<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO ___________.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 1-9640
MERCHANTS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1280763
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
250 MAIN STREET, BUFFALO, NEW YORK 14202
(Address of principal executive offices) (Zip Code)
716-849-3333
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class - COMMON STOCK, $.01 PAR VALUE PER SHARE
Name of each exchange on which registered - AMERICAN STOCK EXCHANGE, INC.
Securities registered pursuant to Section 12 (g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of February 29, 2000, 2,543,452 shares of common stock were outstanding. The
aggregate market value of the common shares held by non-affiliates of Merchants
Group, Inc. on February 29, 2000 was $47,054,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2000 Annual Meeting of
stockholders are incorporated by reference into Part III.
<PAGE> 2
MERCHANTS GROUP, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2000
<TABLE>
<CAPTION>
PART I PAGE #
------ ------
<S> <C> <C>
ITEM 1. BUSINESS. 3
ITEM 2. PROPERTIES. 19
ITEM 3. LEGAL PROCEEDINGS. 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 19
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED 20
STOCKHOLDER MATTERS.
ITEM 6. SELECTED FINANCIAL DATA. 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 23
CONDITION AND RESULTS OF OPERATIONS.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 29
ABOUT MARKET RISK.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 31
ACCOUNTING AND FINANCIAL DISCLOSURE.
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 32
ITEM 11. EXECUTIVE COMPENSATION. 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 32
AND MANAGEMENT.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 32
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND 33
REPORTS ON FORM 8-K.
</TABLE>
2
<PAGE> 3
PART I
Item 1. BUSINESS.
General
- -------
Merchants Group, Inc. (the "Company") was incorporated in August 1986 as a
Delaware holding company which, through its wholly owned subsidiary Merchants
Insurance Company of New Hampshire, Inc. ("MNH"), offers property and casualty
insurance to preferred risk individuals and small to medium sized businesses in
the northeastern United States.
Administration
- --------------
The Company and MNH operate and manage their business in conjunction with
Merchants Mutual Insurance Company ("Mutual"), a New York domiciled mutual
property and casualty insurance company, under a management agreement (the
"Management Agreement"). Mutual owns 10.0% of the Company's issued and
outstanding common stock. The Company and MNH do not have any operating assets
and have no employees. Under the Management Agreement, Mutual provides the
Company and MNH with the facilities, management and personnel required to
operate their day-to-day business. All costs incurred by Mutual with respect to
underwriting expenses are shared pro rata between Mutual and MNH based upon
their annual direct premiums written, and unallocated loss adjustment expenses
are allocated on the basis of the number of claims outstanding each month that
are attributable to each company. All of Mutual's and MNH's investment expenses
are shared pro rata based upon the average book value of the invested assets of
each company. MNH also pays Mutual an annual management fee of $50,000. The
Management Agreement requires that the Company and MNH pay Mutual 110% of
Mutual's costs of providing them with non-insurance related services, and that
the Company pay Mutual an annual fee of one half of one percent (.5%) of the
average book value of the Company's invested assets exclusive of the Company's
shares of MNH. Since the inception of the Management Agreement, Mutual has not
provided the Company or MNH with any non-insurance related services.
The Management Agreement has certain features that are intended to prevent
conflicts of interest or to deal with them on an equitable basis should they
occur. Generally, business opportunities which are presented to the common
officers or employees of the companies must be presented to each company's Board
of Directors and approved and determined to be fair to each company in the
transaction by a majority of the directors of each company who are not
affiliated with any other company in the transaction.
Any amendment to or modification of the Management Agreement must be
approved by the New York Insurance Department (the "Department"). The Management
Agreement provides that it may be terminated by any party to the agreement upon
five years written notice. On July 23, 1998, the Company gave notice of its
intention to terminate the Management Agreement to Mutual. Mutual and MNH have
jointly developed and paid for all accounting, computer and insurance marketing
systems used in their businesses. Upon termination of the Management Agreement,
each company will have the right, at no cost, to obtain copies of all these
systems, together with the right to use these systems in perpetuity.
3
<PAGE> 4
Marketing
- ---------
The Company markets its products through approximately 684 independent
agents, which also represent Mutual. The Company's primary marketing efforts are
directed to those independent agents that are dedicated to providing superior
service to their customers. The Company believes the opportunity for growth
exists through further penetration of agencies that are strategically aligned
with the Company's commitment to growth in its targeted markets.
The Company believes that as a regional insurance company it has certain
advantages, including a closer relationship with its agents and a better
knowledge of its operating territories, that enable it to compete effectively
against larger regional and national carriers. The Company believes it
distinguishes itself from its competitors by providing its agents and
policyholders with superior service and ease of doing business, products that
target certain segments of the commercial and personal insurance markets, and an
agents' compensation program which, in addition to standard commission rates,
provides agents with a profit sharing plan.
The Company services its agents from five Strategic Business Centers and
from its home office in Buffalo, New York. The Strategic Business Centers are
located in the Company's operating territories and focus primarily on policy
sales and underwriting. The manager of a Strategic Business Center appoints new
agents, agrees upon annual unit sales and premium objectives with the principal
of the agency, and ensures that the principal of the agency communicates these
objectives to the agency's sales staff. Strategic Business Center managers and
Territorial Managers, or "TM's," develop customized business plans for each
agent, which identify the opportunities to increase business and the actions
required to achieve the objectives agreed to by the agent and the Company.
TM's meet with targeted agents' sales staff on a frequent basis to
underwrite the Company's renewal policies, as well as to solicit policies new to
the agent and/or to the Company. TM's are equipped with electronic technology to
provide prompt and efficient pricing and communication and can provide quotes
for all lines of business at the agents' offices. The Company believes personal
contact between TM's, who have underwriting authority, and an agent's sales
staff provides the Company with a competitive advantage compared to many other
property and casualty insurers, whose field representatives have limited or no
underwriting authority. By placing an underwriting decision maker in the agent's
office, and thereby simplifying the underwriting process, the Company believes
it can maintain and improve the retention rate on its renewal policies, as well
as attract new policies.
Each Strategic Business Center has an Agents' Advisory Council that meets
at least twice a year. The Advisory Councils provide a forum for the Company and
its agents to discuss issues of mutual interest, and to assure that the agents'
business needs are being met. Additionally, the Chairpersons of the Advisory
Councils from each Strategic Business Center meet twice each year with senior
officers of MNH.
In addition to standard commissions paid as a percentage of premiums
written, the Company's agents are eligible to participate in the Agents' Profit
Sharing Plan. This plan rewards agents based on premiums written and the loss
and allocated loss adjustment expense ("LAE") ratio on business placed by the
agent with the Company. Payments under the Agents' Profit Sharing Plan for 1999
totaled $2,375,000, or 2.4% of total direct premiums written. The Company
believes the terms of its
4
<PAGE> 5
Agents' Profit Sharing Plan encourage its agents to increase the volume of
profitable business they place with the Company.
Unlike many of its competitors, the Company pays the same commission rate
on policies billed directly to the insured by the Company and on policies billed
to the agent and, in turn, re-billed to the insured by the agent. By offering to
bill the insured directly for both personal and commercial policies, the Company
helps its agents minimize their administrative costs without a reduction in
commission income. Approximately 90% of the voluntary premiums written by the
Company in 1999 were billed directly to policyholders.
In order to assist its independent agents to compete more effectively with
insurance companies that have direct sales forces, and to strengthen its
relationship with those agents, the Company provides advanced automation
services. In 1999, the Company introduced the Merchants MerLink(TM) system.
MerLink(TM) enables independent agents to submit policies to Merchants over the
Internet using their existing business computer and software, and to have these
submissions automatically update the Company's insurance policy processing
system. The benefits to agents are simplified client management, more time
available for sales activities, and fewer errors. Currently, the Company is
using MerLink(TM) for policy transactions with approximately 82 agents for
private passenger automobile and homeowners' policies. The Company plans to
offer MerLink(TM) capability for commercial lines insurance policies during the
first half of 2000. The Company believes that developing automation capabilities
to facilitate the sharing of information with its agents will improve its
competitive position compared to other property and casualty insurers that do
not have such capabilities.
Insurance Underwriting
- ----------------------
The Company is licensed to issue insurance policies in 13 states,
primarily in the northeastern United States. In 1999, net premiums written
totaled $94,470,000, with 58% of the net premiums written derived from
commercial lines of insurance and 42% from personal lines of insurance.
The following table sets forth the distribution of the Company's direct
premiums written by state for the years indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
New York 66% 65% 64%
New Jersey 15 18 19
New Hampshire 10 9 8
Rhode Island 3 3 4
Pennsylvania 2 2 2
Massachusetts 2 2 2
Other 2 1 1
--- --- ---
Total 100% 100% 100%
=== === ===
</TABLE>
5
<PAGE> 6
The Company is licensed to underwrite most major lines of property and
casualty insurance. It issues policies primarily to preferred risk individuals
and small to medium sized commercial risks. In general, the Company does not
insure risks that involve a high potential of loss or have a long-tail reporting
period. The types of risks insured in the Company's lines of business include:
o Personal automobile - full coverage of family-owned standard
performance automobiles, generally requiring drivers with good
driving records during the past three years.
o Homeowners' - properties generally with no losses in the last
three years that are less than 30 years old and valued between
$125,000 and $500,000.
o Commercial automobile - primarily light and medium use
vehicles operating in a limited radius, with complete
background information required of all drivers.
o Commercial multi-peril - properties with medium to high
construction quality and low to moderate fire exposure, and
occupancies with low to moderate exposure to hazardous
materials and processes.
o General liability - low hazard service, mercantile and light
processing businesses, generally with three years of business
experience and with no losses in the last three years.
o Workers' compensation - risks with low loss frequency and
severity, low to moderate exposure to hazardous materials and
processes, and favorable experience modification factors.
Generally, workers' compensation insurance is written in
conjunction with other commercial insurance.
The Company's underwriting strategy is to offer its insurance at rates
which are designed to cover its costs, including the costs of any involuntary
business associated with a particular line of insurance or a particular
territory. This pricing strategy makes the Company's rates non-competitive with
respect to certain lines of insurance or certain geographic regions. For
example, the Company's published rates for personal automobile insurance in the
densely populated areas within its region of operations are significantly higher
than those of some of its competitors. The Company believes that its pricing
strategy allows the Company to write the types of insurance for which the price
charged reflects the cost of providing coverage.
Agents of the Company are also agents of Mutual, which generally sells the
same lines of insurance as the Company to standard risk individuals and
businesses. Applicants that meet the Company's preferred risk criteria are
issued policies by the Company. Applicants that do not meet the Company's
underwriting criteria, but which meet the less restrictive criteria of Mutual,
are issued policies by Mutual, generally at higher premium rates. From 1993
through 1995, under a quota share reinsurance agreement with Mutual, MNH assumed
10% of the standard risks insured by Mutual, which would not generally meet
MNH's more stringent underwriting guidelines. The terms of that agreement allow
Mutual to reduce its cessions to MNH to 0% of Mutual's direct voluntary premiums
written for any calendar year prior to the beginning of that calendar year.
Mutual has not ceded any of its voluntary direct written premiums to MNH under
this agreement since 1995 and has informed the Company that it will not cede any
of its voluntary direct written premiums to MNH in 2000.
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<PAGE> 7
The Company establishes premium rates for most of its policies based on
its loss experience, in some cases after considering prospective loss costs
suggested by the Insurance Services Office, Inc., an industry advisory group,
for the preferred individual and commercial classes of business that it insures.
The Company establishes rates independently for its personal automobile and
homeowners insurance policies and its specialty products, such as its
Contractors Coverall Plus and businessowners' policies.
The following table shows, for each of the years in the three year period
ended December 31, 1999 (i) the amount of the Company's net premiums written
attributable to various personal lines and commercial lines and (ii)
underwriting results attributable to each such line as measured by the calendar
year loss ratio for such line. The loss ratio is the ratio of incurred losses to
net premiums earned for a given period.
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------------------------------------------------------
1997 1998 1999
------------------------------------------------------------------------------------------------
Premiums Premiums Premiums
Written Written Written
------------------------------------------------------------------------------------------------
Loss Loss Loss
Amount % Ratio Amount % Ratio Amount % Ratio
------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Personal
Auto Liability $26,187 27.0% 69.7% $21,394 23.1% 79.3% $18,915 20.0% 77.1%
Auto Physical Damage 13,570 14.0 45.8 13,199 14.2 45.8 12,328 13.1 49.0
Homeowners'
Multi-Peril 7,789 8.0 35.7 8,066 8.7 36.5 8,630 9.1 56.2
------- ----- ------- ----- ------- -----
Total 47,546 49.0 57.5 42,659 46.0 61.8 39,873 42.2 64.1
Commercial
Auto Liability 12,377 12.8 100.7 12,986 14.0 41.5 14,816 15.7 50.9
Auto Physical Damage 2,948 3.1 45.8 3,025 3.3 49.8 3,819 4.1 54.7
Commercial
Multi-Peril 21,287 22.0 44.6 21,878 23.6 49.5 22,854 24.2 69.5
Workers'
Compensation 7,070 7.3 169.0 7,159 7.7 87.8 7,692 8.1 22.0
Other Lines 5,583 5.8 6.0 5,051 5.4 39.1 5,416 5.7 37.6
------- ----- ------- ----- ------- -----
Total 49,265 51.0 73.6 50,099 54.0 50.6 54,597 57.8 53.7
------- ----- ------- ----- ------- -----
Total Personal &
Commercial $96,811 100.0% 65.7 $92,758 100.0% 56.5 $94,470 100.0% 58.2
======= ===== ======= ===== ======= =====
</TABLE>
Calendar year loss ratios set forth in the table above include an estimate
of losses for that accident year, as well as increases or decreases in estimates
made in that year for prior accident year losses. Depending on the size of the
increase or decrease in prior accident year losses, calendar year loss ratios
may not be as indicative of the profitability of policies in force in a
particular year as accident year loss ratios, which do not take into account
increases or decreases in reserves for prior accident year losses.
