<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
-------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
Commission File Number 1-9640
-------------
MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
16-1280763
(I.R.S. Employer Identification No.)
250 Main Street, Buffalo, New York
(Address of principal executive offices)
14202
(Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [ x ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of July 31, 1998:
2,909,252 shares of Common Stock.
1
<PAGE> 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
Assets 1997 1998
------ ---- ----
(unaudited)
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$20,327 in 1997 and $19,172 in 1998) $ 19,631 $ 18,248
Available for sale at fair value (amortized cost
$172,996 in 1997 and $174,547 in 1998) 174,927 176,187
Preferred stock at fair value 10,582 10,674
Other long-term investments at fair value 634 667
Short-term investments 4,470 7,125
-------- --------
Total investments 210,244 212,901
Cash 10 5
Interest due and accrued 1,858 2,021
Premiums receivable, net of allowance for doubtful
accounts of $543 in 1997 and $465 in 1998 21,084 20,527
Deferred policy acquisition costs 12,597 12,305
Ceded reinsurance balances receivable 11,132 10,728
Prepaid reinsurance premiums 2,871 2,845
Receivable from affiliate 527 --
Deferred federal income taxes 6,319 5,859
Other assets 7,332 7,629
-------- --------
Total assets $273,974 $274,820
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
2
<PAGE> 3
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31, June 30,
1997 1998
---- ----
(unaudited)
Liabilities and Stockholders' Equity
------------------------------------
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $ 141,205 $ 140,700
Unearned premiums 50,406 49,282
Payable to affiliate -- 367
Other liabilities 14,901 13,977
--------- ---------
Total liabilities 206,512 204,326
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized,
issued and outstanding 2,906,502
shares at December 31, 1997 and
2,909,352 shares at June 30, 1998 32 32
Additional paid in capital 35,455 35,511
Treasury stock, 319,600 shares at December
31, 1997 and 320,500 shares at June 30, 1998 (5,906) (5,925)
Accumulated other comprehensive income 1,061 1,483
Accumulated earnings 36,820 39,393
--------- ---------
Total stockholders' equity 67,462 70,494
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 273,974 $ 274,820
========= =========
</TABLE>
See Notes to the Consolidated Financial Statements
3
<PAGE> 4
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1998 1997 1998
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $ 24,158 $23,875 $47,158 $47,615
Net investment income 3,190 3,331 6,219 6,621
Net realized investment gains
(losses) (4) -- 103 --
Other revenues 25 42 86 84
-------- ------- ------- -------
Total revenues 27,369 27,248 53,566 54,320
-------- ------- ------- -------
Expenses:
Net losses and loss adjustment
expenses 17,768 16,789 35,664 33,636
Amortization of deferred policy
acquisition costs 6,402 6,327 12,497 12,618
Other underwriting expenses 1,804 2,034 3,393 4,122
-------- ------- ------- -------
Total expenses 25,974 25,150 51,554 50,376
-------- ------- ------- -------
Income before income taxes 1,395 2,098 2,012 3,944
Income tax provision 336 578 472 1,078
-------- ------- ------- -------
Net income $ 1,059 $ 1,520 $ 1,540 $ 2,866
======== ======= ======= =======
Earnings per share:
Basic $ .35 $ .52 $ .51 $ .99
======== ======= ======= =======
Diluted $ .35 $ .52 $ .51 $ .98
======== ======= ======= =======
Weighted average shares outstanding:
Basic 2,999 2,909 3,013 2,908
Diluted 3,008 2,928 3,022 2,922
</TABLE>
See Notes to the Consolidated Financial Statements
4
<PAGE> 5
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1998 1997 1998
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Net income $ 1,059 $1,520 $ 1,540 $2,866
------- ------ ------- ------
Other comprehensive income before tax:
Unrealized gains
on securities 2,550 280 538 639
Less: reclassification adjustment
for gains and losses included
in net income (4) -- (73) --
------- ------ ------- ------
Other comprehensive income
before tax 2,546 280 465 639
Income tax provision related to
items of other comprehensive income 866 95 158 217
------- ------ ------- ------
Other comprehensive income, net of tax 1,680 185 307 422
------- ------ ------- ------
Comprehensive income $ 2,739 $1,705 $ 1,847 $3,288
======= ====== ======= ======
</TABLE>
See Notes to the Consolidated Financial Statements
5
<PAGE> 6
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1997 1998
---- ----
(unaudited)
<S> <C> <C>
Common stock, beginning and end $ 32 $ 32
-------- --------
Additional paid in capital:
Beginning of period 35,372 35,455
Exercise of common stock options 83 56
-------- --------
End of period 35,455 35,511
-------- --------
