<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NUMBER 1-9640
MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
DELAWARE 16-1280763
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
250 MAIN STREET, BUFFALO, NEW YORK 14202
(Address of principal executive offices) (Zip Code)
</TABLE>
716-849-3333
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class - COMMON STOCK, $.01 PAR VALUE PER SHARE
Name of each exchange on which registered - AMERICAN STOCK EXCHANGE, INC.
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. Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ x ]
As of March 18, 1998, 2,908,852 shares of common stock were outstanding. The
aggregate market value of the common shares held by non-affiliates of Merchants
Group, Inc. on March 18, 1998 was $57,721,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 1998 Annual Meeting of
stockholders are incorporated by reference into Part III.
<PAGE> 2
MERCHANTS GROUP, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 1997
<TABLE>
<CAPTION>
PART I PAGE
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<S> <C> <C>
ITEM 1. BUSINESS. 2
ITEM 2. PROPERTIES. 19
ITEM 3. LEGAL PROCEEDINGS. 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 20
PART II
--------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED 21
STOCKHOLDER MATTERS.
ITEM 6. SELECTED FINANCIAL DATA. 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 23
CONDITION AND RESULTS OF OPERATIONS.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 30
ACCOUNTING AND FINANCIAL DISCLOSURE.
PART III
---------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 31
ITEM 11. EXECUTIVE COMPENSATION. 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 31
AND MANAGEMENT.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 31
PART IV
--------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 32
REPORTS ON FORM 8-K.
</TABLE>
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PART I
Item 1. BUSINESS.
General
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 Mutual owns 8.8% of the Company's common stock. 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 pays 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.
Any amendment or modification of the Management Agreement must be approved
by the New York Insurance Department (the "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 the right, at no cost, to obtain copies of all these
systems, together with the right to use these systems in perpetuity.
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Prior Pooling Agreements
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
The Company markets its products through approximately 650 independent
agents, which also represent Mutual. The Company primarily directs its marketing
efforts to its independent agents and believes by working closely with those
agents, it becomes more likely 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.
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 targeted agents' 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
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with a competitive advantage compared to many other property and casualty
insurers, whose field representatives have no underwriting authority. By placing
an underwriting decision maker in the agent's office, and thereby simplifying
the underwriting process, the Company believes it can maintain and 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 Chairperson of the Advisory
Councils from each Strategic Business Center meet twice each 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 1997 totaled $1,779,000 or
1.8% of direct premiums written, and increased participating agents' commissions
received from the Company by approximately 28%. 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.
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 1996 and 1997 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 120 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 1997, net premiums written
totaled $96,811,000, with 51% of the net premiums written derived from
commercial lines of insurance and 49% from personal lines of insurance.
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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,
------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
New York 64% 64% 66%
New Jersey 14 15 15
New Hampshire 11 11 10
Rhode Island 4 3 3
Pennsylvania 3 3 2
Massachusetts 3 3 2
Other 1 1 2
--- --- ---
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 risk 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:
o 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.
o 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.
o Commercial automobile - primarily light and medium use vehicles
operating in a limited radius, with complete background information
required of all drivers.
o 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.
o 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.
o 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.
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
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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 or 1997 and has informed the Company that it
will not cede any of its voluntary direct written premiums to MNH in 1998.
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.
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The following table shows, for each of the years in the three year period
ended December 31, 1997 (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,
----------------------------------------------------------------------------------
1995 1996 1997
----------------------------------------------------------------------------------
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 $22,556 23.1% 78.2% $23,964 24.8% 80.9% $26,187 27.0% 69.7%
Auto Physical Damage 11,546 11.8 52.1 12,241 12.7 60.3 13,570 14.0 45.8
Homeowners'
Multi-Peril 6,606 6.8 77.8 7,269 7.5 68.1 7,789 8.0 35.7
------- ----- ------- ----- ------- -----
Total 40,708 41.7 70.7 43,474 45.0 73.1 47,546 49.0 57.5
Commercial
Auto Liability 13,496 13.8 69.5 13,050 13.5 43.4 12,377 12.8 100.7
Auto Physical Damage 3,047 3.1 51.8 3,225 3.3 51.7 2,948 3.1 45.8
Commercial
Multi-Peril 20,845 21.4 71.3 20,725 21.5 59.9 21,287 22.0 44.6
Workers'
Compensation 12,223 12.5 94.7 10,023 10.4 110.7 7,070 7.3 169.0
Other Lines 7,258 7.5 56.0 6,125 6.3 57.4 5,583 5.8 6.0
------- ----- ------- ----- ------- -----
Total 56,869 58.3 72.7 53,148 55.0 63.5 49,265 51.0 73.6
------- ----- ------- ----- ------- -----
Total Personal &
Commercial $97,577 100.0% 71.9 $96,622 100.0% 67.7 $96,811 100.0% 65.7
======= ===== ======= ===== ======= =====
</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 or
decrease 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 or decreases in
reserves for prior accident year losses.
The following table sets forth the composition of voluntary direct
premiums written for 1993 through 1997:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial 60% 62% 62% 60% 57%
Personal 40 38 38 40 43
--- --- --- --- ---
Total 100% 100% 100% 100% 100%
=== === === === ===
</TABLE>
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Commercial Lines
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 in recent years in
most of its commercial lines and the significant level of 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 than average 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
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 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 applicant.
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.
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The Company's gross (direct and assumed) premiums written attributable to
involuntary policies were $11,317,000, $11,325,000 and $12,719,000 in 1995, 1996
and 1997, respectively, mostly in New York. The Company is unable to predict the
level of its annual involuntary business for 1998 or future years.
Claims
Insurance claims on policies written by the Company are investigated and
settled by claims adjusters 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 adjusters 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 adjusters 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.
Claims settlement authority levels are established for each adjuster,
supervisor and manager based on their expertise and experience. When the Company
receives notice of a claim, it is assigned to an adjuster 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
amount relating to workers' compensation claims, loss reserves are not
discounted for financial statement purposes.
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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, 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 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 and 1997, the Company experienced greater than anticipated
severity (claim value) in liability claims primarily related to its workers'
compensation line of insurance.
The following table sets forth the changes in the reserve for losses and
LAE for 1995, 1996 and 1997.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Reserve for losses and LAE at beginning of year $104,015 $119,722 $133,479
Less reinsurance recoverables 6,401 6,004 7,219
-------- -------- --------
Net balance at beginning of year 97,614 113,718 126,260
-------- -------- --------
Provision for losses and LAE for claims occurring in:
Current year 67,150 72,771 67,119
Prior years 11,045 6,832 4,508
-------- -------- --------
78,195 79,603 71,627
-------- -------- --------
Losses and LAE payments for claims occurring in:
Current year 25,175 28,512 26,100
Prior years 36,916 38,549 40,954
-------- -------- --------
62,091 67,061 67,054
-------- -------- --------
Reserve for losses and LAE at end of year, net 113,718 126,260 130,833
Plus reinsurance recoverables 6,004 7,219 10,372
-------- -------- --------
Balance at end of year $119,722 $133,479 $141,205
======== ======== ========
</TABLE>
In 1995, 1996 and 1997, the Company increased its reserves for prior years
by $11,045,000, $6,832,000 and $4,508,000, 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 insurance. The increases in
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<PAGE> 12
reserves for prior years made in 1996 and 1997 were primarily attributable to
higher than anticipated severity of claims on workers' compensation policies.
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 1997.
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.
