
Total revenues for the nine months ended September 30, 1997 were $80,639,000,
down 1% from $81,527,000 for the nine months ended September 30, 1996.
Net premiums earned for the nine months ended September 30, 1997 were
$70,922,000, a decrease of $875,000, or 1%, from $71,797,000 for the nine months
ended September 30, 1996. The decrease in net premiums earned was consistent
with the change in direct premiums written. Direct premiums written for the nine
months ended September 30, 1997 were $75,204,000, substantially unchanged from
$75,207,000 for the nine months ended September 30, 1996.
Voluntary personal lines direct premiums written for the nine months ended
September 30, 1997 were $29,773,000, an increase of 6% from $27,995,000 for the
nine months ended September 30, 1996, primarily due to private passenger
automobile ("PPA") direct premiums written, which increased 7% from the year
earlier period. This increase in PPA business resulted from a 3% increase in the
number of policies in force and a 4% increase in average premium per policy.
Voluntary personal lines direct premiums written represented 44% and 40% of
total voluntary direct premiums written for the nine months ended September 30,
1997 and 1996, respectively.
Voluntary commercial lines direct premiums written for the nine months ended
September 30, 1997 were $37,536,000, a decrease of 9% from $41,142,000 for the
nine months ended September 30, 1996. This decrease resulted primarily from a
34% reduction in workers' compensation direct premiums written, due to the
Company's decision to exit certain unprofitable classes of that business during
the fourth quarter of 1996 and the first nine months of 1997.
Involuntary direct premiums written, primarily PPA insurance, which comprised
10% and 8%, of all direct premiums written during the nine months ended
September 30, 1997 and 1996 respectively, increased by 30% to $7,895,000 in the
nine months ended September 30, 1997 from $6,069,000 for the nine months ended
September 30, 1996. This increase resulted from increased mandatory assignments
from the New York Automobile Insurance Plan (the "Plan"), which provides
coverage for individuals who are unable to obtain auto insurance in the
voluntary market. Assignments from the Plan vary depending upon a company's
voluntary PPA market share and the size of the Plan.
Net investment income was $9,442,000 for the nine months ended September 30,
1997, an increase of 11% from $8,528,000 for the nine months ended September 30,
1996. Average invested assets during the nine months ended September 30, 1997
increased 4% compared to the same period 1996. On a taxable equivalent basis
using statutory tax rates, net investment income increased 7%. The percentage
increase in net investment income on a taxable equivalent basis was lower than
the percentage increase in net investment income, due to a reduction in the
percentage of invested assets allocated to tax exempt investments compared to
the prior period.
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Net realized gains on the sale of investments were $112,000 for the nine months
ended September 30, 1997, a decrease of $888,000 from $1,000,000 for the nine
months ended September 30, 1996. Realized gains during the nine months ended
September 30, 1996 included a $900,000 gain on the sale of the Company's
investment in Signet Group, PLC.
Losses and loss adjustment expenses ("LAE") were $53,152,000 for the nine months
ended September 30, 1997, a decrease of $1,660,000 or 3% from $54,812,000 for
the nine months ended September 30, 1996. The loss and LAE ratio decreased to
74.9% for the nine months ended September 30, 1997 from 76.3% for the nine
months ended September 30, 1996. Losses and LAE in the nine months ended
September 30, 1996 included $2,200,000 of losses related to unusually severe
winter weather that affected the northeastern United States during that period.
These higher than normal weather related losses increased the loss and LAE ratio
in the nine months ended September 30, 1996 by 3.1 percentage points. There has
not been comparable severe winter weather during the first nine months of 1997.
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 33.5% for the nine months ended
September 30, 1997 from 33.6% for the nine months ended September 30, 1996.
Commissions, premium taxes and other state assessments that vary directly with
the Company's premium volume represented 20.5% of net premiums earned in the
nine months ended September 30, 1997 compared to 20.8% of net premiums earned in
the nine months ended September 30, 1996.