Treasury stock:
Beginning of period (2,983) (5,906)
Purchase of treasury shares (1,374) (19)
-------- --------
End of period (4,357) (5,925)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period (603) 1,061
Other comprehensive income 307 422
-------- --------
End of period (296) 1,483
-------- --------
Accumulated earnings:
Beginning of period 33,211 36,820
Net income 1,540 2,866
Cash dividends (298) (293)
-------- --------
End of period 34,453 39,393
-------- --------
Total stockholders' equity $ 65,287 $ 70,494
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
6
<PAGE> 7
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1997 1998
---- ----
(unaudited)
<S> <C> <C>
Cash flows from operations:
Collection of premiums $ 44,989 $ 47,564
Payment of losses and loss adjustment expenses (33,564) (34,166)
Payment of other underwriting expenses (16,474) (17,229)
Investment income received 6,259 6,424
Investment expenses paid (154) (143)
Income taxes paid -- (1,337)
Other cash receipts 86 84
-------- --------
Net cash provided by operations 1,142 1,197
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 42,374 44,154
Purchase of fixed maturities (42,210) (43,306)
Net increase in preferred stock (2,068) --
Net (increase) decrease in other long-term investments 389 (33)
Net increase in short-term investments (6,392) (2,655)
Purchase of equipment, net (12 --
-------- --------
Net cash used in investing activities (7,919) (1,840)
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances (527) 894
Proceeds from exercise of common stock options 83 56
Cash borrowed to purchase securities 8,884 --
Purchase of treasury stock (1,374) (19)
Cash dividends (298) (293)
-------- --------
Net cash provided by financing activities 6,768 638
-------- --------
Decrease in cash and cash equivalents (9) (5)
Cash:
Beginning of period 11 10
-------- --------
End of period $ 2 $ 5
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
7
<PAGE> 8
MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1997 1998
---- ----
(unaudited)
<S> <C> <C>
Net income $ 1,540 $ 2,866
Adjustments:
Depreciation and amortization (accretion) 21 (67)
Realized investment gains (103) --
(Increase) decrease in assets:
Interest due and accrued (25) (163)
Premiums receivable (279) 557
Deferred policy acquisition costs 62 292
Ceded reinsurance balances receivable (2,471) 404
Prepaid reinsurance premiums 217 26
Federal income tax receivable 527 --
Deferred federal income taxes (54) 243
Other assets (67) (408)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 2,935 (505)
Unearned premiums (453) (1,124)
Other liabilities (708) (924)
------- -------
Net cash provided by operations $ 1,142 $ 1,197
======= =======
</TABLE>
See Notes to the Consolidated Financial Statements
8
<PAGE> 9
MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation, Basis of Presentation and New Accounting
Pronouncements
The consolidated balance sheet as of June 30, 1998, the related consolidated
statements of operations and of comprehensive income for the three months and
six months ended June 30, 1997 and 1998 and of changes in stockholders' equity
and of cash flows for the six months ended June 30, 1997 and 1998 are unaudited.
In the opinion of management, the interim financial statements reflect all
adjustments necessary for a fair presentation of financial position and results
of operations. Such adjustments consist only of normal recurring items. Interim
results are not necessarily indicative of results for a full year.
The consolidated financial statements include the accounts of Merchants Group,
Inc. (the "Company"), its wholly-owned subsidiary, Merchants Insurance Company
of New Hampshire, Inc. ("MNH"), and M.F.C. of New York, Inc., an inactive
premium finance company which is a wholly-owned subsidiary of MNH. The
accompanying consolidated financial statements should be read in conjunction
with the following notes and the Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1997.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP") which differ in some respects
from those followed in reports to insurance regulatory authorities. All
significant intercompany balances and transactions have been eliminated.
During 1998, the Company adopted Statement of Financial Accounting Standards No.
130 ("SFAS No. 130") "Reporting Comprehensive Income" and restated prior period
financial statements to conform to the new standard. SFAS No. 130 establishes
standards for reporting comprehensive income in a full set of general purpose
financial statements. Comprehensive income includes all changes to stockholders'
equity during a period except those resulting from investments by and
distributions to owners. The adoption of SFAS No. 130 resulted in revised and
additional disclosures but had no effect on the financial position, results of
operations or liquidity of the Company.
