<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
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 28, 2000.
2,463,052 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 1999 2000
------------ -----------
(unaudited)
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$14,705 in 1999 and $14,720 in 2000) $ 14,547 $ 14,501
Available for sale at fair value (amortized cost
$183,209 in 1999 and $173,245 in 2000) 182,082 171,097
Preferred stock at fair value 12,941 13,269
Other long-term investments at fair value 797 735
Short-term investments 2,544 8,125
-------- --------
Total investments 212,911 207,727
Cash 2 3
Interest due and accrued 2,117 2,268
Premiums receivable, net of allowance for doubtful
accounts of $431 in 1999 and $423 in 2000 19,964 21,278
Deferred policy acquisition costs 12,309 12,617
Ceded reinsurance balances receivable 5,396 5,899
Prepaid reinsurance premiums 3,168 8,229
Deferred income taxes 6,002 6,061
Other assets 7,654 7,829
-------- --------
Total assets $269,523 $271,911
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
2
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MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands except share amounts)
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------- ----------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $ 133,526 $ 132,399
Unearned premiums 49,616 55,839
Demand loan 1,025 450
Payable to affiliate 618 533
Other liabilities 15,351 13,842
--------- ---------
Total liabilities 200,136 203,063
--------- ---------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,595,852 shares issued and
outstanding at December 31, 1999 and 2,463,252 shares issued and
outstanding at June 30, 2000 32 32
Additional paid in capital 35,680 35,680
Treasury stock, 646,000 shares at December 31, 1999
and 778,600 shares at June 30, 2000 (13,139) (15,491)
Accumulated other comprehensive loss (1,188) (1,490)
Accumulated earnings 48,002 50,117
--------- ---------
Total stockholders' equity 69,387 68,848
--------- ---------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 269,523 $ 271,911
========= =========
</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,
1999 2000 1999 2000
------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $23,524 $23,606 $47,186 $46,639
Net investment income 3,208 3,388 6,479 6,844
Net realized investment gains 6 5 7 5
Other revenues 124 16 266 82
------- ------- ------- -------
Total revenues 26,862 27,015 53,938 53,570
------- ------- ------- -------
Expenses:
Net losses and loss adjustment
expenses 16,231 16,703 32,558 34,196
Amortization of deferred policy
acquisition costs 6,234 6,256 12,504 12,359
Other underwriting expenses 1,540 1,273 3,524 2,960
------- ------- ------- -------
Total expenses 24,005 24,232 48,586 49,515
------- ------- ------- -------
Income before income taxes 2,857 2,783 5,352 4,055
Income tax provision 1,007 982 1,853 1,437
------- ------- ------- -------
Net income $ 1,850 $ 1,801 $ 3,499 $ 2,618
======= ======= ======= =======
Basic and diluted earnings per share $ .67 $ .72 $ 1.24 $ 1.04
======= ======= ======= =======
Weighted average shares outstanding:
Basic 2,774 2,488 2,813 2,524
Diluted 2,778 2,489 2,817 2,526
</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,
1999 2000 1999 2000
------- ------ ------- -------
(unaudited)
<S> <C> <C> <C> <C>
Net income $ 1,850 $1,801 $ 3,499 $ 2,618
------- ------ ------- -------
Other comprehensive income (loss)
before taxes:
Unrealized gains (losses)
on securities (1,065) 195 (1,158) (596)
Reclassification adjustment
for gains and losses included
in net income -- -- -- --
------- ------ ------- -------
Other comprehensive income (loss)
before taxes (1,065) 195 (1,158) (596)
Income tax provision (benefit) related to
items of other comprehensive income (362) 74 (394) (294)
------- ------ ------- -------
Other comprehensive income (loss) (703) 121 (764) (302)
------- ------ ------- -------
Comprehensive income $ 1,147 $1,922 $ 2,735 $ 2,316
======= ====== ======= =======
</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,
1999 2000
-------- --------
(unaudited)
<S> <C> <C>
Common stock, beginning and end $ 32 $ 32
-------- --------
Additional paid in capital:
Beginning of period 35,511 35,680
Exercise of common stock options 169 --
-------- --------
End of period 35,680 35,680
-------- --------
Treasury stock:
Beginning of period (7,097) (13,139)
Purchase of treasury shares (2,396) (2,352)
-------- --------
End of period (9,493) (15,491)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period 1,173 (1,188)
Other comprehensive loss (764) (302)
-------- --------
End of period 409 (1,490)
-------- --------
Accumulated earnings:
Beginning of period 42,164 48,002
Net income 3,499 2,618
Cash dividends (419) (503)
-------- --------
End of period 45,244 50,117
