<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
-------------
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 October 27, 2000.
2,435,752 SHARES OF COMMON STOCK.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERCHANTS GROUP, INC.
CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
December 31, September 30,
Assets 1999 2000
------ -------- --------
(unaudited)
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost (fair value
$14,705 in 1999 and $13,290 in 2000) $ 14,547 $ 12,856
Available for sale at fair value (amortized cost
$183,209 in 1999 and $180,977 in 2000) 182,082 179,350
Preferred stock at fair value 12,941 13,795
Other long-term investments at fair value 797 861
Short-term investments 2,544 4,760
-------- --------
Total investments 212,911 211,622
Cash 2 8
Interest due and accrued 2,117 2,514
Premiums receivable, net of allowance for doubtful
accounts of $431 in 1999 and $410 in 2000 19,964 20,591
Deferred policy acquisition costs 12,309 12,545
Ceded reinsurance balances receivable 5,396 7,252
Prepaid reinsurance premiums 3,168 5,554
Receivable from affiliate -- 279
Deferred income taxes 6,002 5,953
Other assets 7,654 7,557
-------- --------
Total assets $269,523 $273,875
======== ========
</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, September 30,
1999 2000
--------- ---------
(unaudited)
Liabilities and Stockholders' Equity
------------------------------------
<S> <C> <C>
Liabilities:
Reserve for losses and loss adjustment expenses $133,526 $136,239
Unearned premiums 49,616 52,893
Demand loan 1,025 -
Payable to affiliate 618 -
Other liabilities 15,351 14,507
-------- --------
Total liabilities 200,136 203,639
-------- --------
Stockholders' equity:
Common stock, 10,000,000 shares authorized, 2,595,852
shares issued and outstanding at December 31, 1999
and 2,443,852 shares issued and outstanding
at September 30, 2000 32 32
Additional paid in capital 35,680 35,680
Treasury stock, 646,000 shares at December 31, 1999
and 798,000 shares at September 30, 2000 (13,139) (15,834)
Accumulated other comprehensive loss (1,188) (1,183)
Accumulated earnings 48,002 51,541
-------- --------
Total stockholders' equity 69,387 70,236
-------- --------
Commitments and contingent liabilities - -
Total liabilities and stockholders' equity $269,523 $273,875
======== ========
</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 Nine Months
Ended September 30, Ended September 30,
1999 2000 1999 2000
------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C>
Revenues:
Net premiums earned $24,040 $23,822 $71,226 $70,461
Net investment income 3,280 3,481 9,759 10,325
Net realized investment gains 53 104 60 109
Other revenues 95 81 361 163
------- ------- ------- -------
Total revenues 27,468 27,488 81,406 81,058
------- ------- ------- -------
Expenses:
Net losses and loss adjustment
expenses 16,646 17,387 49,204 51,583
Amortization of deferred policy
acquisition costs 6,371 6,313 18,875 18,672
Other underwriting expenses 1,994 1,171 5,518 4,131
------- ------- ------- -------
Total expenses 25,011 24,871 73,597 74,386
------- ------- ------- -------
Income before income taxes 2,457 2,617 7,809 6,672
Income tax provision 807 947 2,660 2,384
------- ------- ------- -------
Net income $ 1,650 $ 1,670 $ 5,149 $ 4,288
======= ======= ======= =======
Basic and diluted earnings per share $ .61 $ .68 $ 1.85 $ 1.71
======= ======= ======= =======
Weighted average shares outstanding:
Basic 2,715 2,457 2,780 2,501
Diluted 2,722 2,459 2,785 2,503
</TABLE>
See Notes to the Consolidated Financial Statements
4
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
1999 2000 1999 2000
------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C>
Net income $ 1,650 $ 1,670 $ 5,149 $ 4,288
Other comprehensive income (loss)
before taxes:
Unrealized gains (losses)
on securities (980) 593 (2,153) (3)
Reclassification adjustment
for gains and losses included
in net income (53) (100) (38) (100)
------- ------- ------- -------
Other comprehensive income (loss)
before taxes (1,033) 493 (2,191) (103)
Income tax provision (benefit) related to
items of other comprehensive income (351) 186 (745) (108)
------- ------- ------- -------
Other comprehensive income (loss) (682) 307 (1,446) 5
------- ------- ------- -------
Comprehensive income $ 968 $ 1,977 $ 3,703 $ 4,293
======= ======= ======= =======
</TABLE>
See Notes to the Consolidated Financial Statements
5
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 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 (5,483) (2,695)
-------- --------
End of period (12,580) (15,834)
-------- --------
Accumulated other comprehensive income (loss):
Beginning of period 1,173 (1,188)
Other comprehensive income (loss) (1,446) 5
-------- --------
End of period (273) (1,183)
-------- --------
Accumulated earnings:
Beginning of period 42,164 48,002
Net income 5,149 4,288
Cash dividends (692) (749)
-------- --------
End of period 46,621 51,541
-------- --------
Total stockholders' equity $ 69,480 $ 70,236
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