2. Related Party Transactions
The Company and MNH do not have any paid employees. Under a Management Agreement
dated September 29, 1986 between the Company, MNH and Merchants Mutual Insurance
Company ("Mutual") (the "Management Agreement"), Mutual, which owns 8.8% of the
Company's common stock at June 30, 1998, provides the Company and MNH with the
facilities, management and personnel required to manage their day-to-day
business. On July 23, 1998, the Company gave notice of termination of the
Management
9
<PAGE> 10
Agreement which, under its terms, terminates five years after the date of
notice. All underwriting, administrative, claims and investment expenses
incurred on behalf of Mutual and MNH are shared under the Management Agreement
on an allocated cost basis, determined as follows: for underwriting and
administrative expenses, the respective share of total direct premiums written
for Mutual and MNH serves as the basis of allocation; for claims expenses, the
average number of outstanding claims is used; investment expenses are shared
based on each company's share of total invested assets.
3. Earnings Per Share
Basic and diluted earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during each
period, increased by the assumed exercise of 75,500 and 34,250 shares of common
stock options in 1998 and 1997, respectively, which would have resulted in
14,441 and 9,275 additional shares outstanding, respectively, assuming the
proceeds to the Company from exercise were used to purchase shares of the
Company's common stock at its average market value per share during the quarter.
10
<PAGE> 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations for the Six Months Ended June 30, 1998 As Compared to the
Six Months Ended June 30, 1997
Total revenues for the six months ended June 30, 1998 were $54,320,000, up 1%
from $53,566,000 for the six months ended June 30, 1997.
Net premiums earned for the six months ended June 30, 1998 were $47,615,000, an
increase of $457,000, or 1%, from $47,158,000 for the six months ended June 30,
1997. The increase in net premiums earned resulted primarily from a 1% increase
in direct premiums written. Direct premiums written for the six months ended
June 30, 1998 were $49,334,000, an increase of $571,000 from $48,763,000 for the
six months ended June 30, 1997.
Voluntary personal lines direct premiums written for the six months ended June
30, 1998 were $19,344,000, an increase of 1% from $19,162,000 for the six months
ended June 30, 1997. Voluntary personal lines direct premiums written
represented 42% and 43% of total voluntary direct premiums written for the six
months ended June 30, 1998 and 1997, respectively.
Voluntary commercial lines direct premiums written for the six months ended June
30, 1998 were $26,998,000, an increase of 8% from $25,060,000 for the six months
ended June 30, 1997. The increase in voluntary commercial lines direct premiums
written resulted from increases in workers' compensation, commercial auto and
commercial package premiums written. Commercial lines new business policies
(policies written by the Company for the first time) increased 32% in the six
months ended June 30, 1998, compared to the six months ended June 30, 1997.
Involuntary direct premiums written, primarily private passenger automobile
insurance decreased by 34% to $2,992,000 in the six months ended June 30, 1998
from $4,543,000 for the six months ended June 30, 1997 as the New York
Automobile Insurance Plan ("NYAIP") adjusts 1998 assignments for having
over-assigned policies to the Company in 1997. Involuntary direct premiums
written comprised 6% and 9% of all direct premiums written during the six months
ended June 30, 1998 and 1997, respectively.
Net investment income was $6,621,000 for the six months ended June 30, 1998, an
increase of 6% from $6,219,000 for the six months ended June 30, 1997, due to a
5% increase in average invested assets.
There were no net realized gains on the sale of investments for the six months
ended June 30, 1998 compared to $103,000 of net realized gains for the six
months ended June 30, 1997.
Losses and loss adjustment expenses ("LAE") were $33,636,000 for the six months
ended June 30, 1998, a decrease of $2,028,000 or 6% from $35,664,000 for the six
months ended June 30, 1997. The ratio of losses and LAE to premiums earned
decreased to 70.6% for the six months ended June 30, 1998 from 75.6% for the six
months ended June 30, 1997, due to a lower accident year loss
11
<PAGE> 12
ratio in 1998 compared to 1997 and the fact that in 1998 there were no increases
recorded in reserves for prior accident year losses.
The ratio of amortized policy acquisition costs and other underwriting expenses
to net premiums earned increased to 35.2% for the six months ended June 30, 1998
from 33.7% for the six months ended June 30, 1997, primarily due to increased
agency incentive commissions related to the improved underwriting results.