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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.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for losses and LAE:
$44,778 $55,412 $66,892 $71,222 $77,274 $86,159 $89,939 $97,614 $113,718 $126,260
Liability re-estimated as of:
One year later 47,519 57,238 75,614 77,548 80,841 88,284 94,921 108,659 120,550 130,768
Two years later 47,112 61,534 76,310 75,987 81,743 91,224 100,607 113,091 128,192
Three years later 51,023 61,928 73,578 78,106 83,693 95,396 106,382 121,051
Four years later 52,104 61,014 75,672 79,563 87,105 99,779 112,983
Five years later 51,249 61,787 76,746 81,308 90,428 104,699
Six years later 51,764 62,201 77,026 84,530 92,370
Seven years later 52,141 62,332 79,690 85,219
Eight years later 52,035 64,388 79,890
Nine years later 53,836 64,194
Ten years later 53,340
Cumulative Deficiency:
$ ( 8,562) ( 8,782) (12,998) (13,997) (15,096) (18,540) (23,044) (23,437) (14,474) (4,508)
% (19.1) (15.8) (19.4) (19.7) (19.5) (21.5) (25.6) (24.0) (12.7) (3.6)
Paid (Cumulative) as of:
One year later 20,649 21,393 32,538 32,666 30,082 35,724 34,551 36,916 38,549 40,954
Two years later 28,049 37,459 47,816 47,339 50,490 56,003 56,965 60,074 64,323
Three years later 38,936 47,816 58,489 61,585 63,925 69,863 72,963 77,982
Four years later 44,819 52,758 66,466 70,219 72,917 80,156 83,998
Five years later 46,931 56,732 71,322 75,018 79,374 86,808
Six years later 48,985 59,162 73,558 78,398 82,602
Seven years later 50,547 59,994 75,822 79,884
Eight years later 50,815 61,546 76,683
Nine years later 51,795 62,183
Ten years later 52,043
</TABLE>
12
<PAGE> 14
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,
------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Loss and LAE reserves on a STAT basis $113,059 $125,821 $130,781
Adjustments:
Loss reserves ceded under a quota share
agreement with an unrelated party 595 379 --
Ceded reinsurance balances recoverable 6,004 7,219 10,372
Write-down of reinsurance recoverable 64 60 52
-------- -------- --------
Loss and LAE reserves on a GAAP basis $119,722 $133,479 $141,205
======== ======== ========
</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.
Effective January 1, 1998, the Company changed its primary reinsurer and
coverage. Prior to that time, the Company's excess of loss arrangements for
automobile liability, general liability and workers' compensation insurance
provided 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 was
indexed for inflation for casualty lines other than workers' compensation and
New York State no-fault, and applied retroactively to all occurrences until they
are settled. There was no index provision for casualty claims occurring after
1992. This coverage was supplemented by additional treaty reinsurance covering
losses up to $5,000,000 in excess of the first $5,000,000.
Prior to January 1, 1998, property reinsurance agreements provided 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 provided for recovery of 95% of $40,000,000, subject to
aggregate retained losses of $5,000,000 for each natural disaster. The
reinsurance premium rate paid varied for each line of business.
13
<PAGE> 15
Effective January 1, 1998, the new property and casualty excess of loss
reinsurance agreements provide for recovery of casualty losses over $500,000 up
to $10,000,000 per occurrence and property losses over $500,000 up to
$13,000,000 per occurrence. This coverage is supplemented by a contingent
casualty layer of reinsurance for workers' compensation claims of $5,000,000 in
excess of the first $10,000,000 subject to a calendar year limit of $20,000,000.
Property catastrophe coverage provides for recovery of 95% of $50,000,000,
subject to aggregate retained losses of $5,000,000 per occurrence. The property
catastrophe reinsurance 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.
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 to the reinsurer. At December 31, 1997, recoverable losses exceeded
the cap 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 may assume up to 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 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
from a maximum of 10% to a minimum of 0% of Mutual's direct voluntary premiums
written for any calendar year prior to the beginning of that calendar year.
Mutual did not cede to MNH any portion of its direct voluntary written premiums
in 1996 or 1997 and has informed the Company that it will not cede any voluntary
direct written premiums to MNH in calendar year 1998.
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 are available to 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 held by the Company are typically purchased at
expected yields which are greater than comparable maturity Treasury securities
and are AAA or AA rated.
14
<PAGE> 16
The Company had $28,764,000 of tax-exempt bonds in its investment
portfolio at December 31, 1997. 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, 1997, the Company had $4,470,000 of short-term investments
with maturities less than 30 days, and $861,000 of non-investment grade
securities. These non-investment grade securities represented .4% of its
investment portfolio.
The table below gives information regarding the Company's investments as
of the dates indicated.
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------------
1995 1996 1997
---------------------------------------------------------------
Amount % Amount % Amount %
------ --- ------ --- ------ ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities (1):
U.S. Government and Agencies $ 58,421 30.4% $49,990 24.8% $ 48,734 23.2%
Corporate Bonds 63,997 33.3 86,308 42.8 117,060 55.7
Tax-Exempt Bonds 60,837 31.7 46,818 23.2 28,764 13.7
-------- ----- -------- ----- -------- -----
Total Bonds 183,255 95.4 183,116 90.8 194,558 92.6
Preferred stocks (2) -- -- 7,928 3.9 10,582 5.0
Short-Term Investments (3) 4,470 2.3 8,248 4.1 4,470 2.1
Other (4) 4,493 2.3 2,305 1.2 634 .3
-------- ----- -------- ----- -------- -----
Total Invested Assets $192,218 100.0% $201,597 100.0% $210,244 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
(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 fair value.
(3) Shown at cost, which approximates fair value.
(4) Shown at estimated fair value or unpaid principal balance, which
approximates estimated fair value.
15
<PAGE> 17
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,
----------------------------------------
1995 1996 1997
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Average investments (1) $181,760 $194,677 $202,041
Net investment income 10,368 11,724 12,770
Net investment income as a percentage
of average investments (2) 5.7% 6.0% 6.3%
Net realized gains (losses) on investments $ (832) $ 996 $ 112
</TABLE>
(1) At amortized cost.
(2) The taxable equivalent yield for the years ended December 31, 1995, 1996
and 1997 were 6.6%, 6.6%, and 6.9%, respectively, assuming an effective
tax rate of 34%.
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,
--------------------------------------------------------------
1995 1996 1997
--------------------------------------------------------------
Amount % Amount % Amount %
------ --- ------ --- ------ ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
1 year or less $ 24,175 13.2% $ 15,518 8.5% $ 47,499 24.4%
1 year through 5 years 114,823 62.6 123,856 67.6 116,508 59.9
5 years through 10 years 36,967 20.2 32,452 17.7 27,877 14.3
More than 10 years 7,290 4.0 11,290 6.2 2,674 1.4
-------- ----- -------- ----- -------- -----
Total $183,255 100.0% $183,116 100.0% $194,558 100.0%
======== ===== ======== ===== ======== =====
</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
16
<PAGE> 18
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 eleven years due primarily to
intense premium rate competition. Many of the circumstances which led to the
current cyclical downturn in the property and casualty insurance 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 policyholders' surplus as of the
preceding December 31st. The maximum amount of dividends that MNH could pay
during any twelve month period ending in 1998 without the prior approval of the
New Hampshire Insurance Commissioner is $4,601,000.
17
<PAGE> 19
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,
1997, 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, 1997.
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. One of the Company's
ratios as of December 31, 1997 relating to loss reserve development fell outside
of the acceptable range of ratios. The ratio was outside of the acceptable range
due to the $6,832,000 and $4,508,000 increases in the provision for losses and
LAE recorded in 1996 and 1997 respectively, for claims occurring in prior years,
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
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.