6
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1999 2000
-------- --------
(unaudited)
<S> <C> <C>
Cash flows from operations:
Collection of premiums $ 72,143 $ 70,333
Payment of losses and loss adjustment expenses (49,525) (50,443)
Payment of other underwriting expenses (25,549) (23,845)
Investment income received 9,813 9,850
Investment expenses paid (265) (304)
Income taxes paid (2,183) (2,059)
Other 362 163
-------- --------
Net cash provided by operations 4,796 3,695
-------- --------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 75,074 50,975
Purchase of fixed maturities (69,767) (46,057)
Net increase in preferred stock (2,790) (961)
Net (increase) decrease in other long-term investments 75 (64)
Net increase in short-term investments (3,735) (2,216)
Disposition of equipment 696 -
-------- --------
Net cash provided by (used in) investing activities (447) 1,677
-------- --------
Cash flows from financing activities:
Settlement of affiliate balances (3,798) (897)
Increase (decrease) in demand loan, net 500 (1,025)
Cash borrowed to purchase securities 4,946 -
Proceeds from exercise of common stock options 169 -
Purchase of treasury stock (5,483) (2,695)
Cash dividends (692) (749)
-------- --------
Net cash used in financing activities (4,358) (5,366)
-------- --------
Increase (decrease) in cash (9) 6
Cash:
Beginning of period 16 2
-------- --------
End of period $ 7 $ 8
======== ========
</TABLE>
See Notes to the Consolidated Financial Statements
7
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MERCHANTS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1999 2000
------- -------
(unaudited)
<S> <C> <C>
Net income $ 5,149 $ 4,288
Adjustments:
Accretion of bond discount (90) (382)
Realized investment gains (60) (109)
(Increase) decrease in assets:
Interest due and accrued (71) (397)
Premiums receivable 855 (627)
Deferred policy acquisition costs 26 (236)
Ceded reinsurance balances receivable 4,087 (1,856)
Prepaid reinsurance premiums (443) (2,386)
Deferred income taxes (302) 157
Other assets (351) 97
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses (3,938) 2,713
Unearned premiums 346 3,277
Other liabilities (412) (844)
------- -------
Net cash provided by operations $ 4,796 $ 3,695
======= =======
</TABLE>
See Notes to the Consolidated Financial Statements
8
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MERCHANTS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation and Basis of Presentation
-----------------------------------------------------
The consolidated balance sheet as of September 30, 2000 and the related
consolidated statements of operations, of comprehensive income, of changes in
stockholders' equity and of cash flows for the three and nine month periods
ended September 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 September
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 shares of common stock
options for the three and nine month periods in 2000 and 49,000 shares of common
stock options for the three and nine month periods in 1999 which would have
resulted in 1,489 and 6,868 additional shares outstanding for the three month
periods, respectively, and 1,432 and 4,913 additional shares outstanding for the
nine 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 Nine Months Ended September 30, 2000 As Compared
------------------------------------------------------------------------------
to the Nine Months Ended September 30, 1999
-------------------------------------------
Total revenues for the nine months ended September 30, 2000 were $81,058,000, a
decrease of $348,000 or less than 1%, from $81,406,000 for the nine months ended
September 30, 1999.
Direct premiums written for the nine months ended September 30, 2000 were
$82,292,000, an increase of $7,195,000 or 10%, from $75,097,000 for the nine
months ended September 30, 1999. Voluntary direct premiums written for the nine
months ended September 30, 2000 were $81,372,000, an increase of $7,917,000 or
11%, from $73,455,000 for the nine months ended September 30, 1999. Involuntary
direct premiums written for the nine months ended September 30, 2000 were
$920,000, a decrease of $722,000 or 44%, from $1,642,000 for the nine months
ended September 30, 1999. Net premiums written for the nine months ended
September 30, 2000 were $71,352,000, an increase of $223,000 or less than 1%,
from $71,129,000 for the nine months ended September 30, 1999.
During the second quarter of 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 nine months ended
September 30, 2000 were $28,510,000, a decrease of $438,000 or 2%, from
$28,948,000 for the nine months ended September 30, 1999. Private passenger
automobile (PPA) direct premiums written, which represented 75% and 77% of total
voluntary personal lines direct premiums written for the nine months ended
September 30, 2000 and 1999, respectively, decreased 4% 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 nine
months ended September 30, 2000 increased 5% compared to the nine months ended
September 30, 1999.