-------- --------
Total stockholders' equity $ 71,872 $ 68,848
======== ========
</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,
1999 2000
-------- --------
(unaudited)
<S> <C> <C>
Cash flows from operations:
Collection of premiums $ 46,196 $ 46,239
Payment of losses and loss adjustment expenses (33,824) (35,547)
Payment of other underwriting expenses (17,577) (17,191)
Investment income received 6,635 6,678
Investment expenses paid (177) (216)
Income taxes paid (1,322) (1,353)
Other 266 81
-------- --------
Net cash provided by (used in) operations 197 (1,309)
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 50,580 35,276
Purchase of fixed maturities (44,805) (24,516)
Net increase in preferred stock (1,128) (416)
Net decrease in other long-term investments 98 62
Net increase in short-term investments (840) (5,581)
Disposition of equipment 697 --
-------- --------
Net cash provided by investing activities 4,602 4,825
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances (2,138) (85)
Decrease in demand loan, net -- (575)
Proceeds from exercise of common stock options 169 --
Purchase of treasury stock (2,396) (2,352)
Cash dividends (419) (503)
-------- --------
Net cash used in financing activities (4,784) (3,515)
-------- --------
Increase in cash 15 1
Cash:
Beginning of period 16 2
-------- --------
End of period $ 31 $ 3
======== ========
</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,
1999 2000
------- -------
(unaudited)
<S> <C> <C>
Net income $ 3,499 $ 2,618
Adjustments:
Accretion of bond discount (15) (231)
Realized investment gains (7) (5)
(Increase) decrease in assets:
Interest due and accrued 44 (151)
Premiums receivable (303) (1,314)
Deferred policy acquisition costs 29 (308)
Ceded reinsurance balances receivable (80) (503)
Prepaid reinsurance premiums (354) (5,061)
Deferred income taxes 182 235
Other assets (254) (175)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses (1,771) (1,127)
Unearned premiums 247 6,223
Other liabilities (1,020) (1,509)
------- -------
Net cash provided by (used in) operations $ 197 $(1,308)
======= =======
</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, 2000 and the related consolidated
statements of operations, of comprehensive income, of changes in stockholders'
equity and of cash flows for the three and six month periods ended June 30, 1999
and 2000, respectively, 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, 1999.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) which differ in some respects
from those followed in reports to insurance regulatory authorities. All
significant intercompany balances and transactions have been eliminated. Certain
prior year balances have been reclassified to conform with current year
presentation.
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 owned 10.4% of the Company's common stock at June 30,
2000, provides the Company and MNH with the facilities, management and personnel
required to manage their day-to-day business. All underwriting, administrative,
claims and investment expenses incurred on behalf of Mutual and MNH are shared
on an allocated cost basis, determined as follows: for underwriting and
administrative expenses, the respective share of total direct premiums written
for Mutual and MNH serves as the basis of allocation; for claims expenses, the
average number of outstanding claims is used; investment expenses are shared
based on each company's share of total invested assets.
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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 8,000 and 49,000 shares of common
stock options for the three and six month periods in 2000 and 1999,
respectively, which would have resulted in 900 and 3,867 additional shares
outstanding for the three month periods, respectively, and 1,407 and 3,942
additional shares outstanding for the six month periods, 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, 2000 AS COMPARED TO THE
SIX MONTHS ENDED JUNE 30, 1999
Total revenues for the six months ended June 30, 2000 were $53,570,000, a
decrease of $368,000 or 1%, from $53,938,000 for the six months ended June 30,
1999.
Direct premiums written for the six months ended June 30, 2000 were $58,294,000,
an increase of $8,589,000 or 17%, from $49,705,000 for the six months ended June
30, 1999. Voluntary direct premiums written for the six months ended June 30,
2000 were $57,739,000, an increase of $9,076,000 or 19%, from $48,663,000 for
the six months ended June 30, 1999. Involuntary direct premiums written for the
six months ended June 30, 2000 were $556,000, a decrease of $486,000 or 47%,
from $1,042,000 for the six months ended June 30, 1999. Net premiums written for
the six months ended June 30, 2000 were $47,802,000, an increase of $722,000 or
2%, from $47,080,000 for the six months ended June 30, 1999.