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<PAGE> 8
The following table sets forth the composition of voluntary direct
premiums written for 1995 through 1999:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Commercial 62% 60% 57% 58% 61%
Personal 38 40 43 42 39
--- --- --- --- ---
Total 100% 100% 100% 100% 100%
=== === === === ===
</TABLE>
Commercial Lines
- ----------------
The Company's commercial business is primarily retail and mercantile in
nature and generally consists of small to medium sized, low hazard commercial
risks which as a group have relatively stable loss ratios. The Company's
underwriting criteria exclude lines of business and classes of risks that are
considered by the Company to be high hazard or volatile, or which involve latent
injury potential or other long-tail liability exposures. Although the commercial
underwriting objectives of the Company and Mutual are similar, the Company has
refined its selection criteria to include specific classes of businesses,
occupancies, and operations with lower hazard ratings, which present a
relatively lower exposure to loss and are charged a correspondingly lower
premium. The Company offers specialized products within the commercial
multi-peril line such as the Contractors Coverall Plus for artisan and trade
contractors, and BusinessElite for specified retail, service and office risks.
Despite the lack of significant premium rate increases in recent years in
most of its commercial lines and the significant level of competition in the
lines of business that the Company targets, the Company believes it can insure
commercial business profitably by selecting those classes of risks that offer
better than average profit potential. The Company competes for commercial
business based upon the service it provides to agents and policyholders, the
compensation it pays to its agents, and in certain instances, the price of its
products. The Company establishes prices after considering its costs, the
exposures inherent in a particular class of risk, estimated investment income,
projected future trends in loss frequency and severity, and the degree of
competition within a specific territory. Accordingly, the relative prices of the
Company's commercial products may vary considerably in relation to competitors'
prices.
Personal Lines
- --------------
The Company offers personal automobile and homeowners' insurance to
preferred risk individuals, generally requiring experienced drivers with no
accidents or moving violations in the last three years for personal automobile
insurance, and medium to high value homes with systems that are less than thirty
years old in fire protected areas for homeowners' insurance. Personal automobile
premium rates attempt to cover costs associated with required participation in
involuntary personal automobile programs, in addition to the costs directly
associated with the policies written voluntarily.
The Company and Mutual have developed automated underwriting procedures
for personal automobile, homeowners and certain commercial lines of business,
which perform an initial review of policy applications based upon established
underwriting guidelines. Applications that do not meet the guidelines for
automated acceptance are either referred to underwriters who review the
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<PAGE> 9
applications and assess exposure, or rejected if the risk characteristics are
such that neither the Company nor Mutual would accept the applicant.
As a condition to writing voluntary business in most states in which it
operates, the Company must participate in state-mandated programs which provide
insurance for individuals and businesses unable to obtain insurance voluntarily,
primarily for personal automobile insurance. The legislation creating these
programs usually allocates a pro rata portion of the risks attributable to such
insureds to each company writing voluntary business in the state on the basis of
its voluntary premiums written or the number of automobiles which it insures
voluntarily.
The Company's gross (direct and assumed) premiums written attributable to
involuntary policies were $12,719,000, $6,036,000 and $3,726,000 in 1997, 1998
and 1999, respectively, mostly in New York. The Company is unable to predict the
level of its annual involuntary business for 2000 or future years.
Claims
- ------
Insurance claims on policies written by the Company are investigated and
settled by claims adjusters employed by Mutual pursuant to the Management
Agreement. The Company and Mutual maintain several claims offices within their
operating territories. In areas where there is insufficient claim volume to
justify the cost of internal claims staff, the Company and Mutual use
independent appraisers and adjusters to investigate claims. The Company's claims
policy emphasizes timely investigation of claims, settlement of valid claims for
equitable amounts, maintenance of adequate reserves for claims and control of
external claims adjustment expenses. In order to support its claims policy, the
Company has implemented a program designed to ensure that as soon as practical,
claims are assigned an accurate value based on available information. The
program includes the centralization of certain branch claims operations and an
emphasis on the training of claims adjusters and supervisors by senior claims
staff. This claims policy is designed to support the Company's marketing policy
and provide agents and policyholders with prompt service and support.
Claims settlement authority levels are established for each adjuster,
supervisor and manager based on their expertise and experience. When the Company
receives notice of a claim, it is assigned to an adjuster based upon its type,
severity and line of business. The claims staff then reviews the claim, obtains
appropriate information and establishes a loss reserve. Claims that exceed
certain dollar amounts or that cannot be readily settled are assigned to more
senior claims staff.
Loss and LAE Reserves
- ---------------------
The Company, like other insurance companies, establishes reserves for
losses and LAE. These reserves are estimates intended to cover the probable
ultimate cost of settling all losses incurred and unpaid, including those losses
not yet reported to the Company. An insurer's ultimate liability is likely to
differ from its interim estimates because during the life of a claim, which may
be many years, additional facts affecting an insurer's liability may become
known. The reserves of an insurer are frequently adjusted based on monitoring by
the insurer and periodic review by state insurance departments. The Company
retains an independent actuarial firm to satisfy state insurance departments'
requirements with respect to the certification of reserves for losses and LAE.
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<PAGE> 10
Loss reserves are established for known claims based on the type and
circumstance of the loss and the results of similar losses. For claims not yet
reported to the Company, loss reserves are based on statistical information from
previous experience periods adjusted for inflation, trends in court decisions
and economic conditions. LAE reserves are intended to cover the ultimate cost of
investigating all losses that have occurred and defending lawsuits, if any,
arising from these losses. LAE reserves are evaluated periodically using
statistical techniques which compare current costs with historical data.
Inflation is implicitly reflected in the reserving process through analysis of
cost trends and review of historical reserve results. With the exception of
workers' compensation claims, loss reserves are not discounted for financial
statement purposes.
The Company's reserving process is based on the assumption that past
experiences, adjusted for the effect of current developments and trends, are
relevant in predicting future events. In the absence of specific developments,
the process also assumes that the legal climate regarding the claims process and
underlying liabilities remains constant. Other assumptions employed by the
Company or its actuarial firm change from time to time as circumstances change.
In estimating loss and LAE reserves, the Company employs a number of actuarial
methods, depending on their applicability to each line of business, in order to
balance the advantages and disadvantages of each method. No single method is
used to estimate loss and LAE reserves. Although different actuarial methods may
give rise to different reserve estimates, which may be higher or lower than the
reserves actually established by the Company, the Company believes that those
differences are not material.
The Company has recorded changes in reserves for prior accident year
losses in most years. In 1997, the Company increased its reserves for prior
years by $4,508,000 primarily due to higher than anticipated severity of claims
on workers' compensation policies. In 1998 and 1999, the Company decreased its
reserves for prior years by $2,145,000 and $3,749,000, respectively, primarily
due to favorable loss experience related to automobile liability policies in
1998 and workers compensation policies in 1999.
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The following table sets forth the changes in the reserve for losses and
LAE for 1997, 1998 and 1999.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Reserve for losses and LAE at beginning of year $133,479 $141,205 $136,685
Less reinsurance recoverables 7,219 10,372 9,816
-------- -------- --------
Net balance at beginning of year 126,260 130,833 126,869
-------- -------- --------
Provision for losses and LAE for claims occurring in:
Current year 67,119 67,379 69,835
Prior years 4,508 (2,145) (3,749)
-------- -------- --------
71,627 65,234 66,086
-------- -------- --------
Losses and LAE payments for claims occurring in:
Current year 26,100 26,765 28,330
Prior years 40,954 42,433 37,125
-------- -------- --------
67,054 69,198 65,455
-------- -------- --------
Reserve for losses and LAE at end of year, net 130,833 126,869 127,500
Plus reinsurance recoverables 10,372 9,816 6,026
-------- -------- --------
Balance at end of year $141,205 $136,685 $133,526
======== ======== ========
</TABLE>
The first line of the following table presents, as of the end of the year
at the top of each column, the estimated amount of unpaid losses and LAE for
claims arising in that year and in all prior years, including claims that had
occurred but were not yet reported to the Company. For each column, the rows of
the table present, for the same group of claims, the amount of unpaid losses and
LAE as re-estimated as of the end of each succeeding year. The estimate is
modified as more information becomes known about the number and severity of
claims for each year. The "cumulative redundancy (deficiency)" represents the
change in the estimated amount of unpaid losses and LAE from the end of the year
at the top of each column through the end of 1999.
For each column in the table, the change from the liability for losses and
LAE shown on the first line to the liability as re-estimated as of the end of
the following year was included in operating results for the following year.
That change includes the change in the previous year's column from the liability
as re-estimated one year later to the liability as re-estimated two years later
which, in turn, includes the change in the second preceding column from the
liability as re-estimated two years later to the liability as re-estimated three
years later, and so forth.
The rows of the lower portion of the table present, as of the end of each
succeeding year, the amount of paid losses and LAE for claims unpaid at the end
of the year at the top of each column.
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<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for losses and LAE:
$66,892 $71,222 $77,274 $ 86,159 $ 89,939 $ 97,614 $113,718 $126,260 $130,781 $126,820
Liability re-estimated as of:
One year later 75,614 77,548 80,841 88,284 94,921 108,659 120,550 130,768 128,636 123,071
Two years later 76,310 75,987 81,743 91,224 100,607 113,091 128,192 133,029 130,498
Three years later 73,578 78,106 83,693 95,396 106,382 121,051 129,724 132,948
Four years later 75,672 79,563 87,105 99,779 112,983 121,791 131,647
Five years later 76,746 81,308 90,428 104,699 112,963 122,886
Six years later 77,026 84,530 92,370 104,808 112,963
Seven years later 79,690 85,219 93,046 105,183
Eight years later 79,890 84,765 93,346
Nine years later 79,415 84,896
Ten years later 80,020
Cumulative Redundancy (Deficiency):
$ (13,128) (13,674) (16,072) (19,024) (23,024) (25,272) (17,929) (6,688) 283 3,749
% (19.6) (19.2) (20.8) (22.1) (25.6) (25.9) (15.8) (5.3) .2 3.0
Paid (Cumulative) as of:
One year later 32,538 32,666 30,082 35,724 34,551 36,916 38,549 40,954 42,433 37,125
Two years later 47,816 47,339 50,490 56,003 56,965 60,074 64,323 69,035 66,477
Three years later 58,489 61,585 63,925 69,863 72,963 77,982 84,638 86,364
Four years later 66,466 70,219 72,917 80,156 83,998 91,948 96,491
Five years later 71,322 75,018 79,374 86,808 93,295 99,171
Six years later 73,558 78,398 82,602 91,919 96,949
Seven years later 75,822 79,884 84,707 94,022
Eight years later 76,683 80,706 85,920
Nine years later 76,996 81,320
Ten years later 77,351
</TABLE>
The loss and LAE reserves reported in the Company's consolidated financial
statements prepared in accordance with generally accepted accounting principles
("GAAP") differ from those reported in the statements filed by MNH with the New
Hampshire Insurance Department in accordance with statutory accounting
principles ("STAT") as follows:
<TABLE>
<CAPTION>
As of December 31,
---------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Loss and LAE reserves on a STAT basis $130,781 $126,820 $127,458
Adjustments:
Ceded reinsurance balances recoverable 10,372 9,816 6,026
Write-down of reinsurance recoverable 52 49 42
-------- -------- --------
Loss and LAE reserves on a GAAP basis $141,205 $136,685 $133,526
======== ======== ========
</TABLE>
12
<PAGE> 13
Reinsurance
- -----------
The Company follows the customary industry practice of reinsuring a
portion of the exposure under its policies and as consideration pays to its
reinsurers a portion of the premium received on its policies. Insurance is ceded
principally to reduce an insurer's liability on individual risks and to protect
against catastrophic losses. Although reinsurance does not legally discharge an
insurer from its primary liability for the full amount of coverage provided by
its policies, it does make the assuming reinsurer liable to the insurer to the
extent of the reinsurance ceded.
The Company is a party to reinsurance contracts under which certain types
of policies are automatically reinsured without the need for approval by the
reinsurer with respect to the individual risks that are covered ("treaty"
reinsurance). The Company also is a party to reinsurance contracts which are
handled on an individual policy or per risk basis and require the specific
agreement of the reinsurer as to each risk insured ("facultative" reinsurance).
Occasionally, the Company may secure facultative reinsurance to supplement its
coverage under treaty reinsurance.
Effective January 1, 1998, the Company changed its primary reinsurer and
coverage. Prior to that time, the Company's excess of loss arrangements for
automobile liability, general liability and workers' compensation insurance
provided for recovery of losses over $500,000 up to a maximum of $5,000,000 per
occurrence. For claims occurring prior to 1993, the $500,000 threshold was
indexed for inflation for casualty lines other than workers' compensation and
New York State no-fault, and applied retroactively to all occurrences until they
are settled. There was no index provision for casualty claims occurring after
1992. This coverage was supplemented by additional treaty reinsurance covering
losses up to $5,000,000 in excess of the first $5,000,000.
Prior to January 1, 1998, property reinsurance agreements provided for
recovery of property losses over $500,000 up to $2,000,000 per occurrence
without any index provision. Property catastrophe coverage placed with many
reinsurers worldwide provided for recovery of 95% of $40,000,000, subject to
aggregate retained losses of $5,000,000 for each natural disaster. The
reinsurance premium rate paid varied for each line of business.
Effective January 1, 1998, the new property and casualty excess of loss
reinsurance agreements provide for recovery of casualty losses over $500,000 up
to $10,000,000 per occurrence and property losses over $500,000 up to
$10,000,000 per occurrence. This coverage is supplemented by a contingent
casualty layer of reinsurance for workers' compensation claims of $5,000,000 in
excess of the first $10,000,000 subject to a calendar year limit of $20,000,000.
Property catastrophe coverage provides for recovery of 95% of $50,000,000,
subject to aggregate retained losses of $5,000,000 per occurrence. The property
catastrophe reinsurance coverage is shared by the Company and Mutual on a pro
rata basis based upon the gross reported losses of the Company and Mutual for a
covered event.
In 1987, the Company and its primary reinsurer agreed to limit the losses
which could be recovered by the Company under its excess of loss treaties for
the 1980 through 1986 accident years in exchange for a cap on retrospective
premiums due to the reinsurer. At December 31, 1999, recoverable losses exceeded
the cap and the excess losses have been retained by the Company.