The Company's effective federal income tax rate for the nine months ended
September 30, 1997 was 23.6%. This rate was calculated using the Company's
estimate of its effective federal income tax rate for all of 1997. Non-taxable
investment income, primarily tax-exempt bond income, reduced the Company's
effective tax rate by approximately 10 percentage points. During the nine months
ended September 30, 1996, the Company recorded an income tax benefit equal to
29.7% of its pre-tax income. An income tax benefit resulted since tax exempt
income was larger than pre-tax income.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AS COMPARED
- -------------------------------------------------------------------------------
TO THE THREE MONTHS ENDED SEPTEMBER 30, 1996
- --------------------------------------------
Total revenues for the three months ended September 30, 1997 were $27,073,000,
substantially unchanged from $27,047,000 for the three months ended September
30, 1996.
Net premiums earned for the three months ended September 30, 1997 were
$23,764,000, a decrease of $160,000, or less than 1%, from $23,924,000 for the
three months ended September 30, 1996. Net premiums written for the three months
ended September 30, 1997 were $24,877,000, an increase of $269,000, or 1%, from
$24,608,000 for the three months ended September 30, 1996. Direct premiums
written for the three months ended September 30, 1997 were $26,441,000, an
increase of $1,386,000, or 6%, from $25,055,000 for the three months ended
September 30, 1996. The increase in net premiums written was less than the
increase in direct premiums written due to a $1,084,000 decrease in assumed
premiums written, primarily from the National Workers' Compensation Pool. This
pool provides insurance coverage to
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insureds that are unable to obtain workers' compensation insurance in the
voluntary market, in certain states in which the Company sells insurance.
Voluntary personal lines direct premiums written for the three months ended
September 30, 1997 were $10,611,000, an increase of $478,000 or 5% from
$10,133,000 for the three months ended September 30, 1996, primarily due to a 3%
increase in private passenger automobile policies in force.
Voluntary commercial lines direct premiums written for the three months ended
September 30, 1997 were $12,560,000, a decrease of $485,000 or 4% from
$13,045,000 for the three months ended September 30, 1996. The decrease in
commercial lines direct premiums written was primarily due to a 27% decrease in
workers' compensation direct premiums written, from $1,885,000 for the three
months ended September 30, 1996 to $1,378,000 for the three months ended
September 30, 1997. The decrease in workers' compensation direct premiums
written resulted from the Company's decision to exit certain unprofitable
classes of that business.
Involuntary direct premiums written increased by 74% to $3,270,000 for the three
months ended September 30, 1997 from $1,877,000 for the three months ended
September 30, 1996 primarily as a result of increased assignments from the Plan.
Assignments from the Plan vary depending upon a company's voluntary PPA market
share and the size of the Plan.
Net investment income was $3,223,000 for the three months ended September 30,
1997, an increase of 10% from $2,921,000 for the same period in 1996. Average
invested assets during the three months ended September 30, 1997 increased 4%
compared to the three months ended September 30, 1996. On a taxable equivalent
basis, calculated using statutory rates, net investment income increased 7%.
Losses and LAE were $17,488,000 for the three months ended September 30, 1997, a
decrease of $932,000, or 5%, from $18,420,000 for the three months ended
September 30, 1996. The loss and LAE ratio decreased to 73.6% for the three
months ended September 30, 1997 from 77.0% for the three months ended September
30, 1996.
The ratio of the amortization of deferred policy acquisition costs and other
underwriting expenses to net premiums earned decreased to 33.2% for the three
months ended September 30, 1997 from 35.1% for the three months ended September
30, 1996. Other underwriting expenses for the three months ended September 30,
1996 included $355,000 of higher than anticipated charges related to the
Company's profit sharing plan with its agents, which added approximately 1.5% to
this ratio.
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 flow
from investments, has provided the Company with short-term funds in excess of
normal operating demands for cash.
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<PAGE> 13
Net cash provided by operations increased $75,000 to $6,153,000 for the nine
months ended September 30, 1997 from $6,078,000 for the nine months ended
September 30, 1996.