18
<PAGE> 20
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 1998 and subsequent years.
Employees
The Company has no employees. At December 31, 1997, Mutual had 378
full-time equivalent 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.
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.
During 1997, the New York State Supreme Court dismissed a shareholder
derivative lawsuit brought against the Company, Mutual, MNH and certain
directors of the Company and of Mutual (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
19
<PAGE> 21
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 decision 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.
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.
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
20
<PAGE> 22
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>
1997: High Low
- ----- ---- ---
<S> <C> <C>
Fourth Quarter $21.25 $18.63
Third Quarter 20.38 17.38
Second Quarter 20.50 18.75
First Quarter 19.13 17.50
1996: High Low
- ----- ---- ---
Fourth Quarter $18.88 $18.00
Third Quarter 19.25 18.50
Second Quarter 19.50 17.00
First Quarter 18.75 17.50
</TABLE>
The number of stockholders of record of the Company's Common Stock as of
February 28, 1998 was 117. 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 1998 without prior
approval of the New Hampshire Insurance Commissioner is $4,601,000.
21
<PAGE> 23
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, 1997 have been derived from the
audited consolidated financial statements of the Company.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net premiums written $ 91,192 $ 90,187 $ 97,577 $ 96,622 $ 96,811
======== ========= ========= ========= ========
Net premiums earned $ 88,181 $ 90,845 $ 94,749 $ 95,752 $ 96,054
Net investment income 9,155 9,849 10,368 11,724 12,770
Net realized investment gains (losses) 1,467 20 (832) 996 112
Other revenues 693 638 259 172 214
-------- --------- --------- --------- --------
Total revenues 99,496 101,352 104,544 108,644 109,150
-------- --------- --------- --------- --------
Net losses and loss adjustment expenses 62,407 70,800 78,195 79,603 71,627
Amortization of deferred policy acquisition costs 23,739 24,424 25,458 25,374 25,454
Other underwriting expenses 6,020 5,892 7,709 6,700 6,647
-------- --------- --------- --------- --------
Total expenses 92,166 101,116 111,362 111,677 103,728
Income (loss) before income taxes 7,330 236 (6,818) (3,033) 5,422
Provision (benefit) for income taxes 1,727 (895) (2,999) (1,885) 1,224
Income (loss) before cumulative effect of change
in accounting for income taxes 5,603 1,131 (3,819) (1,148) 4,198
Cumulative effect of change in accounting for
income taxes 306 -- -- -- --
-------- --------- --------- --------- --------
Net income (loss) $ 5,909 $ 1,131 $ (3,819) $ (1,148) $ 4,198
======== ========= ========= ========= ========
Basic and diluted earnings (loss) per share:
Before cumulative effect of change in
accounting for income taxes $ 2.12 $ .36 $ (1.19) $ (.36) $ 1.41
Cumulative effect of change in
accounting for income taxes .12 -- -- -- --
-------- --------- --------- --------- --------
Basic and diluted earnings (loss)
per share $ 2.24 $ .36 $ (1.19) $ (.36) $ 1.41
======== ========= ========= ========= ========
Weighted average number of shares
outstanding:
Basic 2,641 3,158 3,214 3,174 2,973
Diluted 2,641 3,177 3,219 3,182 2,980
Balance Sheet Data: (at year end)
Total investments $175,762 $ 170,747 $ 192,218 $ 201,597 $210,244
Total assets 219,188 227,750 252,808 262,123 273,974
Reserve for losses and loss
adjustment expenses 93,896 104,015 119,722 133,479 141,205
Unearned premiums 46,006 45,449 48,773 49,710 50,406
Stockholders' equity 75,083 67,279 69,970 65,029 67,462
Dividend Data:
Cash dividend per common share $ .10 $ .20 $ .20 $ .20 $ .20
</TABLE>
22
<PAGE> 24
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
1997 Compared to 1996.
Total revenues, net premiums earned, net premiums written and direct
premiums written were all substantially unchanged when compared to 1996. Total
revenues for 1997 were $109,150,000, compared to $108,644,000 in 1996. Net
premiums earned for 1997 were $96,054,000, compared to $95,752,000 in 1996. Net
premiums written for 1997 were $96,811,000, compared to $96,622,000 in 1996.
Direct premiums written for 1997 were $101,064,000, compared to $101,007,000 in
1996.
Voluntary personal lines direct premiums written for 1997 were
$39,415,000, an increase of 5% from $37,616,000 in 1996. Private passenger
automobile direct premiums written, which comprised 79% of total voluntary
personal lines direct premiums written in 1997 and 1996, increased 5% in 1997
compared to 1996. This increase resulted primarily from a 6% increase in average
premium per policy at December 31, 1997 compared to December 31, 1996.
Homeowners direct premiums written increased 4% in 1997 compared to 1996 due to
a 6% increase in average premium per policy.
Voluntary commercial lines direct premiums written for 1997 were
$51,572,000, a decrease of 7% from $55,467,000 in 1996. This decrease resulted
primarily from a $2,416,000 or 28% decrease in workers' compensation direct
premiums written and an $804,000 or 5% decrease in commercial auto direct
premiums written. The decrease in workers' compensation direct premiums written
resulted from the Company's decision in late 1996 to exit certain unprofitable
classes of that business starting in late 1996 and continuing throughout 1997.
The decrease in commercial auto direct premiums written resulted from a 4%
decrease in policies in force at December 31, 1997 compared to December 31,
1996. The decrease in commercial auto policies in force resulted in part from
the Company's decision not to write certain related workers' compensation
policies.
Involuntary direct premiums written, primarily involuntary private
passenger automobile insurance, which comprised 10% and 8% of total direct
premiums written during 1997 and 1996, respectively, were $10,077,000 for 1997
compared to $7,923,000 in 1996. This 27% 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 private passenger automobile market share and the size of the Plan.
Net investment income was $12,770,000 in 1997, an increase of 9% from
$11,724,000 in 1996, primarily due to a 4% increase in average invested assets
and a 5% increase in the investment portfolio yield. Realized investment gains
were $112,000 in 1997 compared to $996,000 in 1996.
Losses and loss adjustment expenses ("LAE") were $71,627,000 for 1997, a
decrease of 10% from $79,603,000 in 1996. The loss and LAE ratio decreased to
74.6% in 1997 from 83.1% in 1996. In 1997, the Company recorded increases to its
reserve for losses that occurred prior to 1997, primarily for its workers'
compensation line of business. The net increase in the reserve for prior year
losses and LAE was $4,508,000 and added 4.7 percentage points to the loss and
LAE ratio in 1997.
23
<PAGE> 25
Losses and LAE in 1996 included a $6,896,000 increase in reserves for
accidents that occurred prior to 1996 which added 7.2 percentage points to the
loss and LAE ratio in 1996.
Losses and LAE in 1996 included $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.
There were no such higher than normal weather related losses in 1997.
Involuntary automobile insurance business increased the Company's
calendar year loss and LAE ratio by approximately 3.4 and .7 percentage points
for the years ended December 31, 1997 and 1996, 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 33.4% in 1997 from 33.5% in 1996.
Commissions, premium taxes and other state assessments that vary directly
with the Company's premium volume represented 20.8% and 22.0% of net premiums
earned in 1997 and 1996, 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 provision in 1997 and an income tax
benefit in 1996. The amounts recorded for income taxes differed from those
calculated using the statutory federal income tax rate primarily due to tax
exempt bond income.
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.
24
<PAGE> 26
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 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 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.
25
<PAGE> 27
Losses and LAE in 1996 included $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.
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.