During the quarter ended June 30, 2000 the Company implemented a program to
underwrite specialized commercial auto insurance (the Auto Program). All
policies issued under the Auto Program are 100% reinsured through certain Lloyds
syndicates and therefore have no impact on net premiums written, net premiums
earned or net losses and loss adjustment expenses (LAE) incurred by the Company.
The Company records all direct underwriting expenses incurred, including
commissions with respect to the acquisition of these policies, which are offset
by reinsurance commission income.
Voluntary personal lines direct premiums written for the six months ended June
30, 2000 were $18,018,000, a decrease of $583,000 or 3%, from $18,601,000 for
the six months ended June 30, 1999. Private passenger automobile (PPA) direct
premiums written, which represented 76% and 78% of total voluntary personal
lines direct premiums written for the six months ended June 30, 2000 and 1999,
respectively, decreased 5% from the year earlier period. PPA direct premiums
written decreased primarily due to fewer new policies being issued and fewer
renewal policies being retained, resulting from price-based market competition.
Homeowners direct premiums written for the six months ended June 30, 2000
increased 2% compared to the six months ended June 30, 1999.
Voluntary commercial lines direct premiums written for the six months ended June
30, 2000 were $39,721,000, an increase of $9,659,000 or 32%, from $30,062,000
for the six months ended June 30, 1999. This increase was primarily attributable
to $6,579,000 of direct premiums written for the Auto Program. There were no
Auto Program direct premiums written in the six months ended June 30, 1999.
Voluntary commercial lines direct premiums written, excluding Auto Program
premiums, were $33,142,000, an increase of $3,080,000 or 10%, from $30,062,000
for the six months ended June 30, 1999. This increase was due primarily to
increases in commercial automobile (20%) and contractors coverall (16%) premiums
written.
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The increase in commercial automobile direct premiums written was attributable
to an 11% increase in policies in force at June 30, 2000 compared to June 30,
1999 and to a 6% increase in average premium per commercial auto policy. The
increase in contractors coverall direct premiums written resulted primarily from
a 28% increase in policies in force somewhat offset by an 8% decrease in average
premium per policy. The increase in contractors coverall policies in force
resulted primarily from a 31% increase in new business units (policies written
for the first time) in 2000 compared to 1999.
Involuntary direct premiums written, primarily PPA insurance, which comprised 1%
and 2% of all direct premiums written during the six months ended June 30, 2000
and 1999, respectively, 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, 2000 were $46,639,000, a
decrease of 1% from $47,186,000 for the six months ended June 30, 1999. A 5%
increase in voluntary earned premiums was offset by a 58% decrease in
involuntary earned premiums. The decrease in involuntary earned premiums
resulted from the decrease in involuntary direct premiums written and from a
decrease in assumed premiums written by involuntary market facilities.
Net investment income was $6,844,000 for the six months ended June 30, 2000, an
increase of 6% from $6,479,000 for the six months ended June 30, 1999. The
average pre-tax yield associated with the investment portfolio increased 35
basis points. Average invested assets for the six months ended June 30, 2000
increased less than 1% compared to the year earlier period.
Losses and LAE were $34,196,000 for the six months ended June 30, 2000, an
increase of $1,638,000 or 5%, from $32,558,000 for the six months ended June 30,
1999. The loss and LAE ratio increased to 73.3% for the six months ended June
30, 2000 from 69.0% for the six months ended June 30, 1999. This increase
resulted from an increase in claims frequency experienced in the first quarter
of 2000, primarily for private passenger automobile and commercial automobile
policies.
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 32.8% for the six months ended June
30, 2000 from 34.0% for the six months ended June 30, 1999 primarily due to
lower agency incentive commissions. Expenses that vary with the Company's
premium volume such as commissions, premium taxes and other state assessments
represented 20.1% of net premiums earned in the six months ended June 30, 2000
compared to 20.4% for the six months ended June 30, 1999.
The Company's effective income tax rate for the six months ended June 30, 2000
was 35.4%. This rate was calculated based upon the Company's estimate of its
effective income tax rate for all of 2000. Non-taxable investment income,
primarily tax-exempt income, reduced the Company's effective tax rate by
approximately 5 percentage points.