Voluntary commercial lines direct premiums written for the nine months ended
September 30, 2000 were $52,861,000, an increase of $8,354,000 or 19%, from
$44,507,000 for the nine months ended September 30, 1999. This increase was
primarily attributable to $5,235,000 of direct premiums written for the Auto
Program. There were no Auto Program direct premiums written in the nine months
ended September 30, 1999. Voluntary commercial lines direct premiums written,
excluding the Auto Program, were $47,626,000, an increase of $3,119,000 or 7%,
from $44,507,000 for the nine months ended September 30, 1999. This increase was
due primarily to increases in commercial automobile (13%) and contractors
coverall (16%) premiums written.
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<PAGE> 12
The increase in commercial automobile direct premiums written was primarily
attributable to an 8% increase in average premium per commercial auto policy at
September 30, 2000 compared to September 30, 1999. The increase in contractors
coverall direct premiums written resulted primarily from a 13% 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 nine months ended September 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 nine months ended September 30, 2000 were
$70,461,000, a decrease of 1% from $71,226,000 for the nine months ended
September 30, 1999. A 4% increase in voluntary premiums earned excluding the
Auto Program, to $74,516,000 was offset by a 53% decrease in involuntary
premiums earned to $1,352,000. Ceded premiums earned excluding the Auto Program,
of $4,998,000, increased 2% from the year earlier period. The decrease in
involuntary premiums earned 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 $10,325,000 for the nine months ended September 30,
2000, an increase of 6% from $9,759,000 for the nine months ended September 30,
1999. The increase in net investment income resulted primarily from a 35 basis
point increase in the average pre-tax yield associated with the investment
portfolio for the nine months ended September 30, 2000, compared to the nine
months ended September 30, 1999. Average invested assets for the nine months
ended September 30, 2000 increased less than 1% compared to the year earlier
period.
Losses and LAE were $51,583,000 for the nine months ended September 30, 2000, an
increase of $2,379,000 or 5%, from $49,204,000 for the nine months ended
September 30, 1999. The loss and LAE ratio increased to 73.2% for the nine
months ended September 30, 2000 from 69.1% for the nine months ended September
30, 1999. The increase in loss and LAE ratio related primarily to the current
accident year and was attributable to an increase in claims frequency and
severity in the Company's private passenger automobile and commercial automobile
lines of business.
The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 32.4% for the nine months ended
September 30, 2000 from 34.3% for the nine months ended September 30, 1999
primarily due to agency incentive commissions which were $1,111,000 lower in the
first nine months of 2000, compared to the first nine months of 1999. The
decrease in agency incentive commissions resulted from the increase in losses
and LAE and from revisions to the profit sharing program for agents. Expenses
that vary with the Company's premium volume such as commissions, premium taxes
and other state assessments represented 18.0% of net premiums earned in the nine
months ended September 30, 2000 compared to 19.7% for the nine months ended
September 30, 1999, primarily due to the lower agency incentive commissions.
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The Company's effective income tax rate for the nine months ended September 30,
2000 was 35.7%. This rate was calculated based upon the Company's estimate of
its effective income tax rate for all of 2000. Non-taxable investment income,
including tax-exempt income and non-taxable corporate dividends, reduced the
Company's effective tax rate by approximately 5 percentage points.
Results of Operations for the Three Months Ended September 30, 2000 As Compared
-------------------------------------------------------------------------------
to the Three Months Ended September 30, 1999
--------------------------------------------
Total revenues for the three months ended September 30, 2000 were $27,488,000,
an increase of $20,000, or less than 1%, from $27,468,000 for the three months
ended September 30, 1999. Direct premiums written for the three months ended
September 30, 2000 were $23,997,000, a decrease of $1,395,000 or 5%, from
$25,392,000 for the three months ended September 30, 1999.
Voluntary personal lines direct premiums written for the three months ended
September 30, 2000 were $10,493,000, an increase of $146,000, or 1%, from
$10,347,000 for the three months ended September 30, 1999. PPA direct premiums
written decreased 2% from the year earlier period. Homeowners direct premiums
written for the three months ended September 30, 2000 increased 10% compared to
the three months ended September 30, 1999 due to an increase in policies in
force.
Voluntary commercial lines direct premiums written for the three months ended
September 30, 2000 were $13,140,000, a decrease of $1,304,000, or 9%, from
$14,444,000 for the three months ended September 30, 1999, primarily due to
premiums related to the Auto Program that were canceled at the insured's
request. Excluding Auto Program direct premiums written, voluntary commercial
lines direct premiums written increased $40,000, or less than 1%.
Involuntary direct premiums written for the three months ended September 30,
2000 were $364,000, a decrease of $236,000, or 39%, from $600,000 for the three
months ended September 30, 1999. Involuntary direct 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 $3,481,000 for the three months ended September 30,
2000, a $201,000, or 6%, increase from $3,280,000 for the three months ended
September 30, 1999, primarily due to a 37 basis point increase in the average
investment portfolio yield.