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 decreased by $2,331,000 or 20% from
$11,864,000 in 1996 to $9,533,000 in 1997 primarily due to a $2,898,000 decrease
in income taxes recovered. The Company received federal income tax refunds in
1997 and 1996 of $614,000 and $2,521,000 respectively, resulting from the net
losses recorded in 1995 and 1996 respectively.
Net cash used in investing activities decreased $3,204,000 or 35% from
$9,109,000 in 1996 to $5,905,000 in 1997. This decrease resulted from a
$9,130,000 net increase in the purchase of fixed maturities, which was more than
offset by net decreases in cash used to purchase preferred stock ($4,861,000)
and other short-term investments ($7,556,000).
26
<PAGE> 28
Net cash used in financing activities increased $846,000 or 30% from
$2,783,000 in 1996 to $3,628,000 in 1997 primarily due to a $964,000 increase in
payments by the Company to its affiliate to settle monthly transactions under
the Management Agreement.
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 these investments are recorded as a
component of stockholders' equity. At December 31, 1997, the Company recorded
$1,061,000 of unrealized gains, net of tax, associated with its fixed maturity
investments. During 1997 the Company recorded $1,664,000 of unrealized gains,
net of tax, related to its investment portfolio.
At December 31, 1997, the Company's portfolio of fixed maturities
represented 92.5% 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 December 31, 1997, $121,450,000, or 62.4%, of the Company's fixed
maturity portfolio was invested in mortgage-backed and other asset- backed
securities. The Company invests in a variety of collateralized mortgage
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, 1997, only $861,000, or .4%, of the Company's investment
portfolio was invested in non-investment grade securities, which was down from
$3,329,000, or 1.7%, at December 31, 1996. At December 31, 1996, MNH owned an
investment represented by a capital advance issued by Mutual in the principal
amount of $1,350,000. During 1997, MNH received $49,025 of dividends related to
this capital advance and Mutual repaid to MNH the full amount of the advance.
During 1997 the Company repurchased 158,900 shares of its common stock
at an average price of $18.40 and is holding 319,600 shares in treasury as of
December 31, 1997.
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
27
<PAGE> 29
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 1998 without the prior approval of the New Hampshire Insurance
Commissioner is $4,601,000. The Company paid a $.05 per share quarterly cash
dividend to its common stockholders totaling $589,000 in 1997.
The Company relies to a significant degree on computer technology to
operate its insurance business. Mutual is currently preparing all of its
computer systems to be year 2000 compliant. Year 2000 compliance means that
computer systems are able to distinguish date data between the twentieth and
twenty first centuries. As part of this process, Mutual is replacing some of its
systems and upgrading others, and is working to assess the status of its
vendors' and customers' year 2000 compliance. The Company's share of the costs
that have been incurred to upgrade these systems has not had a material adverse
impact on the Company's financial position, results of operations or cash flows.
However, Mutual's inability or the inability of the Company's vendors or
customers to resolve year 2000 issues could result in material financial risk.
The Company has been advised by Mutual that it is devoting appropriate resources
to address year 2000 issues and anticipates that its computer systems will be in
compliance by the end of 1998. The Company does not know the extent of its share
of the future costs that Mutual will incur in this regard, but it does not
believe these costs will have a material adverse impact on 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
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 MNH to meet this 3 to 1 regulatory guideline. MNH's
ratio of net premiums written to statutory surplus for 1997 was 2.1 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.
28
<PAGE> 30
Federal Taxation
The Company and MNH are subject to federal income taxation under the
provisions of the Internal Revenue Code of 1986, as amended.
Possible Change in Relationship with Mutual
The Company's and MNH's business and day-to-day operations are closely
aligned with those of Mutual. This is the result of a combination of factors.
Mutual has had a historical ownership interest in the Company and MNH. Prior to
November 1986 MNH was a wholly-owned subsidiary of Mutual. Following the
Company's initial public offering in November 1986 until a secondary stock
offering in July 1993 the Company was a majority-owned subsidiary of Mutual.
Mutual currently owns 8.8% of the Company. Under the Management Agreement,
Mutual provides the Company and MNH with all facilities and personnel to operate
their business. The only officers of the Company or MNH who are paid full time
employees are employees of the Mutual whose services are purchased under the
Management Agreement. Also, the operation of the Company's insurance business,
which offers substantially the same lines of insurance as Mutual through the
same independent insurance agents, creates a very close relationship among the
companies.
From time to time the Directors of the Company and Mutual have discussed
possible changes in the relationship among the three companies for the purposes
of improving their insurance operations and reducing the instances where there
might be conflicts between MNH and Mutual. For example, in November 1994 when
Mutual filed an application with the New York Insurance Department to convert
from a mutual to a stock corporation, the Company indicated to Mutual its
willingness to consider sponsoring that conversion. However, as a result of an
improvement in its financial condition, Mutual withdrew its conversion
application in September 1996. Another example of the Directors' interest in
changing the relationship among the companies occurred in 1994 when, as part of
the settlement of issues arising out of the allocation of assigned risk
automobile business, the two Boards explored the advisability and feasibility of
pooling the insurance operations of MNH and Mutual in exchange for a reduction
in the notice period required to terminate the Management Agreement. At that
time, after extended arms' length negotiations with Mutual's Board of Directors,
the Company concluded that pooling would not be in its best interest, and no
changes were made. In late 1997 the companies jointly retained an independent
insurance consultant to review their common insurance operations and to
consider, among other things, whether pooling was advisable from each company's
perspective. The independent insurance consultant recommended that the companies
consider pooling, but after extensive consideration Mutual concluded that
pooling would not be in its best interest at this time.
29
<PAGE> 31
The Company has recently been informed by Mutual that Mutual is
considering whether it would be in its best interest to purchase all or
substantially all of the stock of the Company or MNH, and that Mutual has
retained an investment banking firm and independent legal counsel to assist it
in determining whether such a proposal is advisable and, if so, whether Mutual
could finance any such proposal. The Company is studying what alternatives, if
any, are available to it should Mutual either not present a proposal or present
a proposal which is unacceptable to the Company. Among the alternatives being
considered by the Company are the possible sale or merger of the Company or MNH.
There can be no assurance that Mutual will present any proposal to the Company,
or if it does whether such proposal would be acceptable to the Company or
whether Mutual would be able to secure the financing and regulatory approvals
necessary to complete any such proposal. There can also be no assurance that any
of the alternatives being considered by the Company can be implemented on terms
acceptable to the Company.
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>
1997
Net premiums earned $23,000 $24,158 $23,764 $25,132
Net investment income 3,029 3,190 3,223 3,328
Net realized investment gains (losses) 107 (4) 9 --
Other revenues 61 25 77 51
------- ------- ------- -------
Total revenues $26,197 $27,369 $27,073 $28,511
======= ======= ======= =======
Income before income taxes $ 617 $ 1,395 $ 1,689 $ 1,721
Net income $ 481 $ 1,059 $ 1,289 $
1,369
Net income per common share $ .16 $ .35 $ .43
$ .47
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) $ (261) $ 2,065 $ 310 $(3,262)
Net income (loss) per common share $ (.08) $ .64 $ .10 $ (1.05)
</TABLE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
30
<PAGE> 32
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.
31
<PAGE> 33
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-22:
Report of Independent Accountants
Consolidated Balance Sheet - December 31, 1996 and 1997.
Consolidated Statement of Operations - Years ended
December 31, 1995, 1996 and 1997.
Consolidated Statement of Changes in Stockholders' Equity - Years
ended December 31, 1995, 1996 and 1997.
