<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, 1999
COMMISSION FILE NUMBER 1-9640
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MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
16-1280763
(I.R.S. Employer Identification No.)
250 MAIN STREET, BUFFALO, NEW YORK
(Address of principal executive offices)
14202
(Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of July 30, 1999:
2,744,652 SHARES OF COMMON STOCK.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
Assets 1998 1999
------ ------------ --------
(unaudited)
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$17,756 in 1998 and $16,218 in 1999) $ 17,000 $ 15,724
Available for sale at fair value (amortized cost
$178,641 in 1998 and $174,878 in 1999) 180,784 175,040
Preferred stock at fair value 10,373 11,658
Other long-term investments at fair value 735 637
Short-term investments 6,280 7,120
-------- --------
Total investments 215,172 210,179
Cash 16 31
Interest due and accrued 1,923 1,879
Premiums receivable, net of allowance for doubtful
accounts of $454 in 1998 and $453 in 1999 20,629 20,932
Deferred policy acquisition costs 12,390 12,361
Ceded reinsurance balances receivable 9,741 9,821
Prepaid reinsurance premiums 2,629 2,983
Receivable from affiliate -- 817
Deferred federal income taxes 5,055 5,268
Other assets 6,968 6,476
-------- --------
Total assets $274,523 $270,747
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ -----------
(unaudited)
Liabilities and Stockholders' Equity
------------------------------------
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $ 136,685 $ 134,914
Unearned premiums 49,382 49,629
Payable to affiliate 1,321 --
Other liabilities 15,352 14,332
--------- ---------
Total liabilities 202,740 198,875
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,851,452
shares issued and outstanding at December 31, 1998
and 2,752,752 shares issued and outstanding
at June 30, 1999 32 32
Additional paid in capital 35,511 35,680
Treasury stock, 378,400 shares at December 31, 1998
and 489,100 shares at June 30, 1999 (7,097) (9,493)
Accumulated other comprehensive income 1,173 409
Accumulated earnings 42,164 45,244
--------- ---------
Total stockholders' equity 71,783 71,872
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 274,523 $ 270,747
========= =========
</TABLE>
See Notes to the Consolidated Financial Statements
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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,
1998 1999 1998 1999
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $23,875 $23,524 $47,615 $47,186
Net investment income 3,331 3,208 6,621 6,479
Net realized investment gains -- 6 -- 7
Other revenues 42 124 84 266
------- ------- ------- -------
Total revenues 27,248 26,862 54,320 53,938
------- ------- ------- -------
Expenses:
Net losses and loss adjustment
expenses 16,789 16,231 33,636 32,558
Amortization of deferred policy
acquisition costs 6,327 6,234 12,618 12,504
Other underwriting expenses 2,034 1,784 4,122 3,938
------- ------- ------- -------
Total expenses 25,150 24,249 50,376 49,000
------- ------- ------- -------
Income before income taxes 2,098 2,613 3,944 4,938
Income tax provision 578 763 1,078 1,439
------- ------- ------- -------
Net income $ 1,520 $ 1,850 $ 2,866 $ 3,499
======= ======= ======= =======
Earnings per share:
Basic $ .52 $ .67 $ .99 $ 1.24
======= ======= ======= =======
Diluted $ .52 $ .67 $ .98 $ 1.24
======= ======= ======= =======
Weighted average shares outstanding:
Basic 2,909 2,774 2,908 2,813
Diluted 2,928 2,778 2,922 2,817
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1998 1999 1998 1999
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Net income $ 1,520 $ 1,850 $ 2,866 $ 3,499
------- ------- ------- -------
Other comprehensive income before taxes:
Unrealized gains (losses)
on securities 280 (1,065) 639 (1,158)
Less: reclassification adjustment
for gains and losses included
in net income -- -- -- --
------- ------- ------- -------
Other comprehensive income (loss)
before taxes 280 (1,065) 639 (1,158)
Income tax provision (benefit) related to
items of other comprehensive income 95 (362) 217 (394)
------- ------- ------- -------
Other comprehensive income (loss) 185 (703) 422 (764)
------- ------- ------- -------
Comprehensive income $ 1,705 $ 1,147 $ 3,288 $ 2,735
======= ======= ======= =======
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1998 1999
-------- --------
(unaudited)
<S> <C> <C>
Common stock, beginning and end $ 32 $ 32
-------- --------
Additional paid in capital:
Beginning of period 35,455 35,511
Exercise of common stock options 56 169
-------- --------
End of period 35,511 35,680
-------- --------
Treasury stock:
Beginning of period (5,906) (7,097)
Purchase of treasury shares (19) (2,396)
-------- --------
End of period (5,925) (9,493)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period 1,061 1,173
Other comprehensive income (loss) 422 (764)
-------- --------
End of period 1,483 409
-------- --------
Accumulated earnings:
Beginning of period 36,820 42,164
Net income 2,866 3,499
Cash dividends (293) (419)
-------- --------
End of period 39,393 45,244
-------- --------
Total stockholders' equity $ 70,494 $ 71,872
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1998 1999
-------- --------
(unaudited)
<S> <C> <C>
Cash flows from operations:
Collection of premiums $ 47,564 $ 46,196
Payment of losses and loss adjustment expenses (34,166) (33,824)
Payment of other underwriting expenses (17,229) (17,577)
Investment income received 6,424 6,635
Investment expenses paid (143) (177)
Income taxes paid (1,337) (1,322)
Other cash receipts 84 266
-------- --------
Net cash provided by operations 1,197 197
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 44,154 50,580
Purchase of fixed maturities (43,306) (44,805)
Net increase in preferred stock -- (1,128)
Net (increase) decrease in other long-term investments (33) 98
Net increase in short-term investments (2,655) (840)
Disposition of equipment -- 697
-------- --------
Net cash provided by (used in) investing activities (1,840) 4,602
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances 894 (2,138)
Proceeds from exercise of common stock options 56 169
Purchase of treasury stock (19) (2,396)
Cash dividends (293) (419)
-------- --------
Net cash provided by (used in) financing activities 638 (4,784)
-------- --------
Increase (decrease) in cash and cash equivalents (5) 15
Cash:
Beginning of period 10 16
-------- --------
End of period $ 5 $ 31
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
1998 1999
------- -------
(unaudited)
<S> <C> <C>
Net income $ 2,866 $ 3,499
Adjustments:
Depreciation and amortization (accretion) (67) (15)
Realized investment gains -- (7)
(Increase) decrease in assets:
Interest due and accrued (163) 44
Premiums receivable 557 (303)
Deferred policy acquisition costs 292 29
Ceded reinsurance balances receivable 404 (80)
Prepaid reinsurance premiums 26 (354)
Deferred federal income taxes 243 182
Other assets (408) (254)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses (505) (1,771)
Unearned premiums (1,124) 247
Other liabilities (924) (1,020)
------- -------
Net cash provided by operations $ 1,197 $ 197
======= =======
</TABLE>
See Notes to the Consolidated Financial Statements
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MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation and Basis of Presentation
-----------------------------------------------------
The consolidated balance sheet as of June 30, 1999, the related consolidated
statements of operations and of comprehensive income for the three months and
six months ended June 30, 1998 and 1999 and of changes in stockholders' equity
and of cash flows for the six months ended June 30, 1998 and 1999 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, 1998.