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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 AS COMPARED TO
THE THREE MONTHS ENDED JUNE 30, 1999
Total revenues for the three months ended June 30, 2000 were $27,015,000, an
increase of $153,000, or 1%, from $26,862,000 for the three months ended June
30, 1999. The increase in total revenues resulted primarily from an increase in
net investment income. Direct premiums written for the three months ended June
30, 2000 were $34,825,000, an increase of $8,400,000 or 32%, from $26,425,000
for the three months ended June 30, 1999.
Voluntary personal lines direct premiums written for the three months ended June
30, 2000 were $9,554,000, an increase of $38,000, or less than 1%, from
$9,516,000 for the three months ended June 30, 1999. PPA direct premiums written
decreased 1% from the year earlier period. Homeowners direct premiums written
for the three months ended June 30, 2000 increased 3% compared to the three
months ended June 30, 1999.
Voluntary commercial lines direct premiums written for the three months ended
June 30, 2000 were $24,972,000, an increase of $8,649,000, or 53%, from
$16,323,000 for the three months ended June 30, 1999, primarily due to
$6,579,000 of direct premiums written related to the Auto Program. Excluding
Auto Program premiums written, voluntary commercial lines direct premiums
written increased $2,070,000, or 13%, due to increases in commercial automobile
(25%) and contractors coverall (20%) premiums written.
Involuntary direct premiums written for the three months ended June 30, 2000
were $300,000, a decrease of $285,000, or 49%, from $585,000 for the three
months ended June 30, 1999. 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 $3,388,000 for the three months ended June 30, 2000, a
$180,000, or 6%, increase from $3,208,000 for the three months ended June 30,
1999, primarily due to a 36 basis point increase in the average investment
portfolio yield.
Losses and LAE were $16,703,000 for the three months ended June 30, 2000, an
increase of $472,000, or 3%, from $16,231,000 for the three months ended June
30, 1999. The loss and LAE ratio increased to 70.8% for the three months ended
June 30, 2000 from 69.0% for the three months ended June 30, 1999.
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 31.9% for the three months ended
June 30, 2000 from 33.0% for the three months ended June 30, 1999 primarily due
to lower agency incentive commissions and to the net impact of the Auto Program.
Commissions, premium taxes and other state assessments that vary with the
Company's premium volume represented 20.4% of net premiums earned in the three
months ended June 30, 2000 compared to 19.8% for the three months ended June 30,
1999.
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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 stockholders' equity and maintaining
flexibility. 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 relative to the duration of its 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. At June 30,
2000, the Company had recorded $1,490,000 of unrealized losses, net of taxes,
associated with its investments classified as "available for sale" as
accumulated other comprehensive income. During the six months ended June 30,
2000 the Company recorded $302,000 of unrealized losses, net of tax, associated
with its available for sale investments as other comprehensive income.
At June 30, 2000, the Company's portfolio of fixed maturities represented 89.2%
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, 2000, $91,243,000, or 49.2%, 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, 2000, $9,806,000, or 4.7% of the Company's investment portfolio was
invested in non-investment grade securities, compared to $11,082,000, or 5.2% at
December 31, 1999.
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During the six months ended June 30, 2000, the Company repurchased 132,600
shares of its common stock at an average price per share of $17.74. The Company
is holding 778,600 shares of its common stock in treasury at June 30, 2000.
The Company has arranged for a $2,000,000 unsecured credit facility from a bank
in the form of a master grid note. Any borrowings under this facility are
payable on demand and carry an interest rate which can be fixed or variable and
is negotiated at the time of each advance. This facility is available for
general working capital purposes and for repurchases of the Company's common
stock. At June 30, 2000, $450,000 was outstanding related to this loan.
As a holding company, the Company is dependent on cash dividends from MNH to
meet its obligations, pay any cash dividends and repurchase its shares. 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
31st. The maximum amount of dividends that MNH could pay during any twelve month
period ending in 2000 without the prior approval of the New Hampshire Insurance
Commissioner is $5,328,000. Dividends of $1,600,000, $2,200,000 and $1,500,000,
were paid in September 1999, February 2000 and May 2000, respectively. On July
26, 2000, MNH's Board of Directors approved a $1,500,000 dividend to be paid to
the Company on September 5, 2000. The Company declared dividends to its common
stockholders of $.20 per share during the six months ended June 30, 2000.