Consolidated Statement of Cash Flows - Years ended December 31,
1995, 1996 and 1997. 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, 1997.
(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).
(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).
32
<PAGE> 34
(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, (incorporated by
reference to Exhibit No. 10f to the Company's 1996 Annual Report
on Form 10-K filed on March 28, 1997).
*(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 (incorporated by referenced to
Exhibit 10(h) to the Company's 1996 Annual Report on Form 10-K
(File No. 1-9640) filed on March 28, 1997).
*(i) Merchants Mutual Capital Accumulation Plan Trust Agreement
(restated as of January 1, 1996 (incorporated by reference to
Exhibit 10(i) to the Company's 1996 Annual Report on Form 10-K
(File No. 1-9640) filed on March 28, 1997).
33
<PAGE> 35
*(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 (incorporated by reference to Exhibit
No. 10(n) to the Company's 1996 Annual Report on Form 10-K (File
No. 1-9640) filed on March 28, 1997).
*(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 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).
* Indicates a management contract or compensation plan or arrangement.
34
<PAGE> 36
MERCHANTS GROUP, INC.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
Amount at
which shown
Amortized Cost/ Market in the balance
Type of Investment Cost value sheet
- ------------------ ---- ----- -----
<S> <C> <C> <C>
Fixed maturities:
United States Government and
government agencies and authorities $ 23,902 $ 23,767 $ 23,796
Corporate bonds 20,035 20,548 20,548
Mortgage and asset backed securities 120,473 122,175 121,450
Tax exempt bonds 28,217 28,764 28,764
-------- -------- --------
Total fixed maturities 192,627 195,254 194,558
-------- -------- --------
Preferred stocks 10,038 10,582 10,582
Short-term investments 4,470 4,470 4,470
Other 634 634 634
-------- -------- --------
$207,769 $210,940 $210,244
======== ======== ========
</TABLE>
35
<PAGE> 37
MERCHANTS GROUP, INC.
SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES,
AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER
THAN RELATED PARTIES
Years ended December 31, 1995, 1996 and 1997
(in thousands)
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Receivable from (payable to) Merchants Mutual
Insurance Company(1):
Balance at beginning of period $ (397) $1,091 $327
Increase (decrease) 1,488 (764) 200
------ ------ ----
Balance at end of period $1,091 $ 327 $527
====== ====== ====
</TABLE>
(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.
36
<PAGE> 38
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands except per share and share amounts)
<TABLE>
<CAPTION>
BALANCE SHEET December 31,
----------------------------
1996 1997
---- ----
<S> <C> <C>
Assets
Investment in subsidiary $ 63,764 $67,116
Other assets 1,346 407
-------- -------
Total Assets $ 65,110 $67,523
=======
Liabilities and Stockholders' Equity
Other liabilities $ 81 $ 61
-------
Total liabilities $ 81 $ 61
-------
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 3,059,652 shares at December 31,
1996 and 2,906,502 shares at December 31, 1997 32 32
Additional paid in capital 35,372 35,455
Treasury stock, 319,600 shares at December 31, 1997 (2,983) (5,906)
Unrealized investment gains (losses), net of tax (603) 1,061
Accumulated earnings 33,211 36,820
-------- -------
Total stockholders' equity 65,029 67,462
-------- -------
Total liabilities and stockholders' equity $ 65,110 $67,523
======== =======
</TABLE>
37
<PAGE> 39
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Continued
(in thousands except per share and share amounts)
<TABLE>
<CAPTION>
INCOME STATEMENT
Year ended December 31,
--------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Revenues:
Equity in net income (loss) of subsidiary $(2,856) $(1,570) $4,485
Investment income 73 133 21
Net realized investment gains (losses) (840) 902 2
------- ------- ------
Total revenues (3,623) (535) 4,508
Expenses:
General and administrative expenses 246 281 230
------- ------- ------
Operating income before income taxes (3,869) (816) 4,278
Income tax expense (benefit) (50) 332 80
------- ------- ------
Net income $(3,819) $(1,148) $4,198
======= ======= ======
</TABLE>
38
<PAGE> 40
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,
----------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities: $ (311) $ 560 $ (227)
------- ------- -------
Cash flows from investing activities:
Receipt of subsidiary common stock dividend 800 -- 2,800
Sale (purchase) of other investments, net (480) 2,992 853
------- ------- -------
Cash flows from investing activities 320 2,992 3,653
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock -- (2,983) (2,923)
Cash dividend on common stock (635) (634) (589)
Exercise of common stock options 624 70 83
------- ------- -------
Cash flows from financing activities (11) (3,547) (3,429)
------- ------- -------
Net increase (decrease) in cash and cash equivalents (2) 5 (3)
Cash and cash equivalents, beginning of year 5 3 8
------- ------- -------
Cash and cash equivalents, end of year $ 3 $ 8 $ 5
======= ======= =======
Reconciliation of net income to net cash provided by operations:
Net income (loss) $(3,819) $(1,148) $ 4,198
Adjustments to reconcile net income to net cash provided by operations:
Equity in (income) loss of subsidiary 2,856 1,570 (4,485)
Net realized investment (gains) losses 840 (902) (2)
Increase (decrease) in liabilities 98 (219) (20)
(Increase) decrease in other
(non-investment) assets 94 514 93
Other, net (380) 745 (11)
------- ------- -------
Net cash provided by (used in) operating activities $ (311) $ 560 $ (227)
======= ======= =======
</TABLE>
39
<PAGE> 41
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
Cash dividends of $800,000 and $2,800,000 were paid to the Registrant by
its consolidated subsidiary in the years ended December 31, 1995 and 1997,
respectively. No cash dividends were paid to the Registrant by its consolidated
subsidiary in 1996.
40
<PAGE> 42
MERCHANTS GROUP, INC.
SCHEDULE VI - REINSURANCE
YEARS ENDED DECEMBER 31, 1995, 1996, 1997
(in thousands) Percentage
<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, 1995
Property and Casualty Premiums $ 98,533 $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%
Year Ended December 31, 1997
Property and Casualty Premiums $101,064 $6,895 $2,642 $96,811 2.7%
</TABLE>
41
<PAGE> 43
MERCHANTS GROUP, INC.
SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING
PROPERTY - CASUALTY SUBSIDIARIES
Years ended December 31, 1995, 1996 and 1997
(in thousands)
<TABLE>
<CAPTION>
Reserves Losses & loss
Deferred for Discount adjustment expenses Amoritiza-
policy losses & if any, Net incurred related to tion of Paid losses
acquis- loss ad- deducted Net invest- (1) (2) deferred & loss ad- Direct
ition justment from Unearned earned ment Current Prior acquisition justment premium
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, 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
December 31, 1997 $12,597 $141,205 $6,394 $50,406 $96,054 $12,770 $67,119 $ 4,508 $25,454 $67,054 $101,064
</TABLE>
42
<PAGE> 44
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
Certain statements made in this Annual Report on Form 10-K 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
those statements. 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.
43
<PAGE> 45
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 30, 1998 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 30, 1998
- ------------------------- of the Board
Richard E. Garman
/s/ BRENT D. BAIRD Director, President March 30, 1998
- -------------------------
Brent D. Baird
/s/ ROBERT M. ZAK Director, Sr. VP & March 30, 1998
- ------------------------- Chief Operating
Robert M. Zak Officer
/s/ KENNETH J. WILSON Vice President & CFO March 30, 1998
- ------------------------- (principal financial
Kenneth J. Wilson and accounting officer)
/s/ ANDREW A. ALBERTI Director March 30, 1998
- -------------------------
Andrew A. Alberti
/s/ FRANK J. COLANTUONO Director March 30, 1998
- -------------------------
Frank J. Colantuono
/s/ HENRY P. SEMMELHACK Director March 30, 1998
- -------------------------
Henry P. Semmelhack
</TABLE>
44
<PAGE> 46
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 32 present fairly, in all material
respects, the financial position of Merchants Group, Inc. and its subsidiary at
December 31, 1997 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, 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.