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.
2. Related Party Transactions
--------------------------
The Company and MNH have no paid employees. Under a management agreement dated
September 29, 1986 (the Management Agreement), Merchants Mutual Insurance
Company (Mutual), which owns 9.3% of the Company's common stock at June 30,
1999, 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
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.
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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 49,000 and 75,500 shares of common
stock options in 1999 and 1998, respectively, which would have resulted in 3,942
and 14,441 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 period.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations for the Six Months Ended June 30, 1999 As Compared to the
- -------------------------------------------------------------------------------
Six Months Ended June 30, 1998
- ------------------------------
Total revenues for the six months ended June 30, 1999 were $53,938,000, down 1%
from $54,320,000 for the six months ended June 30, 1998.
Direct premiums written for the six months ended June 30, 1999 were $49,705,000,
an increase of $371,000 or 1%, from $49,334,000 for the six months ended June
30, 1998. Voluntary direct premiums written for the six months ended June 30,
1999 were $48,663,000, an increase of $2,321,000 or 5%, from $46,342,000 for the
six months ended June 30, 1998. Involuntary direct premiums written for the six
months ended June 30, 1999 were $1,042,000, a decrease of $1,950,000 or 65%,
from $2,992,000 for the six months ended June 30, 1998. Net premiums written for
the six months ended June 30, 1999 were $47,080,000, an increase of $564,000 or
1% from $46,516,000 for the six months ended June 30, 1998.
Voluntary personal lines direct premiums written for the six months ended June
30, 1999 were $18,601,000, a decrease of $743,000 or 4% from $19,344,000 for the
six months ended June 30, 1998. Private passenger automobile (PPA) direct
premiums written, which represented 78% and 80% of total voluntary personal
lines direct premiums written for the six months ended June 30, 1999 and 1998
respectively, decreased 6% from the year earlier period. Homeowners direct
premiums written for the six months ended June 30 ,1999 increased 5% compared to
the six months ended June 30, 1998.
The decrease in PPA direct premiums written was primarily the result of an 8%
decrease in policies in force at June 30, 1999, compared to policies in force at
June 30, 1998. Average premium per PPA policy at June 30, 1999 was relatively
unchanged compared to June 30, 1998. Average premium per homeowners policy at
June 30, 1999 increased 4% compared to the year earlier period.
Voluntary commercial lines direct premiums written for the six months ended June
30, 1999 were $30,062,000, an increase of $3,064,000 or 11% from $26,998,000 for
the six months ended June 30, 1998, primarily due to increases in commercial
automobile (21%) and contractors coverall (19%) premiums written.
The increase in commercial auto direct premiums written was due to a 10.8
percentage point improvement in the commercial auto policy retention rate during
the first six months of 1999 as compared to the year earlier period and a 16%
increase in new business units in 1999 as compared to 1998. The increase in
contractors coverall direct written premiums resulted primarily from a 33%
increase in new business units during the six months ended June 30, 1999 as
compared to the six months ended June 30, 1998.
Involuntary direct premiums written, primarily PPA insurance, which comprised 2%
and 6% of all direct premiums written during the six months ended June 30, 1999
and 1998 respectively,
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decreased because the New York Automobile Insurance Plan (NYAIP) continues to
adjust assignments as a result of having over-assigned policies to the Company
in 1997 and due to an overall decrease in the NYAIP pool of business.
Net premiums earned for the six months ended June 30, 1999 were $47,186,000, a
decrease of $429,000 or 1% from $47,615,000 for the six months ended June 30,
1998. This decrease in net premiums earned resulted from a 4% increase in
voluntary net earned premiums offset by a 43% decrease in involuntary net earned
premiums, which in turn resulted primarily from the 65% decrease in involuntary
direct premiums written.
Net investment income was $6,479,000 for the six months ended June 30, 1999, a
decrease of 2% from $6,621,000 for the six months ended June 30, 1998. The
average pre-tax yield associated with the investment portfolio decreased 22
basis points to 6.32%. Average invested assets for the six months ended June 30,
1999 increased less than 1% compared to the year earlier period.
Losses and loss adjustment expenses (LAE) were $32,558,000 for the six months
ended June 30, 1999, a decrease of $1,078,000 or 3% from $33,636,000 for the six
months ended June 30, 1998. The loss and LAE ratio decreased to 69.0% for the
six months ended June 30, 1999 from 70.6% for the six months ended June 30,
1998. This decrease resulted from lower losses associated with private passenger
and commercial automobile business in 1999 compared to 1998, partially offset by
higher losses related to homeowners and businessowners premiums due to the
severe winter weather that occurred in Western New York in early January 1999.
The ratio of deferred amortized policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 34.8% for the six months ended June
30, 1999 from 35.2% for the six months ended June 30, 1998. Commissions, premium
taxes and other state assessments that vary with the Company's premium volume
represented 21.3% of net premiums earned in the six months ended June 30, 1999
compared to 21.8% for the six months ended June 30, 1998.
The Company's effective federal income tax rate for the six months ended June
30, 1999 was 29.1%. This rate was calculated based upon the Company's estimate
of its effective interest rate for all of 1999. Non-taxable investment income,
primarily tax-exempt income, reduced the Company's effective tax rate by
approximately 5 percentage points.
Results of Operations for the Three Months Ended June 30, 1999 As Compared to
- -----------------------------------------------------------------------------
the Three Months Ended June 30, 1998
- ------------------------------------
Total revenues for the three months ended June 30, 1999 were $26,862,000, a
decrease of $386,000, or 1%, from $27,248,000 for the three months ended June
30, 1998. The decrease in total revenues earned resulted primarily from a
decrease in involuntary net earned premiums, due to the decrease in NYAIP
assignments.
Direct premiums written for the three months ended June 30, 1999 were
$26,425,000, an increase of $691,000 or 3%, from $25,734,000 for the three
months ended June 30, 1998.
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Voluntary personal lines direct premiums written for the three months ended June
30, 1999 were $9,516,000, a decrease of $511,000 or 5% from $10,027,000 for the
three months ended June 30, 1998. Private passenger automobile direct premiums
written decreased 8% from the year earlier period. Homeowners direct premiums
written for the three months ended June 30, 1999 increased 6% compared to the
three months ended June 30, 1998.
Voluntary commercial lines direct premiums written for the three months ended
June 30, 1999 were $16,323,000, an increase of $1,977,000, or 14% from
$14,346,000 for the three months ended June 30, 1998, primarily due to increases
in commercial automobile (23%) and contractors coverall (24%) premiums written.
Involuntary direct premiums written for the three months ended June 30, 1999
were $585,000, a decrease of $776,000, or 57% from $1,361,000 for the three
months ended June 30, 1998. Involuntary written premiums were affected by the
adjustments in policy assignments made to the Company by the NYAIP and an
overall decrease in the NYAIP pool of business.