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 2000 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 that may have a time element. The Company has not
encountered any Year 2000 related problems as of the date of this report.
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
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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. For certain classes of commercial risks, MNH adopted endorsements to
its policies that exclude coverage for losses resulting from Year 2000 problems
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 10.4% 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. With the exception of the Company's President, 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 determined that the
terms proposed by Mutual were inadequate. The Company 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. However, the
Company believes that the Management Agreement, as currently written, creates
conflicts of interest between the Company and Mutual in their joint operations
and prevents the Company's shareholders from realizing the fair value of their
shares.
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<PAGE> 17
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 $207,727,000 at June 30, 2000 is subject to
changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The following table provides information related to the Company's fixed maturity
investments at June 30, 2000. The table presents cash flows of principal amounts
and related weighted average interest rates by expected maturity dates. The cash
flows are based upon the maturity date or, in the case of mortgage-backed and
asset-backed securities, expected payment patterns. Actual cash flows could
differ from those shown in the table.
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<PAGE> 18
FIXED MATURITIES
Expected Cash Flows of Principal Amounts ($ in 000's):
<TABLE>
<CAPTION>
Total
-----------------------
Amor- Estimated
There- Tized Market
HELD TO MATURITY 2000 2001 2002 2003 2004 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 $ 1,647 $ 0 $ 0 $ 0 $ 0 $ 0 $ 1,647 $ 1,600
Average interest rate 5.4% 0.0% 0.0% 0.0% 0.0% 0.0% -- --
Mortgage & asset backed
securities 0 196 1,815 1,710 1,556 7,577 12,854 13,120
Average interest rate 0.0% 7.2% 7.2% 7.1% 7.1% 7.3% -- --
------- ------- ------- ------- ------ ------ -------- --------
Total $ 1,647 $ 196 $ 1,815 $ 1,710 $1,556 $7,577 $ 14,501 $ 14,720
======= ======= ======= ======= ====== ====== ======== ========
AVAILABLE FOR SALE
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $7, 400 $18,642 $ 3,814 $ 0 $ 0 $ 0 $ 29,856 $ 29,580
Average interest rate 5.3% 5.4% 6.7% 0.0% 0.0% 0.0% -- --
Obligations of states and
political subdivisions 2,399 8,704 1,711 6,175 0 635 19,624 19,666
Average interest rate 4.9% 4.9% 5.6% 5.2% 0.0% 5.4% -- --
Corporate securities 2,885 17,415 14,640 7,522 862 805 44,129 43,550
Average interest rate 5.5% 6.9% 7.1% 8.4% 8.6% 9.5% -- --
Mortgage & asset
backed securities 16,550 30,665 19,303 6,064 3,334 3,720 79,636 78,301
Average interest rate 6.8% 6.9% 6.9% 7.0% 7.1% 7.2% -- --
------- ------- ------- ------- ------ ------ -------- --------
Total $29,234 $75,426 $39,468 $19,761 $4,196 $5,160 $173,245 $171,097
======= ======= ======= ======= ====== ====== ======== ========
</TABLE>
The above discussion and the estimated amounts referred to above include
forward-looking statements of market risk which involve certain assumptions as
to market interest rates and the credit quality of the fixed maturity
investments. Actual future market conditions may differ materially from such
assumptions. Accordingly, the forward-looking statements should not be
considered projections of future events by the Company.
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<PAGE> 19
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On May 3, 2000 the Company held its annual meeting of stockholders. During the
meeting, Thomas E. Kahn was elected and Henry P. Semmelhack and Robert M. Zak
were re-elected Directors of the Company for three year terms to expire at the
annual meeting in 2003. Andrew A. Alberti, Brent D. Baird, Frank J. Colantuono
and Richard E. Garman are Directors of the Company whose terms of office as
Director continue beyond the date of the meeting. Mr. Baird's and Mr. Garman's
terms expire in 2001 and Mr Alberti's and Mr. Colantuono's terms expire in 2002.
A summary of stockholder voting with respect to the election of Directors is as
follows:
Election of Election of Election of
T. Kahn H. Semmelhack R. Zak
------- ------------- ------
For 1,890,089 1,889,889 1,890,089
Withheld 4,952 5,152 4,952
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(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.
* * * * * * * * *
"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
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<PAGE> 20
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.
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<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 14, 2000 By:/s/ Kenneth J. Wilson
----------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
21