/s/ Price Waterhouse LLP
Buffalo, New York
February 16, 1998
F-1
<PAGE> 47
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
December 31,
---------------------
1996 1997
---- ----
Assets
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost $ 19,549 $ 19,631
Available for sale at fair value 163,567 174,927
Preferred stock at fair value 7,928 10,582
Other long-term investments at fair value 2,305 634
Short-term investments 8,248 4,470
-------- --------
Total investments
201,597 210,244
Cash
Interest due and accrued 11 10
Premiums receivable, net of allowance for doubtful accounts 1,793 1,858
of $571 in 1996 and $543 in 1997
Deferred policy acquisition costs 20,501 21,084
Ceded reinsurance balances receivable 12,396 12,597
Prepaid reinsurance premiums 7,835 11,132
Receivable from affiliate 2,932 2,871
Federal income taxes receivable 327 527
Deferred federal income taxes 1,266 --
Other assets 6,645 6,319
6,820 7,332
-------- --------
Total assets
$262,123 $273,974
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
<PAGE> 48
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1997
---- ----
Liabilities and Stockholders' Equity
------------------------------------
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $ 133,479 $ 141,205
Unearned premiums 49,710 50,406
Other liabilities 13,905 14,901
--------- ---------
Total liabilities 197,094 206,512
--------- ---------
Stockholders' equity:
Common stock, issued and outstanding 3,059,652
shares at December 31, 1996 and 2,906,502
shares at December 31, 1997 32 32
Additional paid in capital 35,372 35,455
Treasury stock, 160,700 shares at December 31, 1996
and 319,600 shares at December 31, 1997 (2,983) (5,906)
Unrealized investment gains (losses), net of tax (603) 1,061
Accumulated earnings 33,211 36,820
--------- ---------
Total stockholders' equity 65,029 67,462
--------- ---------
Commitments and contingent liabilities (Note 9) -- --
Total liabilities and stockholders' equity $ 262,123 $ 273,974
========= =========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
<PAGE> 49
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Revenues:
Net premiums earned $ 94,749 $ 95,752 $ 96,054
Net investment income 10,368 11,724 12,770
Net realized investment gains (losses) (832) 996 112
Other revenues 259 172 214
--------- --------- --------
Total revenues 104,544 108,644 109,150
--------- --------- --------
Expenses:
Net losses and loss adjustment expenses 78,195 79,603 71,627
Amortization of deferred policy acquisition costs 25,458 25,374 25,454
Other underwriting expenses 7,709 6,700 6,647
--------- --------- --------
Total expenses 111,362 111,677 103,728
--------- --------- --------
Income (loss) before income taxes (6,818) (3,033) 5,422
Income tax provision (benefit) (2,999) (1,885) 1,224
--------- --------- --------
Net income (loss) $ (3,819) $ (1,148) $ 4,198
========= ========= ========
Basic and diluted earnings (loss) per share $ (1.19) $ (.36) $ 1.41
========= ========= ========
Weighted average number of shares outstanding:
Basic 3,214 3,174 2,973
Diluted 3,219 3,182 2,980
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
<PAGE> 50
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Common stock:
Beginning and end of year $ 32 $ 32 $ 32
-------- -------- --------
Additional paid in capital:
Beginning of year 34,678 35,302 35,372
Exercise of common stock options 624 70 83
-------- -------- --------
End of year 35,302 35,372 35,455
-------- -------- --------
Treasury stock:
Beginning of year -- -- (2,983)
Purchase of treasury shares -- (2,983) (2,923)
-------- -------- --------
End of year -- (2,983) (5,906)
-------- -------- --------
Unrealized investment gains (losses), net of tax:
Beginning of year (6,878) (357) (603)
Appreciation (depreciation) 9,880 (373) 2,521
Deferred income tax benefit (expense) (3,359) 127 (857)
-------- -------- --------
End of year (357) (603) 1,061
-------- -------- --------
Accumulated earnings:
Beginning of year 39,447 34,993 33,211
Net income (loss) (3,819) (1,148) 4,198
Cash dividends (635) (634) (589)
-------- -------- --------
End of year 34,993 33,211 36,820
-------- -------- --------
Total stockholders' equity $ 69,970 $ 65,029 $ 67,462
======== ======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
<PAGE> 51
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Cash flows from operations:
Collection of premiums $ 95,432 $ 96,684 $ 96,102
Payment of losses and loss adjustment expenses (62,091) (67,061) (67,054)
Payment of underwriting expenses (29,903) (32,311) (32,019)
Investment income received 10,479 11,917 12,763
Investment expenses paid (125) (287) (309)
Income taxes (paid) recovered (58) 2,734 (164)
Other cash receipts 259 188 214
-------- -------- --------
Net cash provided by operations 13,993 11,864 9,533
-------- -------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 15,321 55,899 81,035
Purchase of fixed maturities (27,800) (55,910) (90,176)
Net increase in preferred stock -- (6,928) (2,067)
Net decrease in other long-term investments 164 2,148 1,671
Net (increase) decrease in short-term investments (15) (3,778) 3,778
Purchase of equipment, net (143) (540) (146)
-------- -------- --------
Net cash used in investing activities (12,473) (9,109) (5,905)
-------- -------- --------
Cash flows from financing activities:
Settlement of affiliate balances (1,488) 764 (200)
Purchase of treasury stock -- (2,983) (2,923)
Proceeds from exercise of common stock options 624 70 83
Cash dividends (635) (634) (589)
-------- -------- --------
Net cash used in financing activities (1,499) (2,783) (3,629)
-------- -------- --------
Increase (decrease) in cash 21 (28) (1)
Cash, beginning of year 18 39 $ 11
-------- -------- --------
Cash, end of year $ 39 $ 11 10
======== ======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
<PAGE> 52
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,
------------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $ (3,819) $ (1,148) $ 4,198
Adjustments:
Depreciation and amortization 100 33 (19)
Net realized investment (gains) losses 832 (996) (112)
(Increase) decrease in assets:
Interest due and accrued 79 93 (65)
Premiums receivable (2,309) (141) (583)
Deferred policy acquisition costs (578) (231) (201)
Ceded reinsurance balances receivable 618 (821) (3,297)
Prepaid reinsurance premiums (496) (66) 61
Federal income taxes receivable (1,946) 1,877 1,266
Deferred federal income tax benefit (1,111) (1,027) (532)
Other assets (141) 35 8
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 15,707 13,757 7,726
Unearned premiums 3,324 937 696
Other liabilities 3,733 (438) 387
-------- -------- -------
Net cash provided by operations $ 13,993 $ 11,864 $ 9,533
======== ======== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-7
<PAGE> 53
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 its Annual Statement filed with regulatory authorities, MNH
reported policyholders' surplus of $46,006,000 and $43,908,000 at December
31, 1997 and 1996, respectively. MNH's net income (loss) as reported in its
Annual Statement was $3,481,000 in 1997, ($2,788,000) in 1996 and
($4,490,000) in 1995. 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 may differ from those estimates. Certain prior year balances
have been reclassified to conform with 1997 classification.
Investments
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.
In December 1995, the Company reassessed the appropriateness of the
accounting classification of its fixed maturity investments as permitted by
the Financial Accounting
F-8
<PAGE> 54
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.