Commissions, premium taxes and other state assessments that vary directly with
the Company's premium volume represented 21.7% of net premiums earned in the six
months ended June 30, 1998 compared to 21.2% of net premiums earned in the six
months ended June 30, 1997.
The Company's effective federal income tax rate for the six months ended June
30, 1998 was 27.3%. This rate was calculated based upon the Company's estimate
of its effective federal income tax rate for all of 1998. Non-taxable investment
income, primarily tax-exempt bond income, reduced the Company's effective tax
rate by approximately 6 percentage points.
Results of Operations for the Three Months Ended June 30, 1998 As Compared to
the Three Months Ended June 30, 1997
Total revenues for the three months ended June 30, 1998 were $27,248,000,
substantially unchanged from $27,369,000 for the three months ended June 30,
1997.
Net premiums earned for the three months ended June 30, 1998 were $23,875,000, a
decrease of $283,000, or 1%, from $24,158,000 for the three months ended June
30, 1997. The decrease in net premiums earned resulted primarily from a 2%
decrease in direct premiums written. Direct premiums written for the three
months ended June 30, 1998 were $25,734,000, a decrease of $487,000 from
$26,221,000 for the three months ended June 30, 1997.
Voluntary personal lines direct premiums written for the three months ended June
30, 1998 were $10,027,000, unchanged from $10,024,000 for the three months ended
June 30, 1997. Voluntary commercial lines direct premiums written for the three
months ended June 30, 1998 were $24,373,000, an increase of 4% from $23,402,000
for the three months ended June 30, 1997. Involuntary direct premiums written
were $1,361,000, a decrease of 52% from $2,819,000 for the three months ended
June 30, 1997. Involuntary direct premiums written were affected by adjustments
made by the NYAIP after having over-assigned policies to the Company in 1997.
Net investment income was $3,331,000 for the three months ended June 30, 1998,
an increase of 4% from $3,190,000 for the three months ended June 30, 1997, due
to a 5% increase in average invested assets.
Losses and loss adjustment expenses ("LAE") were $16,789,000 for the three
months ended June 30, 1998, a decrease of $979,000 or 6% from $17,768,000 for
the three months ended June 30, 1997. The ratio of losses and LAE to premiums
earned decreased to 70.3% for the three months ended June 30, 1998 from 73.5%
for the three months ended June 30, 1997, due to a lower
12
<PAGE> 13
accident year loss ratio in 1998 compared to 1997 and the fact that in 1998
there were no increases recorded in reserves for prior accident year losses.
The ratio of amortized policy acquisition costs and other underwriting expenses
to net premiums earned increased to 35.0% for the three months ended June 30,
1998 from 34.0% for the three months ended June 30, 1997, primarily due to
increased agency incentive commissions related to the improved underwriting
results. Commissions, premium taxes and other state assessments that vary
directly with the Company's premium volume represented 21.3% of net premiums
earned in the three months ended June 30, 1998 compared to 21.2% of net premiums
earned in the three months ended June 30, 1997.
Liquidity and Capital Resources
In developing its investment strategy, the Company determines a level of cash
and short-term investments which, when combined with expected cash flow, is
estimated to be adequate to meet expected cash obligations. Historically, the
excess of premiums collected over payments on claims, combined with cash flow
from investments, has provided the Company with short-term funds in excess of
normal operating demands for cash.
Net cash provided by operations increased $55,000 from $1,142,000 for the six
months ended June 30, 1997 to $1,197,000 for the six months ended June 30, 1998.
Net cash used in investing activities decreased $6,079,000 from $7,919,000 in
the six months ended June 30, 1997 to $1,840,000 in the six months ended June
30, 1998. This decrease in net cash used in investing activities resulted from a
$684,000 increase in net cash provided by investments in fixed maturities, a
$2,068,000 decrease in cash used to acquire preferred stock, and a $3,737,000
decrease in net cash used to acquire short-term investments.
Net cash provided by financing activities decreased $6,130,000 from $6,768,000
in the six months ended June 30, 1997 to $638,000 in the six months ended June
30, 1998, due primarily to a $8,884,000 decrease in cash borrowed to purchase
securities, which was partially offset by a $1,355,000 decrease in cash used to
purchase treasury stock.