Net investment income was $3,208,000 for the three months ended June 30, 1999, a
$123,000 or 4% decrease from $3,331,000 for the three months ended June 30,
1998, primarily due to a decrease in the average portfolio yield.
Losses and LAE were $16,231,000 for the three months ended June 30, 1999, a
decrease of $558,000 or 3% from $16,789,000 for the three months ended June 30,
1998. The loss and LAE ratio decreased to 69.0% for the three months ended June
30, 1999 from 70.3% for the three months ended June 30, 1998.
The ratio of amortized policy acquisition costs and other underwriting expenses
to net premiums earned decreased to 34.1% for the three months ended June 30,
1999 from 35.0% for the three months ended June 30, 1998. Commissions, premium
taxes and other state assessments that vary with the Company's premium volume
represented 20.6% of net premiums earned in the three months ended June 30, 1999
compared to 21.3% for the three months ended June 30, 1998.
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.
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
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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' equity. During the
six months ended June 30, 1999 the Company recorded $764,000 of unrealized
losses, net of tax, associated with its fixed maturity investments. At June 30,
1999, the Company recorded $409,000 of unrealized gains, net of tax, as
accumulated other comprehensive income related to its investment portfolio.
At June 30, 1999, the Company's portfolio of fixed maturities represented 90.8%
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, 1999, $106,778,000 or 56.0% 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, 1999, $7,799,000 of the Company's investment portfolio was invested
in non-investment grade securities, an increase of $1,093,000 from $6,706,000
at December 31, 1998. Non investment grade securities represented 3.7% and 3.0%
of the Company's investment portfolio at June 30, 1999 and December 31, 1998,
respectively.
During the six months ended June 30, 1999, the Company repurchased 110,700
shares of its common stock. The Company is holding 489,100 shares of its common
stock in treasury at June 30, 1999.
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 1999
without the prior approval of the New Hampshire Insurance Commissioner is
$5,058,000. MNH paid $3,400,000 in dividends to the Company during the six
months ended June 30, 1999. During the three months
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ended June 30, 1999, the Company increased its quarterly cash dividend paid to
stockholders from $.05 to $.10 per common share.
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.
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 1999 MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was 1.8 to 1.
Year 2000
- ---------
The Year 2000 issue relates to the way in which information systems distinguish
date data between the twentieth and twenty-first centuries. Also, many systems
and equipment that are not typically thought of as relating to computers contain
embedded hardware or software ("non-IT") that may have a time element.
Under the Management Agreement, Mutual is responsible for the Company's being
Year 2000 compliant. The Company is relying upon the Mutual for assuring that
the necessary precautions for Year 2000 compliance are taken. Mutual has advised
the Company that the process of preparing all of its computer systems to be Year
2000 compliant is substantially completed. Mutual began work on becoming Year
2000 compliant in 1996. The scope of the project includes: ensuring the
compliance of all computer software applications and operating systems,
mainframe, mid-range and personal computers, local and wide-area networks, and
telecommunications equipment; addressing issues related to non-IT embedded
software and equipment; remediation of affected systems and equipment; and
addressing the compliance of key suppliers.
The project has three phases: assessment of systems, equipment and business
relationships affected by the Year 2000 issue; definition of strategies
necessary to address affected systems and relationships; and remediation or
replacement and testing of affected systems, equipment and relationships.
Mutual's target for completing all phases of the project is the fourth quarter
of 1999. Mutual has completed the assessment and strategy phases for all
systems. Mutual began converting to a mid-range computer based policy and claims
system known as "MOST" (Merchants Optimum Services & Technology) in 1994. The
final phase of the conversion to MOST was completed in October 1998. All new
business and policy renewals for all products are now processed on the MOST
system. Mutual has advised the Company that it believes the MOST system, its
mainframe, mid-range and personal computers, and its local area networks are
substantially Year 2000 compliant.
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Mutual and the Company depend upon a number of key business partners and
suppliers. As part of its Year 2000 project, Mutual has identified key business
partners, vendors, suppliers, and service providers with whom it and the Company
conduct business, and has made substantial progress in contacting these
organizations to determine their Year 2000 readiness. Based upon the responses
to Mutual's inquiries to these organizations, Mutual has taken and will continue
to take appropriate actions. In certain instances where it may not be possible
to verify with certainty a supplier's Year 2000 compliance (for example, it may
not be possible for Mutual to test the operational ability of its
telecommunications, electricity or gas service suppliers in a Year 2000
environment) and where alternate sources of supply are not feasible, Mutual and
the Company may have to rely on the assurances of the supplier.
The Company estimates that its share of the total expenses associated with
becoming Year 2000 compliant approximates $300,000. Approximately $150,000 of
the expenses have been for external costs, which include approximately $112,000
in outside consultant expenses and $38,000 for specific upgrades of software to
address Year 2000 compliance, and $150,000 of the expenses have been for
internal resources dedicated to achieving Year 2000 compliance. It is estimated
that any remaining external or internal costs will not be material. The Company
estimates its share of costs incurred in 1999 to be $10,000, which has been
expensed. There has not been a material impact on the Company's results of
operations or financial condition as a result of information technology projects
being deferred due to resource constraints caused by the Year 2000 project.
Because it is based on the successful implementation of the MOST system, Mutual
has notified the Company that it believes that critical systems are
substantially Year 2000 compliant and that to the best of Mutual's knowledge,
the likelihood that critical systems will have a failure that materially affects
operating results is remote. Mutual also informed the Company that testing will
continue as needed to assure that systems are Year 2000 compliant and that any
situation that develops which needs to be addressed will be corrected by January
1, 2000.
Mutual is continuing to work with third party vendors to assess their ability to
operate in the Year 2000, to assess third-party remediation plans, and to take
steps to identify and transfer support to third party vendors who are Year 2000
compliant. Mutual contracts for the use of a disaster recovery site in Toronto,
Canada, where it maintains information system back-up facilities to be used in
the event of power outages or other causes of system failure. These facilities
are tested quarterly to insure compliance with their intended purpose. Further,
if circumstances such as a power outage at one of its five regional offices were
to require, Mutual could transfer business normally processed at that location
to other locations.
If the Company does not complete its Year 2000 program prior to the commencement
of the Year 2000, if it fails to identify and remediate all critical Year 2000
problems, or if major suppliers or customers experience material Year 2000
problems, the Company's results of operations or financial condition could be
materially affected.
MNH continues to evaluate the complex issues related to insurance coverage for
losses arising from the various possible situations involving Year 2000 problems
and its potential liability to its
16
<PAGE> 17
insureds. The Company believes that the coverages MNH provides do not extend to
the types of losses which are most likely to occur as a result of Year 2000
problems. MNH plans to use coverage exclusion endorsements based on its
evaluation of the potential exposure to Year 2000 problems for certain classes
of commercial risks, and has adopted endorsements to its policies based on forms
provided and filed for approval with various regulatory authorities by the
Insurance Services Office, Inc. Use of these special endorsements is governed by
the law and regulatory policies of states in which MNH is authorized to do
business.