Fixed maturities include mortgage backed and asset backed securities which
are valued using the interest method. The Company estimates prepayments
utilizing published data when applying the interest method. Periodic
adjustments to prepayment assumptions are credited or charged to investment
income.
Preferred stocks are carried at fair value. Other long-term investments
include collateralized mortgage obligation residuals, carried at unpaid
principal balances which do not vary significantly from 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.
Net premiums earned
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.
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 facilities.
Ceded reinsurance premiums, losses and ceding commissions are netted
against earned premiums, losses and commission expense, respectively.
F-9
<PAGE> 55
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
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 actuary regularly
review the estimates of reserves needed and any changes are reflected in
current operating results.
The Company discounts its liability for workers' compensation case reserves
on a tabular basis, using the NCCI Workers Compensation Statistical Plan
Table III A at a rate of 3.5%. The amount of discount at December 31, 1997
is $6,394,000. Reserves for losses incurred but not reported and for LAE
are not discounted.
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 $5,333,000 and $5,942,000 at December 31, 1996 and 1997,
respectively, are recorded in the Company's consolidated balance sheet.
Income taxes
The Company and its wholly owned subsidiary file a consolidated federal
income tax return. The Company follows the asset and liability approach to
account for income taxes, which 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.
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.
Earnings per share
During the fourth quarter of 1997, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". This
statement prescribes new standards for computing and presenting earnings
per share ("EPS") and makes those standards consistent with international
standards. The Company has calculated EPS in conformity with the
requirements of SFAS No. 128 for all periods presented in these financial
statements.
F-10
<PAGE> 56
Other comprehensive income
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 will adopt SFAS No. 130 in the first
quarter of 1998.
2. Related Party Transactions
The Company and MNH have no paid employees. Under a management agreement
Merchants Mutual Insurance Company ("Mutual"), which owns 8.8% of the
Company's outstanding common stock at December 31, 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.
MNH also pays an annual management fee of $50,000 to Mutual. 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 accounted for 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
expense payments made by Mutual on behalf of MNH. This balance is settled
in cash on a monthly basis.
At December 31, 1996, MNH owned an investment represented by a capital
advance issued by Mutual in the amount of $1,350,000. This investment was
included in other long-term investments. During 1997, Mutual repaid to MNH
the full amount of the advance as well as all unpaid dividends.
F-11
<PAGE> 57
3. Investments
Investments in fixed maturities and preferred stocks
The amortized cost and estimated fair values of investments in fixed
maturities held to maturity and available for sale and the cost and
estimated fair value of preferred stocks are as follows:
<TABLE>
<CAPTION>
Amortized Gross Gross
Cost/ Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---- ----- ------ ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1996
-----------------
Fixed maturities:
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
======== ====== ======= ========
Preferred stocks $ 7,928 $ -- $ -- $ 7,928
======== ====== ======= ========
</TABLE>
F-12
<PAGE> 58
<TABLE>
<CAPTION>
Amortized Gross Gross
Cost/ Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---- ----- ------ ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1997
-----------------
Fixed maturities:
Held to maturity
----------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 2,147 $ 1 $ 30 $ 2,118
Mortgage and asset backed
securities 17,484 725 -- 18,209
-------- ------ ---- --------
Total $ 19,631 $ 726 $ 30 $ 20,327
======== ====== ==== ========
Available for sale
------------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 21,755 $ 7 $113 $ 21,649
Obligations of states and
political subdivisions 28,217 547 -- 28,764
Corporate securities 20,035 513 -- 20,548
Mortgage and asset backed
securities 102,989 1,016 39 103,966
-------- ------ ---- --------
Total $172,996 $2,083 $152 $174,927
======== ====== ==== ========
Preferred stocks $ 10,038 $ 544 $ -- $ 10,582
======== ====== ==== ========
</TABLE>
F-13
<PAGE> 59
The amortized cost and fair value of fixed maturities by expected maturity
at December 31, 1997 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 $ 3,619 $ 3,749
Due after one year through five years 12,526 12,948
Due after five years through ten years 3,101 3,229
Due after ten years 385 401
-------- --------
Total $ 19,631 $ 20,327
======== ========
Available for sale
- ------------------
Due in one year or less $ 43,809 $ 43,880
Due after one year through five years 102,604 103,982
Due after five years through ten years 24,315 24,776
Due after ten years 2,268 2,289
-------- --------
Total $172,996 $174,927
======== ========
</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, 1997 with various state insurance departments in compliance
with applicable insurance laws.
Proceeds from sales of available for sale fixed maturity securities and
preferred stocks and gross realized gains and losses related to such sales
are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Proceeds from sales $1,797 $38,499 $26,652
Gross realized gains 8 1,012 138
Gross realized losses -- 16 26
</TABLE>
F-14
<PAGE> 60
Net investment income
Net investment income consists of:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Fixed maturities $10,078 $10,956 $11,472
Short-term investments 238 443 686
Other 177 612 921
------- ------- -------
Total investment income 10,493 12,011 13,079
Investment expenses 125 287 309
------- ------- -------
Net investment income $10,368 $11,724 $12,770
======= ======= =======
</TABLE>
4 Reinsurance
MNH follows the customary practice of reinsuring a portion of the exposure
under its 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.
The effect of reinsurance on premiums written and earned for the years
ended December 31, 1996 and 1997 is as follows:
<TABLE>
<CAPTION>
1996 1997
------------------------------ ---------------------------
Premiums Premiums Premiums Premiums
Written Earned Written Earned
------- ------ ------- ------
(in thousands)
<S> <C> <C> <C> <C>
Direct $101,007 $99,858 $101,064 $100,146
Assumed 3,401 3,614 2,642 2,864
Ceded (7,786) (7,720) (6,895) (6,956)
-------- ------- -------- --------
Net premiums $ 96,622 $95,752 $ 96,811 $ 96,054
======== ======= ======== ========
</TABLE>
F-15
<PAGE> 61
Reinsurance ceded transactions decreased losses and LAE by $1,920,000 and
$5,528,000 for the years ended December 31, 1996 and 1997, 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, 1997, MNH has recognized amounts to be
recovered from its primary reinsurer related to ceded losses and ceded
unearned premiums totaling $11,936,000. MNH generally does not require
collateral for reinsurance recoverable.
5. Reserve for Losses and Loss Adjustment Expenses
Activity in the reserve for losses and LAE is summarized as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
(in thousands)
<S> <C> <C>
Reserve for losses and LAE at beginning of year $119,722 $133,479
Less reinsurance recoverables 6,004 7,219
-------- --------
Net balance at beginning of year 113,718 126,260
-------- --------
Provision for losses and LAE for claims occurring in:
Current year 72,771 67,119
Prior years 6,832 4,508
-------- --------
79,603 71,627
-------- --------
Loss and LAE payments for claims occurring in:
Current year 28,512 26,100
Prior years 38,549 40,954
-------- --------
67,061 67,054
-------- --------
Reserve for losses and LAE at end of year, net 126,260 130,833
Plus reinsurance recoverables 7,219 10,372
-------- --------
Balance at end of year $133,479 $141,205
======== ========
</TABLE>
In 1996 and 1997, the Company increased its reserves for prior years by
$6,832,000 and $4,508,000, respectively. The increase in reserves for prior
years made in 1996 and 1997 were primarily attributable to higher than
anticipated severity of claims on workers' compensation policies.