The Company's objectives with respect to its investment portfolio include
maximizing total return while protecting policyholders' surplus, maintaining
flexibility and liquidity, and maintaining a reasonable duration match between
assets and liabilities. Like other property and casualty insurers, the Company
relies on premiums as a major source of cash, and therefore liquidity. Cash
flows from the Company's investment portfolio, either in the form of interest or
principal payments, are an additional source of liquidity. Because the duration
of the Company's investment portfolio and liabilities are closely managed,
increases or decreases in market interest rates are not expected to have a
material effect on the Company's liquidity or its results of operations.
The Company generally designates newly acquired fixed maturity investments as
available for sale and carries these investments at fair value. Unrealized gains
and losses related to these investments are recorded as a component of
accumulated other comprehensive income within stockholders'
13
<PAGE> 14
equity. During the six months ended June 30, 1998 the Company recorded $422,000
of unrealized gains, net of tax, associated with its fixed maturity investments.
At June 30, 1998, the Company recorded $1,483,000 of unrealized gains, net of
tax, related to its investment portfolio. This amount is shown as accumulated
other comprehensive income in the accompanying balance sheet.
At June 30, 1998, the Company's portfolio of fixed maturities represented 91.3%
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 June 30, 1998, $122,661,000 or 63.1% 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 obligation ("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 June 30, 1998, $2,302,000, or 1.1%, of the Company's investment portfolio was
invested in non-investment grade securities.
During the six months ended June 30, 1998, the Company repurchased 900 shares of
its common stock. The Company is holding 320,500 shares of its common stock in
treasury at June 30, 1998.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations and pay any cash dividends. MNH is subject to New Hampshire
insurance laws which place certain restrictions on its ability to pay dividends
without the prior approval of state regulatory authorities. These restrictions
limit dividends to those that, when added to all other dividends paid within the
preceding twelve months, would not exceed 10% of the insurer's statutory
policyholders' surplus as of the preceding December 31. The maximum amount of
dividends that MNH could pay during any twelve month period ending in 1998
without the prior approval of the New Hampshire Insurance Commissioner is
$4,601,000. MNH paid $1,000,000 in dividends to the Company during the six
months ended June 30, 1998. In July 1998, the Board of Directors of MNH
authorized a dividend of $1,600,000 to be paid on August 17, 1998.
Under the Management Agreement, Mutual provides employees, services and
facilities for MNH to conduct its insurance business on a cost reimbursed basis.
The balance in the payable to or receivable from affiliate account represents
the amount owing to or owed by Mutual to the Company for the difference between
premiums collected and payments made for losses, employees, services and
facilities by Mutual on behalf of MNH.
The Company relies to a significant degree on computer technology to operate its
insurance business. Mutual has advised the Company that it is currently
preparing all of its computer
14
<PAGE> 15
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 with certainty 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-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-casualty
insurer's annual net premiums written to its statutory surplus should not exceed
3 to 1. MNH has consistently followed a business strategy that would allow it to
meet this 3 to 1 regulatory guideline. For the first six months of 1998 MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was 1.9 to 1.
Possible Changes in Relationship with Mutual
On March 31, 1998, Mutual filed a Schedule 13D with the Securities and Exchange
Commission in which it reported that it was considering whether it would be
advisable and, if so, whether Mutual could obtain the regulatory approvals and
financing necessary, to purchase all or substantially all of the stock of the
Company or of its wholly owned subsidiary, MNH. To date, Mutual has not
presented any acceptable proposal to the Company, and there can be no assurance
that Mutual will present any acceptable proposal.
The Company is studying what alternatives, if any, are available to it should
Mutual not present a proposal which is acceptable 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 any of the alternatives being
considered by the Company can be implemented on terms acceptable to the Company.
15
<PAGE> 16
On July 23, 1998, the Company gave notice to terminate the Management Agreement
which, under its terms, terminates five years after the date of notice. The
Company does not believe that the issuance of notice will have any immediate
impact on its operations or financial condition.
16
<PAGE> 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Channing T. Lushbough vs. Merchants Group, Inc., et al.
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 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 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.
Item 4. Submission of Matters to a Vote of Security Holders
On May 6, 1998 the Company held its annual meeting of stockholders. During the
meeting, Brent D. Baird and Richard E. Garman were re-elected Directors of the
Company for three year terms to expire at the annual meeting in 2001. Andrew A.
Alberti, Frank J. Colantuono, Henry P. Semmelhack and Robert M. Zak are
Directors of the Company whose terms of office as Director continue beyond the
date of the meeting. Mr. Alberti's and Mr. Colantuono's terms expire in 1999.