It is possible, however, that future court interpretations of policy language
based on specific facts, or legislation mandating coverage, could result in
coverage for losses attributable to Year 2000 problems. Such decisions or
legislation could have a material adverse impact on MNH's results of operations
and financial condition. It is also possible that MNH may incur expenses
defending claims for which it is ultimately determined there is no insurance
coverage. MNH has made no provision for reserves for losses or LAE on claims
based on potential Year 2000 problems.
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 and until a secondary stock offering in
July 1993 the Company was a majority-owned subsidiary of Mutual. Mutual
currently owns 9.3% of the Company's common stock. 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 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.
During 1998, Mutual initiated discussions with the Company concerning proposals
for the acquisition of the Company by Mutual. The Company's Directors who are
not affiliated with Mutual (the Independent Directors) determined that the terms
proposed by Mutual were inadequate. The Independent Directors also determined
that the Management Agreement prevents the Company's shareholders from realizing
the Company's fair value in a sale or merger, and on July 23, 1998 the Company
gave notice to Mutual of its intention to terminate the Management Agreement.
The provisions of the Management Agreement require five year's prior written
notice for its termination. The Company does not expect the notice of
termination to have any material, short-term effect on the Company's operations.
17
<PAGE> 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
- -----------
Market risk represents the potential for loss due to changes in the fair value
of financial instruments. The market risk related to the Company's financial
instruments primarily relates to its investment portfolio. The value of the
Company's investment portfolio of $210,179,000 at June 30, 1999 is subject to
changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The table below provides information related to the Company's fixed maturity
investments at June 30, 1999. The table presents cash flows of principal amounts
and related weighted average interest rates by expected maturity dates. The cash
flows are based upon the maturity date or, in the case of mortgage-backed and
asset-backed securities, expected payment patterns. Actual cash flows could
differ from those shown in the table.
18
<PAGE> 19
Fixed Maturities
- ----------------
Expected Cash Flows of Principal Amounts ($ in 000's):
<TABLE>
<CAPTION>
TOTAL
------------------
Amor- Estimated
There- tized Market
Held to Maturity 1999 2000 2001 2002 2003 after Cost Value
- ---------------- ---- ---- ---- ---- ---- ----- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 0 $ 1,647 $ 0 $ 0 $ 0 $ 0 $ 1,647 $ 1,612
Average interest rate 0.0% 5.4% 0.0% 0.0% 0.0% 0.0% -- --
Mortgage & asset backed
securities 414 1,014 196 1,815 1,710 8,928 14,077 14,606
Average interest rate 8.0% 8.0% 7.7% 7.7% 7.5% 7.3% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 414 $ 2,661 $ 196 $ 1,815 $ 1,710 $ 8,928 $ 15,724 $ 16,218
======== ======== ======== ======== ======== ======== ======== ========
Available for Sale
- ------------------
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 0 $ 7,400 $ 18,604 $ 350 $ 0 $ 0 $ 26,354 $ 26,203
Average interest rate 0.0% 5.4% 5.5% 6.3% 0.0% 0.0%
Obligations of states and
political subdivisions 0 11,854 10,721 1,709 0 1,230 25,514 25,765
Average interest rate 0.0% 4.8% 4.9% 5.6% 0.0% 5.4% -- --
Corporate securities 1,651 8,052 3,603 10,223 6,265 837 30,631 30,900
Average interest rate 5.8% 5.5% 6.3% 7.1% 7.6% 8.6% -- --
Mortgage & asset
backed securities 16,662 22,201 26,492 16,925 3,568 6,531 92,379 92,172
Average interest rate 6.8% 6.9% 6.9% 7.0% 7.1% 7.2% -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 18,313 $ 49,507 $ 59,420 $ 29,207 $ 9,833 $ 8,598 $174,878 $175,040
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
19
<PAGE> 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
10-A Employee Retention Agreement between Robert M. Zak and
Merchants Mutual Insurance Company dated as of March 1,
1999 (filed herewith). #
(11) Statement re computation of per share earnings (filed
herewith).
(27) Financial Data Schedule (filed herewith).
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the period
for which this report is filed.
# Indicates a management compensation plan or arrangement.
* * * * * * * *
"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; 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
date of this report.
20
<PAGE> 21
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 12, 1999 By:/s/ Kenneth J. Wilson
----------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
21
<PAGE> 1
Exhibit 10A
EMPLOYEE RETENTION AGREEMENT
BETWEEN
ROBERT M. ZAK
AND
MERCHANTS MUTUAL INSURANCE COMPANY
DATED: MAY 31, 1999
<PAGE> 2
EMPLOYEE RETENTION AGREEMENT
----------------------------
This AGREEMENT ("Agreement"), dated as of May 31, 1999, is by
and between ROBERT M. ZAK, residing at 242 Doncaster Road, Kenmore, New York
14217 (the "Executive") and MERCHANTS MUTUAL INSURANCE COMPANY, a New York
mutual insurance company with its principal office at 250 Main Street, Buffalo,
New York 14202 (the "Company").
RECITALS:
WHEREAS, the Company is responsible for managing the business
of Merchants Group, Inc. ("MGI") and MGI's wholly-owned subsidiary, Merchants
Insurance Company of New Hampshire, Inc. ("MNH"), under a Management Agreement
dated September 29, 1986 by and among the Company, MGI and MNH (the "Management
Agreement"); and
WHEREAS, MGI has given notice to the Company that it will
terminate the Management Agreement no later than at the end of the required
five-year notice period; and
WHEREAS, the Executive is a key employee of the
Company; and
WHEREAS, the Executive and the Company are parties to an
Employment Agreement dated as of June 1, 1994 (the "Employment Agreement"); and
WHEREAS, the Employment Agreement expires according to
its terms on May 31, 2000; and
WHEREAS, the Company believes that the Executive's continued
employment with the Company beyond the expiration date of the Employment
Agreement will enhance the Company's ability to continue to manage the business
of the Company, MGI and MNH throughout the period prior to the effective date of
the termination of the Management Agreement; and
WHEREAS, the Company believes that the Executive's continued
employment with the Company will be in the collective best interests of the
Company, MGI and MNH; and
WHEREAS, the Company believes that by extending certain
additional financial incentives to the Executive it will assist the Company in
retaining the services of the Executive throughout the period prior to the
effective date of the termination of the Management Agreement; and
WHEREAS, the Executive and the Company desire to terminate the
Employment Agreement and replace it with this Agreement in order to provide for
such financial incentives.
<PAGE> 3
NOW, THEREFORE, in consideration of the promises and the
mutual agreements herein contained, the adequacy and sufficiency of which are
hereby acknowledged, the Company and the Executive agree as follows:
1. TERMINATION OF EMPLOYMENT AGREEMENT.
------------------------------------
The Employment Agreement is hereby terminated and
superceded in its entirety by this Agreement.
2. EMPLOYMENT.
-----------
During the Protection Period, as such term is
defined in paragraph 3 below, the Company shall continue to employ the Executive
as its President and Chief Executive Officer, as such positions may be defined
from time to time in the Company's By-Laws or, if not so defined, as such
positions may be defined by the Company's Board of Directors. In return, the
Executive shall devote all of his business time, attention, skill and efforts to
the faithful performance of his duties as President and Chief Executive Officer.