Effective January 1, 1993, Mutual and MNH entered into a quota share
reinsurance agreement under which MNH may assume up to 10% of Mutual's direct
voluntary written premiums and related
13
<PAGE> 14
losses and allocated LAE in exchange for a reinsurance commission of 35%. The
agreement also provides for MNH to pay a contingent commission to Mutual equal
to any underwriting profit on the premiums assumed. Mutual pays the ceded
premiums, net of commissions and paid losses, to MNH on a monthly basis and MNH
invests these funds and earns investment income. To the extent commissions and
paid losses exceed premiums, MNH is required to pay the net monthly balance to
Mutual. The agreement may be terminated by either party effective as of any
January 1 with the prior approval of the New York Superintendent of Insurance
and upon six months' notice to the other party. In addition, the agreement may
be terminated by MNH at any time if any amount payable to MNH by Mutual becomes
more than 90 days overdue or if there is a change in control of Mutual approved
by the New York Superintendent of Insurance. Further, the agreement allows
Mutual to reduce its cessions to MNH from a maximum of 10% to a minimum of 0% of
Mutual's direct voluntary premiums written for any calendar year prior to the
beginning of that calendar year. Mutual has not ceded any portion of its direct
voluntary written premiums to MNH since 1995 and has informed the Company that
it will not cede any voluntary direct written premiums to MNH in 2000.
Investments
- -----------
The primary source of funds for investment by the Company is premiums
collected. Although premiums, net of commissions and other underwriting costs,
are taken into income ratably over the terms of the policies, they provide funds
for investment from the date they are received. Similarly, although
establishment of and changes in reserves for losses and LAE are included in
results of operations immediately, the amounts so set aside are available to be
invested until the Company pays those claims.
The investments of the Company are regulated by New Hampshire insurance
law and are reviewed by the Board of Directors of the Company. Other than
certain short-term investments held to maintain liquidity, the Company primarily
invests in medium-term bonds, mortgage-backed and other asset-backed securities
including collateralized mortgage obligations, and tax-exempt securities. The
mortgage-backed securities held by the Company are typically purchased at
expected yields which are greater than comparable maturity Treasury securities
and are AAA or AA rated.
The Company had $15,982,000 of tax-exempt bonds in its investment
portfolio at December 31, 1999. The Company believes these tax-exempt bonds are
of high quality (rated A or better) and, at the time of purchase, offered an
after-tax total return greater than comparable taxable securities.
At December 31, 1999, the Company had $2,544,000 of short-term investments
with maturities less than 30 days, and $11,082,000 of non-investment grade
securities. These non-investment grade securities represented 5% of the
investment portfolio as compared to $6,706,000, or 3%, of the investment
portfolio at December 31, 1998.
14
<PAGE> 15
The table below gives information regarding the Company's investments as
of the dates indicated.
<TABLE>
<CAPTION>
As of December 31,
------------------------------------------------------------------
1997 1998 1999
------------------------------------------------------------------
Amount % Amount % Amount %
------ - ------ - ------ -
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities (1):
U.S. Government and Agencies $ 48,734 23.2% $ 30,392 14.1% $ 27,663 13.0%
Corporate Bonds 117,060 55.7 140,326 65.2 152,984 71.9
Tax-Exempt Bonds 28,764 13.7 27,066 12.6 15,982 7.5
-------- ----- -------- ----- -------- -----
Total Bonds 194,558 92.6 197,784 91.9 196,629 92.4
Preferred stocks (2) 10,582 5.0 10,373 4.9 12,941 6.1
Short-Term Investments (3) 4,470 2.1 6,280 2.9 2,544 1.2
Other (4) 634 .3 735 .3 797 .3
-------- ----- -------- ----- -------- -----
Total Invested Assets $210,244 100.0% $215,172 100.0% $212,911 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
(1) Fixed Maturities are shown at their carrying amounts in the respective
balance sheet. Held to Maturity fixed maturities are included at
amortized cost. Available for Sale fixed maturities are included at
fair value.
(2) Shown at fair value.
(3) Shown at cost, which approximates fair value.
(4) Shown at estimated fair value or unpaid principal balance, which
approximates estimated fair value.
The table below sets forth the Company's net investment income and net
realized gains and losses, excluding the effect of income taxes, for the periods
shown:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Average investments (1) $202,041 $ 211,272 $211,596
Net investment income 12,770 13,277 13,147
Net investment income as a percentage
of average investments (2) 6.3% 6.3% 6.2%
Net realized gains (losses) on investments $ 112 $ (2) $ 60
</TABLE>
(1) At amortized cost.
(2) The taxable equivalent yield for the years ended December 31, 1997,
1998 and 1999 was 6.9%, 6.8%, and 7.0%, respectively, assuming an
effective tax rate of 34%.
15
<PAGE> 16
The table below sets forth the carrying value of bonds and percentage
distribution of various maturities at the dates indicated. Fixed Maturities are
shown at their carrying amounts in the respective balance sheet. Held to
Maturity fixed maturities are included at amortized cost. Available for Sale
fixed maturities are included at fair value. The estimated repayment date is
used instead of the ultimate repayment date for mortgage backed and other asset
backed securities.
<TABLE>
<CAPTION>
As of December 31,
------------------------------------------------------------------
1997 1998 1999
------------------------------------------------------------------
Amount % Amount % Amount %
------ - ------ - ------ -
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
1 year or less $ 47,499 24.4% $ 51,892 26.2% $ 49,742 25.3%
1 year through 5 years 116,508 59.9 126,631 64.0 132,421 67.4
5 years through 10 years 27,877 14.3 17,721 9.0 12,619 6.4
More than 10 years 2,674 1.4 1,540 .8 1,847 .9
-------- ----- -------- ----- -------- -----
Total $194,558 100.0% $197,784 100.0% $196,629 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
Competition
- -----------
The property and casualty insurance business is highly competitive. The
Company is in direct competition with many national and regional multiple-line
insurers, many of which are substantially larger than the Company and have
considerably greater financial resources. Competition is further intensified by
the independent agency system because each of the independent agents who sells
the Company's policies also represents one or more other insurers. Also, the
Company's agents compete with direct writing insurers and this indirectly
affects the Company.
Historically, the property and casualty industry has tended to be cyclical
in nature. During the "up" cycle, or "hard market," the industry is
characterized by price increases, strengthening of loss and LAE reserves,
surplus growth and improved underwriting results. Near the end of the "up"
cycle, an increase in capacity causes insurance companies to begin to compete
for market share on the basis of price. This price competition causes the
emergence of the "down" cycle, or "soft market," characterized by a reduction in
the premium growth rate and a general decline in profitability. Generally, the
down cycle is eventually accompanied by a decline in the adequacy of loss and
LAE reserves and a decrease in premium writing capacity. The property and
casualty insurance industry has experienced a cyclical downturn for the past
several years due primarily to intense premium rate competition and an excess
capacity to write premiums. Many of the circumstances which led to the current
cyclical downturn in the property and casualty insurance industry continue to
exist, and the Company cannot predict when or if market conditions for the
industry will improve.
Regulation
- ----------
General
- -------
MNH is subject to regulation under applicable insurance statutes,
including insurance holding company statutes, of the various states in which it
writes insurance. Insurance regulation is intended to provide safeguards for
policyholders rather than to protect stockholders of insurance companies or
their holding companies. Insurance laws of the various states establish
regulatory agencies with broad administrative powers including, but not limited
to, the power to grant or revoke licenses to transact
16
<PAGE> 17
insurance business and to regulate trade practices, investments, premium rates,
the deposit of securities, the form and content of financial statements and
insurance policies, accounting practices and the maintenance of specified
reserves and capital. The regulatory agencies of each state have statutory
authority to enforce their laws and regulations through various administrative
orders, civil and criminal enforcement proceedings, and the suspension or
revocation of certificates of authority. In extreme cases, including insolvency,
impending insolvency and other matters, a regulatory authority may take over the
management and operation of an insurer's business and assets.
Under insolvency or guaranty laws in the states in which MNH operates,
insurers doing business in those states can be assessed up to prescribed limits
for policyholder losses caused by other insurance companies that become
insolvent. The extent of any requirement for MNH to make any further payment
under these laws is not determinable. Most laws do provide, however, that an
assessment may be excused or deferred if it would threaten a solvent insurer's
financial strength. In addition, MNH is required to participate in various
mandatory pools or underwriting associations in certain states in which it
operates.
The property and casualty insurance industry has been the subject of new
regulations and legislative activity in various states attempting to address the
affordability and availability of different lines of insurance. The regulations
and legislation generally restrict the discretion an insurance company has in
operating its business. It is not possible to predict the effect, if any, that
new regulations and legislation would have on the Company and MNH.
The Company depends on cash dividends from MNH to pay cash dividends to
its stockholders and to meet its expenses. MNH is subject to New Hampshire state
insurance laws which restrict its ability to pay dividends without the prior
approval of state regulatory authorities. These restrictions limit dividends to
those that, when added to all other dividends paid within the preceding twelve
months, would not exceed 10% of the insurer's policyholders' surplus as of the
preceding December 31st. The maximum amount of dividends that MNH could pay
during any twelve month period ending in 2000 without the prior approval of the
New Hampshire Insurance Commissioner is $5,328,000. MNH paid the maximum
allowable dividend to the Company in 1999. Dividends were paid in January 1999,
May 1999 and September 1999, of $2,100,000, $1,400,000 and $1,600,000,
respectively. MNH paid a dividend of $2,200,000 to the Company on February 14,
2000 and as such is restricted from paying another dividend to the Company until
May, 2000.
In certain states in which it operates, MNH is required to maintain
deposits with the appropriate regulatory authority to secure its obligations
under certain insurance policies written in the jurisdiction. At December 31,
1999, investments of MNH having a par value of $1,900,000 were on deposit with
regulatory authorities.
MNH and Mutual are required to file detailed annual reports with the
appropriate regulatory agency in each of the states in which they do business.
Their business and accounts are subject to examination by such agencies at any
time, and the laws of many states require periodic examination. The State of New
Hampshire Insurance Department most recently examined the accounts of MNH as of
December 31, 1997. MNH's annual report as of that date was accepted as
submitted, without adjustment.
In 1993 the National Association of Insurance Commissioners ("NAIC")
adopted a risk-based capital measurement formula to be applied to all property
and casualty insurance companies. The
17
<PAGE> 18
formula calculates a minimum required statutory net worth, based on the
underwriting, investment, credit, loss reserve and other business risks inherent
in an individual company's operations. Any insurance company that does not meet
threshold risk-based capital measurement standards could be forced to reduce the
scope of its operations and ultimately could become subject to statutory
receivership proceedings. MNH's capital substantially exceeds the statutory
minimum as determined by the risk-based capital measurement formula as of
December 31, 1999.
The NAIC has established eleven financial ratios (the Insurance Regulatory
Information System, or "IRIS") to assist state insurance departments in their
oversight of the financial condition of insurance companies operating in their
respective states. The NAIC calculates these ratios based on information
submitted by insurers on an annual basis and shares the information with the
applicable state insurance departments. The ratios relate to leverage,
profitability, liquidity and loss reserve development. Each of the Company's
ratios for 1999 falls within the usual or acceptable range as published by the
NAIC.
Rates
- -----
Premium rate regulations vary greatly among states and lines of insurance,
and frequently require approval of the regulatory authority or limited review by
the authority prior to changes in rates. However, in New York and certain other
states, insurers writing private passenger automobile policies and in designated
commercial risk, professional liability and public entity insurance markets may
periodically revise rates within the limits of applicable flexibility bands
("flex-bands") on a file and use basis, but must obtain the Department's prior
approval in order to implement rate increases or decreases beyond these
flex-bands.
Insurance Holding Companies
- ---------------------------
The Company is subject to statutes governing insurance holding company
systems. Typically, such statutes require the Company to file information
periodically concerning its capital structure, ownership, financial condition
and general business operations and material inter-company transactions not in
the ordinary course of business. Under the terms of applicable New Hampshire
statutes, any person or entity desiring to purchase shares which would result in
such person beneficially owning 10% or more of the Company's outstanding voting
securities would be required to obtain regulatory approval prior to the
purchase.
Involuntary Insurance
- ---------------------
As a condition to writing voluntary insurance in most of the states in
which it operates, the Company must participate in programs that provide
insurance for persons or businesses unable to obtain insurance voluntarily.
Uncertainties as to the size of the involuntary market population make it
difficult to predict the amount of involuntary business in a given year.
Employees
- ---------
The Company has no employees. At December 31, 1999, Mutual had 346
full-time equivalent employees. The Company believes that Mutual's relationship
with its employees is satisfactory.
18
<PAGE> 19
Item 2. PROPERTIES.
Although the Company has no facilities, it benefits from the facilities of
Mutual pursuant to the Management Agreement, under which the Company is charged
a proportionate share of the costs of such facilities.
The Company's corporate headquarters are located in Buffalo, New York in a
building owned by Mutual that contains approximately 113,000 square feet of
office space. Mutual also has regional underwriting and/or claims office
facilities in Buffalo, Albany and Hauppauge, New York; Manchester, New
Hampshire; and Moorestown, New Jersey. All of the offices except the Buffalo
office are leased.
Item 3. LEGAL PROCEEDINGS.
MNH, like many other property and casualty insurance companies, is subject
to environmental damage claims asserted by or against its insureds. Management
of the Company is of the opinion that based on various court decisions
throughout the country such claims should not be recoverable under the terms of
MNH's insurance policies because of either specific or general coverage
exclusions contained in the policies. However, there is no assurance that the
courts will agree with MNH's position in every case, nor can there be assurance
that material claims will not be asserted under policies which a court will find
do not explicitly or implicitly exclude claims for environmental damages.
Management, however, is not aware of any pending claim or group of claims which
would result in a liability that would have a material adverse effect on the
financial condition of the Company or MNH.
In addition to the foregoing matters, MNH is a defendant in a number of
other legal proceedings in the ordinary course of its business. Management of
the Company is of the opinion that the ultimate aggregate liability, if any,
resulting from such proceedings will not materially affect the financial
condition of the Company or MNH.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
19
<PAGE> 20
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is traded on the American Stock Exchange (AMEX
symbol: MGP). The following table sets forth the high and low closing prices of
the common stock for the periods indicated as reported on the American Stock
Exchange.