Mr. Semmelhack's and Mr. Zak's terms expire in 2000.
A summary of stockholder voting with respect to the election of Directors is as
follows:
Election of Election of
B. Baird R. Garman
-------- ---------
For 2,500,273 2,499,443
Withheld 1,640 2,470
17
<PAGE> 18
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Statement re computation of per share earnings (filed
herewith).
(27) Financial Data Schedule (filed herewith).
(b) Reports on Form 8-K.
In a report filed on Form 8-K dated June 17, 1998 the
Company reported that Mutual had filed Amendment No.
1 to Schedule 13D which Mutual previously filed with
the Securities and Exchange Commission on March 31,
1998.
In a report filed on Form 8-K dated July 23, 1998,
the Company reported that it had delivered Notice of
Termination of Management Agreement to Mutual.
* * * * * * * *
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
With the exception of historical information, the matters and
statements discussed, made or incorporated by reference in this Quarterly Report
on Form 10-Q constitute forward-looking statements and are discussed, made or
incorporated by reference, as the case may be, pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve certain assumptions, risks and uncertainties
that could cause actual results to differ materially from those included in or
contemplated by the statements. These assumptions, risks and uncertainties
include, but are not limited to, those associated with factors affecting the
property-casualty insurance industry generally, including price competition,
size and frequency of claims, increasing crime rates, escalating damage awards,
natural disasters, fluctuations in interest rates and general business
conditions; the Company's dependence on investment income; the geographic
concentration of the Company's business in the Northeastern United States and in
particular in New York, New Hampshire, New Jersey, Rhode Island, Pennsylvania
and Massachusetts; the adequacy of the Company's loss reserves; government
regulation of the insurance industry; exposure to environmental claims;
dependence of the Company on its relationship with Mutual; the future of the
Company's relationship with Mutual as a result of the notice to terminate the
Management Agreement; 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.
18
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCHANTS GROUP, INC.
(Registrant)
Date: August 10, 1998 By: /s/ KENNETH J. WILSON
---------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
19
<PAGE> 1
EXHIBIT 11
MERCHANTS GROUP, INC.
Computation of Income Per Share
(in thousands except per share data)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income for computing earnings per
common share - without dilution and
fully diluted $1,059 $1,520 $1,540 $2,866
====== ====== ====== ======
Weighted average number of common shares
outstanding - without dilution 2,999 2,909 3,013 2,908
Addition from assumed exercise as of the
beginning of the period of common stock
options outstanding as of the end of the
period, reduced by the number of shares
assumed to have been repurchased by the
company with the proceeds from exercise,
at the average market value per share
during the period 9 19 9 14
------ ------ ------ ------
Weighted average number of common shares
and common share equivalents outstanding,
basic and diluted 3,008 2,928 3,022 2,922
====== ====== ====== ======
Earnings per share:
Basic $ .35 $ .52 $ .51 $ .99
====== ====== ====== ======
Diluted $ .35 $ .52 $ .51 $ .98
====== ====== ====== ======
</TABLE>
20
<TABLE> <S> <C>
<ARTICLE> 7
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 176,187,000
<DEBT-CARRYING-VALUE> 18,248,000
<DEBT-MARKET-VALUE> 19,172,000
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 212,901,000
<CASH> 5
<RECOVER-REINSURE> 10,728,000
<DEFERRED-ACQUISITION> 12,305,000
<TOTAL-ASSETS> 274,820,000
<POLICY-LOSSES> 140,700,700
<UNEARNED-PREMIUMS> 49,282,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 32,000
<OTHER-SE> 70,462,000
<TOTAL-LIABILITY-AND-EQUITY> 274,820,000
47,615,000
<INVESTMENT-INCOME> 6,621,000
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 84,000
<BENEFITS> 33,636,000
<UNDERWRITING-AMORTIZATION> 12,618,000
<UNDERWRITING-OTHER> 4,122,000
<INCOME-PRETAX> 3,944,000
<INCOME-TAX> 1,078,000
<INCOME-CONTINUING> 2,866,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,866,000
<EPS-PRIMARY> .99
<EPS-DILUTED> .98
<RESERVE-OPEN> 130,833,000
<PROVISION-CURRENT> 31,432,000
<PROVISION-PRIOR> 2,204,000
<PAYMENTS-CURRENT> 16,143,000
<PAYMENTS-PRIOR> 18,023,000
<RESERVE-CLOSE> 130,303,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