Net cash used in investing activities increased $1,330,000 to $12,496,000 in the
nine months ended September 30, 1997 from $11,166,000 in the nine months ended
September 30, 1996. This increase in net cash used in investing activities
resulted primarily from a $2,016,000 decrease in net cash provided by the
purchase and sale of investments in fixed maturities, partially offset by a
$1,857,000 decrease in net cash used to purchase preferred stock and a
$1,507,000 decrease in net cash used to acquire other long-term investments.
Net cash provided by financing activities increased $1,035,000 to $6,339,000 in
the nine months ended September 30, 1997 from $5,304,000 in the nine months
ended September 30, 1996, primarily due to a $2,122,000 increase in cash
borrowed to purchase securities, partially offset by a $1,408,000 increase in
cash used to repurchase the Company's common stock.
The Company's objectives with respect to its investment portfolio 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 carefully 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 the Company's investments are recorded as a component of
stockholders' equity. During the nine months ended September 30, 1997 the
Company recorded a $1,515,000 improvement in unrealized gains (losses), net of
tax. At September 30, 1997, the Company had recorded $912,000 of unrealized
gains, net of tax, associated with its investment portfolio.
At September 30, 1997, the Company's portfolio of fixed maturities represented
85% of invested assets. Management believes that this level of bond holdings is
consistent with the Company's liquidity needs because it anticipates that cash
receipts from net premiums written and investment income will enable the Company
to satisfy its cash obligations. 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 September 30, 1997, $115,412,000 or 53% of the Company's investment portfolio
was invested in mortgage-backed and other asset-backed securities. The Company
invests in a variety of collateralized mortgage obligation ("CMO") products but
has not invested in the more volatile types 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 marketability does not
significantly differ from that of the Company's other fixed maturity
investments. The Company does not own any other derivative financial
instruments.
13
<PAGE> 14
At September 30, 1997, $1,853,000, or 1%, of the Company's investment portfolio
was invested in non-investment grade securities. This amount included a
$1,000,000 capital advance to Mutual. Subsequent to September 30, 1997, Mutual
requested and received permission from the New York Insurance Department to
repay the advance. On November 6, 1997, Mutual repaid to the Company the full
amount of this advance as well as all unpaid dividends amounting to $13,370.
During the nine months ended September 30, 1997, the Company repurchased 156,800
shares of its common stock at an average price of $18.39 per share. As of
October 28, 1997, the Company has authority from its Board of Directors to
repurchase up to 107,100 additional shares of its common stock. The Company was
holding 317,500 shares of its common stock in treasury at September 30, 1997.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations and pay any cash dividends. MNH is subject to New Hampshire
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 statutory 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. MNH paid $1,800,000 in
dividends to the Company during the nine months ended September 30, 1997. On
October 23, 1997 MNH declared an additional $1,000,000 cash dividend to the
Company to be paid on November 17, 1997.
Under a management agreement, Mutual provides employees, services and facilities
for MNH to conduct its insurance business on a cost reimbursed basis. The
balance in the receivable from affiliate account represents the amount owed by
Mutual to the Company for the difference between premiums collected and payments
made for losses, employees, services and facilities by Mutual on behalf of MNH.
The receivable is settled monthly.
The Company relies on technology to operate its insurance business. As the year
2000 approaches, Mutual is preparing all of its computer systems to be year 2000
compliant. As part of this process, Mutual expects to both replace some systems
and upgrade others. The Company's share of the costs incurred to upgrade systems
will be expensed as incurred. The Company does not believe that these costs will
materially impact the Company's results of operations or financial condition.
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
14
<PAGE> 15
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. MNH has consistently followed a business strategy that would
allow it to meet this 3 to 1 regulatory guideline. For the first nine months of
1997 MNH's ratio of net premiums written to statutory surplus, annualized for a
full year, was 2.1 to 1.
15
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
-----------------
CHANNING T. LUSHBOUGH VS. MERCHANTS GROUP, INC., ET AL.
- -------------------------------------------------------
On March 31, 1997, the New York State Supreme Court in New York City dismissed a
shareholder derivative lawsuit brought against the Company, MNH, Mutual and
certain directors of the Company and Mutual (collectively, the "defendants").