<TABLE>
<CAPTION>
1999: High Low
- ----- ---- ---
<S> <C> <C>
Fourth Quarter $20.13 $19.50
Third Quarter 24.38 22.38
Second Quarter 22.38 21.25
First Quarter 22.50 21.00
<CAPTION>
1998: High Low
- ----- ---- ---
<S> <C> <C>
Fourth Quarter $21.75 $18.50
Third Quarter 24.38 19.25
Second Quarter 26.25 23.63
First Quarter 22.75 19.75
</TABLE>
The number of stockholders of record of the Company's Common Stock as of
February 29, 2000 was 104. Securities held by nominees are counted as one
stockholder of record.
The Company has paid a quarterly cash dividend to its common stockholders
since the third quarter of 1993. Continued payment of this dividend and its
amount will depend upon the Company's operating results, financial condition,
capital requirements and other relevant factors, including legal restrictions
applicable to the payment of dividends by its insurance subsidiary, MNH.
As a holding company, the Company depends on dividends from its
subsidiary, MNH, to pay cash dividends to its stockholders. MNH is subject to
New Hampshire state insurance laws which restrict its ability to pay dividends
without the prior approval of state regulatory authorities. These restrictions
limit dividends to those that, when added to all other dividends paid within the
preceding twelve months, would not exceed 10% of the insurer's policyholders'
surplus as of the preceding December 31. The maximum amount of dividends that
MNH could pay during any twelve month period ending in 2000 without prior
approval of the New Hampshire Insurance Commissioner is $5,328,000.
20
<PAGE> 21
Item 6. SELECTED FINANCIAL DATA.
The selected financial data set forth in the following table for each of
the five years in the period ended December 31, 1999 have been derived from the
audited consolidated financial statements of the Company.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net premiums written $ 97,577 $ 96,622 $ 96,811 $ 92,758 $ 94,470
======== ======== ======== ======== ========
Net premiums earned $ 94,749 $ 95,752 $ 96,054 $ 93,540 $ 94,775
Net investment income 10,368 11,724 12,770 13,277 13,147
Net realized investment gains (losses) (832) 996 112 (2) 60
Other revenues 259 172 214 153 434
-------- -------- -------- -------- --------
Total revenues 104,544 108,644 109,150 106,968 108,416
-------- -------- -------- -------- --------
Net losses and loss adjustment expenses 78,195 79,603 71,627 65,234 66,086
Amortization of deferred policy acquisition costs 25,458 25,374 25,454 24,788 25,115
Other underwriting expenses 7,709 6,700 6,647 8,689 7,552
-------- -------- -------- -------- --------
Total expenses 111,362 111,677 103,728 98,711 98,753
-------- -------- -------- -------- --------
Income (loss) before income taxes (6,818) (3,033) 5,422 8,257 9,663
Provision (benefit) for income taxes (2,999) (1,885) 1,224 2,334 2,870
-------- -------- -------- -------- --------
Net income (loss) $ (3,819) $ (1,148) $ 4,198 $ 5,923 $ 6,793
======== ======== ======== ======== ========
Earnings (loss) per share:
Basic $ (1.19) $ (.36) $ 1.41 $ 2.05 $ 2.48
======== ======== ======== ======== ========
Diluted $ (1.19) $ (.36) $ 1.41 $ 2.04 $ 2.48
======== ======== ======== ======== ========
Weighted average number of shares
outstanding:
Basic 3,214 3,174 2,973 2,895 2,738
Diluted 3,219 3,182 2,980 2,904 2,743
Balance Sheet Data: (at year end)
- ------------------- -------------
Total investments $192,218 $201,597 $210,244 $215,172 $212,911
Total assets 252,808 262,123 273,974 274,523 269,523
Reserve for losses and loss
adjustment expenses 119,722 133,479 141,205 136,685 133,526
Unearned premiums 48,773 49,710 50,406 49,382 49,616
Stockholders' equity 69,970 65,029 67,462 71,783 69,387
Dividend Data:
- --------------
Cash dividend per common share $ .20 $ .20 $ .20 $ .20 $ .35
</TABLE>
21
<PAGE> 22
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995:
Certain statements made in this Annual Report on Form 10-K constitute
forward-looking statements and are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve certain assumptions, risks and uncertainties that could cause
actual results to differ materially from those included in or contemplated by
those statements. These assumptions, risks and uncertainties include, but are
not limited to, those associated with factors affecting the property and
casualty insurance industry generally, including price competition, size and
frequency of claims, increasing crime rates, escalating damage awards, natural
disasters, fluctuations in interest rates and general business conditions; the
Company's dependence on investment income; the geographic concentration of the
Company's business in the northeastern United States and in particular in New
York, New Hampshire, New Jersey, Rhode Island, Pennsylvania and Massachusetts;
the adequacy of the Company's loss reserves; government regulation of the
insurance industry; exposure to environmental claims; dependence of the Company
on its relationship with Mutual; and the other risks and uncertainties discussed
or indicated in all documents filed by the Company with the Commission. The
Company expressly disclaims any obligation to update any forward-looking
statements as a result of developments occurring after the filing of this
report.
22
<PAGE> 23
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
1999 Compared to 1998.
- ----------------------
Total revenues for 1999 were $108,416,000, an increase of $1,448,000, or
1%, from $106,968,000 in 1998.
Direct premiums written for 1999 were $100,227,000, an increase of
$1,271,000, or 1%, from $98,956,000 in 1998. Net written premiums for 1999 were
$94,470,000, an increase of $1,712,000, or 2%, from $92,758,000 in 1998.
Voluntary personal lines direct premiums written for 1999 were
$38,493,000, a decrease of 3% from $39,518,000 in 1998. Private passenger
automobile direct premiums written, which comprised 76% and 78% of total
voluntary personal lines direct premiums written in 1999 and 1998, respectively,
decreased 5% in 1999 compared to 1998 primarily due to fewer new policies and
renewal policies retained resulting from price-based market competition.
Voluntary private passenger automobile policies in force at December 31, 1999,
decreased 7% compared to December 31, 1998. Homeowners direct premiums written
increased 6% in 1999 compared to 1998 due to a 9% increase in policies in force
resulting from an increase in new business units in 1999 as compared to 1998.
Voluntary commercial lines direct premiums written for 1999 were
$59,621,000, an increase of 10% from $54,246,000 in 1998. This increase resulted
primarily from a $3,173,000, or 21%, increase in commercial auto direct premiums
written, a $573,000, or 8%, increase in workers' compensation direct premiums
written and a $1,406,000, or 22%, increase in contractors coverall direct
premiums written.
The increase in commercial auto direct premiums written was primarily due
to a 25% increase in policies in force at December 31, 1999 compared to December
31, 1998, partially offset by a 3% decrease in average premium per commercial
auto policy at December 31, 1999 compared to December 31, 1998. The commercial
auto market continues to respond favorably to the Company's commercial auto
product enhancements and premium rate decreases enacted in early 1998. The
increase in workers' compensation direct premiums written was due to a 9%
increase in new business units in 1999 as compared to 1998. The increase in
contractors coverall direct premiums written was primarily due to a 14% increase
in average policies in force in 1999 compared to 1998 which in turn was due to
rate decreases in this line of business effective in the first quarter of 1999.
Involuntary direct premiums written, primarily involuntary private
passenger automobile insurance, which comprised 2% and 5% of total direct
premiums written during 1999 and 1998, respectively, were $2,113,000 for 1999
compared to $5,192,000 in 1998. This 59% decrease resulted primarily from
decreased mandatory assignments from the New York Automobile Insurance Plan
("NYAIP"), which provides coverage for individuals who are unable to obtain auto
insurance in the voluntary market. During 1999 the NYAIP continued to adjust its
assignments as a result of having over assigned policies to the Company in 1997
and an overall decrease in the NYAIP's pool of business. Assignments from the
NYAIP vary depending upon a company's private passenger automobile market share
and the size of the NYAIP.
23
<PAGE> 24
Net premiums earned for 1999 were $94,775,000, an increase of $1,235,000,
or 1%, from $93,540,000 in 1998. Net premiums earned increased primarily due to
the 1% increase in direct premiums written.
Net investment income was $13,147,000 in 1999, a decrease of 1% from
$13,277,000 in 1998, due to a decrease in average portfolio yield. Average
invested assets in 1999 were substantially unchanged from 1998.
Other revenues were $434,000 for 1999, an increase of $281,000 or 184%
from $153,000 in 1998, primarily due to increased income from residual market
facilities.
Net losses and LAE were $66,086,000 for 1999, an increase of 1% from
$65,234,000 in 1998. The increase in net losses and LAE was primarily
attributable to a non-recurring charge related to insurance related assessments,
which was offset by a non-recurring reduction in other underwriting expenses.
Absent this non-recurring charge, net losses and LAE were relatively unchanged
compared to 1998. The Company recorded decreases to its reserves for losses
related to prior accident years of $3,749,000 and $2,145,000 in 1999 and 1998,
respectively. These decreases in reserves for prior accident years reduced the
loss and LAE ratio in 1999 and 1998 by 3.9 and 2.3 percentage points,
respectively, and were primarily the result of favorable loss experience related
to auto liability policies in 1998 and workers' compensation policies in 1999.
The decrease in reserves for prior accident years was somewhat offset by an
increase in the loss and LAE ratio for losses and LAE occurring in the current
accident year.
Involuntary automobile insurance business increased the Company's
calendar year loss and LAE ratio by approximately 1.1 and 3.5 percentage points
for the years ended December 31, 1999 and 1998, respectively. The combined ratio
on involuntary automobile business was greater than the combined ratio on
voluntary automobile business.
The ratio of policy acquisition costs and other underwriting expenses to
net premiums earned decreased to 34.5% in 1999 from 35.8% in 1998, primarily due
to the aforementioned non-recurring reduction in insurance related assessments.
Expenses that vary directly with the Company's premium volume, primarily
commissions, premium taxes and state assessments, represented 20.6% and 21.7% of
net premiums earned in 1999 and 1998, respectively. Certain other underwriting
expenses, such as salaries, employee benefits and other operating expenses vary
indirectly with volume and comprise the remainder of the Company's underwriting
expenses.
The amounts recorded by the Company for income taxes in 1999 and 1998
differed from those calculated using the statutory federal income tax rate
primarily due to tax exempt bond income.
1998 Compared to 1997.
- ----------------------
Total revenues for 1998 were $106,968,000, a decrease of $2,182,000, or
2%, from $109,150,000 in 1997.
Direct premiums written for 1998 were $98,956,000, a decrease of
$2,108,000, or 2%, from $101,064,000 in 1997. Net premiums written for 1998 were
$92,758,000, a decrease of $4,053,000, or 4%, from $96,811,000 in 1997.
24
<PAGE> 25
Voluntary personal lines direct premiums written for 1998 were
$39,518,000, substantially unchanged from $39,415,000 in 1997. Private passenger
automobile direct premiums written, which comprised 78% and 79% of total
voluntary personal lines direct premiums written in 1998 and 1997, respectively,
decreased 1% in 1998 compared to 1997 primarily due to intensified price-based
market competition. Homeowners direct premiums written increased 5% in 1998
compared to 1997 due to a 5% increase in average premium per policy.
Voluntary commercial lines direct premiums written for 1998 were
$54,246,000, an increase of 5% from $51,572,000 in 1997. This increase resulted
primarily from a $1,260,000, or 9%, increase in commercial auto direct premiums
written, a $1,014,000, or 17%, increase in workers' compensation direct premiums
written and a $530,000, or 6%, increase in commercial package policies direct
premiums written.
The increase in commercial auto direct premiums written was primarily due
to an 8% increase in average premium per policy at December 31, 1998 compared to
December 31, 1997. The increase in workers' compensation direct premiums written
was due to a 36% increase in new business units in 1998 as compared to 1997. The
increase in commercial package policy direct premiums written was due to an 11%
increase in policies in force at December 31, 1998 compared to 1997, partially
offset by a 3% decrease in average premium size.
Involuntary direct premiums written, primarily involuntary private
passenger automobile insurance, which comprised 5% and 10% of total direct
premiums written during 1998 and 1997, respectively, were $5,192,000 for 1998
compared to $10,077,000 in 1997. This 48% decrease resulted primarily from
decreased mandatory assignments from the NYAIP, which provides coverage for
individuals who are unable to obtain auto insurance in the voluntary market.
During 1998 the NYAIP adjusted its assignments as a result of having over
assigned policies to the Company in 1997 and an overall decrease in the NYAIP's
pool of business.
Net premiums earned for 1998 were $93,540,000, a decrease of $2,514,000,
or 3%, from $96,054,000 in 1997. Net premiums earned decreased primarily due to
a $2,503,000 (22%) decrease in involuntary earned premiums.
Net investment income was $13,277,000 in 1998, an increase of 4% from
$12,770,000 in 1997, due to a 5% increase in average invested assets. Realized
investment losses were $2,000 in 1998 compared to $112,000 of realized gains in
1997.
Net losses and LAE were $65,234,000 for 1998, a decrease of 9% from
$71,627,000 in 1997. The loss and LAE ratio decreased to 69.7% in 1998 from
74.6% in 1997. The decrease in net losses and LAE resulted from the fact that
there was a net decrease of $2,145,000 recorded during 1998 for losses occurring
in prior accident years. The Company recorded an increase to its reserves for
losses related to prior accident years of $4,508,000 in 1997.
Involuntary automobile insurance business increased the Company's
calendar year loss and LAE ratio by approximately 3.5 and 3.4 percentage points
for the years ended December 31, 1998 and 1997, respectively.
25
<PAGE> 26
The ratio of policy acquisition costs and other underwriting expenses to
net premiums earned increased to 35.8% in 1998 from 33.4% in 1997 primarily due
to increased agency incentive commissions related to the Company's improved
underwriting results.
Commissions, premium taxes and other state assessments that vary directly
with the Company's premium volume represented 21.7% and 20.8% of net premiums
earned in 1998 and 1997, respectively. The increase was due primarily to the
increase in agency incentive commissions. Certain other underwriting expenses,
such as salaries, employee benefits, and other operating expenses vary
indirectly with volume and comprise the remainder of the Company's underwriting
expenses.
The amounts recorded by the Company for income taxes in 1998 and 1997
differed from those calculated using the statutory federal income tax rate
primarily due to tax exempt bond income.
Liquidity and Capital Resources
- -------------------------------
In developing its investment strategy, the Company determines a level of
cash and short-term investments which, when combined with expected cash flow, is
estimated to be adequate to meet expected cash obligations. Historically, the
excess of premiums collected over payments on claims, combined with cash income
from investments, has provided the Company with short-term funds in excess of
normal operating demands for cash.