In connection with his employment hereunder, the Executive shall be based at the
principal office of the Company in Buffalo, New York.
3. PROTECTION PERIOD.
------------------
The "Protection Period" shall be that period of
time from the date of this Agreement through and including
December 31, 2003.
4. REGULAR COMPENSATION.
---------------------
For the performance of his duties under this
Agreement during the Protection Period the Company shall pay the Executive a
fixed annual salary of at least $260,000 ("Initial Annual Salary"). The
Executive's annual salary shall be subject to annual review by the Compensation
Committee of the Board of Directors of the Company, subject to approval by the
Company's Board of Directors, but shall not be reduced without his written
consent below the Initial Annual Salary during the Protection Period. The
Executive's salary shall be payable semi-monthly or otherwise in accordance with
the Company's customary practice for its other executives. Notwithstanding the
foregoing, the Executive shall be entitled to defer the receipt of his salary
and/or bonus pursuant to procedures adopted or plans maintained by the Company.
5. ADDITIONAL BENEFITS.
--------------------
(a) The Executive shall be eligible to participate
in and receive benefits under any incentive
- 2 -
<PAGE> 4
compensation plan or arrangement, any stock option or other stock-based plan,
any defined benefit retirement plan, defined contribution retirement plan,
supplemental retirement plan, health and dental plan, disability plan, survivor
income plan, and life insurance plan or other employee benefit or compensation
plan or arrangement (collectively, "Benefit Plans"), made available by the
Company to all of its senior executives from time to time, subject to and on a
basis consistent with the terms, conditions and overall administration of such
Benefit Plans.
(b) The Executive shall be entitled to paid vacations
in accordance with the Company's customary vacation practice (provided that the
Executive shall receive at least four (4) weeks vacation per year) and all paid
holidays given by the Company to its other senior executives.
(c) In addition to his annual salary, the Executive
shall be entitled to receive fringe benefits and perquisites given by the
Company to its senior executives.
(d) The Company shall promptly pay (or reimburse the
Executive for) all reasonable expenses incurred by him in the performance of his
duties hereunder, including business travel and entertainment expenses. The
Executive shall furnish to the Company such receipts and records as the Company
may require to verify the foregoing expenses.
6. TERMINATION BENEFITS.
---------------------
(a) The purpose of this paragraph 6 is to provide the
Executive with certain benefits in the event it is necessary or advisable for
the Company, through no fault of the Executive, to either terminate the
Executive's employment or eliminate his position. In order to give effect to
this purpose, the Executive shall receive certain payments and benefits from the
Company if there is a "Termination of Employment," as that term is defined
below, during the Protection Period subject to the following terms and
conditions.
(b) "Termination of Employment" is defined to mean
the termination of the Executive's full-time employment with the Company for any
reason other than (i) the Executive's death, (ii) the Executive's "total
disability" (as defined in paragraph 7(e) below), (iii) the Executive's
voluntary termination of employment with the Company, (iv) the termination of
the Executive's employment by the Company for "good cause" (as defined in
paragraph 7(b) below), or (v) the termination of the Executive's employment by
the Company as a result of the Company's determination in its sole judgment that
the Executive has either (A) repeatedly failed to perform the duties and
assignments given to him or (B) consistently failed to perform the duties and
assignments given to him in a manner that is
- 3 -
<PAGE> 5
acceptable to the Company, based on the level and quality of performance
expected from an experienced executive at the Executive's level in the Company.
(c) If there is a Termination of Employment prior to
June 1, 2000, the Executive or his duly designated beneficiary shall be entitled
to the following benefits:
A. All unpaid salary through the date of
Termination of Employment plus credit for any
vacation earned but not taken through the date of
Termination of Employment and the amount of any bonus
which has been awarded but not paid under any bonus
plan together with reimbursement for expenses not
previously reimbursed through the date of
termination, all of which will be paid immediately.
B. As a severance benefit, the Executive shall be
entitled to an amount equal to two (2) times the
aggregate annual compensation (consisting of base
salary and incentive compensation) paid to the
Executive by the Company during the calendar year
preceding the date of termination. This amount, less
all proper payroll deductions, must be paid to the
Executive immediately in a lump sum discounted by an
interest rate equal to the prime rate then quoted by
Chemical Bank, N.A. assuming that payment would
otherwise have been made ratably in equal
semi-monthly installments over the period of time
through May 31, 2000.
Termination by the Company under this paragraph 6(c) shall have no effect upon
the Executive's other rights, including but not limited to rights under Benefit
Plans.
(d) If there is a Termination of Employment during the
Protection Period but subsequent to May 31, 2000, the Executive or his duly
designated beneficiary will continue to receive his gross bi-weekly salary in
effect on the date of Termination of Employment, subject to all required
withholding taxes, in the form of salary continuation ("Salary Continuation"),
during each of the thirty-four (34) months following the date of Termination of
Employment (the "Salary Continuation Period").
(e) In addition to the Salary Continuation provided under
paragraph 6(d) above, during the Salary Continuation Period the Company shall
maintain in full force for the Executive's and his family's benefit, all life
insurance, health and accident insurance, and disability and medical
reimbursement plans in which the Executive and his family were entitled to
participate immediately prior to the date of Termination of Employment, under
- 4 -
<PAGE> 6
the same terms as are made available during the Salary Continuation Period to
other executive employees of the Company from time to time, if the continued
participation of the Executive and his family in such plans is possible under
the general terms and provisions of such plans, programs and arrangements. The
costs of the Executive's and his family's continued participation in such
insurance and reimbursement plans shall be allocated between the Company and the
Executive in the same proportion as such costs were allocated prior to the date
of Termination of Employment. If the Executive's or his family's continued
participation is not possible, the Company shall reimburse the Executive for his
cost in obtaining comparable coverage, subject to a maximum reimbursement during
the Salary Continuation Period equal to 10% of the Executive's base annual
salary for the calendar year preceding the date of Termination of Employment.
For purposes of the Consolidated Omnibus Budget Reconciliation Act ("COBRA"),
the qualifying event that begins the Executive's period of coverage shall be
considered to occur on the last day for which health coverage is provided during
the Salary Continuation Period and for which the Company contributes to the
costs of such coverage pursuant to this paragraph 6(e).
(f) This paragraph 6 shall not be applicable to any
Termination of Employment following a "change in control" as defined in
paragraph 7(c) of this Agreement.
(g) The payments and benefits provided for in paragraphs 6(c),
(d) and (e) shall be in lieu of any other severance payments the Executive might
otherwise be entitled to from the Company whether in this Agreement, under any
employment agreement, or under a severance plan or policy maintained by the
Company for employees of Executive's rank and seniority.
(h) The Executive shall not be considered to be an employee of
the Company during the Salary Continuation Period for purposes of accruing any
benefits under the Company's 401(k) retirement plan, or any other retirement,
pension, profit sharing, savings or incentive or bonus plan maintained,
sponsored or administered by the Company ("Retirement or Bonus Plans") or under
the Company's vacation policy. During the Salary Continuation Period the
Executive shall not be entitled to any contribution by the Company on his behalf
or to his account under any Retirement or Bonus Plans nor shall he be entitled
to accrue any benefits under the Company's vacation policy.