F-16
<PAGE> 62
6. Income Taxes
The provision (benefit) for federal income taxes consists of:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Current $(1,888) $(1,208) $ 1,756
Deferred (1,111) (677) (532)
------- ------- -------
Total federal income tax provision (benefit) $(2,999) $(1,885) $ 1,224
======= ======= =======
</TABLE>
A reconciliation of the difference between the Company's total federal
income tax provision and that calculated using the federal statutory income
tax rate is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------
1995 1996 1997
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Computed provision (benefit) at
statutory rate $(2,318) $(1,031) $ 1,843
Adjustments:
Tax-exempt investment income (878) (726) (491)
Dividend exclusion (18) (47) (147)
Other items 215 (81) 19
------- ------- -------
Total federal income tax provision (benefit) $(2,999) $(1,885) $ 1,224
======= ======= =======
</TABLE>
F-17
<PAGE> 63
Deferred federal tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1997
---- ----
(in thousands)
<S> <C> <C>
Deferred policy acquisition costs $ 4,215 $ 4,283
Unrealized investment gains -- 547
Other 400 287
-------- --------
Total deferred federal tax liabilities 4,615 5,117
-------- --------
Discounting of reserve for losses and
loss adjustment expenses (5,993) (7,450)
Unearned premiums (3,181) (3,232)
Unrealized investment losses (311) --
Other (466) (311)
Minimum tax credit carryforward (1,309) (443)
-------- --------
Total deferred federal tax assets (11,260) (11,436)
-------- --------
Net deferred federal income taxes $ (6,645) $ (6,319)
======== ========
</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.
7. 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, 1996 or
December 31, 1997. 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 3,059,652 shares at December 31, 1996 and 2,906,502 shares at
December 31, 1997.
Dividends
The Company depends 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
F-18
<PAGE> 64
policyholders' surplus as of the preceding December 31. The maximum amount
of dividends that MNH could pay during any twelve month period ending in
1998, without the prior approval of the New Hampshire Insurance
Commissioner, is $4,601,000. The Company paid a quarterly cash dividend to
its common stockholders in 1995, 1996 and 1997.
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 Mutual, under a qualified and non-qualified stock
option plan (the "Plan"). The Plan expired in 1996. Under the Plan, options
were granted at amounts 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. 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 of options to purchase a total of 25,000
shares of the Company's common stock to certain of MNH's independent
insurance agents. In June 1994, the Company issued options to purchase
22,500 shares of common stock under the program at $16.38 per share. These
options became exercisable on June 1, 1996.
In 1996, the Company adopted the disclosure provisions of SFAS No. 123
"Accounting for Stock Based Compensation", but opted to remain under the
expense recognition provisions of Accounting Principles Board 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 1995, 1996 or 1997.
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 No. 123, the Company's net
income (loss) and earnings (loss) per share for the years ended December
31, 1996 and 1997 would have been as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net income (loss):
As reported ($1,148,000) $4,198,000
Pro forma ($1,316,000) $4,123,000
Basic and diluted earnings (loss) per share:
As reported ($.36) $1.41
Pro forma ($.41) $1.38
</TABLE>
F-19
<PAGE> 65
The fair value of each option granted in 1996 was estimated using a
binomial option pricing model which is a modification of the Black-Scholes
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, 1995, 1996 and 1997, and changes during the years ending on
those dates is presented below:
<TABLE>
<CAPTION>
1995 1996 1997
------------------------- ----------------------- -----------------------
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 104,789 $12.74 49,083 $ 14.51 90,750 $18.28
Granted -- -- 53,000 21.00 -- --
Exercised (55,706) 11.20 (6,458) 12.01 (5,750) 14.64
Forfeited -- -- (4,875) 18.50 (5,750) 20.40
------- ------ ------
End of year 49,083 14.51 90,750 18.28 79,250 18.39
======= ====== ======
Options exer-
cisable at
year-end 22,083 12.61 40,750 14.93 45,500 16.45
======= ====== ======
</TABLE>
The following table summarizes information about the Company's outstanding
stock options at December 31, 1997:
<TABLE>
<CAPTION>
Number Remaining Average Number
Outstanding Contractual Exercise Exercisable
at 12/31/97 Life in Years Price at 12/31/97
----------- -------------- ----- -----------
<S> <C> <C> <C> <C>
4,000 1.2 $ 9.38 4,000
10,500 4.1 14.38 10,500
19,750 6.4 16.38 19,750
45,000 8.1 21.00 11,250
------ ------
79,250 45,500
====== ======
</TABLE>
Common stock repurchases
Beginning in 1996 the Company commenced the repurchase of shares of its
common stock in the open market. During 1996 and 1997, the Company
repurchased 160,700 and 158,900 shares of its common stock, respectively.
The Company was holding 319,600 of these shares in treasury as of December
31, 1997.
F-20
<PAGE> 66
8. Earnings Per Share
The computations for basic and diluted earnings per share are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Basic:
Net income (loss) $(3,819) $(1,148) $4,198
Weighted average shares outstanding 3,214 3,174 2,973
Basic earnings (loss) per share $ (1.19) $ (.36) $ 1.41
Diluted:
Net income (loss) $(3,819) $(1,148) $4,198
Weighted average shares outstanding 3,214 3,174 2,973
Plus incremental shares from assumed
conversion of stock options 5 8 7
------- ------- ------
Weighted average shares
outstanding-adjusted 3,219 3,182 2,980
======= ======= ======
Diluted earnings (loss) per share $ (1.19) $ (.36) $ 1.41
</TABLE>
Options to purchase 45,000 shares of common stock at $21.00 per share were
outstanding at December 31, 1997. They were not considered in the
computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares during
1997. Of these options, 11,250 were exercisable at December 31, 1997.
9. 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 $186,000, $238,000 and $457,000 for the years ended December 31, 1995,
1996 and 1997, respectively.
10. Commitments and Contingencies
During 1997, the New York State Supreme Court dismissed a shareholder
derivative lawsuit brought against the Company, Mutual, MNH and certain
directors of the Company and of Mutual (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
F-21
<PAGE> 67
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
decision 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.
MNH, like many other property and 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.
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-22
<PAGE> 1
Exhibit 23
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 16, 1998 appearing on page F-1 of this Form 10-K.
/s/ Price Waterhouse LLP
Buffalo, New York
March 30, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 174,927,000
<DEBT-CARRYING-VALUE> 19,631,000
<DEBT-MARKET-VALUE> 20,327,000
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 210,244,000
<CASH> 10,000
<RECOVER-REINSURE> 11,132,000
<DEFERRED-ACQUISITION> 12,597,000
<TOTAL-ASSETS> 273,974,000
<POLICY-LOSSES> 141,205,000
<UNEARNED-PREMIUMS> 50,406,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 32,000
<OTHER-SE> 67,430,000
<TOTAL-LIABILITY-AND-EQUITY> 273,974,000
96,054,000
<INVESTMENT-INCOME> 12,770,000
<INVESTMENT-GAINS> 112,000
<OTHER-INCOME> 214,000
<BENEFITS> 71,627,000
<UNDERWRITING-AMORTIZATION> 25,454,000
<UNDERWRITING-OTHER> 6,647,000
<INCOME-PRETAX> 5,422,000
<INCOME-TAX> 1,244,000
<INCOME-CONTINUING> 4,198,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,198,000
<EPS-PRIMARY> 1.41
<EPS-DILUTED> 1.41
<RESERVE-OPEN> 126,260,000
<PROVISION-CURRENT> 67,119,000
<PROVISION-PRIOR> 4,508,000
<PAYMENTS-CURRENT> 26,100,000
<PAYMENTS-PRIOR> 40,954,000
<RESERVE-CLOSE> 130,833,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