The Company's objectives with respect to its investment portfolio include
maximizing total return while protecting policyholders' surplus 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 is
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
accumulated other comprehensive income within stockholders' equity. At December
31, 1999, the Company had recorded $1,188,000 of unrealized losses, net of tax,
associated with its fixed maturity investments as accumulated other
comprehensive loss. During 1999 the Company recorded $2,361,000 of unrealized
losses, net of tax, related to its investment portfolio as a component of other
comprehensive income.
At December 31, 1999, the Company's portfolio of fixed maturity
investments represented 92.4% of invested assets. Management believes that this
level of bond holdings is consistent with the Company's liquidity needs because
it anticipates that cash receipts from net premiums written and investment
income will enable the Company to satisfy its cash obligations. Furthermore, a
portion of the Company's bond portfolio is invested in mortgage-backed and other
asset-backed securities which, in addition to interest income, provide monthly
paydowns of bond principal.
At December 31, 1999, $106,752,000, or 54.3%, of the Company's fixed
maturity portfolio was invested in mortgage-backed and other asset-backed
securities. The Company invests in a
26
<PAGE> 27
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 December 31, 1999, $11,082,000, or 5%, of the Company's investment
portfolio was invested in non-investment grade securities compared to
$6,706,000, or 3%, at December 31, 1998. All of the Company's non-investment
grade securities are currently performing to the Company's purchase
expectations.
During 1999 the Company repurchased 267,600 shares of its common stock
at an average price of $22.58 and was holding 646,000 shares in treasury as of
December 31, 1999.
In August 1999, the Company 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 December 31, 1999, $1,025,000 was outstanding on this
loan.
As a holding company, the Company is dependent upon cash dividends from
MNH to meet its obligations and to 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
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
$5,329,000. MNH paid the maximum allowable dividend to the Company in 1999.
Dividends were paid in January 1999, May 1999 and September 1999, of $2,100,000,
$1,400,000 and $1,600,000, respectively. MNH paid a dividend of $2,200,000 to
the Company on February 14, 2000 and as such is restricted from paying another
dividend to the Company until May, 2000. The Company paid a cash dividend to its
common stockholders of $.05 per share in the first quarter of 1999 and $.10 per
share in the second, third and fourth quarters of 1999. Total dividends paid
amounted to $955,000 in 1999.
Industry and regulatory guidelines suggest that the ratio of a property
and casualty insurer's annual net premiums written to its statutory surplus
should not exceed 3 to 1. The Company has consistently followed a business
strategy that would allow MNH to meet this 3 to 1 regulatory guideline. MNH's
ratio of net premiums written to statutory surplus for 1999 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.
27
<PAGE> 28
The Company estimates that its share of the total expenses associated
with becoming Year 2000 compliant approximated $300,000. Approximately $150,000
of the expenses were for external costs, which included $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. 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.
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 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.
Environmental Claims
- --------------------
MNH, like many other property and casualty insurance companies, is
subject to environmental damage claims asserted by or against its insureds.
Management of the Company is of the opinion that based on various court
decisions throughout the country, such claims should not be recoverable under
the terms of MNH's insurance policies because of either specific or general
coverage exclusions contained in the policies. However, there is no assurance
that the courts will agree with MNH's position in every case, nor can there be
assurance that material claims will not be asserted under policies which a court
will find do not explicitly or implicitly exclude claims for environmental
damages. Management, however, is not aware of any pending claim or group of
claims which would result in a liability that would have a material adverse
effect on the financial condition of the Company or MNH.
Inflation
- ---------
Inflation affects the Company, like other companies in the property and
casualty insurance industry, by contributing to higher losses, LAE and operating
costs, as well as greater investment income resulting from the higher interest
rates which can prevail in an inflationary period. Premium rates, however, may
not keep pace with inflation since competitive forces generally limit the
Company's ability to increase premium rates. The Company considers inflationary
trends in estimating its reserves for claims reported and for incurred but not
reported claims.
28
<PAGE> 29
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 10.0% 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 MNH'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 years' 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 a conflict of interest between the Company and Mutual in their
joint operations and prevents the Company's shareholders from realizing the fair
market value of their shares.
Item 7A. 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 $212,911,000 at December 31, 1999 is
subject to changes in interest rates and to a lesser extent on credit quality.
Further, certain mortgage-backed and asset-backed securities are exposed to
accelerated prepayment risk generally caused by interest rate movements. If
interest rates were to decline, mortgage holders would be more likely to
refinance existing mortgages at lower rates. Acceleration of future repayments
could adversely affect future investment income, if reinvestment of the
accelerated receipts was made in lower yielding securities.
The table below provides information related to the Company's fixed
maturity investments at December 31, 1999. The table presents cash flows of
principal amounts and related weighted average interest rates by expected
maturity dates. The cash flows are based upon the maturity date or, in the case
of mortgage-backed and asset-backed securities, expected payment patterns.
Actual cash flows could differ from those shown in the table.
29
<PAGE> 30
Expected Cash Flows of Principal Amounts ($ in 000's):
<TABLE>
<CAPTION>
TOTAL
--------------------
Esti-
Amor- mated
There- tized Market
2000 2001 2002 2003 2004 after Cost Value
---- ---- ---- ---- ---- ----- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Held to Maturity
- ----------------
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 1,647 $ 0 $ 0 $ 0 $ 0 $ 0 $ 1,647 $ 1,602
Average interest rate 5.4% 0.0% 0.0% 0.0% 0.0% 0.0% -- --
Mortgage & asset backed
securities 0 183 1,698 1,601 1,795 7,623 12,900 13,103
Average interest rate 0.0% 7.2% 7.2% 7.1% 7.1% 7.3% -- --
------- ------- ------- ------- ------ ------ -------- --------
Total $ 1,647 $ 183 $ 1,698 $ 1,601 $1,795 $7,623 $ 14,547 $ 14,705
======= ======= ======= ======= ====== ====== ======== ========
Available for Sale
- ------------------
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ 7,400 $18,622 $ 350 $ 0 $ 0 $ 0 $ 26,732 $ 26,016
Average interest rate 5.3% 5.4% 6.3% 0.0% 0.0% 0.0% -- --
Obligations of states and
political subdivisions 4,595 8,720 1,710 700 0 215 15,940 15,982
Average interest rate 4.9% 4.9% 5.6% 5.4% 0.0% 7.3% -- --
Corporate securities 7,887 15,423 14,568 7,415 849 317 46,459 46,233
Average interest rate 5.5% 6.6% 7.1% 8.0% 8.6% 9.5% -- --
Mortgage & asset
backed securities 28,488 36,458 16,929 4,306 1,887 6,370 94,438 93,851
Average interest rate 6.8% 6.9% 6.9% 7.0% 7.1% 7.2% -- --
------- ------- ------- ------- ------ ------ -------- --------
Total $48,370 $79,223 $33,557 $12,421 $2,736 $6,902 $183,209 $182,082
======= ======= ======= ======= ====== ====== ======== ========
</TABLE>
The 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.
30
<PAGE> 31
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements required in response to this Item
are submitted as part of Item 14 (a) of this report, and are incorporated in
this item by reference.
Quarterly data for the two most recent fiscal years is set forth below:
<TABLE>
<CAPTION>
Three months ended
------------------
3/31 6/30 9/30 12/31
---- ---- ---- -----
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
1999
- ----
Net premiums earned $23,662 $23,524 $24,040 $23,549
Net investment income 3,271 3,208 3,280 3,388
Net realized investment gains 1 6 53 --
Other revenues 142 124 95 73
------- ------- ------- -------
Total revenues $27,076 $26,862 $27,468 $27,010
======= ======= ======= =======
Income before income taxes $ 2,325 $ 2,613 $ 2,367 $ 2,358
Net income $ 1,649 $ 1,850 $ 1,650 $ 1,644
Net income per diluted share $ .58 $ .67 $ .61 $ .63
1998
- ----
Net premiums earned $23,740 $23,875 $23,448 $22,477
Net investment income 3,290 3,331 3,317 3,339
Net realized investment losses -- -- (2) --
Other revenues 42 42 51 18
------- ------- ------- -------
Total revenues $27,072 $27,248 $26,814 $25,834
======= ======= ======= =======
Income before income taxes $ 1,846 $ 2,098 $ 2,041 $ 2,272
Net income $ 1,346 $ 1,520 $ 1,483 $ 1,574
Net income per diluted share $ .46 $ .52 $ .51 $ .55
</TABLE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
31
<PAGE> 32
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information in response to this item is incorporated by reference
herein to the information under the caption "Election of Directors" presented in
the Company's definitive proxy statement filed or to be filed pursuant to
Regulation 14A and used in connection with the Company's 2000 Annual Meeting of
Shareholders to be held on or about May 3, 2000.
Item 11. EXECUTIVE COMPENSATION.
The information in response to this item is incorporated by reference
herein to the information under the caption "Executive Compensation" and
"Compensation of Directors" presented in the Company's definitive proxy
statement filed or to be filed pursuant to Regulation 14A and used in connection
with the Company's 2000 Annual Meeting of Shareholders to be held on or about
May 3, 2000, provided, however that information appearing under the captions
"Compensation Committee Report on Executive Compensation" and "Performance
Comparison" is not incorporated herein and should not be deemed to be included
in this document for any purpose.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The information in response to this item is incorporated by reference
herein to the information under the caption "Security Ownership of Certain
Beneficial Owners" and "Security Ownership of Management" presented in the
Company's definitive proxy statement filed or to be filed pursuant to Regulation
14A and used in connection with the Company's 2000 Annual Meeting of
Stockholders to be held on or about May 3, 2000.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information in response to this item is incorporated herein by
reference to the information under the caption "Management Agreement" and
"Certain Transactions" presented in the Company's definitive proxy statement
filed or to be filed pursuant to Regulation 14A and used in connection with the
Company's 2000 Annual Meeting of Shareholders to be held on or about May 3,
2000.
32
<PAGE> 33
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) The following financial statements of Merchants Group, Inc.
are included on pages F-1 to F-23:
Report of Independent Accountants
Consolidated Balance Sheet - December 31, 1998 and 1999.
Consolidated Statement of Operations - Years ended December 31,
1997, 1998 and 1999.
Consolidated Statement of Changes in Stockholders' Equity - Years
ended December 31, 1997, 1998 and 1999.
Consolidated Statement of Cash Flows - Years ended December 31,
1997, 1998 and 1999.
Notes to Consolidated Financial Statements.
(2) The following financial statement schedules of Merchants
Group, Inc. are filed herewith pursuant to Item 8:
Schedule I -
Summary of Investments - Other Than Investments in Related
Parties.
Schedule II -
Amounts Receivable From/Payable to Related Parties, and
Underwriters, Promoters and Employees Other Than Related
Parties.
Schedule III -
Condensed Financial Information of Registrant.
Schedule V -
Supplemental Insurance Information (see Schedule X).
Schedule VI - Reinsurance
Schedule X -
Supplemental Insurance Information Concerning Property -
Casualty Subsidiaries
(b) Reports on Form 8-K. There were no reports on Form 8-K filed
for the quarter ended December 31, 1999.
(c) Exhibits required by Item 601 of Regulation S-K:
(3) (a) Restated Certificate of Incorporation (incorporated by
reference to Exhibit No. 3C to Amendment No. 1 to the
Company's Registration Statement (No. 33-9188) on Form S-1
filed on November 7, 1986).
(b) Restated By-laws (incorporated by reference to Exhibit No. 3D
to Amendment No. 1 to the Company's Registration Statement
(No. 33-9188) on Form S-1 filed on November 7, 1986).
33
<PAGE> 34
(10) (a) Management Agreement dated as of September 29, 1986 by and
among Merchants Mutual Insurance Company, Registrant and
Merchants Insurance Company of New Hampshire, Inc.
(incorporated by reference to Exhibit No. 10A to the Company's
Registration Statement (No. 33-9188) on Form S-1 filed on
September 30, 1986).
(b) Agreement of Reinsurance No. 6922 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation
(incorporated by reference to Exhibit No. 10E to the Company's
Registration Statement (No. 33-9188) on Form S-1 filed on
September 30, 1986).
(c) Agreement of Reinsurance No. 7299 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation,
(incorporated by reference to Exhibit No. 10o to the Company's
1987 Annual Report on Form 10-K (File No. 1-9640) filed on
March 19, 1988).
(d) Agreement of Reinsurance dated January 27, 1993, between
Merchants Mutual Insurance Company and Merchants Insurance
Company of New Hampshire, Inc. (incorporated by reference to
Exhibit (3) in the Company's Current Report on Form 8-K (File
No. 1-9640) filed on January 29, 1993).
(e) Agreement of Reinsurance No. 8009 between Merchants Mutual
Insurance Company, Merchants Insurance Company of New
Hampshire, Inc. and General Reinsurance Corporation,
(incorporated by reference to Exhibit 10e to the Company's
1995 Annual Report on Form 10-K filed on March 28, 1996).
(f) Property Catastrophe Reinsurance Agreement (HCI Agreement No.
439) between Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and General
Reinsurance Corporation, et. al., dated January 1, 1997,
(incorporated by reference to Exhibit No. 10f to the Company's
1996 Annual Report on Form 10-K filed on March 28, 1997).
(g) Property and Casualty Excess of Loss Reinsurance Agreement
between Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and American
Reinsurance Company, including endorsement, (incorporated by
reference to Exhibit 10g to the Company's 1998 Annual Report
on Form 10-K filed on March 29, 1999).
(h) Property Catastrophe Excess of Loss Reinsurance Agreement
between Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and the Subscribing
Reinsurers Executing the Interest and Liabilities Contracts
attached to this agreement, effective January 1, 1998
(incorporated by reference to Exhibit 10h to the Company's
1998 Annual Report on Form 10-K filed on March 29, 1999).
34
<PAGE> 35
* (i) Merchants Mutual Capital Accumulation Plan (incorporated by
reference to Exhibit No. 10G to the Company's Registration
Statement (No. 33-9188) on Form S-1 filed on September 30,
1986).
* (j) Merchants Mutual Capital Accumulation Plan, fourth amendment,
effective January 1, 1996 (incorporated by referenced to
Exhibit 10(h) to the Company's 1996 Annual Report on Form 10-K
(File No. 1-9640) filed on March 28, 1997).