7. CHANGE IN CONTROL PAYMENTS.
---------------------------
(a) If during the Protection Period there is a "change in
control" and within two (2) years thereafter (i) the employment of the Executive
is terminated by the Company for other than "good cause" or the death or "total
disability" of the Executive or (ii) the Executive shall declare his employment
- 5 -
<PAGE> 7
terminated for "good reason," then the Executive shall be
entitled to the following:
A. All unpaid salary through the date of
termination of employment plus credit for any
vacation earned but not taken through the date of
termination of employment (as permitted by the
Company's policy on vacations) together with
reimbursement for expenses not previously reimbursed
through the date of termination, all of which will be
paid immediately subject to all required withholding
taxes.
B. As a severance benefit, the Executive shall be
entitled to an amount equal to his current base
annual salary ("X") plus the annual average of all
incentive compensation paid to the Executive by the
Company during the three (3) calendar years preceding
the date of termination or such portion of that
period during which Executive was an employee ("Y"),
multiplied by two and nine-tenths [2.9] ("Severance
Benefit"). The Severance Benefit will equal (X + Y)
multiplied by 2.9.
C. This Severance Benefit, less all proper
payroll deductions, shall be paid immediately to the
Executive in a lump sum.
D. In addition to the Severance Benefit, the
Executive shall be entitled to continued
participation for thirty-four (34) months following
the date of the termination of his employment, in all
life insurance, health and accident insurance,
disability and medical reimbursement plans, programs
and arrangements in which the Executive and his
family were entitled to participate immediately prior
to the date of a "change in control," if the
continued participation of the Executive and his
family in such plans, programs and arrangements is
possible under the general terms and provisions of
such plans, programs and arrangements. The costs of
the Executive's and his family's continued
participation in such plans, programs and
arrangements shall be allocated between the Company
and the Executive in the same proportion as such
costs were allocated prior to the date of the
termination of his employment. If the Executive's or
his family's continued participation is not possible,
the Company shall reimburse the Executive at the end
of each month during the thirty-four (34) month
period for his
- 6 -
<PAGE> 8
cost in obtaining comparable coverage, subject to a
maximum reimbursement during each month equal to 2%
of the Executive's base annual salary for the
calendar year preceding the date of the termination
of his employment. For purposes of COBRA, the
qualifying event that begins the Executive's period
of coverage shall be considered to occur on the last
day for which health coverage is provided and for
which the Company contributes to the costs of such
coverage pursuant to this paragraph 7(a)D. The
Company's obligations under this paragraph 7(a)D.
with respect to life, health, accident and disability
coverage shall be suspended with respect to any such
coverage at any time that the Executive is eligible
for comparable coverage from another employer.
The parties agree that the payments provided
for in this paragraph 7(a) shall be liquidated damages which are in lieu of any
other severance payments that the Executive would otherwise be entitled to under
this Agreement or under any severance plan or policy that would apply to him but
for this Agreement, and the Company agrees that the Executive shall not be
required to mitigate his damages by seeking other employment or otherwise.
(b) "Good cause" shall mean (i) the Executive's
dishonesty, fraud or breach of trust, or substantial misconduct in the
performance of or substantial nonperformance of his duties as an employee of the
Company, (ii) any act or omission by the Executive that results in a felony
conviction or in a regulatory body with jurisdiction over the Company removing
the Executive from office or requesting or recommending the suspension or
removal of the Executive or taking punitive action against the Executive, or
(iii) a material breach by the Executive of paragraphs 8 or 9 of this Agreement.
(c) For purposes of this Agreement, a "change in
control" shall have occurred if, after the date of this
Agreement:
A. Any person (as such term is used in Section
13(d) or Section 14(d)(2) of the Securities Exchange
Act of 1934, as amended, and the rules and
regulations thereunder and including any affiliate or
associate of such person, as defined in Rule 12b-2
under said Act, and any person acting in concert with
such person), directly or indirectly acquires or
becomes the beneficial owner of (within the meaning
of Rule 13d-3 under said Act), or otherwise becomes
entitled to vote, stock of the Company or MGI or MNH
(hereinafter referred to individually as a
- 7 -
<PAGE> 9
"Merchants Company" and collectively as the
"Merchants Companies") with 25% or more of the voting
power entitled to be cast at elections for directors
(excluding any acquisition of stock in one Merchants
Company by another Merchants Company or the voting of
stock in one Merchants Company by another Merchants
Company); or
B. There occurs any merger or consolidation of a
Merchants Company (excluding any merger or
consolidation of one Merchants Company with another)
or any sale, lease or exchange of all or any
substantial part of the assets of any of the
Merchants Companies and their subsidiaries to any
other person, excluding any of the Merchants
Companies, and (i) in the case of a merger or
consolidation, the holders of the outstanding stock
of any of the Merchants Companies entitled to vote in
elections of directors ("voting stock") immediately
before such merger or consolidation hold less than
50% of the voting stock of the survivor of such
merger or consolidation or its parent; or (ii) in the
case of any such sale, lease or exchange, neither the
Company nor either of the other Merchants Companies
or the Merchants Companies as a group owns at least
50% of the voting stock of the other person; or
C. During any period of two (2) consecutive
years, individuals who at the beginning of such
period constitute the entire Board of Directors of
any of the Merchants Companies shall cease for any
reason to constitute a majority thereof, unless the
election or the nomination for the election by that
company's shareholders or policyholders of each new
Director was approved by a vote of at least
two-thirds of the Directors then still in office who
were Directors at the beginning of the period.
(d) "Good reason" shall mean any of the following
subsequent to a "change in control" (i) the requirement that the Executive
relocate his principal place of business to a location that is more than 25
miles from the Executive's principal place of business immediately prior to the
date of a "change in control," (ii) any assignment to the Executive without his
express written consent of any material duties, functions, authority or
responsibilities with respect to any of the Merchants Companies other than those
duties, functions, authority and responsibilities assigned to the Executive by
the Company prior to the "change in control," or any material limitation or
expansion without the Executive's express written consent of the material
duties, functions, authority and responsibilities
- 8 -
<PAGE> 10
assigned to the Executive by the Company prior to the "change in control," any
such assignment, limitation or expansion being deemed a continuing breach of
this Agreement, (iii) a reduction in the Executive's then annual salary paid by
any of the Merchants Companies or (iv) failure by the Company to obtain the
assumption of, and the agreement to perform, this Agreement by any successor or
assign as contemplated in paragraph 13 hereof, and such relocation described in
the foregoing clause (i), such assignment, limitation or expansion described in
the foregoing clause (ii), reduction described in the foregoing clause (iii) or
failure described in the foregoing clause (iv) is not cured within thirty (30)
days after receipt by the Company of written notice from the Executive
describing such event, or (v) any removal of the Executive from, or any failure
to re-designate or re-elect the Executive to the position he held immediately
prior to the "change in control"; provided that in any event set forth above in
this subparagraph 7(d), the Executive shall have elected to terminate his
employment under this Agreement upon not less than sixty (60) days' advance
written notice to the Company, given, except in the case of a continuing breach,
within three calendar months after (A) failure to be so elected or re-elected,
or such removal, or (B) expiration of the thirty-day cure period with respect to
such event. An election by the Executive to terminate his employment given under
the provisions of this paragraph 7(d) shall not be deemed a voluntary
termination of employment by the Executive for the purpose of this Agreement or
any plan or practice of the Company.