The court held that the complaint failed to state a cause of action against any
of the defendants. The lawsuit was originally filed in 1993 as a purported class
action and was amended in 1995 to a derivative action after the court held that
the plaintiff's claims were derivative in nature. The plaintiff alleged that the
defendants breached their fiduciary obligations to the then 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 alleged was an inadequate price.
After the lawsuit was amended to a derivative action, the Company's Board of
Directors appointed a special committee composed of disinterested directors to
review the merits of the case. That committee determined that the Company's
Board had acted reasonably in approving the note restructuring and the public
offering, and decided that the plaintiff's lawsuit should be dismissed. The
court held that the case should be dismissed because the determination of the
special committee to discontinue the lawsuit was valid and appropriate under
Delaware law. The plaintiff has appealed the court's position and has also filed
a motion with the court for permission to renew and reargue the defendants'
motion to dismiss. The plaintiff's motion was argued on July 28, 1997 and the
court has it under consideration.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
-------------------------------------
(a) Exhibits
(11) Statement re computation of per share earnings (filed
herewith).
(27) Financial Data Schedule (filed herewith).
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the period
for which this report is filed.
16
<PAGE> 17
* * * * * *
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
Certain statements made in this Quarterly Report on Form 10-Q
constitute forward-looking statements and are made 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 statements. These assumptions, risks and uncertainties
include, but are not limited to, those associated with factors affecting the
property-casualty insurance industry generally, including price competition,
size and frequency of claims, 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.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS GROUP, INC.
(Registrant)
Date: November __, 1997 By:/S/ KENNETH J. WILSON
---------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
18
<PAGE> 1
EXHIBIT 11
MERCHANTS GROUP, INC.
Computation of Income Per Share
(in thousands except per share data)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
1996 1997 1996 1997
------------------- -------------------
<S> <C> <C> <C> <C>
Net income for computing earnings per common
share - without dilution and fully diluted $ 310 $1,289 $2,114 $2,829
====== ====== ====== ======
Weighted average number of common shares
outstanding - without dilution 3,172 2,959 3,198 2,995
Addition from assumed exercise as of the beginning of
the period, of common stock options outstanding as of the end of the period,
reduced by the number of shares assumed to have been repurchased by the
company with the proceeds from exercise, at the
average market value per share during the period 10 7 10 7
------ ------ ------ ------
Weighted average number of common shares and
common share equivalents outstanding, primary
and fully diluted 3,182 2,966 3,208 3,002
====== ====== ====== ======
Primary and fully diluted earnings per share $ .10 $ .43 $ .66 $ .94
====== ====== ====== ======
</TABLE>
19
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 164,517,000
<DEBT-CARRYING-VALUE> 19,607,000
<DEBT-MARKET-VALUE> 19,921,000
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 216,549,000
<CASH> 7,000
<RECOVER-REINSURE> 8,684,000
<DEFERRED-ACQUISITION> 12,628,000
<TOTAL-ASSETS> 278,747,000
<POLICY-LOSSES> 136,079,000
<UNEARNED-PREMIUMS> 50,485,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 32,000
<OTHER-SE> 66,095,000
<TOTAL-LIABILITY-AND-EQUITY> 278,747,000
70,922,000
<INVESTMENT-INCOME> 9,422,000
<INVESTMENT-GAINS> 112,000
<OTHER-INCOME> 163,000
<BENEFITS> 53,152,000
<UNDERWRITING-AMORTIZATION> 18,794,000
<UNDERWRITING-OTHER> 4,992,000
<INCOME-PRETAX> 3,701,000
<INCOME-TAX> 872,000
<INCOME-CONTINUING> 2,829,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,829,000
<EPS-PRIMARY> .94
<EPS-DILUTED> .94
<RESERVE-OPEN> 126,260,000
<PROVISION-CURRENT> 49,705,000
<PROVISION-PRIOR> 3,447,000
<PAYMENTS-CURRENT> 21,439,000
<PAYMENTS-PRIOR> 28,987,000
<RESERVE-CLOSE> 128,986,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