* (k) Merchants Mutual Capital Accumulation Plan Trust Agreement
(restated as of January 1, 1996 (incorporated by reference to
Exhibit 10(i) to the Company's 1996 Annual Report on Form 10-K
(File No. 1-9640) filed on March 28, 1997).
* (l) Merchants Mutual Supplemental Executive Retirement Plan dated
as of December 29, 1989 and Agreement of Trust dated as of
December 29, 1989 (incorporated by reference to Exhibit No.
10K to the Company's 1989 Annual Report on Form 10-K (File No.
1-9640) filed on March 21, 1990).
* (m) Amendment dated June 10, 1992 to Agreement of Trust under
Merchants Mutual Supplemental Executive Retirement Plan dated
as of December 29, 1989 (incorporated by reference to Exhibit
No. 10R to the Company's 1992 Annual Report on Form 10-K (File
No. 1-9640) filed on March 31, 1993).
* (n) Merchants Group, Inc. 1986 Stock Option Plan As Amended
Through February 16, 1993 (incorporated by reference to
Exhibit No. 10E to the Company's 1992 Annual Report on Form
10-K (File No. 1-9640) filed on March 31, 1993).
* (o) Form of Amended Indemnification Agreement entered into by
Registrant with each director and executive office of
Registrant (incorporated by reference to Exhibit No. 10N to
Amendment No. 1 to the Company's Registration Statement on
(No. 33-9188) Form S-1 filed on November 7, 1986).
* (p) Merchants Mutual Insurance Company Incentive Compensation
Plan, as amended January 24, 1996 (incorporated by reference
to Exhibit No. 10(n) to the Company's 1996 Annual Report on
Form 10-K (File No. 1-9640) filed on March 28, 1997).
* (q) Employee Retention Agreement between Robert M. Zak and
Merchants Mutual Insurance Company dated as of March 1, 1999
(incorporated by reference to Exhibit No. 10-A to the
Company's June 30, 1999 Quarterly Report on Form 10-Q filed on
August 12, 1999).
* (r) Employee Retention Agreement between Edward M. Murphy and
Merchants Mutual Insurance Company dated as of March 1, 1999
(incorporated by reference to Exhibit 10r to the Company's
1998 Annual Report on Form 10-K filed on March 29, 1999).
35
<PAGE> 36
* (s) Employee Retention Agreement between Kenneth J. Wilson and
Merchants Mutual Insurance Company dated as of March 1, 1999
(incorporated by reference to Exhibit 10s to the Company's
1998 Annual Report on Form 10-K filed on March 29, 1999).
(11) (a) Statement re computation of per share earnings (incorporated
herein by reference to Note 9 to the Consolidated Financial
Statements included in Item 8).
(21) List of Subsidiaries of Registrant (incorporated by reference
to Exhibit No. 22 to the Company's Registration Statement (
No. 33-9188) on Form S-1 filed on September 30, 1986).
(23) Consent of Independent Accountants (filed herewith).
(27) Financial Data Schedule (filed herewith).
* Indicates a management contract or compensation plan or arrangement.
36
<PAGE> 37
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1999
(in thousands)
<CAPTION>
Amount at
which shown
Amortized Cost/ Market in the balance
Type of Investment Cost value sheet
- ------------------ ---- ----- -----
<S> <C> <C> <C>
Fixed maturities:
United States Government and
government agencies and authorities $ 28,019 $ 27,618 $ 27,663
Corporate bonds 46,459 46,233 46,233
Mortgage and asset backed securities 107,338 106,954 106,751
Tax exempt bonds 15,940 15,982 15,982
-------- -------- --------
Total fixed maturities 197,756 196,787 196,629
Preferred stocks 13,082 12,941 12,941
Short-term investments 2,544 2,544 2,544
Other 797 797 797
-------- -------- --------
$214,179 $213,069 $212,911
======== ======== ========
</TABLE>
37
<PAGE> 38
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE II - AMOUNTS RECEIVABLE FROM/PAYABLE TO RELATED PARTIES,
AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER
THAN RELATED PARTIES
Years ended December 31, 1997, 1998 and 1999
(in thousands)
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Receivable from (payable to) Merchants Mutual
Insurance Company(1):
Balance at beginning of period $327 $ 527 $(1,321)
Change during the period 200 (1,848) 703
---- ------- -------
Balance at end of period $527 $(1,321) $ (618)
==== ======= =======
</TABLE>
(1) Under a Management Agreement, Merchants Mutual Insurance Company
("Mutual") provides employees, services and facilities for Merchants
Insurance Company of New Hampshire, Inc. ("MNH") to carry on its
insurance business on a cost reimbursed basis. The balance in the
intercompany receivable (payable) account indicates the amount due from
(to) Mutual for the excess (deficiency) of premiums collected over
(from) payments for losses, employees, services and facilities provided
to MNH.
38
<PAGE> 39
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands except per share and share amounts)
<CAPTION>
BALANCE SHEET
- -------------
December 31,
---------------------
1998 1999
---- ----
<S> <C> <C>
Assets
------
Investment in subsidiary $70,788 $70,362
Other assets 1,043 98
------- -------
Total assets $71,831 $70,460
======= =======
Liabilities and Stockholders' Equity
------------------------------------
Other liabilities $ 48 $ 48
Demand loan -- 1,025
------- -------
Total liabilities 48 1,073
------- -------
Stockholders' equity:
Preferred stock, $.01 par value, authorized and
unissued 3,000,000 shares -- --
Preferred stock, no par value, $424.30 stated value,
no shares issued or outstanding at December 31,
1998 or 1999 -- --
Common stock, $.01 par value, authorized 10,000,000 shares; issued and
outstanding of 2,851,452 shares at December 31,
1998 and 2,595,852 shares at December 31, 1999 32 32
Additional paid in capital 35,511 35,680
Treasury stock, 378,400 shares at December 31, 1998
and 646,000 shares at December 31, 1999 (7,097) (13,139)
Accumulated other comprehensive income (loss) 1,173 (1,188)
Accumulated earnings 42,164 48,002
------- -------
Total stockholders' equity 71,783 69,387
------- -------
Total liabilities and stockholers' equity $71,831 $70,460
======= =======
</TABLE>
39
<PAGE> 40
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Continued
(in thousands)
<CAPTION>
INCOME STATEMENT
- ----------------
Year ended December 31,
------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Revenues:
Equity in net income of subsidiary $4,485 6,161 $6,937
Investment income 21 61 39
Net realized investment gains 2 -- --
------ ------ ------
Total revenues 4,508 6,222 6,976
Expenses:
General and administrative expenses 230 337 237
------ ------ ------
Operating income before income taxes 4,278 5,885 6,739
Income tax expense (benefit) 80 (38) (54)
------ ------ ------
Net income $4,198 $5,923 $6,793
====== ====== ======
</TABLE>
40
<PAGE> 41
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands)
<CAPTION>
STATEMENT OF CASH FLOWS
- -----------------------
Increase (Decrease) in Cash and Cash Equivalents:
Year ended December 31,
---------------------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities: $ (227) $ (251) $ (142)
------- ------- -------
Cash flows from investing activities:
Receipt of subsidiary common stock dividend 2,800 2,600 5,000
Sale (purchase) of other investments, net 853 (630) 936
------- ------- -------
Cash flows from investing activities 3,653 1,970 5,936
------- ------- -------
Cash flows from financing activities:
Purchase of treasury stock (2,923) (1,191) (6,042)
Proceeds of demand loan -- -- 1,025
Cash dividends (589) (579) (955)
Exercise of common stock options 83 56 169
------- ------- -------
Cash flows from financing activities (3,429) (1,714) (5,803)
------- ------- -------
Net increase (decrease) in cash and cash equivalents (3) 5 (9)
Cash and cash equivalents, beginning of year 8 5 10
------- ------- -------
Cash and cash equivalents, end of year $ 5 $ 10 $ 1
======= ======= =======
Reconciliation of net income to net
cash provided by operations:
Net income $ 4,198 $ 5,923 $ 6,793
Adjustments to reconcile net income
to net cash provided by operations:
Equity in income of subsidiary (4,485) (6,161) (6,937)
Net realized investment gains (2) -- --
Decrease in other liabilities (20) (13) --
(Increase) decrease in other
(non-investment) assets 93 (6) --
Other, net (11) 6 2
------- ------- -------
Net cash used in operating activities $ (227) $ (251) $ (142)
======= ======= =======
</TABLE>
41
<PAGE> 42
MERCHANTS GROUP, INC.
SCHEDULE III - CONDENSED FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
- ---------------------------------------
Cash dividends of $2,800,000, $2,600,000 and $5,000,000 were paid to the
Registrant by its consolidated subsidiary in the years ended December 31, 1997,
1998 and 1999 respectively.
42
<PAGE> 43
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE VI - REINSURANCE
YEARS ENDED DECEMBER 31, 1997, 1998, 1999
(in thousands except percentages)
<CAPTION>
Percentage
Ceded Assumed of amount
Gross to other from other Net assumed
amount companies companies amount to net
------ --------- --------- ------ ------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997
Property and Casualty Premiums $101,064 $6,895 $2,642 $96,811 2.7%
Year ended December 31, 1998
Property and Casualty Premiums $ 98,956 $7,042 $ 844 $92,758 .9%
Year ended December 31, 1999
Property and Casualty Premiums $100,227 $7,369 $1,612 $94,470 1.7%
</TABLE>
43
<PAGE> 44
<TABLE>
MERCHANTS GROUP, INC.
SCHEDULE X - SUPPLEMENTAL INSURANCE INFORMATION CONCERNING
PROPERTY - CASUALTY SUBSIDIARIES
Years ended December 31, 1997, 1998 and 1999
(in thousands)
<CAPTION>
Reserves Losses & loss
Deferred for Discount adjustment expenses Amoritiza-
policy losses & if any, Net incurred related to tion of Paid losses
acquis- loss ad- deducted Net invest- (1) (2) deferred & loss ad- Direct
ition justment from Unearned earned ment Current Prior acquisition justment premium
costs expenses reserves premiums premiums income years years costs expenses written
----- -------- -------- -------- -------- ------ ----- ----- ----- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended:
December 31, 1997 $12,597 $141,205 $6,394 $50,406 $96,054 $12,770 $67,119 $ 4,508 $25,454 $67,054 $101,064
December 31, 1998 $12,390 $136,685 $9,256 $49,382 $93,540 $13,277 $67,379 $(2,145) $24,788 $69,198 $ 98,956
December 31, 1999 $12,309 $133,526 $8,492 $49,616 $94,775 $13,147 $69,835 $(3,749) $25,115 $65,455 $100,227
</TABLE>
44
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Merchants Group, Inc.