Losses and LAE were $17,387,000 for the three months ended September 30, 2000,
an increase of $741,000, or 4%, from $16,646,000 for the three months ended
September 30, 1999. The loss and LAE ratio increased to 73.0% for the three
months ended September 30, 2000 from 69.2% for the three months ended September
30, 1999 primarily due to an increase in claims frequency and severity in the
Company's private passenger automobile and commercial automobile lines of
business.
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The ratio of amortized deferred policy acquisition costs and other underwriting
expenses to net premiums earned decreased to 31.4% for the three months ended
September 30, 2000 from 34.8% for the three months ended September 30, 1999,
primarily due to lower agency incentive commissions. Commissions, premium taxes
and other state assessments that vary with the Company's premium volume
represented 18.3% of net premiums earned in the three months ended September 30,
2000 compared to 20.3% for the three months ended September 30, 1999.
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 September
30, 2000, the Company recorded as accumulated other comprehensive loss in its
Consolidated Balance Sheet $1,183,000 of unrealized losses, net of taxes,
associated with its investments classified as available for sale. During the
nine months ended September 30, 2000 the Company recorded $307,000 of unrealized
gains, net of tax, associated with its available for sale investments as other
comprehensive income.
At September 30, 2000, 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 September 30, 2000, $87,050,000, or 45.3%, 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
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liquidity does not differ from that of other fixed maturity investments. The
Company does not own any other derivative financial instruments.
At September 30, 2000, $9,480,000, or 4.5% 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.
During the nine months ended September 30, 2000, the Company repurchased 152,000
shares of its common stock at an average price per share of $17.73. The Company
is holding 798,000 shares of its common stock in treasury at September 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. No amount was outstanding related to this loan at September 30, 2000.
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 $2,200,000, $1,500,000 and $1,500,000
were paid in February 2000, May 2000 and September 2000, respectively. The
Company declared dividends to its common stockholders of $.30 per share during
the nine months ended September 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 nine months of 2000 MNH's
ratio of net premiums written to statutory surplus, annualized for a full year,
was 1.8 to 1.
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
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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 officers of the Company and
MNH are paid full time 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.
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 $211,622,000 at September 30, 2000 is subject
to changes in interest rates and to a lesser extent on credit quality. Further,
certain mortgage-backed and asset-backed securities are exposed to accelerated
prepayment risk generally caused by interest rate movements. If interest rates
were to decline, mortgage holders would be more likely to refinance existing
mortgages at lower rates. Acceleration of future repayments could adversely
affect future investment income, if reinvestment of the accelerated receipts was
made in lower yielding securities.
The following table provides information related to the Company's fixed maturity
investments at September 30, 2000. The table presents cash flows of principal
amounts and related weighted average interest rates by expected maturity dates.
The cash flows are based upon the maturity date or, in the case of
mortgage-backed and asset-backed securities, expected payment patterns. Actual
cash flows could differ from those shown in the table.
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<PAGE> 17
Fixed Maturities
----------------
Expected Cash Flows of Principal Amounts ($ 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>
Mortgage & asset backed
securities 0 0 642 1,644 1,556 9,014 12,856 13,290
Average interest rate 0.0% 0% 7.2% 7.1% 7.1% 7.3% --- ---
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 0 $ 0 $ 642 $ 1,644 $ 1,556 $ 9,014 $ 12,856 $ 13,290
======== ======== ======== ======== ======== ======== ======== ========
Available for Sale
------------------
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 7,000 $ 18,652 $ 3,819 $ 0 $ 0 $ 5,255 $ 34,726 $ 34,585
Average interest rate 5.3% 5.4% 6.8% 0.0% 0.0% 7.5% --- ---
Obligations of states and
political subdivisions 2,000 8,701 1,712 4,491 0 420 17,324 17,393
Average interest rate 4.7% 4.9% 5.6% 5.3% 0.0% 5.3% --- ---
Corporate securities 1,628 19,071 24,682 7,540 0 806 53,727 53,178
Average interest rate 5.6% 7.0% 7.2% 8.4% 0% 9.4% --- ---
Mortgage & asset
backed securities 5,489 31,701 19,922 6,896 3,240 7,952 75,200 74,194
Average interest rate 6.8% 6.9% 6.9% 7.0% 7.1% 7.2% --- ---
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 16,117 $ 78,125 $ 50,135 $ 18,927 $ 3,240 $ 14,433 $180,977 $179,350
======== ======== ======== ======== ======== ======== ======== ========
</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.
17
<PAGE> 18
PART II. OTHER INFORMATION
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, the
Company's dependence on state insurance departments for approval of rate
increases, 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.
18
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
MERCHANTS GROUP, INC.
(Registrant)
Date: November 13, 2000 By:/s/ Kenneth J. Wilson
----------------------
Kenneth J. Wilson
Chief Financial Officer and
Treasurer (duly authorized
officer of the registrant and
chief accounting officer)
19