(e) "Total disability," as used herein, shall mean
total disability as defined in any long-term disability plan sponsored by the
Company in which the Executive participates, or, if there is no such plan or it
does not define such term, then it shall mean the physical or mental incapacity
of the Executive which prevents him from substantially performing his duties as
an employee of the Company for a period of at least 180 days and the incapacity
is expected to be permanent and continues for the remainder of the Executive's
life.
(f) The payments provided for in this paragraph 7 are
in lieu of any payments provided for in the Employment Agreement or in any
severance agreement or similar agreement between the Executive and the Company
which is dated prior to the date of this Agreement ("Severance Agreement"). This
Agreement hereby voids, terminates and supersedes the Employment Agreement and
any such Severance Agreement and the Executive hereby acknowledges that the
Employment Agreement and any such Severance Agreement are hereby terminated and
he no longer has any rights or benefits thereunder.
8. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION.
-------------------------------------------
The Executive will not at any time use or disclose
to any third party any confidential information or trade secrets
- 9 -
<PAGE> 11
relating to the business of any of the Merchants Companies, including business
methods and techniques, research data, marketing and sales information, agent
lists, underwriting and claims procedures, investment strategies, reinsurance
arrangements, agent compensation plans, pricing data, and any other information
concerning the business of any of the Merchants Companies, their manner of
operation, their plans, or other information not disclosed to the general public
or known in the insurance industry, except for disclosure in the course of the
Executive's duties hereunder, or disclosure required by any law, rule,
regulation or court order, or disclosure which the Executive reasonably believes
would subject him or any of the Merchants Companies to liability if not made.
This covenant will survive the termination of this Agreement.
9. COVENANT NOT TO COMPETE.
------------------------
(a) The Executive shall not "compete," as that term
is defined in paragraph 9(c) below, with any of the Merchants Companies while
employed by the Company.
(b) If the Executive is receiving Salary Continuation
payments under paragraph 6(d) of this Agreement, he shall not compete with any
of the Merchants Companies during the first ninety (90) days of the Salary
Continuation Period, nor shall he "solicit," as that term is defined in
paragraph 9(d) below, any employee of the Company for a period of six (6) months
after his last day of employment with the Company, unless he shall have received
prior written approval from the Company.
(c) As used in this paragraph 9, the term "compete"
means the direct or indirect ownership, management, operation or control of, or
participation in the ownership, management, operation, or control of, or the
holding of the position of an officer, employee, partner, director, consultant
or similar positions, or the holding of any financial interest in, or the giving
of any aid or assistance to anyone else in the conduct of, any business that is
engaged in a property-casualty insurance business that offers substantially any
of the same lines of insurance and coverages offered, or proposed to be offered,
by any of the Merchants Companies at the time of the Executive's withdrawal from
or termination of employment with the Company, in any of the geographic markets
in which any of the Merchants Companies is then conducting business. Ownership
of stock of MGI or of one percent (1%) or less of the voting stock of any other
publicly held corporation shall not constitute a violation of this paragraph 9.
(d) As used in paragraph 9(b) above, the term
"solicit" shall mean the solicitation of any employee of the Company for the
purpose of hiring or engaging such employee to work for or otherwise assist any
person who does or intends to compete with any of the Merchants Companies.
- 10 -
<PAGE> 12
(e) In addition to any other remedies that the
Company may have in law or in equity for a breach of the Executive's covenants
set forth in this paragraph 9, the Company may also cancel its obligations to
pay to the Executive any monies and other benefits otherwise due to the
Executive under this Agreement.
10. ENTIRE AGREEMENT.
-----------------
The terms and provisions of this Agreement
constitute the entire agreement between the parties and supersede any previous
oral or written communications, representations, or agreements with respect to
the subject matter hereof, including without limitation the Employment
Agreement.
11. NOTICE.
-------
Any notices given hereunder shall be in writing
and shall be given by personal delivery or by certified or registered mail,
return receipt requested, addressed to the addressee at the address set forth at
the head of this Agreement or such other address that such addressee has duly
notified the other party to forward notices to hereunder.
12. SEVERABILITY.
-------------
The invalidity or unenforceability of any
particular provision of this Agreement shall not affect the other provisions
hereof, and this Agreement shall be construed in all respects as if the invalid
or unenforceable provision had been omitted.
13. COMPANY ASSIGNMENT.
-------------------
The Company may not assign this Agreement, except
that the Company's obligations hereunder shall be binding legal obligations of
any successor to all or substantially all of the Company's business by purchase,
merger, consolidation, or otherwise. The Company shall require any successor or
assign (whether direct or indirect, by purchase, merger, consolidation or
otherwise) to all or substantially all of the business and/or assets of the
Company, by agreement in form and substance satisfactory to the Executive,
expressly, absolutely and unconditionally to assume and agree to perform this
Agreement in the same manner and to the same extent that the Company would be
required to perform it if no such succession or assignment had taken place. Any
failure of the Company to obtain such agreement prior to the effectiveness of
any such succession or assignment shall be a material breach of this Agreement.
As used in this Agreement, the term "Company" shall mean the Company as
hereinbefore defined and any successor or assign to its business and/or assets
as aforesaid which executes and delivers the agreement provided for in this
paragraph 13 or which otherwise
- 11 -
<PAGE> 13
becomes bound by all the terms and provisions of this Agreement
by operation of law.
14. NO ASSIGNMENT BY EXECUTIVE.
---------------------------
No interest of the Executive or the Executive's
spouse or any other beneficiary under this Agreement, or any right to receive
any payments or distributions hereunder, shall be subject in any manner to sale,
transfer, assignment, pledge, attachment, garnishment, or other alienation or
encumbrance of any kind, nor may such interest or right to receive a payment or
distribution be taken, voluntarily or involuntarily, for the satisfaction of the
obligations or debts of, or other claims against, the Executive or the
Executive's spouse or other beneficiary, including claims for alimony, support,
separate maintenance, and claims in bankruptcy proceedings.
15. BENEFITS UNFUNDED.
------------------
All rights of the Executive and the Executive's
spouse or other beneficiary under this Agreement shall at all times be entirely
unfunded, and no provision shall at any time be made with respect to segregating
any assets of the Company for payment of any amounts due hereunder. Neither the
Executive nor the Executive's spouse or other beneficiary shall have any
interest in or rights against any specific assets of the Company, and the
Executive and the Executive's spouse or other beneficiary shall have only the
rights of a general unsecured creditor of the Company.