Date: March 30, 2000 BY: /s/Robert M. Zak, Senior Vice President
Robert M. Zak, Senior Vice President and Chief
Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/Richard E. Garman Director, Chairman March 30, 2000
- ---------------------- of the Board
Richard E. Garman
/s/Brent D. Baird Director, President March 30, 2000
- ----------------------
Brent D. Baird
/s/Robert M. Zak Director, Sr. VP & March 30, 2000
- ---------------------- Chief Operating
Robert M. Zak Officer
/s/Kenneth J. Wilson Vice President & CFO March 30, 2000
- ---------------------- (principal financial
Kenneth J. Wilson and accounting officer)
/s/Andrew A. Alberti Director March 30, 2000
- ----------------------
Andrew A. Alberti
/s/Frank J. Colantuono Director March 30, 2000
- ----------------------
Frank J. Colantuono
/s/Henry P. Semmelhack Director March 30, 2000
- ----------------------
Henry P. Semmelhack
</TABLE>
45
<PAGE> 46
Report of Independent Accountants
---------------------------------
To the Board of Directors
and Stockholders of
Merchants Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) present fairly, in all material respects,
the financial position of Merchants Group, Inc. and its subsidiaries at December
31, 1998 and 1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers
Buffalo, New York
February 14, 2000
F-1
<PAGE> 47
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED BALANCE SHEET
--------------------------
(in thousands)
--------------
<CAPTION>
December 31,
------------
Assets 1998 1999
------ ---- ----
<S> <C> <C>
Investments:
Fixed maturities:
Held to maturity at amortized cost $ 17,000 $ 14,547
Available for sale at fair value 180,784 182,082
Preferred stock at fair value 10,373 12,941
Other long-term investments at fair value 735 797
Short-term investments 6,280 2,544
-------- --------
Total investments 215,172 212,911
Cash 16 2
Interest due and accrued 1,923 2,117
Premiums receivable, net of allowance for doubtful accounts
of $454 in 1998 and $431 in 1999 20,629 19,964
Deferred policy acquisition costs 12,390 12,309
Ceded reinsurance balances receivable 9,741 5,396
Prepaid reinsurance premiums 2,629 3,168
Deferred income taxes 5,055 6,002
Other assets 6,968 7,654
-------- --------
Total assets $274,523 $269,523
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
<PAGE> 48
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED BALANCE SHEET
--------------------------
(in thousands except share and per share amounts)
<CAPTION>
December 31,
------------
1998 1999
---- ----
<S> <C> <C>
Liabilities and Stockholders' Equity
------------------------------------
Liabilities:
Reserve for losses and loss adjustment expenses $136,685 $133,526
Unearned premiums 49,382 49,616
Demand loan -- 1,025
Payable to affiliate 1,321 618
Other liabilities 15,352 15,351
-------- --------
Total liabilities 202,740 200,136
-------- --------
Stockholders' equity:
Common stock, $.01 par value, authorized 10,000,000 32 32
shares, issued and outstanding 2,851,452 shares at
December 31, 1998 and 2,595,852 shares at
December 31, 1999
Additional paid in capital 35,511 35,680
Treasury stock, 378,400 shares at December 31, 1998 (7,097) (13,139)
and 646,000 shares at December 31, 1999
Accumulated other comprehensive income (loss) 1,173 (1,188)
Accumulated earnings 42,164 48,002
-------- --------
Total stockholders' equity 71,783 69,387
-------- --------
Commitments and contingent liabilities (Note 11) -- --
Total liabilities and stockholders' equity $274,523 $269,523
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
<PAGE> 49
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF OPERATIONS
------------------------------------
(in thousands except per share amounts)
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Revenues:
Net premiums earned $ 96,054 $ 93,540 $ 94,775
Net investment income 12,770 13,277 13,147
Net realized investment gains (losses) 112 (2) 60
Other revenues 214 153 434
-------- -------- --------
Total revenues 109,150 106,968 108,416
-------- -------- --------
Expenses:
Net losses and loss adjustment expenses 71,627 65,234 66,086
Amortization of deferred policy acquisition costs 25,454 24,788 25,115
Other underwriting expenses 6,647 8,689 7,552
-------- -------- --------
Total expenses 103,728 98,711 98,753
-------- -------- --------
Income before income taxes 5,422 8,257 9,663
Income tax provision 1,224 2,334 2,870
-------- -------- --------
Net income $ 4,198 $ 5,923 $ 6,793
======== ======== ========
Earnings per share:
Basic $ 1.41 $ 2.05 $ 2.48
======== ======== ========
Diluted $ 1.41 $ 2.04 $ 2.48
======== ======== ========
Weighted average number of shares outstanding:
Basic 2,973 2,895 2,738
Diluted 2,980 2,904 2,743
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
<PAGE> 50
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
----------------------------------------------
(in thousands)
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Net income $4,198 $5,923 $ 6,793
------ ------ -------
Other comprehensive income (loss) before tax:
Unrealized gains (losses)
on securities 2,595 185 (3,540)
Reclassification adjustment
for gains and losses included
in net income (74) (15) (37)
------ ------ -------
Other comprehensive income (loss)
before tax 2,521 170 (3,577)
Income tax provision (benefit) related to
items of other comprehensive income 857 58 (1,216)
------ ------ -------
Other comprehensive income (loss) 1,664 112 (2,361)
------ ------ -------
Comprehensive income $5,862 $6,035 $ 4,432
====== ====== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
<PAGE> 51
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
---------------------------------------------------------
(in thousands)
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Common stock:
Beginning and end of year $ 32 $ 32 $ 32
------- ------- --------
Additional paid in capital:
Beginning of year 35,372 35,455 35,511
Exercise of common stock options 83 56 169
------- ------- --------
End of year 35,455 35,511 35,680
------- ------- --------
Treasury stock:
Beginning of year (2,983) (5,906) (7,097)
Purchase of treasury shares (2,923) (1,191) (6,042)
------- ------- --------
End of year (5,906) (7,097) (13,139)
------- ------- --------
Accumulated other comprehensive income (loss)
Beginning of year (603) 1,061 1,173
Other comprehensive income (loss) 1,664 112 (2,361)
------- ------- --------
End of year 1,061 1,173 (1,188)
------- ------- --------
Accumulated earnings:
Beginning of year 33,211 36,820 42,164
Net income 4,198 5,923 6,793
Cash dividends ($.20/share in 1997 and
1998, $.35/share in 1999) (589) (579) (955)
------- ------- --------
End of year 36,820 42,164 48,002
------- ------- --------
Total stockholders' equity $67,462 $71,783 $ 69,387
======= ======= ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
<PAGE> 52
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
(in thousands)
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Cash flows from operations:
Collection of premiums $ 96,102 $ 94,121 $ 95,612
Payment of losses and loss adjustment expenses (67,054) (69,198) (65,455)
Payment of underwriting expenses (32,019) (32,159) (33,381)
Investment income received 12,763 13,220 13,141
Investment expenses paid (309) (341) (381)
Income taxes paid (164) (1,501) (3,064)
Other cash receipts 214 157 388
-------- -------- ---------
Net cash provided by operations 9,533 4,299 6,860
-------- -------- ---------
Cash flows from investing activities:
Proceeds from fixed maturities sold or matured 81,035 95,217 98,624
Purchase of fixed maturities (90,176) (97,733) (100,385)
Net increase in preferred stock (2,067) -- (2,977)
Net (increase) decrease in other
long-term investments 1,671 (101) (62)
Net (increase) decrease in short-term investments 3,778 (1,810) 3,736
(Purchase) disposition of equipment, net (146) -- 696
-------- -------- ---------
Net cash used in investing activities (5,905) (4,427) (368)
-------- -------- ---------
Cash flows from financing activities:
Settlement of affiliate balances (200) 1,848 (703)
Proceeds of demand loan -- -- 1,025
Purchase of treasury stock (2,923) (1,191) (6,042)
Proceeds from exercise of common stock options 83 56 169
Cash dividends (589) (579) (955)
-------- -------- ---------
Net cash provided by (used in)
financing activities (3,629) 134 (6,506)
-------- -------- ---------
Increase (decrease) in cash (1) 6 (14)
Cash, beginning of year 11 10 16
-------- -------- ---------
Cash, end of year $ 10 $ 16 $ 2
======== ======== =========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-7
<PAGE> 53
<TABLE>
MERCHANTS GROUP, INC.
---------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATIONS
---------------------------------------------------------------
(in thousands)
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Net income $ 4,198 $ 5,923 $ 6,793
Adjustments:
Depreciation and amortization (19) (123) (143)
Net realized investment (gains) losses (112) 2 (60)
(Increase) decrease in assets:
Interest due and accrued (65) (65) (194)
Premiums receivable (583) 455 665
Deferred policy acquisition costs (201) 207 81
Ceded reinsurance balances receivable (3,297) 1,391 4,345
Prepaid reinsurance premiums 61 242 (539)
Deferred income taxes (532) 1,206 270
Other assets 1,274 154 (1,432)
Increase (decrease) in liabilities:
Reserve for losses and loss adjustment expenses 7,726 (4,520) (3,159)
Unearned premiums 696 (1,024) 234
Other liabilities 387 451 (1)
------- ------- -------
Net cash provided by operations $ 9,533 $ 4,299 $ 6,860
======= ======= =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-8
<PAGE> 54
MERCHANTS GROUP, INC.
---------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. Significant Accounting Policies
-------------------------------
Principles of consolidation and basis of presentation
-----------------------------------------------------
The consolidated financial statements of Merchants Group, Inc. (the
"Company") include the accounts of the Company, its wholly owned
subsidiary, Merchants Insurance Company of New Hampshire, Inc. ("MNH"), and
M.F.C. of New York, Inc., an inactive premium finance company which is a
wholly owned subsidiary of MNH. MNH is a stock property and casualty
insurance company domiciled in the state of New Hampshire. MNH offers
property and casualty insurance to preferred risk individuals and small to
medium sized businesses in the northeast United States, primarily in New
York, New Hampshire and New Jersey where a majority of its policies are
written. As a holding company, the Company has had no operations.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP") which differ in some
respects from those followed in reports to insurance regulatory
authorities. In its Annual Statement filed with regulatory authorities, MNH
reported policyholders' surplus of $50,576,000 and $53,278,000 at December
31, 1998 and 1999, respectively. MNH's net income as reported in its Annual
Statement was $3,481,000 in 1997, $7,367,000 in 1998 and $7,141,000 in
1999. All significant intercompany balances and transactions have been
eliminated.
The preparation of consolidated financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results may differ from those estimates.
Investments
-----------
The Company has classified its investments in fixed maturities as either
held to maturity or available for sale. Fixed maturities classified as held
to maturity are presented at amortized cost and consist of debt securities
that management intends and has the ability to hold until maturity. Fixed
maturities classified as available for sale are presented at fair value and
consist of debt securities that management may not hold until maturity. All
preferred stocks are classified as available for sale and are presented at
fair value. The net aggregate unrealized gain or loss, net of applicable
income taxes, related to fixed maturities and preferred stock classified as
available for sale is included as a component of accumulated other
comprehensive income (loss) in stockholders' equity.
F-9
<PAGE> 55
Fixed maturities include mortgage backed and asset backed securities which
are valued using the interest method. The Company estimates prepayments
utilizing published data when applying the interest method. Periodic
adjustments to prepayment assumptions are credited or charged to investment
income.
Other long-term investments include collateralized mortgage obligation
residuals, carried at unpaid principal balances which do not vary
significantly from fair value. Short-term investments, consisting primarily
of money market mutual funds, have original maturities of three months or
less and are carried at cost, which approximates fair value. Realized gains
and losses on the sale of investments are based on the cost of the specific
investment sold.
Net premiums earned
-------------------
Premiums are recorded as revenue ratably over the terms of the policies
written (principally one year). Unearned premiums are calculated using a
monthly pro rata method.
Deferred policy acquisition costs
---------------------------------
Policy acquisition costs, such as commissions (net of reinsurance
commissions), premium taxes and certain other underwriting expenses which
vary directly with premium volume, are deferred and amortized over the
terms of the related insurance policies. Deferred policy acquisition costs
do not exceed estimated recoverable amounts after allowing for anticipated
investment income.
Reinsurance
-----------
Reinsurance assumed from business written through state reinsurance
facilities has been reflected in unearned premiums, loss reserves, premiums
earned and losses incurred based on reports received from such facilities.
Ceded reinsurance premiums, losses and ceding commissions are netted
against earned premiums, losses and commission expense, respectively.
Reserve for losses and loss adjustment expenses
-----------------------------------------------
Liabilities for unpaid losses and loss adjustment expenses ("LAE") are
estimates of future payments to be made to settle all insurance claims for
reported losses and estimates of incurred but not reported losses based
upon past experience modified for current trends. With the exception of
workers' compensation losses, loss reserves are not discounted. Estimated
amounts of salvage and subrogation on paid and unpaid losses are deducted
from the liability for unpaid claims. The estimated liabilities may be more
or less than the amount ultimately paid when the claims are settled.
Management and the Company's independent consulting actuary regularly
review the estimates of reserves needed and any changes are reflected in
current operating results.
F-10
<PAGE> 56
The Company discounts its liability for workers' compensation case reserves
on a tabular basis, using the National Council on Compensation Insurance
Workers' Compensation Statistical Plan Table III A at a rate of 3.5%. The
amount of discount at December 31, 1998 and 1999 is $9,256,000 and
$8,492,000, respectively. Reserves for losses incurred but not reported and
for LAE are not discounted.
Structured settlements have been negotiated for claims on certain insurance
policies. Structured settlements are agreements to provide periodic
payments to claimants, and are funded by annuities purchased from various
life insurance companies. The Company remains primarily liable for payment
of these claims. Accordingly, a liability and a corresponding deposit in
the amount $5,764,000 and $6,456,000 at December 31, 1998 and 1999,
respectively, are recorded in the Company's consolidated balance sheet.
Income taxes
------------
The Company and its wholly owned subsidiary file a consolidated federal
income tax return. The Company follows the asset and liability approach to
account for income taxes, which requires the recognition of deferred tax
liabilities and assets for the expected future tax consequences of
temporary differences between the financial statement carrying amounts and
the tax basis of assets and liabilities.
Other financial instruments
---------------------------
The fair values of the Company's other financial instruments, principally
premiums receivable and certain non-insurance related liabilities, do not
vary significantly from the amounts assigned in these financial statements.
Insurance-related assessments
-----------------------------
In 1997, the American Institute of Certified Public Accountants' Accounting
Standards Executive Committee issued Statement of Position ("SOP") 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments". The accounting guidance of this SOP focuses on the timing of
recognition and measurement of liabilities for insurance-related
assessments. The Company adopted SOP 97-3 in the first quarter of 1999. The
impact of this adoption was not material to the Company's financial
position or results of operations.
2. Related Party Transactions
--------------------------
The Company and MNH have no paid employees. Under a management agreement
Merchants Mutual Insurance Company ("Mutual"), which owns 9.8% of the
Company's outstanding common stock at December 31, 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 on
an allocated cost basis, determined as follows: for underwriting and
administrative expenses, the respective share of total direct premiums
written for Mutual and
F-11
<PAGE> 57
MNH serves as the basis of allocation; for claims expenses, the average
number of outstanding claims is used; investment expenses are shared based
on each company's share of total invested assets. MNH also pays an annual
management fee of $50,000 to Mutual. On July 23, 1998, the Company gave
notice to Mutual of its intent to terminate the management agreement under
its terms, which termination is effective five years after the date of
notice.
MNH's agents are also licensed to sell Mutual's products. The agents are
informed of the underwriting criteria of each company as well as the
classes of business that are acceptable to each company. Underwriters
review each application submitted by an agent to determine which company's
underwriting criteria the risk meets and then issue a policy in the
appropriate company. The payable to or receivable from Mutual is
non-interest bearing and represents the net of premiums collected and loss
and operating expense payments made by Mutual on behalf of MNH. This
balance is settled in cash on a monthly basis.
F-12
<PAGE> 58
================================================================================
3. Investments
-----------
Investments in fixed maturities and preferred stocks
----------------------------------------------------
The amortized cost and estimated fair values of investments in fixed
maturities held to maturity and available for sale and the cost and
estimated fair value of preferred stocks are as follows:
<TABLE>
<CAPTION>
Amortized Gross Gross
Cost/ Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1998
- -----------------
Fixed maturities:
Held to maturity
- ----------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 1,647 $ -- $ 12 $ 1,635
Mortgage and asset backed
securities 15,353 768 -- 16,121
-------- ------ ---- --------
Total $ 17,000 $ 768 $ 12 $ 17,756
======== ====== ==== ========
Available for sale
- ------------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 12,755 $ 21 $-- $ 12,776
Obligations of states and
political subdivisions 26,534 532 -- 27,066
Corporate securities 29,386 693 34 30,045
Mortgage and asset backed
securities 109,966 976 45 110,897
-------- ------ ---- --------
Total $178,641 $2,222 $ 79 $180,784
======== ====== ==== ========
Preferred stocks $ 10,099 $ 408 $134 $ 10,373
======== ====== ==== ========
</TABLE>
F-13
<PAGE> 59
<TABLE>
<CAPTION>
Amortized Gross Gross
Cost/ Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1999
- -----------------
Fixed maturities:
Held to maturity
- ----------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 1,647 $-- $ 45 $ 1,602
Mortgage and asset backed
securities 12,900 213 10 13,103
-------- ---- ------ --------
Total $ 14,547 $213 $ 55 $ 14,705
======== ==== ====== ========
Available for sale
- ------------------
U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies $ 26,372 $-- $ 356 $ 26,016
Obligations of states and
political subdivisions 15,940 79 37 15,982
Corporate securities 46,459 30 256 46,233
Mortgage and asset backed
securities 94,438 134 721 93,851
-------- ---- ------ --------
Total $183,209 $243 $1,370 $182,082
======== ==== ====== ========
Preferred stocks $ 13,082 $ 73 $ 214 $ 12,941
======== ==== ====== ========
</TABLE>
The amortized cost and fair value of fixed maturities by expected maturity
at December 31, 1999 are shown below. Mortgage and asset backed securities
are distributed in the table based upon management's estimate of repayment
periods. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
F-14
<PAGE> 60
<TABLE>
<CAPTION>
Estimated Fair
Amortized Cost Value
-------------- --------------
(in thousands)
<S> <C> <C>
Held to maturity
----------------
Due in one year or less $ 1,647 $ 1,602
Due after one year through five years 5,277 5,360
Due after five years through ten years 7,623 7,743
Due after ten years -- --
-------- --------
Total $ 14,547 $ 14,705
======== ========
Available for sale
------------------
Due in one year or less $ 48,370 $ 48,096
Due after one year through five years 127,937 127,143
Due after five years through ten years 5,044 4,996
Due after ten years 1,858 1,847
-------- --------
Total $183,209 $182,082
======== ========
</TABLE>
Discount and premium pertaining to collateralized mortgage obligations are
amortized over the securities' estimated redemption periods using the
effective interest method. Yields used to calculate premium or discount are
adjusted for prepayments quarterly.
Fixed maturities with a par value of $1,900,000 were on deposit at December
31, 1999 with various state insurance departments in compliance with
applicable insurance laws.
Proceeds from sales of available for sale fixed maturity securities and
preferred stocks and gross realized gains and losses related to such sales
are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Proceeds from sales $26,652 $9,955 $16,968
Gross realized gains 138 1 76
Gross realized losses 26 3 16
</TABLE>
F-15
<PAGE> 61
Net investment income
---------------------
Net investment income consists of:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Fixed maturities $11,472 $12,236 $12,118
Short-term investments 686 513 464
Other 921 869 946
------- ------- -------
Total investment income 13,079 13,618 13,528
Investment expenses 309 341 381
------- ------- -------
Net investment income $12,770 $13,277 $13,147
======= ======= =======
</TABLE>
4. Reinsurance
-----------
MNH follows the customary practice of reinsuring a portion of the exposure
under its policies. Insurance is ceded principally to reduce net liability
on individual risks and to protect against catastrophic losses. Although
reinsurance does not legally discharge an insurer from its primary
liability for the full amount of coverage provided by its policies, it does
make the assuming reinsurer liable to the insurer to the extent of the
reinsurance ceded.
The effect of reinsurance on premiums written and earned for the years
ended December 31, 1998 and 1999 is as follows:
<TABLE>
<CAPTION>
1998 1999
-------------------- ---------------------
Premiums Premiums Premiums Premiums
Written Earned Written Earned
------- ------ ------- ------
(in thousands)
<S> <C> <C> <C> <C>
Direct $98,956 $99,556 $100,227 $99,943
Assumed 844 1,267 1,612 1,663
Ceded (7,042) (7,283) (7,369) (6,831)
------- ------- -------- -------
Net premiums $92,758 $93,540 $ 94,470 $94,775
======= ======= ======== =======
</TABLE>
As a result of the reinsurance agreements maintained by MNH, MNH is exposed
to certain credit risk if one or more of its primary reinsurers were to
become financially unstable. As of December 31, 1999, MNH has recognized
amounts to be recovered from its primary reinsurers related to ceded losses
and ceded unearned premiums totaling $7,725,000. MNH generally does not
require collateral for reinsurance recoverable.
F-16
<PAGE> 62
5. Reserve for Losses and Loss Adjustment Expenses
-----------------------------------------------
Activity in the reserve for losses and LAE is summarized as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
(in thousands)
<S> <C> <C>
Reserve for losses and LAE at beginning of year $141,205 $136,685
Less reinsurance recoverables 10,372 9,816
-------- --------
Net balance at beginning of year 130,833 126,869
-------- --------
Provision for losses and LAE for claims occurring in:
Current year 67,379 69,835
Prior years (2,145) (3,749)
-------- --------
65,234 66,086
-------- --------
Loss and LAE payments for claims occurring in:
Current year 26,765 28,330
Prior years 42,433 37,125
-------- --------
69,198 65,455
-------- --------
Reserve for losses and LAE at end of year, net 126,869 127,500
Plus reinsurance recoverables 9,816 6,026
-------- --------
Balance at end of year $136,685 $133,526
======== ========
</TABLE>
In 1998, the Company decreased its reserves for prior years by $2,145,000,
primarily due to favorable loss experience related to automobile liability
policies. In 1999, the Company decreased its reserves for prior years by
$3,749,000 primarily due to favorable loss experience related to workers'
compensation policies.
6. Demand Loan
-----------
During 1999, the Company arranged for a $2,000,000 unsecured credit
facility from a bank. 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. As of December 31, 1999, $1,025,000 was outstanding under
this facility and carried a weighted average interest rate of 8.12%.
F-17
<PAGE> 63
7. Income Taxes
------------
The provision (benefit) for income taxes consists of:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Current $1,756 $1,127 $2,600
Deferred (532) 1,207 270
------ ------ ------
Total income tax provision $1,224 $2,334 $2,870
====== ====== ======
</TABLE>
A reconciliation of the difference between the Company's total income tax
provision and that calculated using statutory income tax rates is as
follows:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1997 1998 1999
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Computed provision at
statutory rate $1,843 $2,807 $3,285
Adjustments:
Tax-exempt investment income (491) (393) (298)
Dividend exclusion (147) (128) (150)
Other items 19 48 33
------ ------ ------
Total income tax provision $1,224 $2,334 $2,870
====== ====== ======
</TABLE>
F-18
<PAGE> 64
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
December 31,
------------------
1998 1999
---- ----
(in thousands)
<S> <C> <C>
Deferred policy acquisition costs $ 4,213 $ 4,185
Unrealized investment gains 604 --
Accretion of bond discount 349 146
Other 204 131
-------- --------
Total deferred tax liabilities 5,370 4,462
-------- --------
Discounting of reserve for losses and
loss adjustment expenses (6,826) (6,425)
Unearned premiums (3,179) (3,159)
Unrealized investment losses -- (612)
Other (279) (268)
Minimum tax credit carryforward (141) --
-------- --------
Total deferred tax assets (10,425) (10,464)
-------- --------
Net deferred income taxes $ (5,055) $ (6,002)
======== ========
</TABLE>
Although realization is not assured, based upon the evidence available the
Company believes that it is more likely than not that the net deferred
income tax asset will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if
estimates of future taxable income are not achieved.
8. Stockholders' Equity
--------------------
Dividends
---------
The Company depends on dividends from its subsidiary, MNH, to pay cash
dividends to its stockholders and to meet its expenses. MNH is subject to
New Hampshire state insurance laws which restrict its ability to pay
dividends without the prior approval of state regulatory authorities. These
restrictions limit dividends to those that, when added to all other
dividends paid within the preceding twelve months, would not exceed 10% of
an insurer's policyholders' surplus as of the preceding December 31. The
maximum amount of dividends that MNH could pay during any twelve month
period ending in 2000, without the prior approval of the New Hampshire
Insurance Commissioner, is $5,328,000.
Stock option plans
------------------
The Company's stock option plan (the "Plan"), which reserved 200,000 shares
of common stock for issuance to the Company's and MNH's officers and key
employees of the Company's affiliate, Mutual, expired in 1996. Under the
Plan, qualified and non-qualified stock options were granted at amounts not
less than the fair market value of the Company's stock on the
F-19
<PAGE> 65
date of grant. Options granted under the Plan have a 10 year life and may
be exercised in cumulative annual increments of 25% commencing one year
from the date of grant.
In accounting for its stock option plans, the Company remains under the
expense recognition provisions of Accounting Principles Board Opinion No.
25 "Accounting for Stock Issued to Employees" but follows the disclosure
provisions of SFAS No. 123 "Accounting for Stock Based Compensation". No
compensation expense was recognized in 1997, 1998 or 1999 for options
granted under these plans.
Had compensation expense for stock options granted under the Company's
stock option plans been determined based on the fair value at the grant
date consistent with the method required by SFAS No. 123, the Company's net
income and earnings per share for the years ended December 31, 1998 and
1999 would have been as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Net income:
As reported $5,923,000 $6,793,000
Pro forma $5,884,000 $6,777,000
Diluted earnings per share:
As reported $2.04 $2.48
Pro forma $2.03 $2.47
</TABLE>
The fair value of each option granted in 1996 was estimated using a
binomial option pricing model which is a modification of the Black-Scholes
option pricing model, with the following assumptions for 1996: risk free
interest rate of 6.25%, volatility of 18.0%, expected dividend yield of
1.1% and expected life of 10 years.
A summary of the status of the Company's outstanding options as of December
31, 1997, 1998 and 1999, and changes during the years ending on those dates
is presented below:
<TABLE>
<CAPTION>
1997 1998 1999
---------------------- ---------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Options Exercise Options Exercise
Outstanding Price Outstanding Price Outstanding Price
----------- -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Beginning
of year 90,750 $18.28 79,250 $18.39 71,500 $18.38
Granted -- -- -- -- -- --
Exercised (5,750) 14.64 (3,750) 15.04 (12,000) 14.05
Forfeited (5,750) 20.40 (4,000) 21.00 (12,500) 17.12
------ ------ -------
End of year 79,250 18.39 71,500 18.38 47,000 19.87
====== ====== =======
Options exer-
cisable at
year-end 45,500 16.45 51,000 17.37 37,250 19.58
====== ====== =======
</TABLE>
F-20
<PAGE> 66
The following table summarizes information about the Company's outstanding
stock options at December 31, 1999:
<TABLE>
<CAPTION>
Number Remaining Average Number
Outstanding Contractual Exercise Exercisable
at 12/31/99 Life in Years Price at 12/31/99
----------- ------------- -------- -----------
<S> <C> <C> <C>
8,000 2.1 14.38 8,000
39,000 6.1 21.00 29,250
------ ------
47,000 37,250
====== ======
</TABLE>
Common stock repurchases
------------------------
During 1997, 1998 and 1999, the Company repurchased 158,900, 58,800 and
267,600 shares of its common stock, respectively. The Company was holding
378,400 and 646,000 of these shares in treasury as of December 31, 1998 and
1999 respectively.
Preferred stock
---------------
Preferred stock, no par value, $424.30 stated value, 10,000 shares
authorized; no shares issued or outstanding at December 31, 1998 or
December 31, 1999. The Company also has 3,000,000 shares of $.01 par value
preferred stock which is authorized and unissued.
9. Earnings Per Share
------------------
The computations for basic and diluted earnings per share are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1998 1999
---------------------------------------
(in thousands except per share amounts)
<S> <C> <C> <C>
Basic:
Net income $4,198 $5,923 $6,793
Weighted average shares outstanding 2,973 2,895 2,738
Basic earnings per share $ 1.41 $ 2.05 $ 2.48
Diluted:
Net income $4,198 $5,923 $6,793
Weighted average shares outstanding 2,973 2,895 2,738
Plus incremental shares from assumed
conversion of stock options 7 9 5
------ ------ ------
Weighted average shares
outstanding-adjusted 2,980 2,904 2,743
====== ====== ======
Diluted earnings per share $ 1.41 $ 2.04 $ 2.48
</TABLE>
F-21
<PAGE> 67
10. Benefit Programs
----------------
Mutual maintains a capital accumulation plan which is a profit sharing plan
under Section 401(a) of the Internal Revenue Code that covers all employees
who have completed six months of service. Mutual matches at least 15% and
up to 100% of employee contributions, based on the combined net operating
profits of Mutual and MNH. Additional contributions may be made at the
discretion of the Board of Directors of Mutual. Under the terms of the
management agreement, the Company's portion of the total contribution was
$457,000, $554,000 and $580,000 for the years ended December 31, 1997, 1998
and 1999, respectively.
11. Commitments and Contingencies
-----------------------------
MNH, like many other property and casualty insurance companies, is subject
to environmental damage claims asserted by or against its insureds.
Management is of the opinion that based on various court decisions
throughout the country, such claims should not be recoverable under the
terms of MNH's insurance policies because of either specific or general
coverage exclusions contained in the policies. However, there is no
assurance that the courts will agree with MNH's position in every case, nor
can there be assurance that material claims will not be asserted under
policies which a court will find do not explicitly or implicitly exclude
claims for environmental damages. Management, however, is not aware of any
pending claim or group of claims which would result in a liability that
would have a material adverse effect on the financial condition of MNH.
In addition to the foregoing, MNH is a defendant in a number of other legal
proceedings in the ordinary course of its business. Management of the
Company is of the opinion that the ultimate aggregate liability, if any,
resulting from such proceedings will not materially affect the financial
condition of MNH or the Company.
F-22
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-47014) and in the Prospectus constituting part of
the Registration Statement on Form S-3 (No. 333-08951) of Merchants Group, Inc.
of our report dated February 14, 2000 appearing on page F-1 of this Form 10-K.
Buffalo, New York
March 29, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 182,082,000
<DEBT-CARRYING-VALUE> 14,547,000
<DEBT-MARKET-VALUE> 14,705,000
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 212,911,000
<CASH> 2,000
<RECOVER-REINSURE> 5,396,000
<DEFERRED-ACQUISITION> 12,309,000
<TOTAL-ASSETS> 269,523,000
<POLICY-LOSSES> 133,526,000
<UNEARNED-PREMIUMS> 49,616,000
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 32,000
<OTHER-SE> 69,355,000
<TOTAL-LIABILITY-AND-EQUITY> 269,523,000
94,775,000
<INVESTMENT-INCOME> 13,147,000
<INVESTMENT-GAINS> 60,000
<OTHER-INCOME> 434,000
<BENEFITS> 66,086,000
<UNDERWRITING-AMORTIZATION> 25,115,000
<UNDERWRITING-OTHER> 7,552,000
<INCOME-PRETAX> 9,663,000
<INCOME-TAX> 2,870,000
<INCOME-CONTINUING> 6,793,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,793,000
<EPS-BASIC> 2.48
<EPS-DILUTED> 2.48
<RESERVE-OPEN> 126,869,000
<PROVISION-CURRENT> 69,835,000
<PROVISION-PRIOR> 3,749,000
<PAYMENTS-CURRENT> 28,330,000
<PAYMENTS-PRIOR> 37,125,000
<RESERVE-CLOSE> 127,500,000
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