16. WAIVER.
-------
No waiver by any party at any time of any breach
by another party of, or compliance with, any condition or provision of this
Agreement to be performed by the other party shall be deemed a waiver of any
other provisions or conditions at the same time or at any prior or subsequent
time.
17. PAYMENTS IN EVENT OF DEATH.
---------------------------
Upon the death of the Executive all amounts due
and payable to the Executive pursuant to this Agreement shall be paid to the
person or persons designated by him as his beneficiary or beneficiaries on the
Form of Designation of Beneficiary attached hereto as Exhibit A, or if no such
person is designated then to his devisee, legatee or other designee, or in their
absence to his estate.
18. REDUCTION OF PARACHUTE PAYMENTS
-------------------------------
AND EXCESSIVE EMPLOYEE REMUNERATION.
------------------------------------
(a) In the event that a determination is made by
legal counsel for the Company that (i) the Executive would,
- 12 -
<PAGE> 14
except for this paragraph 13, be subject to the excise tax provisions of Section
4999 of the Internal Revenue Code of 1986 (the "Code"), or any successor
sections thereof, as a result of a "parachute payment" (as defined in Section
280G(b)(2)(A) of the Code) made by the Company to the Executive pursuant to this
Agreement or any other agreement, plan or arrangement, or (2) a federal income
tax deduction would not be allowed to the Company for all or a part of such
payments by reason of Section 280G(a) of the Code (or any successor provision),
the payments to which the Executive would otherwise be entitled hereunder shall
be reduced, eliminated, or postponed in such amounts as are required to reduce
the aggregate "present value" (as defined in Section 280G(d)(4) of the Code) of
such payments to one dollar less than an amount equal to three times the
Executive's "base amount" (as defined in Sections 280G(b)(3)(A) and 280G(d)(1)
and (2) of the Code), to the end that the Executive is not subject to tax
pursuant to such Section 4999 and no deduction is disallowed by reason of such
Section 280G(a). To achieve such reduction in aggregate present value, the
Executive shall determine which item or items payable hereunder shall be
reduced, eliminated, or postponed, the amount of each such reduction,
elimination, or postponement, and the period of each postponement. The Company
shall direct its legal counsel to review the payments made to the Executive and
shall provide to the Executive such information as is reasonably necessary for
the Executive to make the determinations contemplated in this paragraph.
(b) In the event that a determination is made by
legal counsel for the Company that the Company would not be allowed to deduct
remuneration payable to the Executive as a result of the limits imposed by
Section 162(m) of the Code, or any successor sections thereof, the payments to
which the Executive would otherwise be entitled hereunder shall be reduced,
eliminated, or postponed in such amounts as are required to avoid the limits
imposed by Section 162(m). The procedures set forth in paragraph 18(a) to
accomplish such reduction, elimination or postponement shall apply to this
paragraph 18(b).
19. APPLICABLE LAW.
---------------
This Agreement shall be construed and interpreted
in accordance with the internal substantive laws of the State of New York
without taking into account its laws on the conflict of law.
20. ARBITRATION.
------------
The Company and the Executive shall attempt to
resolve between them any dispute which arises hereunder. If they cannot agree
within ten (10) days after either party submits a demand for arbitration to the
other party, then the issue shall be submitted to arbitration with each party
having the right to appoint one (1) arbitrator and those two (2) arbitrators
mutually
- 13 -
<PAGE> 15
selecting a third arbitrator. The rules of the American Arbitration Association
for the arbitration of commercial disputes shall apply and the decision of 2 of
the 3 arbitrators shall be final. The arbitrators must reach a decision within
ninety (90) days after the selection of the third arbitrator. The arbitration
shall take place in Buffalo, New York. The arbitrators shall apply New York law.
21. AMENDMENT.
----------
This Agreement shall be amended only by a written
document signed by each party hereto.
22. EMPLOYEE-AT-WILL.
-----------------
Notwithstanding any provision in this Agreement,
the Executive will remain an at-will employee of the Company, whose employment
may be terminated by the Company at any time subject to the Executive's rights
to receive the benefits specifically provided in this Agreement, as applicable.
IN WITNESS WHEREOF, the parties have executed this Agreement
effective as of the day and year first above written.
THE EXECUTIVE:
/s/ Robert M. Zak
---------------------------------
ROBERT M. ZAK
MERCHANTS MUTUAL INSURANCE COMPANY
By /s/ Franklyn S. Barry, Jr.
----------------------------------
FRANKLYN S. BARRY, JR.,
CHAIRMAN OF THE
COMPENSATION COMMITTEE
- 14 -
<PAGE> 16
EXHIBIT A
FORM OF DESIGNATION OF BENEFICIARY
In the event of the death of the undersigned, the undersigned
hereby designates the following person or persons as his beneficiary or
beneficiaries for the receipt of any payments due to the undersigned under the
Employee Retention Agreement between the undersigned and Merchants Mutual
Insurance Company:
Primary Beneficiary
or Beneficiaries:
-----------------
___________________________________
___________________________________
Contingent Beneficiary
or Beneficiaries:
-----------------
___________________________________
___________________________________
Dated: _________________ ______________________________
ROBERT M. ZAK
<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,
1998 1999 1998 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net income for computing earnings per
common share - without dilution and
fully diluted $1,520 $1,850 $2,866 $3,499
====== ====== ====== ======
Weighted average number of common shares
outstanding - without dilution 2,909 2,774 2,908 2,813
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 19 4 14 4
------ ------ ------ ------
Weighted average number of common shares
and common share equivalents outstanding,
basic and diluted 2,928 2,778 2,922 2,817
====== ====== ====== ======
Earnings per share:
Basic $ .52 $ .67 $ .99 $ 1.24
====== ====== ====== ======
Diluted $ .52 $ .67 $ .98 $ 1.24
====== ====== ====== ======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 175,040,000
<DEBT-CARRYING-VALUE> 15,724,000
<DEBT-MARKET-VALUE> 16,218,000
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 210,179,000
<CASH> 31,000
<RECOVER-REINSURE> 9,821,000
<DEFERRED-ACQUISITION> 12,361,000
<TOTAL-ASSETS> 270,747,000
<POLICY-LOSSES> 134,914,000
<UNEARNED-PREMIUMS> 49,629,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 32,000
<OTHER-SE> 71,840,000
<TOTAL-LIABILITY-AND-EQUITY> 270,747,000
47,186,000
<INVESTMENT-INCOME> 6,479,000
<INVESTMENT-GAINS> 7,000
<OTHER-INCOME> 266,000
<BENEFITS> 32,558,000
<UNDERWRITING-AMORTIZATION> 12,504,000
<UNDERWRITING-OTHER> 3,938,000
<INCOME-PRETAX> 4,938,000
<INCOME-TAX> 1,439,000
<INCOME-CONTINUING> 3,499,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,499,000
<EPS-BASIC> 1.24
<EPS-DILUTED> 1.24
<RESERVE-OPEN> 126,869,000
<PROVISION-CURRENT> 32,558,000
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 15,900,000
<PAYMENTS-PRIOR> 17,924,000
<RESERVE-CLOSE> 125,603,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
